Quantitative Easing

Are flexible long/short funds the answer to investors’ inflation problems?

Inflation is expected to hit double digits in the coming months and investors are scrambling to figure out where best to put their money.

The industry’s go-to 60/40 solution increasingly seems as if its days are numbered. That leaves a slew of more modern strategies to choose from, but many have only ever worked in a mild inflationary environment, meaning there’s little indication of how they’ll fare.

That said, Jason Hollands, managing director of Bestinvest, suggests that there is reason to believe that the opportunities for long/short strategies are improving.

Since the global financial crisis, asset markets have been buoyed by ultra-loose monetary policy in the form of near-zero interest rates and repeated cycles of massive central bank money printing. This has generally pushed up asset prices and also led to very high levels of correlations between stocks and bonds, Hollands notes.

“Such an environment has made it difficult for absolute return funds to add value, as the wall of liquidity-boosting markets arguably downplayed the importance of fundamentals and stock selection, and the high correlation of asset classes has reduced the scope of directional trades.”

Hollands argues that we are now in a very different environment where central banks are unlikely to come to the rescue of the markets as they have over the past decade.

He insists that there are big differences between companies that are more resilient to higher borrowing costs or have pricing power, and those that are vulnerable to these changes. “I think stock selection and fundamentals are going to be a lot more important,” he says.

The new era of the market requires a broader toolbox

Nabeel Abdoula (pictured), deputy CIO at Fulcrum Asset Management, agrees that a shift in focus is evident. “Before the pandemic, the past few decades have seen powerful disinflationary forces at play across the world, including globalization, aging populations and technological disruption.”

He adds: “While the latter two are likely to persist, we are now witnessing a global decoupling – a reversal of globalization – which will result in less reliance on trade with China and cheap gas from China. from Russia. These two factors in particular are putting upward pressure on inflation. In such circumstances, it is essential to build diversified investment portfolios using flexible long/short strategies that focus on a wide range of performance drivers over a multitude of time horizons.

Abdoula believes that higher than expected inflation, the end of quantitative easing, the increased need for sustainable investments and political risk will persist.

“The past few months are just the start of a significant change from the benign equity and bond markets. It may be just the start of a new era that requires a broader toolkit than the Traditional investing and the flexible long/short strategy should work well in this scenario.

Flexible options

Luke Newman, UK equity portfolio manager at Janus Henderson Investors, believes a flexible long/short strategy should be as comfortable in bear markets as it is in bull markets, with a short portfolio able to function as a profit center much as a hedging tool.

“Every investment must be made taking into account the risk of loss. Such strategies, if managed properly, should help reduce risk to capital during initial periods of macroeconomic uncertainty, and then transition into a position to take advantage of the subsequent market rebound – or variations in performance between different parts of the market.

This “reduced risk” point is something Hollands picks up on. “Absolute return is a very broad banner that encompasses a very wide range of investment strategies and techniques.

“While many of these strategies have demonstrated their ability to deliver low volatility relative to broader markets, the weakness of many of these strategies has been the lack of meaningful real returns and so, understandably, many investors and advisors have lost confidence in themselves and become particularly skeptical of those who receive performance fees.”

However, many absolute return funds have failed to protect themselves against market declines. Natixis H2O Multireturns Fund and Odey Absolute Return, which were among the biggest laggards in the IA Targeted Absolute Return (TAR) sector during the Covid sell-off in March 2020, underperformed half of the 393 IA UK funds All Companies, UK Equity Income and UK Smaller Companies sectors.

In the volatile environment of 2022, absolute return funds generated a meager total return of 0.1% on average, although this was better than the average fund in the IA Global (-9.3) and IA UK All Companies sectors. (-6.3%).

However, much of the IA TAR sector is sitting on losses comparable to those of its pure equity counterparts.

The worst IA TAR funds since the beginning of the year (%)

Thesis TM Neuberger Berman Absolute Alpha -12.29
Flexible macro of Jupiter -11.11
Baillie Gifford Multi-Asset Growth -10.73
JPM Global Macro Opportunities -10.39
Baillie Gifford Diversified Growth -9.76
Schroder ISF Emerging Markets Debt Absolute Return -8.93
Global absolute efficiency GS -8.87
BNY Mellon Sustainable Real Yield -8.52
iMPG Absolute Return -8.38
Invesco Global Target Income -8.33
Source: FE Fundinfo

Absolute return funds ‘more flattering to deceive’

Fairview Investing’s Ben Yearsley isn’t impressed with either the performance or the fees.

“These funds are often more flattering to deceive and really add nothing to a portfolio. However, they often enrich the fund manager.

“They normally seem to perform well when the fund is small and nimble and at the first sign of big money entering performance, performance seems to deteriorate.

“The problem is that managers have to be good at both disciplines: finding the good companies and the bad ones. The problem with shorting is that the market can stay irrational longer than investors can stay patient – ​​just ask James Clunie, ex-Jupiter, who long shorted Tesla.

See also: End of an era for absolute return mega funds as investors pull in billions during the Covid crisis

Best of breed

Hollands agrees that effectively identifying potential winners and losers is a significant challenge, and the jury is out on how many managers actually possess these skills.

He admits that absolute return funds have performed poorly recently, but singles out some of the stronger names.

“Among multi-asset strategies, the JPM Global Macro Opportunities fund deserves consideration. The process is to take advantage of markets that have misjudged economic trends and movements.

“The team builds a portfolio of long and short positions in equities, fixed income, currencies and gold, with the team actively changing positioning based on its macro outlook. They also use derivatives, where appropriate, to protect the portfolio.

There are also more traditional multi-asset products with a focus on capital preservation and real returns that Hollands likes, such as Personal Assets Trust, the Trojan Fund and Ruffer Investment Company, which each invest in a mix of stocks. , indexed bonds , gold and short-term bonds and cash.

“The products don’t use more complex trading strategies or derivative overlays, but have been effective in delivering ‘steady’ Eddie returns that won’t give investors a sleepless night,” he says.