How to construct absolute return fund allocation?
Thierry Crovetto and Pierre-Yves Dittlot. founding partners of Monaco-based TC Stratégie Financière, give their views on absolute return allocation through alternative Ucits fund selection .
Absolute return Ucits funds can be considered as an alternative, to the bond investment in a very low yield environment, where interest rates increase and some signals of more inflation! Nevertheless, a lot of investors were disappointed by absolute return fund this year due to a wide disparity of the performance.
Nowadays, the tremendous non-conventional monetary policies of major central banks, bring government and some corporate bonds to low or negative yield territory (the lowest ever seen in history).
A lot of investors justify this level due to the weakness of inflation, liquidity and the safety of these bonds; moreover some institutional investors in order to respect prudential ratios have to invest in government bonds whatever their yield may be.
But this bubble in government bonds and high investment grade corporate bonds could blow up if the inflation comes back. In parallel, inflation seems to be the only solution to solve the high level of debt in the world. That’s why, in our humble opinion, it is time to diversify the bond exposure through other uncorrelated investment solutions. Absolute return strategy through alternative Ucits funds is one of these solutions.
In this field, it is not easy to find absolute return fixed income strategies, which provide a good risk adjusted return. You can isolate a few funds, which provide an attractive profile due to their flexible approach such as Candriam Bond Credit Opportunities, Jupiter Dynamic Bonds, Muzinich Global Tactical Credit, or G Fund – Alpha Fixed Income.
Furthermore, additional diversification with the integration of other alternative Ucits strategies is probably a beginning of a solution to the current world of low yields in order to improve the ratio performance / absolute maximum drawdown.
The true question is the following. How to construct an absolute return funds allocation with a good risk adjusted return? Due to the complexity and heterogeneity of the absolute return Ucits universe within which performance dispersions are important, we have focused on finding a way to optimize the risk-return ratio of this asset class.
Within a universe composed of 140 absolute return Ucits funds we have developed an algorithm to build an allocation in order to optimise the risk adjusted return of the selection. This model take in account for example the ratio performance / absolute maximum drawdown, the momentum and the correlation within the funds.
This tool makes possible to get rid of any emotional bias. Obviously, a qualitative analysis supplements the quantitative filter. All the complexity of this asset class is not only to select the best funds, but also to select the best combination of funds, like the coach of a football team with its players…
The risk controls go through a deep analysis and understanding of these strategies and portfolio construction.
We are not making any difference between the different strategies; each fund has to deliver a good risk adjusted return, with a low correlation with the traditional asset classes (stocks and bonds) but also with the other funds of the selection.
We find a lot of event driven funds with an attractive score related to our model; for example the Fund Helium Performance, Cigogne Ucits M&A Arbitrage or Laffitte Risk Arbitrage Ucits have a very good risk adjusted return.
This strategy can be considered as very close of the credit strategy. The credit spread is replaced by the premium of the deal, the default risk by the risk of the failure of the deal, and the recovery rate by the fundamental price of the target company without the merger/acquisition.
Within the long/short equity funds we like Old Mutual UK Specialist fund focused on the UK small and mid caps, and within the Equity Market Neutral the Exane Overdive Fund is clearly the best one but unfortunately closed. From a global point of view, these two categories has suffered this year during the different sectors rotation.
We appreciate also for their risk adjusted return and their low correlation with the other categories the multi-strategies funds focused on the risk premia such as LFIS Vision Ucits – Premia.
Thus we have to be very selective in choice of alternative Ucits funds, and in their combination. They, qualitatively, have to be followed very closely in order to avoid any drift of the strategy. For example a sharp increase of the size, or a modification of the strategy or the investment team can generate a warning. Investing in absolute return funds can be very interesting if we respect a very strict process.