Towards the end of 2013 Harcourt Investment Consulting, the alternatives arm of Vontobel Asset Management, launched a family of three funds under the moniker of “Research-Driven Strategies” (RDS). The objective of these funds was simple: to harvest strategy-specific risk premia in a UCITS fund structure and deliver to investors an absolute return profile independent of market conditions.
The three funds launched in October and December of 2013 are:
• Vontobel Fund – Pure Momentum Strategy;
• Vontobel Fund – Pure Dividend Strategy;
• Vontobel Fund – Pure Premium Strategy.
The collective aim of the three funds is to generate annualised returns of between 300 and 500 basis points above US-dollar three-month Libor. Each strategy is highly systematic and, as the name implies, is based on rigorous academic research.
Jan Viebig (pictured) is CEO and Head of Alternative Investments at Harcourt and the lead portfolio manager of the VF – Pure Momentum Strategy. Discussing the team’s approach to running these strategies Viebig says: “Roughly 90 per cent of the risk/return in investor portfolios (in equities, bonds, commodities) comes from asset class movement. The problem is, interest rates are at historic lows and stocks are no longer cheap; the Shiller P/E ratio is currently in the highest percentile. As the expected returns on traditional risk premia is low, investors search for alternatives.
“Today investors can not only diversify across traditional asset classes, but also across different strategies. Each of our strategies is research-driven and what we found in academic literature was that there are three strategies which have a statistically significant positive return over the long term: momentum strategies; premium strategies, which are no different to what insurance companies are doing by collecting premia through underwriting options to the financial markets and hedging out the tail risks; and finally dividend strategies.”
As the three funds complement each other, when investors allocate one third to each strategy, the overall risk (or volatility) target is nearly halved as compared to investing in, say, just the Pure Momentum Strategy.
On its own, this fund has delivered annualised performance of 7.67 per cent, based on historic back testing between 2003 and 2013, and a volatility profile of 9.82 per cent.
However, when combined with the other two strategies, the volatility falls to 4.35 per cent whilst still preserving performance at 7.20 per cent.
“Each strategy has different risks, they do well in different periods of the market. This reduces the overall risk when allocating across all three strategies,” says Viebig, who continues: “Momentum is a trend following strategy so this is good when markets move substantially. The premium strategy, by design, is extremely good when markets don’t move much (it’s basically a short volatility strategy). Each strategy is designed to offset the risk of the two other strategies.”
Today, the risk in many client portfolios is highly concentrated. The exposure to traditional asset classes – stocks, bonds and commodities – typically explains over 90% of the risk and return variations of most portfolios.
There are upwards of 20 different hedge fund strategies to mitigate asset-class risk. The trick for investors is picking the right selection of strategies. As Viebig explains: “We don’t believe that if an investor has three or four traditional risk premia (in their wider portfolio) that they then need to look at 20 different alternatives strategies.
“They just need to pick the best three to five alternative risk premia to ensure that this strategy-specific risk offsets the asset class risk in their wider portfolio. We want to make sure that our RDS product achieves this for investors.”
Pure Momentum Strategy:
A lot of momentum funds rely solely upon time-series futures market models to detect upward and downward trends. Where the VF – Pure Momentum Strategy differs is that it combines a time-series momentum model with a cross-sectional momentum model.
As Viebig explains: “We look at certain baskets of stocks and build only those baskets that demonstrate positive momentum characteristics. We then hedge out the risk by shorting futures so the basket is effectively market neutral.”
The fund takes advantage of global equity and bond market trends. If it builds a basket of 30 German stocks, for example, it would then achieve risk parity by shorting DAX futures.
“Typically we are investing in up to 40 futures in the time-series model, and anywhere between 40 and 120 global stocks/bonds in the cross-sectional model to diversify away idiosyncratic risk. We use different baskets for different countries,” adds Viebig.
Currently, the VF – Pure Momentum Strategy has a 65.4% net long position in equities which is completely hedged by short positions in futures (cross-sectional strategy).
Pure Dividend Strategy:
Like the Momentum Strategy, the VF – Pure Dividend Strategy offers something different to the market. Most dividend funds seek to identify stocks based on the high dividend yields they offer without necessarily reducing equity market risk.
“The goal of this strategy is to extract value out of the market. The difference between traditional dividend funds and our fund is that we select high dividend stocks with strong cash flows, high earnings and a stable balance sheet – that’s on the long side. Then, we hedge out up to 50 per cent of the market risk using futures and the other 50 per cent we hedge out dynamically using a trend model to make sure we avoid having large drawdowns.
“This ensures that we are extracting dividend premia and hedging out market risk,” says Viebig.
Only high quality liquid stocks such as BP are selected for the long book. Index futures are used depending on which market the stocks reside in i.e. US stocks will be hedged with Russell 2000 futures, European stocks with STOXX Europe 600 futures etc.
Pure Premium Strategy:
The VF – Pure Premium Strategy is designed to harvest the volatility risk premium.
This is achieved by implementing what are referred to as “butterfly structures” in different markets. At the heart of this strategy at-the-money call options are sold to the market to collect the risk premia whilst out-of-the-money options are bought to hedge out tail risk; that is, to guard against any sudden upward movement (volatility) in the markets.
“When markets don’t move your returns are based on harvesting the volatility risk premia. You want to implement the butterfly structure when you get the highest premia based on assessing the spreads between implied volatility and realised volatility. When implied volatility (which is what you collect when selling options) is high compared to realised volatility, that’s when you implement this butterfly structure.”
Aside from the strategy risk diversification benefits, the RDS portfolio has also been designed to offer investors a cost-efficient solution. No double fee layer is imposed and the total charges are a 75 basis point management fee and a 10 per cent performance fee. Regardless of whether investors allocate to one fund or all three, there is no cost impact.
“Alternative UCITS is a growing market segment so it made sense to launch the three funds because investors want more cost-efficient, more liquid, and more transparent alternative funds,” concludes Viebig.