Not enough to just hold beta anymore

By Talib Sheikh, co-fund manager, JP Morgan Global Capital Appreciation fund  

Balanced investing in traditional markets (ie being a buyer of long-only beta) has handsomely rewarded many investors in the years since the financial crisis.

The tide has lifted all boats as virtually every asset class has done relatively well. But relying on long-only beta to deliver returns through the lurches in today’s global markets is not be enough anymore, says fund manager Talib Sheikh.

As a macro-thematic, multi-asset investor who strives for a portfolio that can perform no matter the economic and market conditions, Sheikh has increasingly tapped into a mix of sophisticated strategies to diversify away from traditional asset classes.

Back in 2013 Sheikh had over 56% of his portfolio in traditional risk, investing in a more typical multi-asset split of equities and bonds. But as traditional asset classes have started to look less attractive, Sheikh shifted risk more towards less correlated sophisticated strategies, such as relative value, derivatives, and dynamic hedging strategies.

As a result, he now has 60% of the portfolio in sophisticated risk and just 40% of the portfolio in traditional risk. He’s taken down overall directional risk (meaning exposure to price changes in the broad markets) in the portfolio, focusing instead on pairwise and non-directional positions where he has high conviction.

Sheikh bases his fund on the belief that global macro-economic trends are the primary driver of all asset class returns and he takes a flexible approach to implementing strategies in the portfolio based off those trends. That means he can exploit a particular view through multiple different types of investments in order to generate returns, whether that means using traditional or sophisticated strategies, across any asset class globally.

This process allows him to seek to capture the upside potential in the markets whilst protecting against downside risk. For example, he has identified eight important macro-economic themes dominating the markets and is using as many as 30 different underlying strategies at any given time to play investment ideas based off these themes.

Included below is the macro-thematic framework on which Sheikh runs the fund and tactical examples of how he’s playing these ideas:

  • Europe’s gradual growth recovery: With the ECB’s proactive response to low inflation, growth is returning in Europe and credit conditions are improving, despite the structure risks that remain. Once the situation in Greece stabilizes, the tailwinds of weaker EUR, improving Eurozone confidence, and an upswing in the credit cycle should combine to drive European risk assets higher
    1. How he’s playing it:A Greek deal looks likely, but many political hurdles remain he had has trimmed his tactical allocation to Europe as a partial result.  He thinks any fallout from a Grexit would be contained and that price action has been sanguine because the backstops from the ECB are credible and contagion is not a major concern. Meanwhile, the portfolio has actually benefited from some of the near-term volatility in Europe through its long Europe versus short US variance swap, a trade which allows investors to bet on the volatility of one market relative to another market.
  • Emerging market rebalancing: Unfavourable global conditions and fading credit booms are forcing slower emerging markets growth and external rebalancing, making this an area of concern overall. EM assets are under owned and relatively inexpensive, but until there is greater evidence of structural reform – or assets are and truly discounted levels – we would remain wary.
    1. How he’s playing it: A significant underweight to emerging markets is one of Sheikh’s highest conviction ideas and he is actively shorting emerging market equities. He’s also been meaningfully negative on the global commodities complex and second derivatives of that play.  For example, he’s short emerging market commodity related currencies, such as the Aussie dollar, which is reliant on declining commodities demand from a slowing Chinese economy. He’s similarly done well from shorting emerging markets currencies in preference to the US dollar, including shorting the Korean won and the South African rand.
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