By MARCEL PORCHERON 30/01/2009
In times of economic and financial crisis markets can ignore fundamentals with company valuations becoming seemingly irrelevant. A number of fund managers found the record levels of volatility in 2008 intolerable, as tried and tested investment techniques stopped working and reputations were dashed upon the rocks of uncertainty.
Violent conditions help to weed out weak fund managers, but 2008 may also be remembered as the year that a new breed of manager emerged, those who use more than just long only investment techniques. Unlike the average UK equity fund manager, who underperformed the FTSE All Share by 3% in 2008, these were the managers who turned up to the fight with guns, not knives. They were also the managers who knew how to handle their weapons correctly.
Buying portfolio protection is not new to portfolio management, although few had the skills to do this successfully in the past. Anthony Bolton quietly used it on his Fidelity Special Situations fund to good effect. However, relatively recent changes to fund regulations under the UCITS III Product Directive have given fund managers more flexibility in how to generate returns. For example, UCITS III enables managers to ‘go short’ of stocks – selling shares they do not own in order to profit from falling share prices. And now some managers are beginning to emerge with successful track records of using these enhanced powers.
Absolute return funds like Mark Lyttleton’s Blackrock UK Absolute Alpha and Tim Russell’s Cazenove UK Absolute Target have successfully used cash, long and short positions to produce absolute gains for their investors in 2008; no mean feat given the turbulent conditions, although many managers in the IMA Absolute Return sector have not been so successful.
Extension funds (popularly known as 130/30 funds), which are designed to enhance returns, have had mixed results. However, Fidelity Active Strategy Japan’s June-Yon Kim is 5% ahead of the Topix Index over 2008 and the team behind Cartesian UK Equity 130/30 are 14% ahead of the FTSE All Share over the last year. Other managers have found conditions more difficult, trailing their benchmarks, so investors should bear in mind that extension funds potentially bring higher risks.
Traditional long only funds are increasingly looking for other ways to enhance their returns or protect against losses. Fidelity are again at the forefront here where Sanjeev Shah, Anthony Bolton’s successor on Fidelity Special Situations, has beaten the All Share by 7% over 1 year by carefully using index hedging, leveraged long and short positions and option strategies alongside his core portfolio of long only investments. Schroder Income Maximiser has benefited from higher market volatility as the fund uses a tried and tested option strategy to enhance income. The fund is 8% ahead of the index over 1 year.
Because many of the fund managers using the alternative investment techniques allowed under UCITS III have short track records, we would advise caution when investing in such a fund. It is important that investors understand the huge difference that different investment management techniques can make to the performance of a fund, as in some cases they can increase the risks. However, there are some signs that a new breed of managers with the right skills, experience and solid track records are emerging.