Alternative Investment Strategies (AIS) Model: Restructure

Transcription

1 July 2012 Alternative Investment Strategies (AIS) Model: Restructure EXECUTIVE SUMMARY DFS Portfolio Solutions (DFSPS) proposes to make the following changes to its AIS Model: Recommended Managers Defensive DWS Diversified Income Fund JANA Triplepoint Fund Perennial Tactical Income Trust (NEW) Growth GOLD.ASX GMO Systematic Global Macro Trust Blackrock Asset Alpha Fund Ascalon H3 Commodities Fund Quiris Currency Absolute Return Fund (NEW) Aspect Diversified Futures Fund (NEW) Current Portfolio 19% 20% 10% 16% 16% 19% Proposed Portfolio 6% 22% 5% 25% 25% 17% Appointment of : Perennial s Tactical Income Trust, a specialist domestic fixed interest strategy that actively invests in cash, enhanced cash, fixed interest and credit securities; Quiris Capital, a specialist currency manager that utilises a systematic, riskcontrolled investment strategy; Aspect Capital, a specialist managed futures manager that implements a systematic, medium term trend following investment strategy; Removal of the following managers : Ascalon H3 Commodities Fund; DWS Diversified Income Fund; and Blackrock Asset Alpha Fund; Reduction to Gold exposure and to Jana, a specialist fund of hedge funds manager. BACKGROUND DFSPS relaunched the Alternative Investment Strategies (AIS) Model in September Since this time, the Model generated a return of 3.49%p.a versus 2.26%p.a. for Australian equities and 4.65%p.a. for Cash. The objective of the Model is to provide portfolios with diversifying return

2 drivers against traditional asset classes whilst generating positive absolute returns across rising and falling equity market conditions over the medium term. The AIS Model is dynamically managed with the underlying exposures tactically weighted to manage downside risk. Focus on generating positive returns is underpinned by exploiting the inefficiencies that exist across multiple capital markets. Unlike other model portfolios that provide exposures to a single asset class, the appointed AIS managers reflect our assessment of the macroeconomic landscape, the interrelationship between the drivers of alternative investments and traditional asset classes, and the prevailing headwinds facing investors. The Model also addresses the shortcomings of many alternative strategies highlighted during the Global Financial Crisis with liquidity, leverage and transparency key characteristics in the investment and construction process. MACROECONOMIC ASSESSMENT & RISK ANALYSIS DFSPS currently has a cautious outlook which is underpinned by (1) the high levels of OECD government & consumer debt; (2) the range trading within equity markets since mid 2011; (3) the convergence of significant prevailing inflationary & deflationary forces within the global economy; and (4) the volatility in the Australian Dollar. We believe that markets are susceptible to further pullbacks in the short term and we expect volatility to persist over the next several years. As such, we favour a more defensive approach as the global economy continues to adjust to the prevailing imbalances. Furthermore, there exists uncertainty around the political ability or desire to implement various economic (monetary & fiscal) levers. As such, our objective is to provide multiple diversifying tools to better manage portfolio risk in a highly uncertain world. To assess the level of portfolio risk, we model a number of risk factors and estimate the level of exposure each asset class has to the different factors. A factor model approach gives us a richer picture of the relationships between asset classes. As asset classes are broad categories of assets, we use broad macroeconomic indicators as our risk factors. They are: (1) equity market risk; (2) price inflation; (3) currency movements; and (4) movements in interest rates. In constructing the AIS Model, DFSPS has allocated a considerable amount of time assessing the correlations and relationships between each risk factor s contributions to the returns for each strategy. Our factor analysis highlights that (1) the appointed AIS managers have negligible inherent biases to the macroeconomic factors modelled; and (2) the major driver of returns for each strategy is their fund specific factor. What this means is that something other than equity, currency, inflation, and bond yields is driving the returns of these alternative strategies. This is highly desirable as it suggests the prevalence of legitimate and meaningful portfolio diversification benefits. The next part of our analysis focuses on testing whether the fund specific factors for each of the alternative strategies are highly correlated to one another. If so, this would infer the existence of some other (unnamed fifth) factor common to each strategy. Ultimately, our objective is to appoint alternative managers that are uncorrelated to one another. Although a fifth factor would provide incremental diversification beyond the four, multiple uncorrelated investment strategies would yield the greatest riskadjusted rewards (particularly) over volatile market conditions. Table 1 displays the correlations between the current appointed managers and the proposed managers. The table shows that in the majority of cases, the managers returns are uncorrelated.

3 Table 1: Manager Correlations Aspect GMO BlackRock Quiris JANA Perennial DWS DIF Gold H3 Diversified SGMT AAA Fund Currency Triplepoint TIT Commodities Futures Fund Fund Fund Residuals Fund Aspect Diversified Futures Fund 1.00 GMO SGMT (0.06) 1.00 BlackRock AAA Fund Quiris Currency Fund JANA Triplepoint Fund Perennial TIT (0.16) DWS DIF (0.10) (0.01) (0.09) (0.02) Gold (0.13) (0.08) 1.00 H3 Commodities Fund 0.64 (0.00) (0.02) Of particular interest is the extent of noncorrelation amongst the new managers Quiris, Perennial and Aspect. In addition to the strong diversification benefits discussed, we note that each newly appointed manager has generated strong absolute returns during challenging market conditions. PROPOSED PORTFOLIO ALLOCATION The table below represents the current allocation* to the various strategies comprising the DFS Alternative Investment Strategies Model Portfolio. Composition Strategic Dynamic (Range) Tactical July 2012 Defensive Assets Min Max JANA Triplepoint Fund 35% 0% 40% 6% Perennial Tactical Income Trust 0% 0% 60% 22% Growth Assets GOLD.ASX 15% 0% 25% 5% Aspect Diversified Futures Fund 12.5% 17% 0% 40% GMO Systematic Global Macro Trust 12.5% 25% Quiris Currency Absolute Return Fund 25% 0% 40% 25% * The Dynamic Range across the various AIS sectors has been widened to allow greater flexibility in managing the allocation between defensive and growth strategies There have been a number of changes to the manager lineup within the AIS Model. Notably, DFSPS has reduced the allocation to our specialist longonly commodities manager to nil in favour of our global macro and managed futures managers which can trade commodities, both long and short opportunistically. We previously highlighted our preference to allocate to a specialist long/short commodities strategy that could capitalise in both rising and falling markets. In the absence of this, DFSPS believed the long only investment strategy of H3, which is highly focussed on managing the inherent risks associated with commodities trading, would provide the desirable exposure to this asset class. We reiterate that the ability of H3 to actively reduce the underlying commodities exposures during periods of increased volatility is an appealing characteristic, especially over the short term. The sustained pressures plaguing the global economy does not auger well for commodity markets, strengthening the thesis for a long/short commodities exposure. Importantly, blending Aspect Capital with our current global macro manager GMO maintains the Model s gross exposure to commodities, an important characteristic for diversification purposes, without specifically relying on rising commodity prices. Notwithstanding the systematic, trend following process of Aspect, the manager has proven its ability to generate strong riskadjusted returns over the short term which has seen markets trade sideways conditions that are not generally favourable for trendfollowing

4 strategies. Finally, as displayed in Table 1, the managerspecific portion of returns generated by Aspect and H3 display the strongest correlation of all reservelisted managers. DFSPS has also decided to restructure the allocation to global macro strategies, effectively removing BlackRock from the AIS Model and as such GMO has become our preferred global macro manager. The BlackRock Asset Alpha Fund was initially appointed in July 2010, following the completion of the DFS Alternative Investment Strategies Review in which we highlighted BlackRock s appointment was primarily due to the strategy s discretionary overlay. We considered this factor to provide additional risk management benefits over pure quantitative investment strategies, given our assessment of volatile market conditions. Notwithstanding the exceptional riskadjusted performance of BlackRock during the GFC, the strategy has since struggled to meet our riskadjusted return expectations. DFS believes that, given the heightened volatility across global financial markets, it is appropriate to remove the BlackRock Asset Alpha Fund to ensure that the AIS Model continues to (1) provide diversifying return drivers versus traditional asset classes; and (2) generate positive absolute returns across rising and falling equity market conditions over the medium term. Our factor analysis shows that blending GMO with Aspect maintains the diversification benefits whilst generating superior riskadjusted returns. DFSPS has also appointed Quiris Capital, a specialist currency manager that believes significant and persistent inefficiencies are exhibited in currency markets due to the existence of nonprofit seeking participants within these markets. The appointment of Quiris further enhances the risk management dynamics of the AIS Model. Unlike other asset classes that fluctuate through a market cycle, currency markets are effectively cycleneutral with currency valuations generally a consequence of exogenous variables. Furthermore, the manager has set a volatility target of 10% which mitigates inherent risks associated with currency trading. We highlight (as shown in Table 1), that Quiris generally offers uncorrelated returns against the other appointed managers. Finally, we note Quiris small level of Funds under Management of approximately $50 million gives the manager a distinct and strong trading advantage. The enhanced cash allocation within the AIS Model has been awarded to the Perennial Tactical Income Trust, replacing the DWS Diversified Income Fund. DFSPS initially identified the Perennial strategy as part of the Diversified Credit & Fixed Income Model however ultimately was not appointed due to the fund s ability to tactically tilt between cash, sovereign debt and corporate credit to manage the prevailing risks associated across the different economic and interest rate environments. We reiterate the objective of including an enhanced cash strategy within the AIS Model is to provide added diversification to high growth assets whilst also reducing the overall volatility exposure. Notwithstanding the positive absolute returns generated by the DWS Diversified Income Fund, the macro strategies employed by DWS has consistently muted the fund s risk/return profile. Importantly, we expect the Perennial Tactical Income Trust to reduce the risk profile of the overall AIS Model whilst simultaneously providing stronger returns. DFSPS has decided to reduce the allocation to gold in light of the deflationary forces imbedded across most developed economies. We reiterate that the allocation to gold is to essentially act as portfolio insurance and notwithstanding the excess liquidity injected by central banks, credit growth continues to be subdued and the risk of inflationary pressures is not imminent. The allocation to Jana has also been reduced. We initially appointed Jana as our preferred diversified hedge fund strategy as the manager addresses many of the shortcomings traditionally associated with hedge funds; namely transparency, liquidity and exorbitant fee structures. Notwithstanding the fund s ability to generate positive absolute returns since its appointment, returns have been somewhat muted during the recent riskon/riskoff market conditions.

5 RETURN ANALSIS 12% Rolling 12 Month Excess Return vs. Cash 11% 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% 1% 2% 3% 4% Current Model (equally weighted) Proposed Model (equally weighted) The above chart compares the excess returns of an equallyweighted allocation to the managers of the current AIS Model to that of an equallyweighted allocation to the proposed AIS managers. We observe that the riskadjusted returns of the proposed AIS Model is greater and more consistent that that of the current Model. This highlights the enhanced diversification benefits of blending Perennial, Quiris and Aspect with GMO, Jana and Gold. FEES We note that you will incur buysell sell fee of approximately 0.076% upon affecting the proposed change of the manager composition. We further advise that the headline MER of the Model is increasing from 0.978%p.a. to 1.15%p.a. after the change. Details of the headline fees for each fund are set out in the table below: Performance Proposed Funds APIR Code Buy/Sell Spread MER # Fee Aspect Diversified Futures Fund FSF1086AU 0.0% 1.61% p.a. 20% 1 GMO Systematic Global Macro Trust GMO0006AU 0.0% 1.025% p.a. 20.5% 2 GOLD.ASX GOLD.ASX 0.165% % p.a. Nil JANA Triplepoint Fund MLC0862AU 0.0% 1.35% p.a. Nil Perennial Tactical Income Trust IOF0145AU 0.0% 0.45% p.a. Nil Quiris Currency Absolute Return Fund WHT0050AU 0.02% 1.60% 20% 2 * 1 The performance fee is paid on the dollar value of positive performance generated on the futures and forwards trading accounts net of management fees 2 The performance fee is paid on the outperformance above the UBS Australia Bank Bill Index net of management fees 3 Brokerage cost for GOLD ETF DFSPS has preferred pricing arrangements with a range of fund managers, which are only available on DFSPSsupported platforms. For the Alternative Investment Strategies Model, the preferred pricing translates to a 0.176% p.a. reduction of the Model s overall MER (from 1.15% p.a. to 0.974% p.a.) This highlights the DFSPS value proposition which is aligned to client interests.

6 Disclaimer: Past performance should not be taken as a guarantee for future performance. Use of Material and Information The information and material provided in relation to the DFS Investment Methodology (Information) is proprietary to DFS. Unless expressly stated otherwise, DFS claims copyright ownership of all Information in respect of its Investment Methodology. The Information may be used for the purposes of private study, research, criticism or review, as permitted under the Copyright Act You are not permitted to retransmit, distribute or commercialise the information or material without seeking prior written approval from DFS. Where permission is obtained, the Information must be reproduced in its unaltered form and must acknowledge DFS as the source. DFS reserves the right to revoke such permission at any time.