Last week's Hedge Clippings focussed on the Australian market's exposure, and Australian investors' love affair with the big four banks, or at least their dividend yields. In particular we noted the difficulty that value-based managers were having finding quality companies (which the banks undoubtedly are) that have the potential to continue to provide dividend growth, while still trading below their intrinsic value.

One theme that came out of this was the falling levels of market exposure that many absolute return managers currently have to domestic equities. Of course this is both a problem, and an opportunity, that long only index tracking fund managers don't have as their mandates require them to be fully invested irrespective of the market's direction.

Generally the managers that AFM monitors raise or lower their market exposure depending on their outlook for the market. Some may increase exposure through increased leverage (although this is a relative rarity compared with pre-GFC levels) or by reducing short exposure. At other times when the risk outlook appears excessively high, or when they see the opportunity, reducing exposure to the market might be achieved by increasing short positions.

However consistent with the theme that while not excessively overpriced the market is not exactly cheap, is the current trend for a number of managers to hold higher levels of cash, with some current examples approaching and possibly exceeding 30% of NAV. For value based managers who consistently refuse to overpay for an asset simply because everyone else is doing so, this tactic is simple risk avoidance.

If one assumed that this is particularly prevalent amongst large cap and high yield strategies, think again. There are a number of small to mid-cap specialists who are finding opportunities for value investing outside the ASX100 or 200 increasingly difficult following some recent stellar share price gains. Against this there are more companies to choose from, although the undervalued gems are difficult to find.

Irrespective of market sector, what we are seeing and hearing is that many managers are experiencing a decreased opportunity set following two or three years of strong gains. While some investors may question paying management fees of 1 or possibly 2% of NAV when 30% of the fund's assets are held in cash, this would seem preferable to being 100% invested in fully, or overpriced stocks when the unexpected occurs.

Or as Benjamin Disraeli pointed out "what we anticipate seldom occurs, what we least expect generally happens."

Think Crimea. Or a slower than expected economy in China.

Specific results received this week include the following PERFORMANCE and NEWS UPDATES:

Bennelong's Long Short Equity Fund returned 2.50% in February and 20.61% since inception in January 2003 with below Index volatility.

The Bennelong Kardinia Absolute Return Fund had a strong February (2.69%) making the most of the buoyant equity markets.

Morphic's Global Opportunities Fund returned -0.71% during February with a net exposure of 101% and gross exposure of 157%.

The Optimal Australia Absolute Trust returned 1.06% during February with a net exposure of 3.1%, a 12 month return of 3.20% and volatility of 1.90% (11.49% Index).

Allard's Investment Fund increased 0.2% during  February 2014. The 2.0% appreciation of the Australian dollar, detracted from the Fund's performance.

FUTURE EVENTS

27-29 March 2014: Superannuation Fund Back Office: 2014 Forum in Sydney convenes those responsible for superannuation member administration and investment operation services. It has been designed to explore emerging efficiencies and best practice in a number of key areas.

Also in Sydney on 27-28 March 2014: Operations Risk Management and Mitigation seminar enables participants to prepare and manage the planning and implementation of operational risk management processes.

If you know of any upcoming hedge fund industry Events, or would like your Event listed in our calendar, please contact us.

And now for something completely different this week, it's Billy Crystal's birthday today, so to celebrate here's a clip from one of his early stand up routines.

On that note, I hope you have a happy and safe weekend.

Best wishes,

Chris
CEO, AUSTRALIAN FUND MONITORS

Connect with me on LinkedIn Twitter Facebook

Australian Fund Monitors are helping to raise awareness to support research into prevention and cure for cerebral palsy.  

Cerebral palsy is the most common physical disability in childhood. But despite the incidence of CP, on average only $1 million is invested into CP research each year. To put that into perspective, Australia spent over $10 million on New Year's Eve fireworks last year. We're not suggesting that fireworks money should be spent on CP research, but it just goes to show how drastically underfunded research into cerebral palsy is.

For more information visit www.cpresearch.org.au or contact me by email.

I had the pleasure this week of listening to George Colman of Optimal Australia Funds Management present both his view of the markets, and the thoughts behind his fund's investment strategy. For those not aware of George or Optimal, he launched the fund on the same day that Lehman's failed in 2008, and is one of only a handful of managers that have provided their investors with positive returns every year since.

As such it is fair to say that financially George is what one might describe as a "safe pair of hands". However, in spite of not losing money, and since inception having annualised returns of 10.38%, with volatility of just 3.55%, he was less than enthusiastic about his 2013 returns when the fund significantly underperformed the strongly rising market.

Optimal's long/short investment strategy relies on what George describes as deep value investing. Between them, George and his colleague Peter "Fish" Whiting have almost 60 years' experience in the market, and their major concern in 2013 was the excessive valuations put on Australia's banks as bond yields collapsed and they became the most expensive in the world.

Firstly we make the point that we are not suggesting an imminent collapse in bank share prices, nor are we qualified to do so. The point is that at both an individual household, and the overall market level, Australia is heavily exposed to interest rates and the yield play of the banks. However there are some worrying statistics and signs on the horizon.

One came from a recent report from another local fund manager, Paul Moore of PM Capital which included a chart of the percentage of household share portfolios in banks, which having fallen to a recent low of around 30% in 2000 (think tech wreck) has risen to exceed previous highs to be nudging 60%.  One can safely assume this is the retail investor chasing a dividend yield, further bolstered by the effect of franking credits.

That's fine in a low interest rate environment, but as George pointed out, Australia's 10 year  bond rate has risen to 4.10%, becoming one of the highest in the world, well above Mexico (3.76%), Spain (3.4%) and not far off Brazil (4.75%) and Portugal (4.66%). In addition, RBA governor Glenn Stevens warned this week of the risks of further rises to rates, and the dangers that poses to the property market. This is relevant considering although the cost of servicing household debt has decreased as rates have fallen, the overall level of that debt has remained static - and high - at around 150% of household disposable income.

At the risk of embarrassing him, back to George. His current view (or at least one of them) is that while prices rose over the past two years somewhat irrationally from a value perspective, he refrained from joining the crowded trade, but feels value will become front and centre once again as rates rise.

He also was able to explain to me the real meaning of the term a Gordian knot and his feeling that the US QE program and current tapering exercise was a prime example of one. Altogether an illuminating and informative discussion.

Specific results received this week include the following PERFORMANCE and NEWS UPDATES:

Cor Capital Fund returned 0.92% and 4.87% (annualised) since inception in August 2012.

The Pengana Asia Special Events (Onshore) Fund 2.00% for January, a very difficult month for Asian equity and 11.76% for the 12 months to end-January.

Intelligent Investor Value Fund managed the poor equity market of January with a good return of 1.05%. For the year the Fund recorded  a very strong 37.69% (Index 10.98%).

The Monash Absolute Investment Fund has a sound February returning 2.60% with the twelve month return 24.51% (ASX 200 Acc 10.56%).

FUND REVIEWS RELEASED THIS WEEK:

Aurora Fortitude Absolute Return Fund is characterised by steady returns and very low risk. Since inception (March 2005) the Fund has returned 8.12% pa.

AFM's updated Fund Review for Insync Global Titans Fund for January 2014 shows the Fund delivering  an annualised return of 10.96% and annualised standard deviation of 8.46% (since inception in October 2009) with sound risk-reward statistics.

Morphic Global Opportunities Fund has returned 34.52% for the previous twelve months with a volatility of 10.04% p.a.

AFM's updated Fund Review for Optimal Australia Absolute Trust has been released. The fund is characterised by very low risk with an annualised standard deviation 3.57% (Index 15.06%)and a Sharpe Ratio since inception of 1.73.

FUTURE EVENTS

27-29 March 2014: Superannuation Fund Back Office: 2014 Forum in Sydney convenes those responsible for superannuation member administration and investment operation services. It has been designed to explore emerging efficiencies and best practice in a number of key areas.

Also in Sydney on 27-28 March 2014: Operations Risk Management and Mitigation seminar enables participants to prepare and manage the planning and implementation of operational risk management processes.

If you know of any upcoming hedge fund industry Events, or would like your Event listed in our calendar, please contact us.

And now for something completely different this week, and in particular for Dylan fans (yes RVC, that includes you) here's a clip, that while not very Australian we couldn't help but enjoy.

On that note, I hope you have a happy and safe weekend.

Best wishes,

Chris
CEO, AUSTRALIAN FUND MONITORS

Connect with me on LinkedIn Twitter Facebook

Australian Fund Monitors are helping to raise awareness to support research into prevention and cure for cerebral palsy.  

Cerebral palsy is the most common physical disability in childhood. But despite the incidence of CP, on average only $1 million is invested into CP research each year. To put that into perspective, Australia spent over $10 million on New Year's Eve fireworks last year. We're not suggesting that fireworks money should be spent on CP research, but it just goes to show how drastically underfunded research into cerebral palsy is.

For more information visit www.cpresearch.org.au or contact me by email.

• The Aurora Fortitude Absolute Return Fund  (AFARF) has a 8 year track record investing in ASX listed equities. A Market Neutral overlay is used across a multi strategy approach which allows for flexible asset allocation to maximise returns and minimise risk under a variety of market conditions and cycles.CIO John Corr has over 20 years financial market experience with a strong focus on risk.
• Significant use of low risk "long" derivatives and option overlays has provided positive returns with low volatility during periods of market dislocation. Annualised return since inception is 8.12% with a very low standardised standard deviation of 2.74%. Over 88% of monthly performances have been positive, with no losing months in 2008 with the Fund's largest drawdown -2.09%.
• ASX listed Aurora Funds Limited was established on the merger of three existing fund management businesses, managing approx. $480m on behalf  of more than 2,500 retail and wholesale investors.

Australian Fund Monitors

ATTACHED FILESAurora Fortitude Absolute Return Fund AFM Fund Review January 2014 (pdf format)

INSYNC GLOBAL TITANS FUND

ATTACHED FILESInsync Global Titans Fund AFM Review - January 2014 (pdf format)

MORPHIC GLOBAL OPPORTUNITIES FUND

ATTACHED FILESFund Review: Morphic Global Opportunities Fund (pdf format)