Commentaries

November 2018 - Diversification & liquidity: essential tools to navigate deleveraging markets - Systematic Fund Manager's Comments

14 December 2018

Thomas de Saint-Seine

  

Find below the executive summary of the analysis we produce for our investors.

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October & November’s Pain: A Performance Explanation on our European Strategies

2018 has been a painful year for fundamental stock pickers. It all arguably began in February. The deleveraging effect as markets were already tumbling from the so-called “short volatility” trade – speculative bets that the long period of tranquillity in markets would persist – began, causing the MSCI World Index, a leading indicator for global developed markets, to fall 9% in the space of just 10 days. This was the first of several signs throughout 2018 that markets have entered a new regime of higher volatility as the world’s leading central banks, led by the Fed, withdrew liquidity.

Current Leverage Levels: A Recent Downwards Trend & current market valuation

Significant deleveraging has occurred across regions in November by our peers. Our long/short peers in the U.S. have significantly reduced leveraging. From a valuation perspective, and following the recent sharp correction, equity risk premium remains the highest in Europe relative to the rest of the world, and well outside of their historical interquartile ranges.

Long Book Analysis

We’ve observed a triple negative effect since the acceleration of the deleveraging in October/November in Europe: Value, Momentum and Small/Mid-caps biases have been extremely negative relative to the market. Given this extremely tricky environment, and despite the good fundamentals of our selected stocks, it’s hard to add value on the long side. However, this situation doesn’t surprise us. The short book has delivered positive alpha, underperforming the market and limiting the drawdown on our long book. We believe we have good reserves of performance if the correction continues with our highly asymmetric short book.

Our Latest Allocation Changes in the Portfolio following the correction

Following the strategy’s latest rebalancing, we get a clearer picture of the moves our engines are making on a global basis. Globally, we are seeing an increase of Health Care, Financials and Utilities, and a decrease of IT, Materials and Industrials names.

While the latest episodes in the markets have been particularly technical, impacting our Long/Short approaches, it has also impacting our long-only strategies. In particular the performance of our RAM European Equities Fund has suffered owing to significant underperformance of small cap vs large.

Looking back at what we have experienced in the past in such environments of significant deleveraging and violent sector rotation, the level of this relative drawdown remains in line with what we can expect. It is of course always uncomfortable, but we believe it offers an interesting entry point. Indeed, historically we have recovered quickly following such episodes. Indeed, after a strong deleveraging, we see now higher levels of dispersion in the market, offering an interesting environment that our stock-picking process can potentially profit from. In addition, our all cap allocation has penalised us recently, with small caps underperforming significantly the MSCI Europe. However, historically we can see that such periods are temporary and if small caps do recover vs their larger cap counterparts, our portfolio will be well positioned. Our European Equities Fund have maintained strong fundamentals vs their respective indices.

Risks & Diversification

Given our fundamental approach and current positioning, we remain confident that our Funds can recover quickly. We would also like to remind our investors that the recommended minimum holding period of our Fund to maximize the probability of achieving our targeted return and risk is 3-years across our strategies. Finally, we would like to emphasise to our investors that our Machine Learning strategies have played their role in increasing overall diversification and underlying liquidity, two elements that are vital during periods such as these.

 

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