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#Market Strategy — 19.01.2018

The Importance of Finding Flexible Solutions

Guy ERTZ

2018 Investment Themes series: Late-cycle theme #3
 

The bond universe offers very few opportunities. Indeed, interest rates and bond yields are set to rise moderately in 2018. This suggests that returns on traditional bonds will be very low.  Moreover, some equity markets are already fairly dear and some investors do not tolerate the level of underlying risk on these markets. Alternative strategies, unconstrained funds and certain structured products offer attractive solutions.

Alternative UCITS – “Long/Short Equity” and “Macro” strategies

“Long/Short Equity” strategies take advantage of price anomalies on equity markets. Portfolio managers may take long and short positions at the same time (a strategy consisting of simultaneously betting on the rise of one share and the fall of another share or a group of shares). This helps to limit the portfolio’s sensitivity to a general decline in the equity markets or to a rise in interest rates for example. We have selected several funds, according to their risk and their exposure to equity markets. “Macro” portfolio managers should benefit from a better visibility on central bank interventions in terms of monetary policy, as well as the resulting disparities through commodity price variations for example. “Macro” strategies mainly aim to benefit from the evolution of stock market indices, interest rate movements and fluctuations in commodity prices or currencies. Positive or negative trends may occur but these strategies require a certain stability in the trend for portfolio managers to outperform.

Unconstrained bond funds

We think that bond yields will increase gradually, both in the US and in the eurozone, particularly due to the gradual normalisation of monetary policy in the world’s major economies (except Japan). Traditional bonds risk seeing price corrections. Active management of this interest rate risk is essential. So “unconstrained” funds, which have no benchmark constraints and may be invested in any sub-asset class, should outperform traditional funds.

Structured products

Structured products usually make use of more complex instruments (futures contracts, options or credit default swaps) to which individual investors generally have limited access. Such instruments may be used to optimise the overall return or hedge against losses while limiting the sensitivity to a rise in interest rates. We recommend short-dated defensive products (usually 1-3 years). In other words, investors should favour solutions offering a total or partial protection of the invested capital. Underlying assets may vary in nature (e.g. oil, gold, equity indices, interest rates).

The bond universe remains difficult. Besides, certain equity markets are already fairly dear and some investors do not tolerate the level of underlying risk on these markets. We have presented several alternative fund strategies (“Long/Short Equity” and “Macro”) which help to create value while limiting the associated risk. “Unconstrained” funds and structured products may open up opportunities with the same risk/return objectives.

MAIN RISKS

The liquidity of alternative funds may vary from one fund to the next. It is important to keep into perspective the size of the fund compared with that of the underlying market, while taking into account the daily or weekly liquidity for UCITS funds. Given that these funds may have a flexible management with no benchmark constraints, it is important to monitor that the fund manager respects his/her intended  investment and volatility strategy. The same applies to “unconstrained” funds.

 


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