Hedge Clippings | Friday 13 September, 2019
 

Hedge Clippings attended two very different but equally interesting presentations during the week, one being Livewire's "Live 2019" event, which brought together a range of "best in breed" active fund managers presenting their views on the current market, and sharing some of their wisdom and best ideas.

The event kicked off with a debate between opposing teams who were either in the "risk-on" or "risk-off" camp, a highly topical subject given that irrespective of their view on the length or strength of the current bull run, even the "risk-on" advocates were quick to point out that there are significant risks in the current market.

Managers including Totus Capital's Ben McGarry, Perpetual's Anthony Aboud, and Philip King from Regal Funds Management were of the view that whilst the current market may continue for some time, and where "value" investing is out of favour, specific sections of the "growth" stocks were shaping up as one of the great shorting opportunities.

Overall, the consensus was that interest rates are going to remain at these levels (or lower) for some considerable time. In fact, it was difficult to find anyone who was prepared to predict not only when interest rates may rise, but what factor may be responsible for their doing so. As such it was difficult not to argue that equity markets as a whole would benefit as a result. However, there was some concern (shared by Hedge Clippings) around ETF's and index investing: Firstly, that the rising tide effect lifts all ships, or all stocks if they're part of the index, irrespective of their quality, and secondly that any significant exit from ETF's in the future would lead to a snowball effect.

Of particular interest were two specific sessions, one an interview with Scott Nuttall, Co-COO of US-based global private equity giant KKR, and the other a Q&A session with Magellan's Hamish Douglass, and Platinum's Andrew Clifford.

The second presentation we attended was from Winton Capital Management, the UK-based systematic manager founded in 1997 by CEO and co-CIO, David Harding, following 10 years running AHL using similar statistical and mathematical systems to provide diversified returns trading futures markets.

Winton employs significantly complex trading strategies, backed by large numbers of significantly intelligent "quants", no doubt with buckets of PhD's amongst them. What was interesting in David's presentation was that issues such as risk on vs risk off, growth vs value, or the overall macro view of the world which were debated at length at the Livewire event, didn't really come into their processes at all. Instead, Winton's approach (borrowed from their presentation material) is that their "investment decisions are driven by the empirical analysis of data rather than opinions based on economic and financial theory."

Over 30 years since founding AHL, and subsequently Winton, David's success is undoubted - not only in building a significant global business, but also being financially successful enough, as a result, to have generously, with his wife Claudia, joined the Giving Pledge, a commitment to give away more than half their wealth during their lifetimes. 

We are not espousing quant versus discretionary managers or vice versa (although we are not great fans of index investing for the reasons stated above) because each have their place subject to performance. In fact, without the discretionary managers, and other discretionary investors, the market probably wouldn't have the deficiencies such that quants such as Winton would be able to implement their super smart algorithms.

Hedge Clippings | Friday 06 September, 2019
 

"Good start, Boris!" 

Not our quote (unfortunately), but a heckle from across the floor this week as Great Britain's latest Prime Minister lost not just one, but two crucial votes, plunging the country - and potentially Europe with it - into further confusion. What happens now is anyone's guess, although Boris, while understandably angry, didn't seem to take a backward step. Neither did he seem to flinch when his brother resigned from parliament. One gets the impression that Boris isn't phased by much, but he can't even organise the election he wants, unless he possibly moves a vote of no confidence in his own government.

Watching Boris and the debate on the nightly news, or YouTube, would be entertaining if it weren't so sad. What is really interesting is watching the UK speaker, who is possibly more entertaining than Boris himself. To think that it was only a few years ago that our British friends were suggesting that Australian politics were a little tumultuous! It has almost forced Donald off the front pages, although we doubt that will last for long.

But back to reality - if such a state really exists. The debate between proponents of growth vs. value investing continues, even as value seems to be an old fashioned and out of favour concept. In August the ASX200 total return ended a volatile month in negative territory, as did the S&P500, while both still recording a YTD return of over 20% and 18% respectively, with 20% of the funds on AFM's database outperforming the local index both YTD and over 12 months. In the current environment, more than ever, manager research and fund selection becomes vital, as does portfolio diversification.

With the potential for a slowdown to become a recession, investors are understandably thinking of cash as an alternative in spite of concerns over ever lowering cash rates possibly turning negative. In this environment finding a high yielding but risk averse investment becomes even more difficult, but crucial. Our suggestion is that investors ensure they fully understand the underlying investment, and risks, before being lured by advertising headlines of seemingly attractive regular income.

Hedge Clippings | Friday 30 August, 2019
 

Regular readers of Hedge Clippings would no doubt have noticed that we have been erring on the cautious side for some time, particularly when it comes to prevailing interest rates (which seem set to stay low, for longer, or go lower) and the impact of geo-political issues - or at least of powerful political personalities.

Many investors large and small are lamenting the effect that "unrealistically" low interest rates are having on equity valuations, but should be recognising that low to negative interest rates are the new normal and probably here to stay for the foreseeable future. Equally, given the antics of Xi, Trump and now Boris, it is fair to assume that the political risks which currently abound aren't going to dissipate any time soon.

In this environment the ability for central banks to cushion any market shock - or even do anything but keep reducing rates to try to avoid a recession - seems limited, and therein lies the danger. There's no firepower left to adjust to what might lie ahead. And as pointed out by no lesser hedge fund legend than Ray Dalio of Bridgewater Associates, with central banks considering issuing 50 and 100 year bonds, and with $US16 trillion in negative yielding bonds already on issue, the opportunities are limited.

No one, neither central bankers nor legendary fund managers, and certainly not yours truly, have witnessed this before, and there are no certain models or precedents on which to base the potential outcome.

Hence caution. Cash may well be a safe haven. Even at a negative yield.

Hedge Clippings | Friday 23 August, 2019
 

Hedge Clippings, like many others, avidly reads and then dissects every nuance within the minutes of the RBA's monthly board meetings as we try to interpret or discern their views, and thus the future direction of monetary policy. This week was no different, although having read the August minutes we took a slightly different approach. Using the principal of "a picture paints a thousand words" we downloaded and printed the minutes and then set about highlighting in orange words or phrases that were cautious or negative, and in green those that were positive.

Hey presto, a colour coded picture of the RBA's mood and thoughts on the future. There's an element of discretion or subjectivity in the use of the various colours, which we viewed as having significantly more "orange" risk to the downside, than "green" to the upside, so readers might paint the picture differently.  If you want to try it yourself, here's a link to the RBA's original "blank canvas".

While staying on the visual theme, although significantly more data driven, the chart below (courtesy of Craig Racine's Gyrostat Capital) shows falls of 20% or more in the S&P500 since the crash of 1929, which precedes even Hedge Clippings' experience, however we grew up regularly being reminded of how tough it was back then (although we're sure it was).

The chart not only shows the full % drawdown of each event, indicated by the red section of each bar below the line, but also the time taken (in months) for the fall to take place, indicated by the pink section in the middle, and finally the time taken in months for the market to recover to its pre fall high, represented by the top, or yellow section. 

What it shows is that market events (in this case falls of 20% or more) are not as rare as one might think, having occurred 13 times including the big daddy of them all in 1929. Also, as shown by the date series, they occur frequently.

Next, the time taken for the fall to occur doesn't last long! This is the "down by elevator" effect, while the top section of the bar shows recovery is not even "up by the escalator" by comparison. It's more of a long uphill foot slog. Remember, when an asset or market falls by 50% it needs to rise by 100% to reach its pre fall value.

Taking this forward to the current environment, at a time when many are questioning the equity market's stability in the face of inverted bond yields, and stretched valuations, one other point is worth noting: We're approaching 12 years since the last event, namely the GFC, with the longest previous interval being 13 years from August 1987 to 2000.

"This time it's different" is a claim sometimes heard, and given concerted efforts by central banks around the globe, this time it may well be. That shouldn't stop investors taking some form of downside protection, however, particularly if they're at that stage of life where the time to recovery from the next market event when (not if) it happens, may well exceed their own time to no recovery - if you get the drift.

There have been huge inflows into US and local equity markets, particularly into low fee index funds chasing yield, while in Australia there are significant levels of retiree's cash sitting on the sidelines, earning little, or in some cases no return. There's a risk that investors desperately seeking yield move too much of their safe haven cash to risky equities and ETF's, or private equity look-alikes, without carefully considering the full risks and consequences.

Hedge Clippings | Friday 16 August, 2019
 

Hedge Clippings | Friday 09 August, 2019
 

Hedge Clippings | Friday 02 August, 2019
 

With the US Federal reserve cutting interest rates for the first time in 11 years overnight - the last easing being an early Christmas present way back in 2008 - it was yet another sign that what The Donald wants, The Donald usually gets. 

But not always. No sooner had Donald advised that the Fed's easing was the first in a series (as he had wanted), than Fed Chairman Jerome Powell contradicted him by saying:

"We're thinking of it essentially as a mid-cycle adjustment to policy. I'm contrasting it there with the beginning, for example, the beginning of a lengthy cutting cycle. That's not what we're seeing now. That's not our perspective or outlook."

No wonder the markets were confused! One wonders exactly where the "mid-cycle adjustment to policy" terminology came from, or for those wondering what the next move is, how to factor those comments into their investment decisions. As a result, markets that should have been buoyed by lower interest rates were left decidedly underwhelmed, although while the consensus seems to be that there will be at least one more cut in the US before this year is out, they weren't banking on it.

At the same time Trump flagged the potential for further tariff action against the Chinese, no doubt just to remind everyone that, as far as he's concerned, he holds the upper hand in the trade war.

From Australia's perspective the expectation from economists is certainly that there is at least one more cut of 0.25%, and possibly a further one after that, before the RBA is finished. Obviously what happens in the US will have some impact on that outcome, but so will the effect of the past two cuts and the stimulus provided by tax refunds which should start to flow through.

Elsewhere overnight news came through that the U.K.'s new prime minister had lost his first by-election (that didn't take long!), taking his parliamentary majority down to a minuscule, and minimum, of one. Boris is quite happy, it appears, to take the UK out of the EU with a no deal Brexit, which might just be a better outcome than a general election resulting in a Corbyn Labour government.

Hedge Clippings | Friday 26 July, 2019
 

We'd love to have been able to read ScoMo's mind as he listened to Andrew Bragg's maiden speech in Parliament on Wednesday. The newly elected Senator from NSW suggested that Australia's compulsory superannuation regime, rated by many to be one of the best in the world, should be made optional, particularly for the young and lower paid members of the workforce.

Whilst not doubting that a significant majority of workers would happily opt for a 10% pay rise now (equivalent to a bird in the hand) rather than wait for 30 or 40 years to be self-funded in their retirement (equivalent to 2 in the bush), the reality is that superannuation was set up to reduce the budget's age pension burden from an ageing population. Furthermore, it is precisely the lower paid members of the workforce who are most likely to need both capital and income in retirement.

Bragg was out of order on a number of other fronts. Firstly, using one's maiden speech to lob a contentious idea likely to cause your own party some embarrassment probably wasn't that smart - unless you are just seeking attention. Secondly, it is completely at odds with Bragg's previous arguments in 2016 when working for the Financial Services Council when he wrote "The fact remains that lower superannuation savings would force more Australians onto the age pension, pushing the cost of an ageing population onto future generations."

What a difference three years makes! However the Prime Minister subsequently reiterated that there will be no changes to superannuation even if recommended by the upcoming review into retirement incomes. We take this to mean that under his government the incremental increase in the SGL from the current 9.5% percent and, commencing in 2021, taking it to 12% by 2025 is safe - or as safe as anything is in politics.

That doesn't mean to say there aren't some necessary and meaningful changes that could and should be made to the superannuation system. In addition to many of the 31 changes recommended in the Productivity Commission's report into superannuation released in January - such as reduced fees, removing multiple accounts, and poor performance estimated to make workers $3.8 billion a year, here's a few more from Hedge Clippings just for good measure: 

For a start simplifying the complexity of the rules and regulations surrounding super might make it easier for the majority of the workforce to understand it. Encouraging or incentivising workers to make additional superannuation savings would be another. Ensuring that at least a portion of a worker's superannuation balance on retirement is taken as a pension, rather than a lump-sum, would also be on our "must review" list. Finally, given that superannuation balances accumulate over 40+ years, ensuring that a significant portion of all superannuation is allocated to appropriate infrastructure projects, which also share a long-term timeframe and are in the national interest, would also seem to be a win-win given there's almost $3 trillion in super now.

Of course, being able to use a portion of one's super to assist first-time buyers to get into the property market would be a great idea - if it can be achieved. However unfortunately in the early years super balances are not that high, so in practical terms the level of assistance that affords might be limited.

Superannuation is simple in concept, but complicated in practice, and has been further complicated over the years by successive governments tinkering with the rules. After almost 30 years Australia's superannuation system needs reviewing, updating and simplifying to ensure it meets current and future objectives. Let's just hope Senator Bragg is not part of the decision making process.

In other news this week global politics just became more interesting (if nothing else) with the election of Boris Johnson as Great Britain's 77th PM. Whether he manages to achieve its objectives we will have to wait and see, but boring he is not. Donald is not boring either, (although he probably does qualify as a boor) so between the two of them, apart from a mutual admiration society, expect to see plenty of head (and hair) lines.

Hedge Clippings | Friday 19 July, 2019
 

There has been plenty in the media recently regarding the difficulties facing active fund managers, mainly focusing on the negative side of things, and possibly with good reason. Performance has suffered following a period of one of the more challenging market conditions that most active fund managers we have reviewed can remember - including during the GFC and immediately afterwards.

Naturally with sub-par performance relative to the market (even if not actually negative) comes the difficulty of attracting investors and raising FUM. The rise of passive investing and ETF's with ultra-low fees, particularly with an equity market buoyed by extreme interest rates, makes it hard for the average active manager to build a business.

Diminishing or static FUM has also been accentuated by the move by many institutions and industry super funds to revoke mandates and take them back in-house as they continually attempt to reduce their own fee structure. Once again, the market conditions of the past five years have made low-cost index investing ultra-attractive. As a result, there has been a surge in the number of fund and manager consolidations, whilst others have simply elected to close and return the cash to investors. By and large in Australia there has been limited shuttering of funds, unlike in the UK where a large and previously successful manager has had to "gate" the fund to protect positions and investors in the short-term, but in doing so has inevitably inflicted terminal damage on the management company, or at least its reputation.

In the short to medium term it is hard to argue against this move to index funds. The ASX 200 total return index is up 19.73% year-to-date since January, 11.55% over the past 12 months to 30th June, outperforming even the S&P500's total return, 18.54% YTD and 10.42% over 12 months. In the medium to long-term investors that have taken this path will need to understand that volatility will return at some stage.

In this environment, while 95% of the funds tracked on www.fundmonitors.com have provided positive returns year-to-date, this number drops to 70% over 12 months. More concerning, from both investors' and fund managers' perspective, is the fact that less than 10% of funds have outperformed the ASX200, both year-to-date and over the past 12 months. 

Of course, there is a danger in looking at returns over six or 12 months. All the disclaimers and warnings clearly state that investors should have at least a three and preferably a five year investment horizon. We would add that they should carefully evaluate not only the fund and the investment manager, but also invest across multiple funds and look carefully at how closely each fund's returns are correlated. Even a portfolio of five funds, carefully selected, can provide significantly lower volatility and frequently a higher return than its component parts.

While the chart below shows an unusually high correlation between AFM's index of equity funds and the ASX200 over the past 12 months, over the longer terms it also shows both a higher cumulative result, with lower volatility, principally by avoiding the market drawdowns of 2008, 2001 and 2015.

When the current interest rate cycle ends, even though that doesn't appear to be close by, so that volatility will return.

Hedge Clippings | Friday 05 July, 2019
 

If Hedge Clippings dredges back into his (or his children's) childhood far enough he can recall a tale of a big bad wolf threatening to "huff and puff and blow your house down". Of course, he failed when the house was sturdy and made of bricks.
 
This week the opposition huffed and puffed fighting against tax cuts before finally realising that the government's house, based on its recent election victory, was sturdy enough. So, what did they do? A 180 degree turn, and voted in the Senate to approve them. Pauline's One Nation abstained, and Cori Bernadi was absent, leaving only the Greens voting against.
 
The Greens voted "NO" but they vote NO to anything and everything. What's new? 
 
Whether phase 3 of the tax package ever gets delivered in 2024 is a moot point, but if Albanese and Co are in power by then I'm sure if they wind them back they'll pay the price. That's nearly 2 more elections away, and fancy going to an election with a promise to increase income tax, even if it is for the higher (but not the highest) tax bracket?
 
The question is whether the immediate tax hand out, coupled with the RBA's rate cut, will be enough to make a difference to the economy. For those who say consumers will put the combined effects towards reducing debt rather than spending it, dream on. OK, some might, but most will do the obvious, even if not the most prudent thing, and spend it, whether at the local electrical outlet as Gerry Harvey hopes, or down at the TAB or the pub.
 
As far as the RBA's decision goes, it did seem a little panicky given the previous cut was only 28 days prior, the effects of which are yet to flow through, and the tax cuts were in the offing, even if not in the bag. Added to which reductions in mortgage rates only benefit those with a mortgage, while damaging those with bank savings. What we do concur with is the RBA's call that there's only so much that monetary policy can do.
 
Now it's up to ScoMo, business and consumers to follow through!