Stock market ups and downs can worry investors and can create a barrier to investing by causing an increased fear of poor performance. Given this natural state of mind, it is useful for investors to revisit strategies that can be used to provide extra protection in uncertain times.
Fast Facts
Altin is a Fund-of-hedge-funds meaning it invests in a portfolio of hedge funds
Swiss based but with a London listing meaning you can buy it on many platforms
Hedge Funds are ordinarily only accessible to wealthy investors
They operate various different strategies an investor needs to understand (see article for explanation of strategies)
The difficult task of assessing and selecting funds and managers is undertaken by the Fund-of-Fund manager
Especially suitable to investment trusts because of their long-term nature
Opportunities:
Hedge Funds can mitigate risk
Many aim to produce returns even when the stock market is down
Even a small holding within a portfolio can provide a reasonable degree of protection
Risks/Threats
High charges eat in to investment returns
Double charging due to fees for both the multi-manager and the underlying investments
Many Hedge Funds strategies didn’t following the financial crisis
Two fund-of-hedge-funds compared: Altin vs Dexion – see article below
The impact of choppy stock markets on sentiment is clear from the findings from the latest survey of 300 UK advisers by Natixis Global Asset Management released in September. Nearly three-quarters of advisers felt their clients were now conflicted between making returns and preserving their capital. Over half of financial advisers also said that their clients were only willing to take ‘minimal investment risk.’
One solution to this problem might be found in the world of hedge funds. This sector offers a whole range of strategies that are designed to provide returns in a variety of market conditions. However, before we all reach for our cheque books, the obvious barriers to hedge fund investing are the high minimum investments required, particularly if you wish to get diversification from holding a number of strategies, as well as the technical skills required to assess and monitor the different managers and construct a portfolio.
A solution to this comes in the form of the listed funds of hedge funds. These allow investors to delegate the investment process to experts in the field and gain access to the sector for the price of a single share.
Clearly, some investors and advisers may be wary of hedge or macro fund strategies, but the flexibility of such tools within a closed-ended structure could make them an option for a cornerstone of protection within a wider portfolio. The structure of a closed-ended vehicle is more suitable for this type of investing, as it allows managers to make investments that may take a while to bear fruit without having to worry about redemptions.
We thought it would be worth briefly explaining some of these strategies, given the amount of jargon surrounding the industry but it is worth noting that, given that different strategies exhibit a variety of performances under different market conditions, it is important to have some diversification across strategies with this type of investment.
What do Hedge Funds do?
Equity hedge strategies buy assets on the expectation that they will rise, but have the flexibility to initiate short strategies which profit from assets falling in value. Therefore, the use of shorts can help provide protection in a market correction while not missing out on participation in market rises. However, they tend to have a long bias and will tend to suffer during market corrections.
Macro strategy funds make investments based on the economic and political views of various countries, taking both long (such listed stocks, Bonds etc) and short positions (betting against a stock or other security e.g. by borrowing it). These can suffer when volatility spikes and market corrections tend to be accompanied by such increases in volatility. They can however perform quite well during sustained market downturns.
Relative value strategies involve purchasing a security (such as a stock or a bond) that is expected to appreciate in value, while simultaneously selling short a related investment that is expected to depreciate. Examples include fixed income (Bond) arbitrage, volatility arbitrage as well as many multi-strategy funds and a whole host of other niche strategies.
Protection strategies, as the name suggests, tend to perform well during down markets. Tail protection strategies tend to perform well during sharp periods of market correction.
Event driven strategies make investments that aim to exploit pricing inefficiencies that may occur before or after a corporate event. This could be an acquisition, merger, de-merger or perhaps a bankruptcy. For example the share price decreasing in a stock in receipt of a higher takeover bid presents the opportunity to buy it at a discount if you think the bid will succeed.
Altin and Dexion – two fund-of-hedge-funds compared
Altin performance since launch.
Whilst not seeking to recommend any fund, two examples of London listed funds of hedge funds are Altin AG (LON:AIA) and Dexion Absolute (LON:DABS). Altin targets 6% (post fee) returns with lower volatility (a measure of risk) than and a low correlation to equity markets, with the investment manager using its expertise to select the funds and diversify across different strategies.
The new management team, installed in 2012, refocused the portfolio taking on some risk to improve returns, but also invested in higher return uncorrelated funds, while adding exposure to longer lock up funds (where the investor commitment can run to several years), some of which could not have been included in an open ended fund.
Altin performance by year.
More recently, Altin’s managers have been increasing the amount of protection strategies and relative value strategies, primarily at the expense of macro and equity hedge strategies, reflecting a more cautious global outlook. Taking an overview, Altin’s strategy appears to have paid off and, as discussed below, its performance compares favorably to that of Dexion Absolute.
Dexion Absolute is smaller than Altin. Its market cap is around £124m while Altin’s is £134m. Dexion has been shrinking in an effort to manage its discount to NAV (net asset value), which is the value of its underlying holdings. It has ended up closing its US dollar and Euro share classes after its discount widened to a point where it attracted arbitrageurs onto the register.
Dexion has promised to wind itself up if its discount exceeds an average of 5% over certain measurement periods. It just announced that it has survived the first measurement period intact. The next period covers the first three months of 2016. Of course, time will tell whether Dexion is able to avoid winding up following the next measurement period.
Looking at figures to the end of October 2015, Dexion’s share price performance lagged that of Altin over the past three years. Altin has also been outperforming the other listed single manager and single strategy hedge funds over the past year, and there is a clear advantage to the fund of hedge funds focus for both Dexion and Altin.
Like Dexion, Altin is also trying to get its discount down. Its Board has decided that, if Altin fails to generate returns for shareholders of around 10-12% over a calendar year and the company is trading at an elevated discount (above 10%), the shareholders should be given the chance to exit part of their investment.
Shareholders are allowed to return a specified number of shares at a premium to the prevailing market price. This mechanism has in our view contributed to the discount narrowing on Altin along with increased marketing efforts to UK investors.
In volatile market conditions, it is worth investors looking beyond traditional equity funds to those that have the flexible tools in their armoury that could help them to provide positive returns even in a difficult environment.
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