Citywire’s Samantha Muratori spoke to fund selectors on which managers or strategies they trust to protect their capital during sudden downturns.
Samantha Muratori spoke to selectors from Miami to Montevideo during the Citywire Miami 2018 event to find out more about how selectors tend to deal with times of crisis.
Convertible play
First, I sat down with Ricardo Nunes of Rio de Janeiro’s Monex Financial Consulting to discuss how he is anticipating the next market drop, which selectors at our event estimated will be between 5% and 10%, and how Brazilian clients react to the market differently.
Traditionally in this position, a typical Brazilian investor would rush to bonds, he said, but several factors are contributing to a rising interest rate in the US, which has dampened their appeal. Due to the large exposures that Nunes’s clients already have in Brazil, the firm cannot invest much in emerging markets, as these assets usually suffer during periods of market drop.
‘We usually have a strong concern about the necessity for diversification in our clients’ portfolios, which we implement in different ways through asset types, countries, currencies, jurisdictions and maintaining good credit quality. In market-drop
moments we take off the satellite investments that we usually include to increase gains and return to a core diversification strategy.’
A strategy that his team has implemented to protect against volatility is to invest in funds linked to currencies that tend to strengthen during market drops. When investors divest from higher-risk positions in emerging markets, there is an immediate appreciation of the currencies to which these investments migrated, against emerging market currencies, which Nunes has found extremely advantageous.
For stock market investors, Nunes suggests that convertible bond funds are the best option because they pay equity, provide principal protection like bonds, yet can convert to stocks if the share prices of their issuers rise high enough.
‘I like RWC Global Convertibles because it is a mature fund that has proved to be efficient during the crises of 2008, 2011 and 2015, and it has an experienced manager who has been at RWC since 2005, leading the management of the convertible bond accounts,’ he said.
Short dollar and duration
I approached Philip Gadala-Maria, who is the fund selector for Miami-based Vector Global WMG. Whenever he feels uncomfortable with any condition in the markets that might lead to a dramatic or unexpected drop in prices, he moves his positions to the left of the interest rate curve.
‘The shorter the duration the better; we try to not go above a duration of three. A perfect example of this type of fund would be a short-duration bond fund,’ Gadala-Maria said.
‘In our case, back in June of last year when we felt uneasy about the rise in interest rates we positioned ourselves in Amundi Pioneer’s Short Dollar fund. The move into this fund helped balance our models and acted as a hedge against any potential rise in rates.’
Once the portfolios have been reassessed, the team begins to assimilate the market conditions, reallocating toward higher-risk funds. Recently, Gadala-Maria added a short-duration emerging market fund, noting that they tend to offer the comfort of a short-duration fund and the yield of an emerging market fund.
Diversification is the best protection against volatility, he said, and his group builds its models using both their model outlook and an approach to diversification that allows them to exploit the market and protect themselves from unforeseen downturns.
Gadala-Maria said he prefers to adjust the models according to their positions in investment grade and high yield bond funds by selecting strategies and managers who follow the same diversification directive.
‘There really is no fund manager you can fully rely on in a downturn. The cases when a manager has a fully unconstrained mandate would serve as the best example.’
Pablo Pizzani, a partner at Uruguay’s Stone Capital Wealth Management, agreed that you cannot rely on one fund manager in times of market uncertainty. It is vital to diversify and decorrelate investments to be prepared for different market scenarios.
‘We build our portfolios with a three- to five- year horizon and rebalance actively depending on market conditions. Last year, we realized profits from the equity side of the portfolio and invested in real estate, AI funds and for some clients increased cash balances.
To protect our portfolios we invest in long/short equity funds, from market neutral to more directional funds.’
Alternative thinking
Fatima Leon, an investment products analyst at Credicorp Capital in Lima, Peru, said she trusts liquid alternative Ucits in times of unexpected volatility. Her philosophy is based on finding products with low volatility, low correlation and daily liquidity. For her, two products stand out from the crowd.
‘One product that has worked very well in our clients’ portfolios is Old Mutual Global Equity Absolute Return(Gear) fund. This fund has a global long/short equity market-neutral strategy with a target volatility of 6% over a rolling 12-month period. Old Mutual’s investment strategy has five stock selection components: dynamic valuation, sustainable growth, analyst sentiment, company management and market dynamics. All of them have generated positive alpha contribution since the fund’s inception – especially the market dynamics criterion, which incorporates the use of price information.
She added that Gear has delivered zero correlation with bond and equity markets and consistent positive returns every calendar year since inception. In January 2016 and February 2018, when
the MSCI World TR index dropped by 6% and 4.1% respectively, this fund had positive outcomes of 0.2% and 0.6% (USD share class).
Franklin K2 Alternative Strategies fund is another product focused on hedge strategies with daily liquidity. K2 is a fund of hedge funds that focuses on four strategies: long/short equity, event-driven, relative value and global macro. It follows a flexible approach and adjusts strategy allocations to optimize the portfolio for the market environment.
Be prepared
When I chatted with Felipe Carrión, the fund selection analyst for Santiago’s Toesca Asset Management, he said the firm’s international investment funds are 100% focused on fund picking.
In this broad universe of managers, he seeks to select the best funds with the main objective of generating consistent alpha and capital protection through fund selection, portfolio construction and monitoring.
In the selection process, Carrión focuses evenly on quantitative and qualitative characteristics. For the quantitative process, he first studies a pool of funds from different categories and styles to compare their historical performances.
With the analysis of several ratios for different time periods, such as volatility, beta, information ratio, up/down capture, draw down and sharpe ratio, among others, the team aims to narrow each universe and select potential candidates to be incorporated into its models.
The next step is the qualitative phase, where the manager’s investment style, process and team are all considered.
The portfolio construction process seeks to protect the consistency of alpha generation by combining three different core investment styles and cultures: indexed, defensive and alpha focus funds.
‘Our investment process allows us to be well prepared for market drops. For example, when we analyze the drawdown of funds we like in emerging market equities; we see that more than 80% are able to generate an average alpha of more than 2% in those market corrections.
‘Vontobel is one of the managers we rely on in these types of scenarios. Their philosophy of “high quality growth at sensible prices” and the capabilities of their team work for us.’
