In these still somewhat uncertain times in the equity markets, one may consider a diversified portfolio as sufficient enough to manage risk. Indeed, one may even expand this across countries, sectors and asset classes, in order to limit exposure to any one sector. An opportunity not to be overlooked however, in both showing consistent and steady returns, as well as diversifying risk, is the use of actively managed fund, and fund of funds.
A well managed fund can turn over a profit given a varied amount of market conditions, is often in itself diversified geographically and across security types, and by its nature, has a number of expert portfolio mangers, with many years of expertise in their respective markets, effectively looking after your money.
This was a case argued by three such experts in a conference held by Peregrine Perspectives last month, where Francois Buclez, the Founding Partner of Cube Capital, Jon Macintosh, a Founding Partner at Saltus Partners, and Shiv Taneja, the Managing Director of Cerulli Associates, a research firm specialising in the financial services industry, outlined many of the benefits to investing in a fund.
Francois set out one of the principle benefits of using a fund for ones investments, by outlining the three ways to generate returns in the financial markets i.e. momentum, return to mean and carry. A momentum trade or strategy utilises a trend in the market direction, either positive or negative, to benefit over varying lengths of time, as the trend holds. A simple example would be taking a long or short position in the equity markets, assuming over time the value will appreciate or depreciate. Naturally then, the major necessity for this type of trade, is a solid and persistent trend in the market.
So what then of a directionless market?
A return to mean trade or strategy, seeks to derive returns through the convergence (and divergence) in value between securities, seeking arbitrage opportunities to ‘lock in’ profits. This is often the case with risk arbitrage opportunities with upcoming mergers and acquisitions (M&A), or trading in the fixed income and credit arenas. This is also the aim of many quantitative trading methodologies, and the high tech computer systems generated by ‘Quants’ at the world’s top trading houses.
Return to mean trades also include profit making opportunities derived from event driven moves in the markets, and so called distressed investing. Simply put, this is taking advantage of a markets tendency to overreact to events and disasters, and over sell (or over buy as the case may be) securities in the short term. These price fluctuations inevitably return to near previous levels as sentiment settles down, and a savvy investor could have bought (or sold) at just the right opportunity.
So then to the third category, the carry trade or strategy. The carry strategy is based on investing in securities whose returns come largely in the form of fairly uniform, running yields or amortisation. Generally speaking these are less prone to capital gains or losses, and as such are also generally impacted less my specific market moves or direction (although obviously this is simplifying the case somewhat). Examples would be fixed income securities such as sovereign bonds, where investors are guaranteed to receive back 100% of the principle investment, and also receive annual or bi-annual coupons at a fixed and known rate.
With these three strategies outlined, the key benefit of investing in a fund, or indeed a fund of funds, is clear. An actively managed fund will seek to take advantage of any and all of these strategies, as and when it is beneficial to do so, effectively allowing them to make the most money, no matter what then broader market conditions.
Many of these strategies would go far beyond the capabilities of an individual investor, both in terms of knowledge and experience, in terms of time and expertise, and in terms of the capital (not to mention in some cases the equipment, such as complex trading systems) that a fund can bring, through economies of scale by pooling collective investments. A fund by its nature, will have investment professionals running each aspect of individual strategies, as well as expert portfolio managers combining them in the most appropriate way. This is simply something an individual investor would never be able to do with their own portfolio, at least not to the full extent and capability of a fund.
A fund of funds goes one step further to diversify risk, and invest not in individual securities or investment strategies, but rather select those funds which have a proven record of generating good returns, and actively seek to invest in funds who hold certain criteria (such as a primary trading strategy, key management or a specific portfolio make up), which they as experts themselves, deem fit for current market conditions.
Again this diversifies a potential portfolio exponentially, where in theory one investment in a fund of funds, would effectively hold thousands of securities, across geographical and political regions, with a dozen different investment strategies at work, and a team of hundreds of experts working on each aspect.
This may seem quite obvious, however it is something to consider that is often overlooked. It is after all, in the nature of most investors, to want a lot of control over where their money is, and indeed by placing money in any security, we are showing the belief that somehow our opinion and decision is better than those others who are on the other side of our trade.
By trusting our investment to a team of industry professionals, one could argue we would be making a more sensible decision. We don’t for example, perform surgery on ourselves if we need an operation, or insist on flying our own plan when we go on holiday. There is certainly a case to be argued, that investing our hard earned cash should be no different than any of these.
Considering what has been looked at so far, and the argument put forward in this piece and at the conference, one could be forgiven for assuming all funds are great investments, and we need look no further than placing our money with them and sitting back happy in the knowledge that we have done the best thing.
This however, is of course not true. A fund, like any other investment or business, can be good or bad, hit good times and hard, have a perfect strategy or a failing one. Likewise, an individual investor may be able to show consistently high returns on their portfolio, despite not having the facilities to hand that a fund would.
However for those investors without the time or resources to take advantage of a wide selection of trading strategies, or just for those who are looking for an easy way to diversify their own portfolio, funds and fund of funds offer a great opportunity, and one that is all too often overlooked.
Disclosure: no positions