Commentaries

February 2019 - When market excesses create opportunities for our strategies… - Systematic Fund Manager's Comments

18 March 2019

Thomas de Saint-Seine

 1. From Deleveraging to Low Quality Rally is not an unseen situation on markets and generally leads to positive return for our Long Short strategies…

Global equity markets have experienced two distinct phases over the last 6 months, which proved to be challenging for fundamental stock pickers. The first part (October & November), was characterized by heightened volatility and a deleveraging phase during which both gross and net exposures were quickly and significantly reduced by the investment funds community. The second part (January & February), the market’s behavior was highly unselective, with “low-quality” stocks bought at the expense of “quality” ones in a short covering mood!

High P/E Outperforming Low P/E Stocks

The below table considers the Best P/E metrics across regions by filtering stocks with below 15x P/E versus those above 25x. The performance divergence between the two is significant. In other words, the momentum and fundamentals-agnostic trade has continued to work well globally, supported by central banks’ accommodative action.

High P/E Outperforming Low P/E Stocks

Source: Bloomberg & RAM Active Investments. Filters applied: market cap > $1bn, as at 7th March 2019

The current period we find ourselves in is particularly brutal with little fundamental foundation for stock performance. However, this type of technical setup is relatively common following the end of a major trend and subsequent bounce in the underlying market. The consequence? The inefficiencies we aim to capture across small, mid, and large caps as well as Value, Low-Risk and Growth/Momentum investment styles are significant today. If history is any guide to the future, earnings cycle and company fundamentals should eventually prevail, and this could occur sooner rather than later given the extent of the divergence.

We have previously witnessed similarly challenging market conditions, and this has not altered our long-term excess return objectives. Interestingly, our research and experience indicate that following periods such as these, both our long and short engines can generate significant alpha and we have been quick to recover losses as markets display a high degree of dispersion.

Whenever we’ve observed 6 months of negative cumulative returns on our Long/Short European Equity Fund, our average cumulative returns have been +3.2% over the following 3 months, and +5.1% over the following 6 months (see chart below).

Subsequent 6-month return (y) vs. 4-month return (x)

Important Note: Prior to March 2009, performances are based on a back-test calculated on a hypothetical model. The Back-test performance is calculated using sub-strategies returns calculated based on simulated model portfolios rebalanced monthly on RAM equity investment screenings. The defined allocation of sub-strategies on the long and short side may not represent the exact contribution of strategies in real portfolio. After March 2009, RAM Long/Short European Equities Strategy shows performance net of fee of the RAM L/S European Equities Fund Class-I from December 2011 (1.5% of management fee+20% of performance fee) and of the RAM Absolute Return Fund prior to December 2011.  The RAM Absolute Return Fund followed the same exact investment strategy within a Cayman vehicle (1.75% of Management fee+20% of performance fee) before it was converted to a UCITS.

2. When markets ignore value on small caps in EM

Over the past 3-years, the herd mentality of investors has favoured large over small caps in emerging markets to a degree that has hitherto been unseen since the 1998 Asian Financial Crisis. History tells us that this situation represents an attractive entry point for investors looking for a true all-cap approach to investing in the region. Given the increased likelihood of a positive trend reversal of small and mid-caps relative to their large cap counterparts in the coming quarters, we believe our All-caps Strategy is well positioned to produce significant outperformance and to create diversification.

Rolling 3Yrs performance Delta (MSCI EM Small Caps – MSCI EM Large Caps)

Source: RAM Active Investments as of 28.02.2019, MSCI indices

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