Alternatives review

Given that equities and bonds are both at high valuations we have been increasing our allocations to alternatives, and within alternatives we are looking for investments that can deliver reasonable returns but are not strongly correlated to equities and bonds. For this post we’re giving the main points of our review of two subsets of our diversified alternatives universe: absolute return equity managers and trend following funds (often referred to as CTAs or managed futures funds). We’ve focussed on the managers that are already available on the main investment platforms our clients use.

Alternative assets is a very diverse category and, unlike equity and bond funds, there are substantial differences in the performance and behaviour of funds within each investment style. And it’s important to assess what the fund holds and the way in which it invests, because the investment style of a fund can bring in unintended exposures. For example, a long-short hedge fund that invests in value stocks and shorts quality stocks can be correlated with equities even if its net equity exposure is zero, because its investment style is correlated with equities.

We’ve removed our dedicated trend following manager from our diversified portfolios and introduced an absolute return equity fund with good historical returns but very low exposure to equity markets, sectors or traditional equity styles like value or quality. This reduces the portfolio’s equity exposure and should provide steadier returns while protecting the portfolio from valuation or growth shocks.

Below is a video where we walk through the analysis.

Absolute return equities

Looking at the returns over the last five years we can immediately see differences in the return profiles and the correlation of the investments with equity benchmarks and long/short equity benchmarks (both Australian and international).

Munro Global Growth has been over 80% net long equities for most of its history and has largely been invested in technology stocks over that time. The other funds have had a much lower equity market exposure and had lower returns as a result, as equity markets have been strong. Given that we’re specifically trying to reduce equity exposure, we can remove Munro from the shortlist.

Turning to the factor exposures of the funds, Sage Capital Absolute Return and Perpetual have very low style exposures, with their returns being almost entirely attributed to alpha in this framework. Conversely, Firetrail and Bennelong have very high betas to equity investment styles.

Factor exposures
PortfolioWeight Aust eq, FF, variable beta
AlphaMarketQualitySmallValueMomentum
Abs Return Equity
Bennelong Market Neutral FundTarget0.9%0.64 ***0.96 **0.41 *-0.45 ***-0.02
CC Sage Capital Absolute ReturnTarget9.0% *-0.19 *-0.020.100.030.01
Firetrail Absolute ReturnTarget0.8%0.19 ~0.31 ~0.62 ***0.41 *-0.01
Perpetual Pure Equity AlphaTarget7.9% ***0.02-0.01-0.05 ~0.07 .-0.06 ~
Signifance key: *** = 0.1%, ** = 1%, * = 5%, . = 10%, ~ = 33%

Sage Capital Absolute Return’s investment process actively manages sector allocations: the portfolio managers divide the universe of investment into groups of companies with similar drivers and goes long those stocks with positive characteristics and short those that are less attractive, while seeking to keep the fund’s overall exposure to any one theme or sector low. Bennelong and Firetrail have much higher conviction in particular themes or sectors that they find attractive. (We weren’t able to obtain data on this for Perpetual.)

This shows in the macro exposures, which are low for Sage.

Macro exposures
PortfolioWeight Aus macro
AlphaOilRatesAUDMarket
Abs Return Equity
Bennelong Market Neutral FundTarget3.5%-0.01-5.68 *-0.070.26 .
CC Sage Capital Absolute ReturnTarget10.8% **-0.01-0.050.19 ~-0.19 *
Firetrail Absolute ReturnTarget7.5% ~0.013.52 ~0.63 **0.06
Perpetual Pure Equity AlphaTarget6.5% ***0.001.17 .-0.040.07 *
Signifance key: *** = 0.1%, ** = 1%, * = 5%, . = 10%, ~ = 33%

And the drawdowns also show the difference in risk control between the funds.

Historical blending analysis shows that the risk controlled funds have reduced overall portfolio risk, and have not had lower returns.

On the basis of this analysis, we’ve added the Sage Capital Absolute Return Fund to our portfolios in the alternatives segment.

Trend following

We’ve long had an allocation to trend following managers in our portfolios. Although momentum is a well recognised premium across many markets, returns for the whole style have been poor for the best part of a decade.

Looking into the exposures of the trend following managers, they have been broadly long bonds for most of the last 10 years as interest rates have fallen. Given that we’re anticipating higher rates in future we are concerned about reversals in markets due to high prices across equities and commodities, we have decided to remove dedicated trend following managers from our portfolios for the time being.

Important Information: This document has been prepared by Aequitas Investment Partners ABN 92 644 165 266 (“Aequitas”, “our”, “we”), a Corporate Authorised Representative (no. 1284389) of C2 Financial Services, (Australian Financial Services Licensee no. 502171), and is for distribution within Australia to wholesale clients and financial advisers only.

This document is based on information available at the time of publishing, information which we believe is correct and any opinions, conclusions or forecasts are reasonably held or made as at the time of its compilation, but no warranty is made as to its accuracy, reliability or completeness. To the extent permitted by law, neither Aequitas nor any of its affiliates accept liability to any person for loss or damage arising from the use of the information herein.

Please note that past performance is not a reliable indicator of future performance.

General Advice Warning: This document has been prepared without taking into account your objectives, financial situation or needs, and therefore you should consider its appropriateness, having regard to your objectives, financial situation and needs. Before making any decision about whether to acquire a financial product, you should obtain and read the relevant Product Disclosure Statement (PDS) or Investor Directed Portfolio Service Guide (IDPS Guide) and consider talking to a financial adviser.

Taxation warning: Any taxation considerations are general and based on present taxation laws and may be subject to change. Aequitas is not a registered tax (financial) adviser under the Tax Agent Services Act 2009 and investors should seek tax advice from a registered tax agent or a registered tax (financial) adviser if they intend to rely on this information to satisfy the liabilities or obligations or claim entitlements that arise, or could arise, under a taxation law.

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