Volatility generating strong returns for some
April was a good month for our funds, with our main account being up +70bps for the month, bringing the total year to date to +2.6% (estimated).
We are content with this performance as it is achieved with an 8% cash balance. The invested capital thus generated a return closer to +3%, for the 4 months ending April.
This compares nicely with the S&P which was down -0.4% and the Bloomberg Barclays Aggregate bond index which was down -2.2%, over the same period. The MSCI AC World (a general global composite index of equities) returned 0.16% for the same period.
While it’s good to be outperforming, of greater significance is the low volatility of the returns. A core focus of ours is to design portfolios that will generate stable returns over time, with tight drawdown control and limited volatility.
Our ‘moderate to low risk’ portfolio, for example, has generated around 8% annualised, in our backtesting. This was with less than a third of the market’s volatility and a Sharpe ratio (which is a measure of return adjusted by the underlying volatility) of 2.4 over a 5 year period. Steady returns with very little volatility.
Performance of backtested ‘moderate to low’ risk portfolio:
In terms of attribution for the month of April, the largest contributor was from our exposure to a Fixed Income fund, which was up around 8% for the month. The same fund is up 20%+ YTD. The bulk of their returns from their short 10y UST and Long 10y Bund positioning, as well as from their long USD/EUR and long EUR/CHF.
Their process is based on a very dynamic management style that seeks to unlock performance on the global interest rate and currency markets – investing across different parts of the yield curve and taking ‘bets’ on rates and FX.
They have a long track record of successfully anticipating market moves and have generated a net return since inception to date (ITD) of just over 18% p.a. The fund’s Sharpe is now over 2, since inception (8/2010), an extremely good result. As a firm, they manage over USD15bn in assets and the manager has a 15y+ track record.
We selected the manager on the back of a very strong record of outperformance, but also as we believed they were well positioned to profit from the environment of rising rates.
Other contributors included our allocation to a well-known US based Fund of Hedge Fund (FoHF), which was up around 90bps in April and 3.5% for the year to date. The fund has nicely outperformed the indices.The Mortgage Backed securities market has worked well for a few quarters now and this manager has allocated, amongst others, to those managers that can find value in MBS tranches that may be overlooked by the larger players. We believe the PIMCO Total return fund has also invested heavily in the space and saw it as a good place to find relative value.
While the Equity markets have had a difficult year so far, our allocation to an Asia focused equities fund has generated returns of +2.7% YTD. This was after a negative month of -1% in April. The bulk of the manager’s exposure is in China and Japan. We have liked this manager for some time and consider the allocation to be core to a portfolio. Indeed, we have also recently allocated to their China focused fund which has also enjoyed strong returns.
The manager has a 15 year track record and has an annualized return of 12.1% with a Sharpe of 1.6. Strong returns, particularly when you consider that their maximum drawdown was only 9.4%. This compares to the MSCI AS Asia pacific index drawdown of 56%.
Market environment and Asset Allocation:
As we highlighted in our last Insights piece, we believe the environment requires a relatively balanced and conservative allocation.
The current business cycle is long in the tooth and valuations particularly in the US are on the high side.
There are also some major considerations such as the potential of trade and currency ‘wars’ and, more longer term, the impact of demographics and the underfunded nature of most pension funds in the US and EU (more of this in another Insights).
The recent volatility spike in February should have alerted investors, but the ‘buy the dip’ mentality is still prevalent.
The unfortunate truth is that, when the ‘buy the dip’ doesn’t work, a lot of people will be hurt. Until then greed will prevail.
We prefer to be less driven by our emotions and would rather drive our process on fundamentals, such as valuation, and be well positioned for when better market opportunities surface.
We thus prefer to take increasing exposure in actively managed areas of the market, and look for opportunities to diversify away from ‘passive’ equity or bond exposure. We prefer managers that are not correlated to the ‘traditional financial markets (equities and bonds).
At the moment, we are Underweight Fixed Income, having Overweights in Commodities and Cash.
We are Underweight Direct equities, reducing our exposure towards the end of January. We are though looking to add back exposure very selectively, on a name by name basis.
Within Equities, we are very Overweight the Alternative space, otherwise known as Hedge Equity Long/Short. We like the space and believe it is far better to pay a slight premium for a great manager than take passive exposure. It’s important though that you invest only in those funds that you truly understand, in terms of process, and style. In our case, we tend only to invest in managers that we’ve known for a few years and have ‘best of breed’ track records.Alternatives are not for everybody and we would ask you read our disclaimer tab the bottom of this post.
We have also been careful to select managers that are focused in different areas of the market. One manager, for example, is focused on more non-cyclical defensive areas, while another is more global and focused on cyclicals. Another only trades a few select sectors on a global basis. The point here being is that we are looking for managers that have some form of edge within their space and are also adding to the diversification of the portfolio.
In terms of regional Equity exposures, we are Overweight Japan and Asia but Underweight US, EU and EM. Given we still see liquidity tightening due to QT, we are a little cautious on EM exposure at this time.
Like Equities, we find it better to allocate to Fixed Income specialist managers that can generate returns in a rising yield environment. This has worked very well for us, given how poorly most bond managers have performed.
Given we anticipate rates to continue rising we are not yet encouraged to get back into simply ‘buying yield’.
Our other Overweight is to Commodities and here we still like to hold Gold and a CTA, as a form of insurance on the market and a collapse in confidence investors have in the Central Banks.
We have been looking to add some exposure to the miners and this is something we will talk to in more detail later Insights.
Yes, we do see a stronger USD, but we also see further QE in the future. It’s a matter of timing – we expect a sell off before we see continued QE.
Read our next insights for more.
By way of disclaimer, these numbers are after fees but are unaudited and, due to managers not reporting on a daily basis, there may be a lag in performance reporting. Nothing in this document should be perceived in any way as a recommendation to buy or sell any security or fund. Any individual securities or funds mentioned are simply an example of areas we are currently invested in and will not be suitable for all investors. Any views and current investments may and will change over time and should not be relied on in any way. This document is not an offer to sell nor is it the solicitation of an offer to purchase any services offered, or any fund managed or recommended, by MW Capital Management Pte Ltd. Investment in hedge Funds can involve total loss of principle and are meant for sophisticated investors who understand and can afford the total loss of their investment. Many hedge Funds use leverage which can exacerbate losses. Past performance is not indicative of future returns. It is intended only for accredited investors, domiciled in countries in which collective investment schemes are permitted for public distribution, offering and sale under the applicable local legislation. General business, market, economic and political conditions could cause actual results to differ materially from what the authors presently anticipate. This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. The views expressed may change without notice. All investments involve risk, including the potential loss of principal.