Have your cake and eat it with the contrarian model

Taking a contrarian view to a traditional reading of key indicators of commodity prices boosts the return of traditional portfolios of commodities. Adding a short exposure to the contrarian model allows for drastically lower levels of risk, enhancing the Sharpe ratio to 0.8 over a period of 16 years. According to our analysis, implementation costs are likely to have minimal impact on the overall portfolio performance over the long and short run.

The contrarian model

In our January paper, How to make the best of commodities: the contrarian model, we discussed the concept of a contrarian strategy being applied to indicators that we view as having the largest impact on commodity prices: momentum, inventories, positioning and roll yield.

A traditional reading of these indicators suggests that if price is above its 200-day moving average, inventories are declining, net positioning is increasing or the futures curve (at the short end) is in backwardation, then this should be price positive.

In contrast, the contrarian model is an asset allocation strategy based on the opposite reading of these four indicators. We have derived five unique portfolios out of the contrarian model: one based on each of the above indicators and a fifth one combining all the indicators called the ETFS contrarian model. In this note, we focus on the results of the combined portfolio.

The long only ETFS contrarian model buys a commodity when all four indicators turn price negative and will hold the commodity until all four indicators become price positive. The model will then sell the commodity or take a short exposure to that commodity in the long short version of the model.

The commodity universe is similar to the constituents of the Bloomberg Commodity Index. Each portfolio rebalances to an equal weighting on a quarterly basis and is composed of individual commodity indices using the Bloomberg Commodity Index family as proxy.

A boost with the long only contrarians

In our January paper, our analysis shows that the ETFS contrarian model and inventories are the best performers, posting an annual return of 10.8% on average since 2000. Positioning and roll yield come next with 7.9% per year while momentum underperforms the other model variants with a return of 4% per year.

The ETFS contrarian model outperformed the benchmark, the Bloomberg Commodity Index 3 month forward. The annual return of the model is double the return of the benchmark index over the past 16 years for similar level of volatility, bettering its Sharpe ratio of 0.24 by more than double (0.60).

A cushion with the long short contrarians

So far we looked at the long only version of the ETFS contrarian model where commodities with indicators having a positive impact on prices are simply removed from the portfolio during the rebalancing period. Shorting these commodities actually reduces the annual return of the ETFS contrarian model from 10.8% to 8.3% over the past 16 years.

Although the annual return is lower as shown in the chart below, the volatility of the long short version is also drastically lower than the volatility of the long only version. Adding a short exposure to the model clearly minimises the impact of events such as the financial crisis in 2008 or the slump in commodity prices since 2011.

As a result, the Sharpe ratio increases from 0.24 for the commodity benchmark, to 0.60 for the ETFS long only contrarian model due to higher return, and to 0.78 for the ETFS long short contrarian model thanks to higher return and much lower volatility.

Moving along the futures curves

The total return of an investment into commodities depends on its exposure along the futures curve. The dotted lines in the below chart are portfolios exposed to contracts at the short end of the curve while plain lines are portfolios exposed to the 3 month forward futures contracts, our main focus in this note so far.

While an exposure to front month futures contracts is detrimental to the return of the ETFS long only contrarian model, it actually improves the return of the long short portfolio over the long run.

Efficient also during commodities rout

In this section, we have tested our model over a shorter period, from 2011 to 2016 when commodities were performing poorly and observed similar results: a strong improvement of the Sharpe ratio when implementing the long short version of the ETFS contrarian model.

During these years, the commodity indices were posting an annual return of -11% on average. With the ETFS long only contrarian model, investors were able to reduce the negative return to around -7% and completely erase their loss with the ETFS long short contrarian model. In addition to stronger risk/return ratio, the ETFS long short contrarian model also provides more efficient protection against market downturns.

The above chart shows that fees are likely to have minimal impact on the contrarian portfolio performance. Portfolios composed of commodity ETPs (exchange traded products), on the right hand side, are priced based on the ETP net asset value (NAV) where management fee, swap fee and licence fee are embedded. We can see that the return of the long short contrarian model is down 70bps compared to the portfolio exposed to the front month commodity indices while there is no visible impact on the long only contrarian model. Execution fees applied to portfolios using ETPs also have negligible impact on performance. This is due to the model rebalancing on a quarterly basis and therefore involving a small number of transactions per year.

To sum up, the contrarian model drastically improves the risk/return profile of a portfolio of commodities over the long and short term. The long only contrarian models tend to outperform long short contrarian models in the long run. However, the benefit of the long short contrarian models is much higher thanks to drastically lower volatility. Between 2011 and 2016, the long short contrarian models also provide an effective protection against commodities rout with implementation costs likely to have minimal impact on the model performance.

Investing in hedge funds does not have to be expensive

By Brian Johnson, Head of Investment Solutions, Hedge Funds, at Unigestion.

The high cost structures of hedge funds’ fees are in many respects a remnant of days past. In our view, fees can often be structured in a way that better aligns managers’ interests with those of investors. For those hedge fund investors who are sensitive to relatively high TERs, it is possible to construct more fee-efficient investment solutions, while maintaining the desired risk/return profile.

Unigestion has a long history of working with hedge fund managers, and over time we have seen and invested with expert managers who are able to generate consistent genuine, uncorrelated alpha. We think this is a valuable element of any diversified portfolio, and hence worth paying for. However, a material portion of many hedge fund returns can be explained by market factors, and this is an area where we think it is possible to create fee structures that are more aligned with the value-added by a manager and indeed propose solutions that can deliver market factor exposure in a more fee-efficient manner. Our experience in investing with hedge fund managers enables us to advise clients on the performance profiles that are worth having, as well as how best to structure the fees on such strategies.

In this paper, we offer a case study of a TER-reduction exercise we undertook on behalf of one of our client’s through a two-step approach: making use of lower-cost liquid alternative solutions, and fee transformation discussions with our hedge fund managers.

Please find the full research paper from Unigestion attached on the left.

"A stable development in challenging market environments"

In the new ifund fund manager interview, Markus Pimpl, fund manager of Partners Group Listed Investments SICAV – Listed Infrastructure, explains his approach to investing in listed core infrastructure, the risks of such investments and how to construct an infrastructure portfolio with limited downside risk.

What is your fund all about and what differentiates it from your competitors?

Partners Group Listed Investments SICAV – Listed Infrastructure is a daily liquid fund investing in infrastructure operators globally. The fund targets core infrastructure companies, i.e. the actual owners and operators of core infrastructure assets that exhibit a monopoly-like market situation. Partners Group emphasizes the combination of a top-down and bottom-up approach while most listed infrastructure managers follow a pure bottom-up approach. We believe that regulation, the political environment as well as macro-economic and technological factors can have a major impact on achievable returns and that top-down considerations are therefore of great importance.

How do you add value for your investors?

We believe that active management has the potential to add significant value when investing in listed infrastructure. Consequently we construct our portfolio independently, without reference to infrastructure indices which in our view are overly exposed to certain sectors, geographies and regulatory regimes. Our listed infrastructure portfolios tend to be more diversified both from a sector and geography point of view, which helps to mitigate regulatory or sector-specific risks. For example, our decision to significantly reduce pipeline exposure in late 2014/throughout 2015 meant that the impact of falling oil prices on our portfolio was limited. Partners Group also avoids sectors that do not meet our core infrastructure definition, such as power generation which is heavily exposed to energy prices. We have been investing with the same strategy since 2006, thereby demonstrating one of the longest track records in the industry. Furthermore, the fund benefits from the profound knowledge about the regulatory and political environment of Partners Group's global private infrastructure investment team.

How do you generate investment ideas?

We have been investing in private infrastructure since 2001 and in listed infrastructure since 2005. As a result, we cover a universe of listed core infrastructure companies that we actively follow and decide on sector allocations top-down by analyzing return drivers, regulation, etc. This helps us to identify the most attractive risk-adjusted investment opportunities at a given point in time.

At a portfolio level, we monitor changing demographic, social and technological trends that can help identify long-term investment themes. For example, population growth and the demands this places on transport infrastructure and utilities, or the increase in data consumption and the need for new communications infrastructure. We continue to research new ideas. Finally the overall regulatory attractiveness and potential changes of infrastructure sectors and individual companies play a major role in generating investment ideas.

How is your team structured and who is responsible for the investment decisions?

The team consists of seven individuals, based in Zug, London and Singapore. Reto Munz and myself are responsible for the investment decisions.

In which market environment does your investment style work best?

Partners Group Listed Investments SICAV – Listed Infrastructure was launched almost ten years ago and has outperformed broader equity markets. While the fund was able to develop in line with equity markets in upwards trending markets, the portfolio has proven its defensive characteristic with exposure to inelastic demand and steady, typically inflation-linked, cash-flows which resulted in a more stable development in challenging market environments.

Where do you currently see the best potential and largest risks in the market?

The biggest risk in the market, as always, is market sentiment. Minor events have nowadays the potential to trigger major corrections. That unfortunately also results in drawdowns for companies that are usually not at all affected e.g. defensive infrastructure assets. However, the recovery is usually faster since the fundamentals typically do not change. Negative regulatory changes and deflation are the biggest risks currently. Even though we are still very cautious about emerging markets, they might offer opportunities selectively. Furthermore, we have a positive view on European transportation infrastructure.

Which aspects of responsible investing do you consider in your investment process?

Partners Group implemented responsible investing standards many years back on a firm wide level. Already in 2008, Partners Group became signatory to the United Nations Principles for Responsible Investments (UNPRI). In our listed funds we actually follow two strategies to ensure ESG compliant investment process: passively, like most of our peers, we ensure that we do not invest in companies that are "blacklisted" by various organizations e.g. the Norwegian Government or the World Bank. In addition we apply an active approach that is based on internal assessment and monitoring of potential ESG-risks on company level, the framework of this active process is based on the UNPRI principles. We constantly receive positive feedback in client meetings about the thoroughness of the ESG factors within our investment processes.

How do you invest your own personal assets?

My personal investment philosophy typically matches my professional convictions. Diversification, yield sources outside the "mainstream" and capital protection are key. Private equity and infrastructure obviously plays a major role in this concept. I have also a significant part of my portfolio invested in Partners Group Holding AG shares.

What do you do in your leisure time? What is your preferred hobby and why?

In my leisure time I enjoy running, sailing and skiing.

About Partners Group
Partners Group is a global private markets investment manager, serving over 700 institutional investors worldwide. We have over EUR 46 billion in assets under management, including EUR 5 billion in dedicated infrastructure programs and more than 840 professionals across 18 offices worldwide. We realize potential in private markets by financing and developing great companies, desirable real estate and essential infrastructure. We create value in our investments through active and long-term responsible ownership.

About ifund
ifund provides fund research, manager selection and asset management based on liquid investment funds. Clients include banks, asset managers, family offices, pension funds and insurance companies in Europe. ifund has signed the UN Principles for Responsible Investment and integrates sustainability criteria in fund analysis. www.ifundservices.cominfo@ifundservices.com, +41 44 286 8000

About altii
alternative investor information (altii – altii.com) is the digital marketing and online portal for all asset management strategies in the German-speaking regions (D/A/CH). altii is focusing on institutional investors and has a public and a product area. For investors the service is free of charge. The portal www.altii.de/en is supported by a targeted newsletter and through clear social media campaigns. www.altii.cominfo@altii.de@altii_news, +49 69 57708987 

“Our investment style is designed to work well at any market environment!”

In the latest ifund fundmanager interview Kenji Ueno, manager of the UBAM-SNAM Japan Equity Value, talks about identifying undervalued stocks and the skills necessary to do so in all kinds of markets.

What is your fund all about and what differentiates it from your competitors?

The fund’s strategy is active-managed with bottom-up, aims to outperform the TOPIX® Total Return Index by identifying undervalued stocks in the mid- to long-term. The portfolio is focused, consisting of 40-80 stocks, aims to outperform the market in all conditions.
The stock-picking style identifies stocks that will likely appreciate in value as the market price approaches their intrinsic value. The valuation methodology is the dividend discount model.
The portfolio manager is vigilant in monitoring risks for portfolio construction such as tracking error, single stock limit, liquidity and credit risk requirement. The Buy/Sell discipline is primarily based on expected alpha ranking of the stocks in the universe. The trades should be done in compliance with the best execution practice.

The bullet points below differentiate SNAM’s investment from the competitors.

  • All-native team of Japanese equity analysts provides profound, local fundamental analysis, and investment ideas that drive SNAM portfolios.
  • Sector unbiased research is an important strength of SNAM’s unique research framework. This enables SNAM to invest without sector constraints, comparing investment opportunities across sectors.
  • SNAM’s return analysis approach has proven to be successful. SNAM ranks the investable universe of 700 stocks by expected alpha (intrinsic value / market price = ratio) into quintiles. These quintile rankings have demonstrated strong predictive power for two decades.
  • Four senior analysts have on average 20 years of experience in Japanese equity, and have been together at SNAM for an average of 15 years.
  • The team has successfully followed the same investment style for 20 years. This long-standing experience combined with SNAM’s in-house research has yielded invaluable resources to identify investment opportunities and to avoid value traps in the Japanese equity market.
  • In contrast to our competitors who use DDM for their valuation, SNAM assigns a company specific dividend discount rate for each company in the universe. In SNAM’s valuation system, the dividend discount rate is composed of four elements, real interest rate, expected inflation rate, credit risk premium, and business risk premium. Business risk premium is further broken into 5 criteria being structural change, innovation, market fluctuation, management aggressiveness, and information accessibility. By using this very detailed dividend discount rate, SNAM can adjust and integrate company specific and sector specific risk factors in the discount rate. By using this company specific dividend discount rate, our valuation result can be well fine-tuned.
  • Superior performance and peer ranking of the strategy over an extended period is a testament to the uniqueness and sustainability of SNAM’s intrinsic value/price philosophy, rational investment process, and its fundamental research advantage.

How do you add value for your investors?

In addition to above, please see the bullet points below.

  • UBP publishes regular reports and hosts quarterly conference call.
  • Eleven members of the analyst team have approximately 1500 face-to-face visits with companies every year, which enables the team to understand a company’s financial statements, its business outlook, its corporate governance, etc., in more detail.

How do you generate investment ideas?

The expected alpha rank is assigned to each of the stock in the investable universe. The expected alpha rank is determined by SNAM’s equity valuation system based on analysts’ fundamental research (combination of sector analysis and positioning analysis).
Japanese equity group, including portfolio managers and analysts, shares such basic information and holds regular meetings to discuss more detailed investment assumptions and ideas, stock by stock and sector by sector.

How is your team structured and who is responsible for the investment decisions?

The investment team is SNAM’s Japanese Equity Group (“JEG”) based in Tokyo, Japan. The team is composed of 11 long-tenured professionals and experienced senior members, all located in close proximity. SNAM adopts a dual role system in which each portfolio manager also works as an analyst. Each member covers assigned sub-sectors and:

  • performs fundamental analysis on companies (information gathering & analysis)
  • determines company fundamentals (input to equity valuation system)
  • prepares investment theses (feedback to portfolio manager)

Each strategy managed by JEG has a lead portfolio manager, ultimately responsible for the stock selection and portfolio construction.

In which market environment does your investment style work best? 

SNAM’s investment style is designed to work well at any market environment. It works particularly well when the market stabilizes or normalizes after a certain period of extraordinary market (e.g. boom-and-bust market, theme-driven market) and also in the mid- to long-term.

Where do you currently see the best potential and largest risks in the market?

Polarization of cyclical and defensive sectors is currently at historical high and I see the best potential in IT and Financial sectors in terms of valuation. On the flip side, continuous risk averse attitude and widening of valuation between cyclical and defensive is a risk. 

Which aspects of responsible investing do you consider in your investment process?

SNAM is a signatory of the UNPRI and incorporates ESG (Environmental, Social, Governance) factors in the investment process at different layers as SNAM thinks these factors impact the value of company. In a nutshell, SNAM incorporates ESG factors to determination of intrinsic value. 

How do you invest your own personal assets?

As there are restrictions for SNAM staff to invest directly in stocks, I invest in SNAM’s mutual funds as an alternative for Japanese stock investment. Besides, the Concentrated Strategy which I manage is not offered to retail investors.

What do you do in your leisure time? What is your preferred hobby and why?

I mainly enjoy Kyudo in my leisure time. Kyudo is one of the traditional martial arts of Japan like judo and kendo, and similar to archery of the West. 

Kyudo requires deep mental concentration in addition to physical exercise.This deep-concentrating time brings me mental refreshment and relaxation. In addition, through Kyudo, I can contact with the Japanese traditional culture, such as traditional manners and kimono. That is another reason I am a fan of Kyudo.

About SNAM
Founded in 1986, Sompo Japan Nipponkoa Asset Management Co., Ltd. (SNAM) is an established value strategy manager. Headquartered in Tokyo, it has representative offices in London and New York. SNAM is dedicated to value-biased investment and specialises in Japanese equities. As at 31.12.2015, SNAM manages USD 22.2 billion of assets for clients (including the parent company), of which Japanese equity strategies account for approx. USD 5.5 billion. SNAM has over 140 employees, thereof approx. 60 investment professionals. SNAM’s primary businesses are to provide investment advisory & discretionary asset management for both domestic and overseas institutions, as well as to provide varied investment trust products (mutual funds) for domestic investors.The following asset classes are managed in- house: Japanese Equity, Overseas Equity, Japanese Bonds, Overseas Fixed Income, Balanced/Multi-Asset and Alternative (Ex-Japan Value Equity). UBP and SNAM have well-established relations. SNAM has been known by the CEO of UBP’s Tokyo office for a long period already before UBP has asked SNAM in early 2013, after a thorough due diligence, to team-up in a future and exclusive collaboration, outside of Japan, in Japanese equities. While SNAM brings its long-standing expertise and strength in managing Japanese equities with a unique approach, UBP will add its experience in meeting the requirements from top institutional European clients. The combination of both firm’s strengths has already been implemented successfully, not only for the management of one of UBP’s public funds and investments from institutional clients, but also for a segregated account for a large European pension fund.

About ifund
ifund provides fund research, manager selection and asset management based on liquid investment funds. Clients include banks, asset managers, family offices, pension funds and insurance companies in Europe. ifund has signed the UN Principles for Responsible Investment and integrates sustainability criteria in fund analysis. www.ifundservices.com, info@ifundservices.com, +41 44 286 8000

About altii
alternative investor information (altii – altii.com) is the digital marketing and online portal for all asset management strategies in the German-speaking regions (D/A/CH). altii is focusing on institutional investors and has a public and a product area. For investors the service is free of charge. The portal www.altii.de/en is supported by a targeted newsletter and through clear social media campaigns. www.altii.com, info@altii.de, @altii_news, +49 69 57708987