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Even without fund suspensions and manager moves to contend with, life is looking fairly tricky for long/short investors nowadays. Starved of market dispersion as indices rise in tandem, those with long/short mandates are once more swimming against the tide.
This inevitably threatens returns. A glance at performance figures for the long/short funds backed by DFMs in our MPS tracker shows that just three returned five per cent or more in the last six months, putting most well behind a resurgent market. But performance problems aside, the behaviour of long/short managers can provide a useful insight into how fund firms are thinking.
Having checked in on how DFMs’ top long/short fund picks were positioned at the end of March, we’ve looked at what has changed since then. The results are below:
The direction of travel is fairly obvious this time: two thirds of the long/short offerings backed by wealth firms have reined in net exposure, with a number making double-digit reductions. Of those deciding to go the other way, it’s only Kames UK Equity Absolute Return that has upped its weighting by anything notable.
The shift suggests that, as markets soar ahead, equity managers with greater flexibility have grown cautious about valuations and cut back rather than run their winners. Around two thirds of those in the sample have reduced long exposure.
But caution appears to have taken its toll on short books, too. Nearly half of the names above have a lower short allocation than before. Of those who increased their short exposure, half have also allowed their long weighting to rise.
A sign, if anything, that managers are doubtful about the market gains of late - but not confident enough to fight the current momentum. For DFMs it might be a signal that sizeable but not extreme equity allocations still make some sense for now.
Does investor herding kill alpha? Research has suggested it can do exactly that as investor demand drives up prices on shares deemed attractive. But fresh analysis suggests the crowd is yet to catch up in certain areas.
A Rathbones assessment of six quality metrics, including return on invested capital, found that UK and US companies scoring highly on these consistently tended to outperform peers. That’s over a period of between 17 and 28 years depending on the metric, and not just a post-crash phenomenon: some of the best returns came in the mid-2000s.
What does this mean? For Rathbones asset allocation research head Ed Smith, it throws up questions about whether investors have fully priced in these factors:
There are these constant returns to quality. That’s a little perplexing - surely after many years of excess returns, investors would catch up and bring forward those future returns and that would get rid of that risk premium that you are earning.
There are plenty of possible explanations to choose from. Among other things, Mr Smith suggests that “entrenched” companies continue to dominate their market even as investors expect them to run into disruption of some sort. Investors could also view a share as too expensive even as it continues to outperform.
The usual caveats about being selective also apply: most of the quality metrics used served investors better in the UK than the US, according to the analysis. Applying them in cyclical sectors also proved more fruitful than in defensive ones.
It’s another of many findings to take stock of. For DFMs, the question will be how to put such lessons to use.
What you pay for
The unrelenting cost focus of recent years means even the best-performing managers can find themselves judged on fee levels at times. It’s something we’ve seen asset managers respond to with varying approaches – from fee reductions and new charging structures to campaigns decrying passives – and varying levels of success.
Often managers are simply forced to make concessions on price. So it’s unusual news that reaches us of a hedge fund upping its performance fee from 25 to 40 per cent.
As the FT notes, Element Capital not only has significant assets but remains one of the best performers out of a cohort that has struggled in recent years - and may well have a better case for demanding higher compensation than its peers. But with investors casting a sharper eye on costs, this will provide a test case for any fund firms demanding a premium for good performance.