Expect the unexpected!

A few years ago there was a rush of newspeak around the known knowns, and known unknowns, and unknown unknowns. It was all a little confusing (especially when written like that) and mainly emanated out of US military and political circles, particularly Donald Rumsfield. Thankfully, here at least, the fad passed. But it did make us think about the unexpected, and the old market adage to expect the unexpected.

To be fair the market has seen a fair number of expectations come to pass over the past 12 months, including the well telegraphed end of QE in the US, the inevitability of the ECB's own stimulus program, and although not universally expected, a slowdown in the growth of China's economy.

However there have also been some unexpected and significant market moves over the past six months: Few, if any expected the Swiss to remove the cap on their currency which resulted in the Swiss Franc jumping 15% overnight. Few expected the price of oil to halve. Equally three months ago few would have expected a rally in the Australian equity market of 10% in just eleven days this early in the new year.

But then few were expecting a rate cut of 0.25% in February either, whilst now the expectation is for a cut of a further 0.25% in the next few months. To put the market's rise of 10% in context, the ASX200 (excluding dividends) only rose 1.4% in the whole of 2014, so there'll finally be some happy investors around, particularly those focusing on stocks within the yield theme such as Telstra and the banks.

The question for local investors is whether this can continue, or is this as good as it gets? A further rate cut, and a weaker A$ will no doubt fuel the rally further, but one wonders how long OPEC will continue to pump oil at these levels, and therefore subsidise the price of petrol. However, the opposite side of the cause of the rate cut is falling consumer and business confidence, neither of which will have been improved by the current state of play within the government in Canberra.

We have repeatedly warned that sooner or later interest rates WILL increase, certainly from their near zero or negative levels overseas, whereupon there's likely to be outflows from equity markets. When, or by how much is not known, but when it does occur we suspect it will be a case of expect the expected.

Which I suppose brings us back to hedge funds, and their core purpose of avoiding risk and the danger of the unexpected. Taken over a range of periods equity hedge funds have consistently outperformed the ASX200 Accumulation index.  Over 2014 they returned 7.6% (vs ASX200 5.61%); annualised over five years 8.84% (vs ASX200 6.75%) and over ten years, 9.71% (vs ASX200 7.55%). Over each time frame that's an excess return of over 2%, which over ten years would leave investors 22% better off. Most importantly this has been achieved with around half the volatility and drawdown of the equity market.

There's no doubt a clever line in there somewhere about hedge funds and the unknown unknowns, but as we noted at the beginning thankfully that fad has passed.

Specific results received this week include the following PERFORMANCE UPDATES:

KIS Asia Long Short Fund returned 0.26% during December and 4.76% for 2014 with a volatility of 2.72%.

Chris
CEO, AUSTRALIAN FUND MONITORS

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2015 Market Outlook: "Looking forward, Looking back"

12 Feburary 2015: 12:00 - 2:00pm

2014 is now behind us, and the Australian equity market has essentially moved sideways since January. Interest rates have been on hold all year, and at record low levels of just 2.5%.  The Aussie $ has finally cracked previous support, and if RBA Governor Glen Stevens has his way, has further to fall. Meanwhile the US market has continued to outperform, and YTD is up 7.6%. 

By all accounts 2014 has been a difficult year for many investors, yet as at the end of November almost 60% of local fund managers had outperformed the market, while the best have returned over 20% since the start of the year.

So 2015 looms, with uncertainty probably being the major issue. Uncertainty about the markets, growth in the US and China, commodity prices, property and interest rates abound, while overshadowing all of those might be the performance of the government's handling of their first budget and the economy.

With that in mind, the subject of our first investor event in 2015 is aptly entitled "Looking forward, Looking Back". Join us to hear the opinion of four of our most respected fund managers reflect on 2014, and more importantly, provide their opinion on what the markets might hold in 2015, including:

• Simon Shields from Monash Investors,
• George Colman from Optimal Australia. 
• Monik Kotecha, Insync Fund Managers; and 
• John Corr from Aurora

Date:     Thursday 12th February 2015
Time:    12:00 - 2:00pm (light lunch will be served)
Venue:  Sydney CBD
Cost:     Complimentary for Investors and Advisors

To assist with catering and other arrangement please RSVP here and we will forward your ticket with full details of the venue. 

Last week "Hedge Clippings" noted that while negative, or historically low interest rates around the world caused by QE in the US and European and Japanese Central Bank Intervention (CBI) is working up to a point, it is still a great experiment that we had to have to avoid a complete meltdown during and post the GFC. As such, the end outcome has yet to be determined.

China's economy is still a question mark, although is likely to be a major beneficiary of the lower energy prices - if and while they last. The crackdown on the margin lending which has helped to push the Shanghai market so strongly over the past six months will however be interesting.

Europe won't respond to CBI the way the US did to QE simply because there are 28 different economies and nationalities at work. It is not universal. The world is facing deflation and 0% or negative interest rates, and as we indicated in last week's Hedge Clippings there's likely to be tears before bedtime.

The question is when? Investors will continue to chase whatever yield they can find, and bank deposits aren't where they will find attractive returns for a while. Hence equity markets, and particularly the six great dividend payers in Australia (the big four banks, Wesfarmers and Telstra) although expensive on most counts, will remain well supported, as evidenced by the Commonwealth Bank hitting $90 today.

So there's a significant anomaly: In spite of the risk of concentration in just a handful of stocks, and in spite of the risk of buying assets which on any normal valuation are significantly overpriced, investors are still happily allocating to equities and if the RBA cuts rates again next Tuesday as many expect, are likely to continue to do so. Meanwhile more and more commentators and fund managers are warning of the risks.

They are doing so on the assumption there won't be any shocks to the system, be it an economic or political black swan event, which of course can't be ruled out. For example, oil prices halving in 6 months out of the blue is likely to cause some serious pain in some sectors of the US (shale oil) market and in Russia, even if we can now afford to fill the car's petrol tank.

So what to do? A sensible investor (if they believe the nervous nellies) might buy some insurance in the form of long dated out of the money index put options. Or just continue to dance until the music stops, and hope for the best.

But hope is generally not considered to be the best strategy.

Specific results received this week include the following PERFORMANCE UPDATES:

Paragon Fund returned -0.50% (ASX 200 Accum 2.06%) during December with annual returns at 16.09% (Index 5.61%) with a volatility 15.16% (Index 10.95%).

The Pengana Absolute Return Asia Pacific Fund returned 0.74% in December and 6.20% for the year with a volatility of 2.79% and a Sharpe ratio of 1.29.

Auscap Long Short Australian Equities Fund recorded a return of 0.44% in December with the annual return 23.17% and a volatility of 7.46%.

The Avenir Capital Value Fund returned -4.42% during December 2014 with annual performance of 15.38% and volatility of 11.11% since inception.

Chris
CEO, AUSTRALIAN FUND MONITORS

Connect with me on LinkedIn Twitter

• The Aurora Fortitude Absolute Return Fund  (AFARF) has a 10 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. Risk statistics are impressive and shows the Funds risk philosophy; over 86% of monthly performances have been positive with no losing months in 2008, annualised standard deviation of 2.71%, the Fund's largest drawdown is -2.09% and the Sharpe ratio 1.05.

• ASX listed Aurora Funds Limited was established on the merger of three existing fund management businesses, managing approximately $230m on behalf  of more than 2,500 retail and wholesale investors.

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