(Pictured: Fraser Murray)
Institutional investors around the world are facing some interesting challenges. A big one is what to do in an environment of rising interest rates. An even bigger one is what happens if we get GFC Mark II. A peculiarly Australian problem is that of capacity in the local equity market.
The Frontier Advisors conference in Melbourne last Thursday, June 26, was offered several suggestions for alternative defences in a world of likely rising interest rates and the widespread concerns that another crisis might be just around the corner.
Alan Kosan, head of alpha research at the US consulting firm, SegalRogersCasey, said the key portfolio strategy for rising interest rates was a lower duration across the fixed income portfolio.
Last year Frontier announced the formation of its Global Investment Research Alliance, with SegalRogersCasey and UK firm LCP as foundation members. The Alliance provides for expanding and sharing of research.
Kosan suggested funds could look at: Tilting toward shorter-maturity and higher-coupon fixed income securities reduces duration, which will reduce losses in a rising rate environment. Examples include municipals, high yield and emerging market debt.
Additional portfolio strategies included:
> Reduce credit beta with alternative/opportunistic fixed income investments (distressed, structured credit, mid-market direct lending, and bank loans)
> Increase floating rate debt investment exposure .
> Consider “gap” finance credit opportunities with pricing elasticity as rates rise (mezzanine)
> Increase exposure to low-leveraged, income-producing and inflation- buffering real assets (timber, farmland, infrastructure, and commodities)
> Focus on select private equity strategies less dependent on debt financing (growth equity and venture), and poised to take advantage of any increased financial stress due to higher leverage costs (debt-for-control, turn-around, etc.)
> Private real estate assets with shorter lease terms, CPI inflators, or growth strategy capitalizing on improving fundamentals or distinct market dislocations and alpha opportunities (value-add and opportunistic transactions)
> Global listed real estate securities, which offer inflation-linked cash flows through leases and an attractive dividend component that includes non-U.S. investments benefitting from foreign currency appreciation
> Diversified hedge strategies capitalizing on increased equity market dispersion, volatility, and corporate activity, as well as macro trends and idiosyncratic catalysts (equity long/short, event-driven credit, merger arbitrage, activism, and distressed/restructuring)
> Global and sustainable dividend-oriented strategies (dividend growing/ dividend paying)
> Low/managed volatility strategies as appropriate.
Looking at the big unknown, Fiona Trafford-Walker, Frontier’s director of consulting, said the job of predicting sideways or falling markets fell on the role of dynamic asset allocation modeling and signaling.
The traditional ways to make money in sideways or falling markets included holding: nominal bonds; inflation-linked bonds; cash; gold; defensive equities; infrastructure; and property. General diversification, with more international and currencies, had also been a good ploy.
Less traditional ways, with a ‘net return’ focus, included: successful skill-based strategies in various asset classes; and well-selected absolute return strategies or hedge funds.
For Australian investors, who typically are highly exposed to Australian equities, there is the issue of market capacity, according to Fraser Murray, Frontier’s head of equities research. He believed the biggest issue facing funds was access.
“Many of the best Australian equities broad-cap managers are closed,” he said. “Around 40 per cent of Frontier’s recommended managers are presently closed to new clients. Some will not take further cashflows or will accept only a limited amount.”
The trend to highly credited new boutique firms had slowed dramatically, said. They had helped broaden the market. “Many of the newer offerings are not worthy of consideration.”
The issue for small caps, which Australian investors in particular loved to invest, was even worse. About 70 per cent of Frontier’s recommended small-cap managers were closed to new clients. As a result, some managers were selling their capacity ahead of investment, with clients locking in the ability to invest in the future.
“In a few years time, we may reach a point where it is no longer sensible for large growing funds to keep allocating further to Australian small caps unless we find new manager options,” Murray said.
