Looking beyond the core

Toledo Capital takes a different approach to the core-satellite question facing selectors and allocators, as senior financial advisor Guy Schochet explains.

The past couple of years have seen a significant shift from investors placing their faith in active management to those losing their confidence in the ability to outperform and, in an attempt to cut costs, focus on passives instead.

Consequently, many asset managers have implemented a core-satellite model to their fund selection strategy which relies on a passive core and a satellite of a select number of active funds.

This is not the case at Zurich-based multi family office Toledo Capital, as senior financial adviser Guy Schochet explains: “In an ideal portfolio we will use a core satellite model with hedge funds representing the core and ETFs and mutual funds the satellite.

“However, there are some constraints such as liquidity needs of the client and the client’s knowledge of hedge funds which can change the asset allocation composition. The average portfolio consists of six hedge funds.”

His role entails responsibility for discretionary mandates, giving him significant room for manoeuvre when it comes to deciding on a particular investment strategy.

“Once the client has defined their risk appetite, we construct an appropriate
portfolio, but I need to explain the purpose of alternative investments in general and hedge funds in particular to the client.

“The main idea of the hedge funds is to protect your investments in distress times, losing as little as possible in bad times is key,” he stresses.

What are the reasons for his faith in active management? First and foremost, it is his growing scepticism of an increasingly automated fund selection process. “With the rise of robotics investing, the way to differentiate yourself is through hedge funds because the market is a lot less transparent and therefore harder for robotics to enter,” he argues.

Moreover, he believes that segments of global equity markets are currently overvalued. “If you look at key indicators such as earnings per share, it becomes very obvious that the stocks featured in key indices such as the S&P are currently at least fair if not overvalued and there is not much appreciation potential. In this context, we prefer to employ the best minds,” he argues.

Consequently, Schochet suggests that hedge funds fulfil a fundamentally different role from the short term hunt for profits. “When we decide to invest in a hedge fund, we tend to hold them for a longer period of time. We want them to perform as all-weather funds and tend to have an average
holding period of three to five years,” he explains.

Another key element of his fund selection process is the focus on correlation. “We like low correlation funds to main indices, when selecting a fund to add to our portfolio, we also check the correlation with other funds that we currently have,” Schochet says.

Due to the diverse nature of the hedge fund industry, with individual funds being notoriously hard to compare, his approach to selecting funds is unconventional. “Selecting hedge funds is not easy. We don’t currently use databases like Morningstar, instead, we get our ideas either from other investors, from Bloomberg’s weekly hedge fund bulletin, or from funds of funds we are investing in.”

Similarly, his process requires attention to risk management, but he argues that investors focusing exclusively on regulated funds might miss out on opportunities. “If I can choose between an off shore fund and a Ucits compliant fund from a big house like Blackrock , and I don’t have any liquidity needs, I see no reason to choose the Ucits fund. Ucits can sometimes even destroy value because of limitations to investments. I believe in the liquidity premium,” he argues.

At the same time, testing the fund manager’s knowledge is all the more essential. “We do aim to meet the fund manager in person or at least have a conference call. Of course it depends on the size; if a fund is big enough we don’t need to meet, but for smaller ones we expect a representative to visit our office at least a couple of times. It is crucial that they understand exactly what is going on in the companies they invest in.”

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