Investors who would have preferred not to suffer the market turmoil of last March would have done well to bet on alternative equity funds, the stars of our Fundata list this month.
At the end of the first quarter of 2020, with the S&P/TSX index down 20.9% and the S&P 500 down 12.2% (in CAD terms) according to Morningstar, most funds in the alternative equity funds fell about 8%. The best performers of these funds even posted positive returns, including the CI Munro Global Growth Alternative Fund, up 4.31% for the period, and the Dynamic Alpha II Performance Fund, up 6%.
This remarkable performance is due to a crucial factor: the ability of these funds to sell short, generally up to 50% of the value of their portfolio. “We've made money from our shorts [shorts],” says Nick Griffin, founding partner and chief investment officer of Munro Partners in Melbourne, Australia.
"Our stocks sold short have plunged much lower than our regular purchases," said Noah Blackstein, manager of Dynamic Alpha II Performance Fund in Toronto.
Obviously, the challenge with a short position is to spot the right time to close it, but that's no different than any decision to buy or sell a regular security, according to Nick Griffin. “We closed our positions between the end of March and Easter, and we find that we have done well on both sides of the equation: buying and short selling,” he says.
And just like simply buying a security, short selling involves risk. A fund with an exceptional performance such as the EHP Select Alternative Fund, second in the Fundata rankings with a six-month return of 9.1% as of June 30, sometimes misses the mark with its short sales. In January and February, shortly before the crisis, “we were losing on our short sales, which were more up than our purchases,” says Jason Mann, CEO and chief investment officer of EHP Funds in Toronto.
The success of such alternative funds is not only due to the judicious selection of securities to sell short, but also to the purchase of performing securities. Nick Griffin's fund tops our list in this regard thanks to its exposure to high-tech stocks, such as Amazon, Microsoft, Alibaba, Danaher and ASML Holding. For the first half of 2020, not only did the fund not falter at the height of the crisis, but it is posting an astonishing return of 17.8%.
Noah Blackstein, for his part, ended the first half of the year with a very enviable return of 6.3% thanks to his selection of companies that invest in advanced technologies and profit from them. There are titles like AbbVie, RingCentral and ServiceNow.
The EHP fund adopts a completely different strategy, focused not on growth, but on value, and only among Canadian securities, where we find names like Alimentation Couche-Tard, Quebecor and Northland Power.
Short selling is the opposite – and essential – complement of all these winning strategies. For example, “a good company that invests in its digitization, we buy it; a failing business that doesn't, we sell it short,” says Noah Blackstein.
For its part, the EHP fund evaluates the universe of companies strictly from a matrix of quantitative attributes. “A company that has good value indices [price/cash ratio, debt ratio, etc.], a positive and stable price trend, we buy it. Conversely, a company that appears overvalued, in decline, volatile, we sell it short”, explains Jason Mann.
Short selling is not the only typical feature of liquid alternative equity funds. Their managers also use other tools normally prohibited by traditional mutual funds, including leverage, futures and options.
For example, "we bought put contracts on the S&P 500 and NASDAQ, and that gave us a lot of protection when the markets took a dive," says Nick Griffin.
Not all of these tools are without risk, agrees Jason Mann. “We carry a leverage of 1.4 to 1.6 times [the fund's assets], he explains. We expose ourselves to market timing risk, trading to reduce or enhance risk. We also have a concentration risk by holding only 50 securities in our portfolio. »
However, the formula provides convincing results in terms of performance and capital protection. This is why most funds in the category have a low to medium risk rating.
Today's exceptional market conditions hold the attention of our three managers, but without worrying them excessively. After all, if the markets dip again, they have the weapons to take advantage of it. It's all about timing, of course.
Nick Griffin and Noah Blackstein focus on the opportunities created by the pandemic, particularly in the technology and healthcare sectors.
Nick Griffin is counting on a marked increase in demand in the sectors of electronic payments, online shopping, artificial intelligence and social networks. “E-commerce took 20 years to carve out an 18% market share. But it only took six months to increase this share to 25%, he points out. Microsoft claims that two months have seen the equivalent of two years in digital transformation. These trends will only get stronger. »
For a value investor like Jason Mann, the current market could lead to a sharp rise in inflation, "which would be positive for us and which means that investors would benefit from favoring cyclical stocks over of growth”.
Each manager seeks growth in their own way, but all have effective ways to save the day when that growth falters.
Source: Fundata Canada Table: Finance and Investment
n/a: Not available
(1) Sharpe ratio: a higher ratio indicates a better return according to the risk incurred
(2) Beta ratio: a lower ratio indicates less volatility than that of the reference market.
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