A recent white paper (We have uploaded the full version to uwj.com.au if you are interested in reviewing the full version) from Fidante Partners (owned by Challenger) highlighted the use of hedge funds over different market cycles, and it finished by concluding that in late stages of a business cycle(like now) one particular style of management performs extremely well.

The whitepaper was written by Joachim Klement, Fidante’s head of investment research, and is positioned in that Fidante like most us believe we closer to the end of this bull cycle then the start.

After analysing data over the last 20 years the paper concluded that a Multi-Strategy approach to investing provided one of the most attractive Risk(Volatility) and Return characteristics over this period.

Klement commenting that “tend to outperform single-strategy hedge funds by a wide margin” during a slowdown. (Fig 1)

 

 

Multi-strategy hedge funds with their combination of different exposures, provide one of the best risk-return trade-offs across the cycle overall, but in the late stage of a business cycle they tend to outperform by a wide margin. Some strategies, including statistical arb and equity market neutral, “barely differ in their risk-return profile during the late stage of the cycle from  their long-term averages.” Those are the strategies that work to exploit mispricing, and the relevant mispricings can occur at any phase of the business cycle.

However other strategies face greater challenges at this point – the returns for long/short equity, event-driven funds, and relative value, on the other hand, decline in this phase of the cycle. (Fig 2)

 Multi-strategy funds have had an annualized positive return of 0.9% in times of equity market declines. And show positive performance in 62% of the situations in which equity prices declined on a rolling three-month basis.

Short-biased hedge funds, unsurprisingly, do well in down markets. They exist for that purpose. But they raise a market timing issue for investors, because the boundaries of the slowdown phase are obvious only in retrospect, they are not predictable. The Multi-Strategies funds on the other hand, not only “can deliver positive returns when equity markets correct but tend also to provide attractive risk-adjusted returns when they don’t.” The paper admits to these funds having statistical drawdowns(losses) during  the  period. If an investor is concerned that there may be a repeat of those extreme dislocations, then he may sensibly be wary. The chart below shows the actual draw down experienced compared to the drawdown that would have been experienced in Global Equities. (Fig 3)

 

Wattle Partners concur totally with the views of Fidante on these issues, and have for

some time shared a very similar view. Our Wattle Partners’ targeted return portfolio is where we hold such investment funds, and we have been tilting toward Multi-strategy funds for some time, with investments into Pinebridge and Invesco’s offerings. We have recently added a third Multi-Strategy fund to our core Targeted Return portfolio. Our view of this fund is as follows;

JP Morgan Global Opportunities Fund

Fund Manager Review – JP Morgan Background: JP Morgan has over 140 years of history in Australia, advising corporations, governments, institutions and sophisticated investors across Investing Banking, Asset Management and Corporate Finance. The business has operations in 17 countries within the Asia Pacific region, 100 around the world, and is one of the largest asset managers in the world with around $1.7tn under management. The multi-asset team, which manages this fund and various other complementary strategies has around $255bn under management, primarily for pension funds and institutions and employs over 80 multi-asset specialists.

Why JP Morgan? JP Morgan has a long track record in successfully managing multi- asset strategies across all market environments. This fund is led by an expert team under the guidance of CIO James Elliot, who has over 20 years of experience. It is by its nature a macroeconomic driven investment strategy, in that the managers seek to identify 8 major themes occurring across the globe in the coming years and then identify the 20-40 individual assets that will benefit most but offer the least downside potential. The multi- asset team is able to leverage off the sheer size and experience of the various asset specialists to deliver a best-of-breed option for investors. The fund offers several benefits compared to competitors in that they offer daily liquidity, complete transparency into the underlying holdings and a competitive management fee with no performance component.

Why Targeted Return Bucket? This fund meets the requirements of the Targeted Return Bucket due to its focus on delivering an annualised return of 7% over the cash rate. Importantly, the managers also focus on achieving this at a lower level of risk than the market, targeting volatility  at  a  level of less than 10% per annum. The strategy of the fund is to generate a consistent return across all market environments by identifying broad macroeconomic themes and investing into them via the appropriate underlying asset, be it bonds, equities or currency. Since its inception the strategy has delivered positive returns in negative equity and bond markets as well as capturing a major portion of the upside in stronger market conditions. Most importantly, the fund has a correlation of only 23% to global sharemarkets and just 3% to global bonds.

Performance & Top Holdings: The fund we are recommending was only launched in 2016 but the same strategy has been running since 1998 globally and 2011 for Australian institutional investors. Over the last 12 months it has performed strongly, adding 8.31% and 5.78% since inception. At present, the fund is exposed to eight major economic themes including: the maturing US economic recovery, slow but steady recovery in Europe, widespread technology adoption and investment, supply side weakness as costs increase, global policy divergence, emerging market convergence as the USD rallies, Japan after Abenomics and the Chinese transition to   a consumption-led economy. The fund currently has around 33% of the portfolio invested in the US, 17% in Japan, 116% in emerging markets and 15% in Asia, with around 40% in equity markets.

Reasoning: It is the Investment Com- mittee’s view that the only way to deliver true diversification and consistent returns is via global diversification across markets, sectors and different asset types. The only way to have a competitive advantage  in this part of the market is to have greater access to information and the best tools   to analyse and utilise this advantage. JP Morgan has consistently set themselves apart in this regard, the returns of this strategy over a long-period of time are a testament to this. Whilst this fund targets a higher return than some other Targeted Return strategies, it aims to do so at a lower level of volatility than the market which should smooth the experience for investors; it must, however, be treated as   a long-term holding of at least five years. We believe the fund offers considerable diversification by applying both a thematic and risk-focused approach to first selecting and then combining the individual investments. One of the biggest reasons for JP Morgan’s success has been leveraging off their informational advantage and adjusting both their thematic ideas and individual investments on a monthly and quarterly basis, rather than remaining static. Importantly, the managers are not restricted to buying other funds or ETF’s to implement their selected exposures, rather they can invest directly into the companies, sectors or managers they believe offer the best risk-reward option. This has meant they outperformed in period when equity markets fell and managed to capture a reasonable amount of the upside when they rose in the last few years. We remain of the view that general sharemarket returns will be lower in the years ahead as interest rates increases and bond markets adjust accordingly. As a result, we believe the investment environment will be volatile and require a great deal of diversification as well as exposure to global markets in order to be successful. This fund has shown an ability to deliver this sort of exposure whilst reducing the overall risk of your portfolio at the same time.

If you are not a Wattle Partners client and interested in investing, the fund is available for anyone that is able to invest $25,000.

Call Jamie Nemtsas on 0403 200 253 for more information.