We build our strategies to improve the characteristics of an investor’s portfolio. In the case of our Multi-Strategy solutions, we have aimed to build a strategy that can offer the most upside potential while maintaining diversification benefits to common risks in traditional portfolios. Part of this improvement comes from adding different asset classes and strategies that are often absent from a client’s portfolio. This is the way we source diversification benefits. Some of these benefits can be measured via correlation. The degree to which our strategies are uncorrelated to client portfolios depends on the client portfolio as well as the specific Picton Mahoney Asset Management (PMAM) strategy, from Market Neutral Equity (which seeks to be largely uncorrelated), to our Multi-Strategy solution which tends to have a higher correlation to traditional asset markets. It is important to remember that “uncorrelated” is distinctly different than “negative correlation” which performs in the opposite direction of most strategies and may “win” in risk-off environments, but “lose” most of the time.
Q1 2020 Review
During the first quarter of 2020, the global economy experienced a deflationary bust of epic proportions. The collapse in oil prices, as an acute example, was gigantic. Market moves and price dislocations were similar to that of the great financial crisis (GFC) in 2008 – but faster. We saw the first couple of weeks of this sell-off (late February 2020 to early March 2020) as being a large sell-off in the usual manner and therefore our Multi-Strategy portfolios performed well relative to their respective benchmarks. We then saw the Saudi Oil shock change the environment into a more systemic risk environment. The decline in oil prices created contagion into the credit markets. Credit spreads blew out and that was the transition to dysfunctional markets. That is when we started to see troubles in money markets, the U.S. Treasury Bond market, ETF price dislocations and all sorts of follow-on problems. Many investors began to sell everything. Random assets began plummeting, gold began behaving erratically and even government bonds were not diversifying as much as they typically should. As well, by that point, the convexity (payoff profile) of our long volatility strategy maxed out, so even our “tail risk” hedge provided all the benefit of which it was capable.
Positioning
We believe in a systematic approach to much of what we do. We built our Multi-Strategy portfolios to be resilient, but are aware that when tested, it’s the opportunity to assess whether the model is fundamentally flawed or whether we’re just dealing with an extremely unusual event in terms of pace of decline and how much forced selling disrupted price discovery (that’s when the conversation tends to turn to relative performance). This past quarter left a lot of carnage out there in what some deem very “safe” stuff. Short-dated investment grade bond funds and principal protected notes come to mind. Within our portfolios we have not experienced any margin calls or limitations on liquidity that caused us to liquidate positions. In terms of operating the portfolios, everything was and is running smoothly and free from duress.
In regard to the performance in our portfolios, our asset allocation layer was impacted the most by the sell-off as one likely would surmise since it is comprised of 9 asset classes and has market exposure. During the period we opportunistically added to our alpha layer which is comprised of low volatility/low correlation strategies managed here at Picton Mahoney Asset Management. Our discretionary hedges which are all about a small risk budget and a good batting average, helped during the period. As allocators of capital, we can add value, but the portfolios do not swing to discretionary allocations despite the state of markets. That is not being true to process. At this point, it is expensive to hedge downside risk with traditional long puts. We remain active by looking for unique opportunities to reap convexity available should downside follow through and our experience managing hedged strategies since before the GFC has enabled us to exploit these as they present themselves.
What next?
Our Multi-Strategy approach is built to be the diversifier with the greatest upside potential. As strange as the environment was this past quarter, we are not altering our core strategy. We expect that when markets turn, we will participate broadly and we are already seeing this within our Multi-Strategy portfolios. If this rally leaves commodities behind, as an example, that would be an opportunity cost for us, per the architecture, but we can scale up equity risk quickly and cost-effectively if it’s an equity-led risk-on bounce. In terms of timing, our fundamental belief is that markets don’t rally when we win the war. They rally when we start fighting back. Massive stimulus and containment efforts are well underway and we await evidence these measures are having their desired impact on the real economy. We will still be in a recession, but markets tend to look through them.
Picking up on a tag line used by our Head of Fixed Income, Phil Mesman, “You don’t have to make your money back the same way you lost it”, Multi-Strategy does not rely on equity risk to generate returns. There are plenty of potential switch opportunities out there for clients who may not be comfortable with broad equity risk in the portfolio, nor want to “bet” on an equity rebound to get them whole. Partnering with a solution that has several uncorrelated return streams is a great approach to navigate these uncertain markets.
VIDEO: MICHAEL WHITE BREAKS DOWN THE INVESTMENT PROCESS BEHIND PICTON MAHONEY FORTIFIED MULTI-STRATEGY ALTERNATIVE FUND
Run time: 4 min. 10 sec.
This material has been published by Picton Mahoney Asset Management (“PMAM”) on April 9, 2020. It is provided as a general source of information, is subject to change without notification and should not be construed as investment advice. This material should not be relied upon for any investment decision and is not a recommendation, solicitation or offering of any security in any jurisdiction. The information contained in this material has been obtained from sources believed reliable, however, the accuracy and/or completeness of the information is not guaranteed by PMAM, nor does PMAM assume any responsibility or liability whatsoever. All investments involve risk and may lose value.
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There is no guarantee that a hedging strategy will be effective or achieve its intended effect. The use of derivatives or short selling carries several risks which may restrict a strategy in realizing its profits, limiting its losses, or, which cause a strategy to realize or magnify losses. There may additional costs and expenses associated with the use of derivatives and short selling in a hedging strategy.
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