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Investment strategies

A good portfolio is more than a long list of good stocks and bonds. It is a balanced whole, providing the investor with protections &
opportunities with respect to a wide range of contingencies. {Harry Markowitz}

Market Neutral Strategies

These Funds use skill-based strategies to express views on the markets and are able to limit the amount of capital at risk for any particular trade. Characteristics include a high Alpha, low Beta, low correlation to equity markets, small falls in value, low volatility, high Sharpe ratio and low risk score. They are highly risk-diversifying since these strategies can seek to make money when markets decline unlike long-only strategies. Success relies on the ability of the Fund Manager to hire and retain highly skilled traders to conceive, formulate and execute strategies. These Funds typically employ significant leverage to achieve their objectives and make extensive use of derivatives. The strategies can be highly complex, using a variety of cash and derivative instruments to express market views and control risk.  The Funds typically have unconstrained investment concentration limits. Key factors when selecting market neutral Funds are to ensure the Fund uses multiple strategies, preferably with several traders, and has the critical mass to manage the complexity of the strategies. Example strategies include yield curve flatteners and steepeners, long-short equities, convertible bond relative value, basis trades, arbitrage and options strategies.

Absolute Return Strategies

These investments have an objective of capital preservation over a stated time period, typically between 1 and 5 years. They are typically long equities most of the time, however they can move into defensive mode by switching into fixed income instruments or utilising derivatives such as equity put options when there is deemed to be excessive risk in the equity markets.  Characteristics include a high Alpha, medium Beta, medium correlation to equity markets, smaller falls in value than equity markets, medium volatility, good Sharpe ratio, medium risk score. They are usually highly reliant on the manager to call the market correctly and are usually dependent on one principal decision maker.  Market timing is more crucial than for long-only strategies. Their previous track record when equity indices dip is highly relevant to the analysis of these Funds.

Real Return Strategies

Investments which can protect against inflation include index-linked government bonds, infrastructure, real estate and commodities.  Except for commodities, these investments typically provide a relatively high level of income.

Listed Equities

These are quoted shares of listed companies and collective investments which invest in equities.  Funds typically have a focus, which could be:

Characteristics include a higher correlation to equity indices, high volatilities and a high risk score.  Equity Funds can experience exceptional performance when equity markets rise, particularly where the Fund has a high Beta or employs leverage. The Fund’s performance is reliant on the manager picking stocks which outperform the market with sufficient success to offset management fees. It is important to be highly confident the manager can produce long-term Alpha otherwise a passive strategy of low-cost index-tracking would be more appropriate.

Private Equity

Will typically comprise investments in private equity funds rather than individual private equity opportunities.

Fixed Income

Fixed income Funds invest in the debt of state and regional governments, supra-nationals, banks and corporates.  Debt can be in the form of fixed rate, variable rate, index-linked and convertible bonds.  Characteristics of fixed income Funds include a low correlation to equity markets, small drawdowns, low volatility and a low risk score.  A significant component of return can arise from regular interest payments which dampens Fund price volatility.  Since debt ranks superior to equity in the capital structure of companies, there is typically lower risk and lower return than traditional long-only equity Funds.  Fixed income strategies offer diversified returns within a portfolio made up predominantly of equity based Funds, however returns tend to be lower in a low interest rate environment.  Success within the fixed income sector is highly dependent on the ability of the manager to correctly position the Fund at different points in the cycle in terms of credit quality, sector, inflation hedging and duration.  One key factor when choosing a bond Fund is the ability to manage a fixed income portfolio in a deflationary/inflationary environment.

Special Situations

Examples of special situations which Activus clients have benefited from include a UK Fund which was trading at a 14% discount to NAV which changed its manager and investment mandate and within 9 months traded at a 2% discount and a US event driven Fund which was trading at a 20% discount whereupon the manager began a formal process of buying back and cancelling shares, resulting in a 15% return to clients due to the discount narrowing.  The gains from these situations are generally uncorrelated to the direction of markets and therefore provide very high quality alpha to clients’ portfolios.