Lessons from Lupus alpha

The absolute returns manager shows how basic principles protect investors, finds David Walker.

If you want to end up making good returns, focus first on not losing money, not just on making it.

Ulf Becker, head of absolute returns at €7.1bn manager Lupus alpha, says portfolios in his unit withstood the
financial crisis well, largely thanks to this approach.

Their 2008 returns ranged from a 5% loss to a 9% gain. The MSCI World equities index plunged 39.1% in euro terms, and hedge funds fell 19% (US dollar terms).

“Not having large downside in bad years means investors do not have so much to catch up on in the good years. The common thread between all our absolute return strategies is a focus on risk management. If you cannot manage risk, you cannot manage absolute return strategies,” Becker explains.

Lupus alpha has €5.6bn in absolute return strategies. Its next such fund has run as a managed account for two years. Awaiting regulatory approval, Lupus hopes to launch it for institutional investors in April.

It focuses primarily on volatility, expressing views on this through everything from equity derivatives to
those on indices or single stocks.

Becker explains: “We believe we have an edge in deciding if volatility is cheap or expensive, so we can generate alpha on implementing trades on this analysis. I do not believe we are better than anyone else saying a large cap will rise or fall more than a certain amount. Unlike our small-cap business, we take a top-down perspective, look at what markets a trade works in, and how to implement it.”

Lupus also runs €1.5bn in long-only small-cap equity funds – it is among Germany’s largest investors in smaller companies – as well as outsourced mandates, Spezialfonds, private label products and a ‘Talent Hotel’.

This helps emerging managers test run strategies with little-correlated investment styles and numerous alpha sources. It already spawned Ucits product Lupus alpha Neurobayes Invest.

Lupus’s absolute return funds have volatility targets, guiding the expected returns, in each case above Euribor. They generally focus on European small- and midcaps; long/short fixed income duration; Bund futures; asymmetric risk/return profiles in European, global and emerging markets equities; macro-economic variables; commodities; and volatility.

Lupus began absolute return products in 2003, as institutional investors found long-only small-cap funds, sometimes volatile, could consume risk budgets. In some cases, regulators forced sales at exactly the wrong time after MSCI World fell 54.2% for three years to March 2003.

Becker says institutions were “fed up with being forced sellers of equities in general in March 2003 after regulators told them to sell, only then to have to figure out a way back into equities later”.

Those who stayed invested benefited, as Lupus’s smallcap funds averaged more than 8% annually last decade. MSCI World fell 22% in ‘the lost decade’ for shares.

At the same time, European family offices and private banks refocused from generating wealth to preserving it.

Most Lupus absolute return clients want annual drawdowns under 5%. Becker’s team work towards the targets. Clients should expect to make money over five-to seven year periods, he says, but not match bull markets.

Becker targets portfolio managers who can think “in terms of risk budgets… people accustomed to taking on risk on a trade-by-trade basis, and to monitoring the risk in their trades”.

He notes illiquidity is another risk, which appeared in many offshore hedge funds during the crisis as redemptions were unexpectedly restricted. Lupus did not restrict.

Becker says the lesson was: “Think the unthinkable, plan beforehand what to do… and be fast executing the plan”.

Since 2003, and through the crunch, Lupus continued launching Ucits absolute return products with regular dealing, and investors generally prefer them. “If it is possible to set up a Ucits compliant fund, we do. We do not find too many constraints on the management.” ■

David Walker

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