{"id":65640,"date":"2017-09-14T01:31:00","date_gmt":"2017-09-13T23:31:00","guid":{"rendered":"http:\/\/beta.next-finance.net\/strategie\/concentrated-long-short-investing-to-achieve-absolute-return\/"},"modified":"2019-12-31T02:09:18","modified_gmt":"2019-12-31T01:09:18","slug":"concentrated-long-short-investing-to-achieve-absolute-return","status":"publish","type":"post","link":"http:\/\/beta.next-finance.net\/en\/strategie\/concentrated-long-short-investing-to-achieve-absolute-return\/","title":{"rendered":"Concentrated long-short investing to achieve absolute return"},"content":{"rendered":"

Such portfolios can provide an element of protection for a company\u2019s capital and profits as market volatility rises.<\/strong> <\/em><\/p>\n

Volatility has moved relentlessly lower during 2017, and any disruption to this trend has been
\nimmediately and completely quashed. This makes sense in light of the dual influences of improving
\nfundamental and ongoing friendly conditions nurtured by central banks around the world. At this
\npoint, investors expect ongoing strength in growth and profits, so any downside surprises could catch
\ninvestors wrong footed. As a result, investors are beginning to add to long-short equity portfolios to
\nnavigate the markets moving forward.<\/p>\n

THE BATON PASSES FROM MONETARY TO FISCAL
\nPOLICYMAKERS<\/strong><\/p>\n

The S&P 500 Index has more than tripled in value since its low in March 2009, while the operating
\nearnings of S&P 500 companies have doubled to around US$1 trillion. This remarkable feat was
\nachieved with huge help from low interest rates, coupled with stimulus in the form of quantitative
\neasing (QE), which some would argue created artificial market conditions by prolonging the economic
\ncycle and dampened volatility. QE brought down the cost of capital for businesses and this low cost of
\nborrowing allowed even subpar businesses to survive and prosper. Without QE to act as a buffer, it is
\nprobable that some of these subpar companies would have struggled.<\/p>\n

Post US elections, investor focus shifted from monetary policy to fiscal policy. Trump\u2019s \u2018America First\u2019
\npolicies have rejuvenated market expectations for growth (fiscal policy, tax reform and deregulation).<\/p>\n

Trump\u2019s \u2018America First\u2019 presidential promise \u2013 where he pledged to spend US$1 trillion on a 10-
\nyear infrastructure programme, overhauling the country\u2019s roads, bridges and tunnels \u2013 has excited
\nthe markets. Trump has also pledged ambitious reforms to the US tax system, which has not been
\nsignificantly reformed since 1986. \u201cThe US corporate tax rate, including state and local taxes, is
\nthe highest among advanced economies\u201d, notes a January 2017 report by PwC. This has rendered
\nAmerican companies uncompetitive compared to their peers in other countries. If Trump\u2019s plan is
\nenacted, this could revitalise the US domestic investment, while the tax amnesty on foreign cash will encourage US companies to bring their foreign cash home and further invest or distribute it in the US.
\nHowever, the fine print contains \u2018border adjustability\u2019 of the taxes with serious ramifications for the
\nlikes of Apple and Walmart.<\/p>\n

Markets have come to agree that the Trump administration is one of the most pro-business
\nadministrations of recent years. However, Trump\u2019s last few months in the White House have raised
\ndoubts on his ability to deliver on his campaign pledges, pushed out the expected timelines of
\nlegislative changes, raised questions on his governance style and created nervousness among the
\nUS allies around his priorities. So this tide is not going to raise all boats. One thing is for sure, going
\nforward there will be winners and losers among US companies.<\/p>\n

On the monetary front, in the years since the financial crisis, the Fed has expanded its balance sheet
\nby almost five times. They have signalled a willingness to reduce their debt burden now. However,
\nthere is clear correlation between balance sheet reduction and market corrections (see Figure 1).
\nAs the baton passes from monetary policy to fiscal policy, will the volatility trend continue to be
\nquashed? Could any downside surprises catch investors wrong footed?<\/p>\n

Figure 1: Correlation between Fed Balance sheet and S&P 500 and the breakdown post US Elections<\/strong>
\n\"figure_1_-_correlation_between_fed_balance_sheet_and_s_p_500_and_the_breakdown_post_us_elections.jpg\"<\/a><\/p>\n

TIME FOR ABSOLUTE RETURN<\/strong><\/p>\n

This is an environment in which long-short equity portfolios are designed to perform well, as their
\nmanagers have the ability to navigate the markets\u2019 volatility by dynamically altering their exposure
\nto equity investments. Such long-short portfolios can benefit more from the diverging fortunes of
\ncompanies, which present greater opportunities for fundamental stock-picking. They can invest not
\nonly in stocks they believe are poised to rise, but also \u2018short\u2019 those likely to fall.<\/p>\n

At Columbia Threadneedle Investments, we believe that an absolute return strategy with a long-short
\nUS equity portfolio could be attractive for investors who are looking for less volatility and the potential
\nfor consistent investment returns.<\/quote><\/p>\n

We believe that turning these opportunities into solid returns takes highly skilled stock-picking, driven
\nby a fundamental research framework. As legendary investor Warren Buffett has said: \u201cIt\u2019s common
\nfor promoters to cause a stock to become valued at 5-10 times its true value, but rare to find a stock
\ntrading at 10-20% of its true value. So you might think short selling is easy, but it\u2019s not.\u201d<\/p>\n

STOCK SELECTION CAN DRIVE OUTPERFORMANCE<\/strong><\/p>\n

Long-short equity portfolios can benefit more from the diverging fortunes of companies, which
\npresent greater opportunities for fundamental stock picking. In managing our US Equity long-short
\nportfolio, the Threadneedle (Lux) American Absolute Alpha Fund, we seek to take advantage of market
\nvolatility by holding long positions in companies we expect to flourish over the long term and go short
\nin companies which are expected to have a tougher time. Unlike many of our peers, we do not invest
\nin complex derivatives. We place great importance on fundamental research and industry analysis and
\nbelieve that this approach will tend to identify quality companies that are more likely to outperform
\nover the long term. We combine our team\u2019s experience and rigor with the extensive resources and
\nrobust risk framework of Columbia Threadneedle Investments to create alpha. A powerful combination
\nof fundamental, bottom-up stock picking, together with top-down analysis, coupled with a strong
\nbuy\/sell discipline, helps us deliver strong risk-adjusted returns.<\/p>\n

Our long book comprises four distinct \u2018buckets\u2019 (Figure 2): core growth and value stocks; cyclical
\ngrowth stocks; special situations such as companies reorganising or involved in mergers; and
\ncatalyst-driven opportunities, such as companies due to make product announcements.<\/p>\n

Figure 2: Long book construction<\/strong>
\n\"figure_2_-_long_book_construction.jpg\"<\/a><\/p>\n

By contrast, our short book (Figure 3) contains: structural shorts; catalyst-driven opportunities; and
\nrelative value\/pair trades.<\/p>\n

Figure 3: Short book construction<\/strong>
\n\"figure_3_-_short_book_construction.jpg\"<\/a><\/p>\n

In order to deliver a smooth return to investors, we aim to invest in companies which we believe
\nwill generate a 15% total operating earnings yield (operating earnings yield plus growth in operating
\nearnings). This target is key because if we select the right companies, they have the potential to
\ndouble their operating earnings yield over five years.<\/p>\n

When the market is low, our short positions help us to maintain smooth returns for investors while
\nalso allowing us to buy more of our quality compounders. When the market recovers, we reduce our
\nshort positions and deliver returns due to our long holdings.<\/quote><\/p>\n

In response to recent market uncertainty, we have reduced the strategy\u2019s number of holdings. At
\npresent, we have approximately 40 long and 40 short stocks. To make it into the portfolio, each
\nstock must have a specific thesis, and we must be clear how the value will be unlocked. We aim to
\nunderstand these businesses very well and also to have a deep understanding of how the stocks will
\nreact to the various market signals. This gives us the conviction to manage our positions precisely.<\/p>\n

This is a stock-pickers equity market and we believe that only those asset managers with a
\nrobust research framework will be able to sustainably deliver alpha. After all, you need to be
\nwhere the puck is going, not where it has been.<\/strong>