Short Extension (130/30) Fund Strategy

Transcription

1 Short Extension (130/30) Fund Strategy Richard Hasson Neil Brown Russell Bodill September 2009 Performance through Focus

2 Why Select Equity Investments? Select Equity investment approach High conviction, unconstrained, fundamentally based SA equity manager Limited capacity and client base to ensure top quality performance and service Proven track record of delivering excess returns through bottom-up stock selection Benefits of being an Old Mutual Investment Group (SA) boutique Highly skilled and extensive investment research team Investment autonomy & accountability Incentives aligned with client interests Uniquely positioned to focus on delivering performance Select Equity Offerings Select Hedged R1bn Select Capital Growth R2bn Select Multi- Cap R11bn We always strive to buy into high quality businesses at prices that are low compared to their long-term investment value. Neil Brown & Richard Hasson Boutique Heads Select GARP R12bn R26bn 2

3 Select Equity - Investment Product offering Institutional Products Retail Products Fund Manager Style Bias Market Cap Size Bias Number of Shares Weighting of Shares 130/30 & Hedge Neil Brown & Richard Hasson Blend Large/Mid Long Short % to15% -1% to -6% Multi-Cap Old Mutual Top Companies Unit Trust Neil Brown & Richard Hasson Blend Large/Mid ± % GARP Capital Growth Old Mutual Growth Unit Trust Nedgroup Investments Growth Unit Trust Richard Hasson GARP Mid/Large ± % Neil Brown Blend Mid ± % Consistent philosophy & process applied across all products 3

4 Select Multi-Cap Portfolio - Returns Old Mutual Top Companies UT to Since managed by Neil Brown and Richard Hasson within Select Equity 4 Jul-06 Aug-06 Sep-06 Oct-06 Nov-06 Dec-06 Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07 Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 R100 initial investment % Cumulative Excess Return Cumulative Excess Return (RHS) Old Mutual Top Companies General Equity Sector Average

5 Select Growth (GARP) Portfolio - Returns Old Mutual Growth UT to Since managed by Richard Hasson Mar-02 Jun-02 Sep-02 Dec-02 Mar-03 Jun-03 Sep-03 Dec-03 Mar-04 Jun-04 Sep-04 Dec-04 Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 R100 initial investment Mar-09 Jun-09 % Cumulative Excess Return Cumulative Excess Return (RHS) Old Mutual Growth General Equity Sector Average

6 Select Capital Growth Portfolio - Returns Nedgroup Investments Growth UT to Since managed by Neil Brown Mar-01 Jun-01 Sep-01 Dec-01 Mar-02 Jun-02 Sep-02 Dec-02 Mar-03 Jun-03 Sep-03 Dec-03 Mar-04 Jun-04 Sep-04 Dec-04 Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 R100 initial investment Mar-09 Jun-09 % Cumulative Excess Return Cumulative Excess Return (RHS) Nedgroup Investments Growth Growth Sector Average

7 SA market indices are extremely concentrated Weighting of Shares in the JSE SWIX index 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% Top 10 shares 55% of index, Top 20 shares 71.5% of index Only 23 shares in SWIX index have a weight above 1.0% 2/3 of the shares in the SWIX index are smaller than 0.2% Therefore only small amounts of alpha can come from underweight positions 7

8 Overview of 130/30 structure 160% Gross Exposure but 100% Net Exposure 130/30 is an equity mandate competing with long only funds Benchmarks (e.g. SWIX) same as long only funds 8

9 Removing the long only constraint results in higher transfer coefficients which means higher portfolio returns for the same level of risk 130 / 30 strategy Long only strategy 9

10 Only a small amount of alpha can come from underweight positions in a long only portfolio Long-only strategy 130 Long / 30 short By relaxing the long only constraint, managers can better express their negative views and therefore improve the information efficiency in the portfolio, thereby increasing alpha and information ratios 10

11 Why 130/30 Ratio a function of A manager s skill (Information Coefficient) managers with higher skill ratios should use a higher ratio Volatility in stock returns the more volatile the environment, the lower the ratio needs to be at a fixed tracking error Correlation between stocks the more correlation that exists in a market, the higher the ratio needs to be at a fixed tracking error Borrowing costs & Transaction costs the higher these are, the lower the ratio should be 11

12 How we select Long and Short shares in practice We hold LONG positions in companies with the following characteristics: Returns on Equity (ROE) & CFROI consistently > Cost of capital Quality (not growth) business models & proven management teams Meaningful ownership of company shares by management Consistent earnings & dividend growth rates > JSE SWIX Cash flows stronger than Income Statement High margin of safety in their fundamental valuations We hold SHORT positions in companies with the following characteristics: Opposite to the LONG position characteristics on previous slide No positive earnings upgrades Low operating leverage (reducing potential fat tail events) Low chance of leveraged or strategic buyout High conviction in forecasting valuations Stable or increasing scrip availability (work in progress) Short positions also used when investing in rump of assets 12

13 Requirements for Successful Short Selling Need an investment process that has a forecast valuation for all shares in the benchmark 16 proprietary equity analysts enable us to have this luxury Higher implementation risks do exist so need to ensure high quality risk monitoring and management systems and team in place OMIGSA risk, compliance and administration support structures a major advantage Experience in Short Selling 3 year history in managing hedge funds Access to scrip availability lists and good broker relationships No counterparty risk in short selling as using JSE Single Stock Futures Size of short position actively monitored 13

14 How we Construct 130/30 Funds Steps 1 Load existing optimal long only Select Multi-Cap fund vs. SWIX benchmark into I-Maps. 3 2 We implement 30% short positions based on our Select Equity sell list into I-Maps model portfolio. The size of individual short positions is based on underlying valuations, paired vs. unpaired ideas, our assessment of upside vs. downside potential, liquidity, and other hedge fund strategies We use the proceeds from the 30% shorts introduced to add to existing long positions or new long positions which may be chosen to pair against these short positions. We also use strategies to invest in the rump of assets e.g. ARI/HAR ARI Rump 10,000 70,000 9,000 8,000 7,000 60,000 50,000 6,000 5,000 4,000 3,000 2,000 1,000 40,000 30,000 20,000 10,000 16% of HAR ARI Rump /01/ /10/ /08/ /06/ /04/ /01/ /11/ /09/ /06/ /04/ /02/ /12/ /09/ /07/ /05/ /02/ /12/ /10/ /07/ /05/ /03/ /12/

15 How we Construct 130/30 Funds Steps 1 Load existing optimal long only Multi-Cap fund vs. SWIX benchmark into I-Maps. 3 2 We implement 30% short positions based on our Select Equity sell list into I-Maps model portfolio. The size of individual short positions is based on underlying valuations, paired vs. unpaired ideas, our assessment of upside vs. downside potential, liquidity, and other hedge fund strategies We use the proceeds from the 30% shorts introduced to add to existing long positions or new long positions which may be chosen to pair against these short positions. We also use strategies to invest in the rump of assets e.g. ARI/HAR 4 In applying these new long positions, we ensure that our original SA & Rand hedge industrial, financial and resource sector weights are re-established to ensure we do not change the sectoral characteristics of the original portfolio 5 Once the long positions have been accumulated we ensure that the New Tilt in I-Maps has returned to zero, leaving the fund with 130% long positions, 30% short positions and 100% effective exposure to the equity market. 6 As a final portfolio construction measure, we check the weightings of the shares in the benchmark to ensure that the long or short positions in the fund reflect our relative benchmark view and that these positions comply with the various mandate requirements and risk controls. 7 We compare the changes in tracking error and beta of the Short Extension (130/30) Fund to the original long only fund to ensure that the risk characteristics have changed in line with our expectations and are within the limits as defined in the client mandate. 15

16 Portfolio Risk Management In constructing the portfolio, we are cognisant of the current structure of the portfolio in terms of correlations, the expected standard deviation as a measure of absolute risk, and the expected tracking error for relative risk. We decompose the tracking error to ensure that it is coming from stock picks, and not from unintended stock or sector tilts. We monitor the portfolio's exposure to various market conditions compared to the benchmark e.g. moves in exchange rates, interest rates and commodities. We monitor the contribution of a share to the tracking error of the portfolio. We ensure that bottom up share selection is validated by the share s contribution to the expected tracking error. In addition, pre-trade risk management takes place via our Decalog system. Mandate and regulatory restrictions have been coded on Decalog s orders system and this will notify the portfolio manager if a proposed trade could breach any mandate or regulatory rules. 16

17 Comparing Current Long Portfolio to Current 130/30 Portfolio Long Only Portfolios 35 shares Tracking Error to SWIX 4.4 Beta to SWIX 1.05 Volatility /30 Portfolio 45 long shares, 14 short positions Tracking Error to SWIX 8.1 Beta to SWIX 1.08 Volatility

18 Why Short Extension investing? The Short Extension (130/30) portfolio offers different performance characteristics, being well-positioned to exploit long and short opportunities and mispricings. Value added to clients equity blend due to taking active positions against shares that have low benchmark weightings, a feature long only portfolios cannot replicate. It has the potential to achieve sound performance in all market conditions, unlike long only funds which will find it difficult to significantly outperform the benchmark when large cap shares are doing well. Investments can be made in the rump of assets, a strategy that long only funds cannot employ. Short Extension (130/30) strategies are a more effective and efficient method of building portfolios as the long only constraint is removed (greatest impact on transfer coefficient). Higher excess returns and higher information ratios possible due to improved use of knowledge & with no change to underlying investment process. 18

19 Cost Benefit Analysis of 130/30 funds Cost Analysis Benefit Analysis Assuming Tracking Error (TE) remains constant at 4%, an increase in the Transfer Coefficient of 48% is achievable (source: Cadiz) This therefore results in a 48% higher alpha forecast Using an Information Ratio of 0.75 and a TE of 4%, Long fund will deliver 3% of alpha while 130/30 fund will deliver 4.5% of alpha Overall Portfolio Benefit in the order of 100bps after costs (assuming TE constant we are however running this fund at far higher TEs) Analytics (OMAM US Subsidiary) has achieved additional 47bps net return over last 5 years 19

20 Why invest with Select Equity? We have a wealth of combined experience across the entire SA equity market and proven & award winning track records We make use of an excellent base of proprietary research skills & systems and top quality OMIGSA platform Total investment autonomy and uniquely positioned to focus on fund management Incentives aligned with client interests Constrained asset capacity should enable excess return generation, while a limited client base results in superb service 20

21 Regulatory Information Old Mutual Investment Group (South Africa) (Pty) Limited Physical Address: Mutualpark, Jan Smuts Drive, Pinelands, 7405 Telephone number: Old Mutual Investment Group (South Africa) (Pty) Limited is a licensed financial services provider, FSP 604, approved by the Registrar of Financial Services Providers ( to provide intermediary services and advice in terms of the Financial Advisory and Intermediary Services Act 37 of Old Mutual Investment Group is a wholly owned subsidiary of Old Mutual (South Africa) Limited. Reg No 1993/003023/07. The investment portfolios may be market-linked or policy based. Investors rights and obligations are set out in the relevant contracts. Market fluctuations and changes in rates of exchange or taxation may have an effect on the value, price or income of investments. Since the performance of financial markets fluctuates, an investor may not get back the full amount invested. Past performance is not necessarily a guide to future investment performance. Personal trading by staff is restricted to ensure that there is no conflict of interest. All directors and those staff who are likely to have access to price sensitive and unpublished information in relation to the Old Mutual Group are further restricted in their dealings in Old Mutual shares. All employees of Old Mutual Investment Group are remunerated with salaries and standard short-term and long-term incentives. No commission or incentives are paid by Old Mutual Investment Group to any persons. All inter-group transactions are done on an arms lengths basis. In respect of pooled, life wrapped products, the underlying assets are owned by Old Mutual Life Assurance Company (South Africa) Limited who may elect to exercise any votes on these underlying assets independently of Old Mutual Investment Group. In respect of these products, no fees or charges will be deducted if the policy is terminated within the first 30 days. Returns on these products depend on the performance of the underlying assets. Old Mutual Investment Group has comprehensive crime and professional indemnity insurance. For more detail, as well as for information on how to contact us and on how to access information please visit 21