Now we are well back from festive cheer we turn to looking at what the New Year holds, apart from uncertainty. Should we go passive or active, what asset classes will work and what strategies are suitable? Those with long term views and discipline in mind should avoid the herd. Unfortunately the madness of the crowd often prevails.
Is timing right for equities?
The issue that concerns me the most is whether investors are going passive at the right time. As an active investment manager, I have always found it hardest to outperform when everything is gung-ho and equity markets just go up and up. In my opinion, that is the perfect time to go passive. Not now, when everything is far from easy, and one could make a very persuasive argument for active management.
In fact, right now is it at all the right time to overweight equities? In a recent study by Create Research global equities came out as the number one asset class deemed most suitable to meet European pension plans goals over the next three years. Over the years, I have learned (the hard way) that when investors’ opinions are largely undivided, they are more often than not wrong.
It is not at all about the average investor being stupid. Far from it. It is quite simply the result of herding. When smart investors express a view, they have already ensured that they are appropriately positioned before going public. Then the rest follow.
What about alternative investments?
Using the same argument, nothing could be better for hedge funds than a couple of major investors pulling out (Dutch pension fund PMT and CalPERS both announced late last year they were pulling out of hedge funds). If that trend continues, hedge funds as a whole may not be the best performing strategy, but they will almost certainly be near the top.
But one needs to be selective. Equity long/short will certainly struggle to deliver sparkling returns in a low return environment for equities, but it is not as simple as that. Take two alternative strategies that we have done a lot of work on, both of which are seriously capacity constrained – insurance linked securities (ILS) and direct lending.
Both are interesting strategies and should theoretically do relatively well in the kind of environment we expect to unfold. However, whereas ILS investment managers have been relatively disciplined about how much capital they have accepted, many (though not all) direct lending investment managers have not, resulting in significant return compression in that strategy.
The other problem facing many hedge fund strategies is the rising correlation with long-only equities. Some ‘alternative’ strategies are no longer truly alternative. The herding mentality has caused a major migration into alternative strategies without any recognition of what ‘alternative’ really means or is. So it is no surprise that there is something of a reshuffle going on as investors rethink and revise their exposure to alternatives.
Beyond 2015
Over the next several years, there is very good reason to look for star performers away from equities – whether long-only or long/short – and bonds.
Some of the more esoteric alternative investment strategies are likely to do comparatively well. Being capacity constrained these strategies will more likely be able to defend their fee structure. But, as a consequence of accepting too much capital, some of them will also disappoint.
All that lies ahead relates to global growth. Some countries will do better and some will do worse. In my book, the U.S. economy is a favourite to outperform and the continental European economy looks the most likely to be named the tortoise of the race. It is (almost) all about demographics. In other words, it is a structural and not a cyclical trend, and not a million well-meaning words from Mario Draghi can change that.
Niels Jensen is CIO of Absolute Return Partners
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