Fixed-income funds with high cash and government bond exposure, an equity fund focused on digital transformation and a low-vol fund with tail hedges for out-of-the-blue events were among the hedge funds that emerged stronger from the first phase of the global pandemic last year.
Hedge fund managers discussed their funds and strategies at the Canadian Hedge Fund Awards Winners Showcase 2021 on Tuesday, a virtual conference organized by Alternative IQ.
The managers shared how their award-winning funds thrived despite the pandemic’s shock, and how they’ll aim to generate alpha amid ongoing uncertainty and historic low rates.
Paul Sandhu, president and CEO with Marret Asset Management, highlighted his firm’s diversified bond fund, which won best one-year return in the credit category. (All winning funds, announced in fall 2020, are listed online and were judged based on performance ending in June 2020.)
Because corporate spreads were tight at the time, the fund had almost no credit exposure heading into the pandemic.
“This mandate was almost totally exposed to government bonds at the beginning of 2020,” Sandhu said. As central banks dropped interest rates in response to the pandemic, the fund benefited from having “high-quality exposure to duration during that time,” he said.
A large proportion of the fund consists of high-conviction trades from the firm’s other hedge funds, Sandhu said. Exposures may also include equities, commodities, currencies and inflation-linked securities.
With no asset class constraints, the fund can seek the best risk-adjusted returns in fixed income, based on the economic, interest rate and credit cycles, Sandhu said.
When Sandhu asked about the subreddit-fuelled short-seller squeeze this year, he said it influenced the firm but only modestly, given that fixed income is traded over-the-counter and is thus less visible than equities.
“We are more cognizant of our short positions,” regarding such things as size and liquidity, he said.
Sandy Liang, portfolio manager with Purpose Investments, manages a credit opportunities fund that won first place for best three-year return and second place for best three-year Sharpe ratio in the credit category. The fund uses a bottom-up approach that ultimately results in 50 to 70 securities.
The fund typically has a high cash balance as a way to put investing ideas to work, and that was the case heading into the pandemic. “You want to be buying when everyone else is selling,” Liang said. The fund took advantage of market dislocation last year to lend to mortgage REITs.
Liang noted that special purpose acquisition companies (SPACs) will be “a real tailwind” for high yield in 2021, as SPACs buy private companies during this period of accommodative monetary policy. “If you’re a lender to the high-yield market, you’re a beneficiary [of SPACs’ acquisitions] because there’s a lot of equity capital in there,” he said.
With the fund largely generating returns from high yield, one way it can protect against a potential increase in interest rates is by shorting. “We think there’s an asymmetric opportunity in shorting investment-grade corporate debt,” Liang said.
Noah Blackstein, vice-president and senior portfolio manager with Dynamic Funds, discussed his firm’s global growth opportunities fund (the fund won for best three- and five-year returns in the equity category).
One way the fund, which takes a bottom-up approach, benefited last year was with its focus on secular growth across industries in areas such as digital transformation.
Blackstein noted that tech has transformed over the last couple of decades from products to platforms, and industries in the early stages of that revolution will provide investing opportunities ahead. Internet-only banks in emerging markets are an example, he said.
When valuing tech, Blackstein said he analyzes earnings over the next three to five years. “If we can’t get past the stock price relative to the future earnings, then we’re going to move on,” he said.
Low interest rates pose a challenge for valuation based on discounted cash flows, noted James Cole, senior vice-president and portfolio manager with Portland Investment Counsel. That may be a particular challenge for Cole, considering his focused equity fund zeroes in on a small number of names with large percentage weights — up to 40%.
When rates are low, he uses a floor of 8% — the long-term return on equities — as a discount rate for apples-to-apples comparisons across companies, he said.
While the fund dials up leverage to capitalize on volatility, Cole said his approach in 2020 was measured. “There was real economic damage, and I wanted to … be positive we would see through to the other side,” he said. The fund held no pandemic-affected stocks in sectors such as travel and accommodation, and energy.
With historic low rates, Cole said he expects equities will be “the best performing asset class for a considerable period of time.” When rates start to rise, causing dislocation, the fund will seize opportunities, he said. It placed third for five-year return in the equity category.
Jim McGovern, managing director and CEO with Arrow Capital Management, said his team aims to provide alpha, low correlation to equities and bonds, and low volatility in its alternative macro fund (it won third place for five-year return in the global macro category). One way the fund manages risk is with tail hedges for out-of-the-blue events.
The fund’s investment process is supported in part by short-term economic forecasts, allowing the fund to take advantage of marginal changes in GDP and inflation (which affect, respectively, profits and discount rates for discounted cash flow analysis).
He expects a disinflationary environment in Q3, requiring a more defensive stance. “We’ll start positioning for that probably in April or May of this year,” McGovern said.
Regardless of market developments, Liang said advantage ultimately lies in “investment sense and doing the work,” so that risk/reward theses are well founded.