Hedge Clippings | Friday 17 April, 2020

Hedge Clippings | Thursday 09 April, 2020

It doesn't take a genius to know, or for that matter to write, that markets have been unbelievably volatile, not only over the past two months, but weekly, daily, and intraday as well. However, making sense of markets, or for that matter the longer-term effects of the unprecedented disruption and dislocation caused by COVID-19, is a whole different matter.

There are obviously varying views in this regard. On the one hand, the market is speaking, rallying sharply off the lows reached on the 23rd of March. At a recent presentation by Longview Economics, CEO Chris Watling quoted Benjamin Graham who said that "In the short run the market is a voting machine, but in the long run the market is a weighing machine".

So, having rallied almost 1,000 points, the market is clearly suggesting that it was oversold. However, as Watling also points out, this merely reflects a voter-registration test that requires only money, not intelligence or emotional stability. In the longer term, the market as a weighing machine will determine how much damage has been done to the global economy, and specifically to individual sectors and companies.

The unprecedented level of government and central bank support is obviously influencing the market's short-term voting machine characteristics. However, this is also influencing its longer-term weighing machine characteristics, which is a trend that is simply continuing (albeit to an even greater degree) the distortions which exceptionally low interest rates have had on markets over the past 3 to 4 years.

While certainly supporting what governments globally have been doing to ensure there is no repeat of a 1930's type depression, the risk is that the capitalist system which should let companies sink or swim based on their merits - both management and balance sheet - won't operate efficiently, at least in the short to medium term.

Eventually, the question will have to be answered whether capitalism in its pure form still exists. In the meantime, we should all be thankful for government intervention.

Turning for a moment to the performance of funds where the range of returns remains extreme. As might be expected (although forgotten by many during the flood of investors and their capital into low cost, low fee index tracking ETFs), Absolute Return funds as a group have outperformed the index after fees by 13% YTD since December 31, and by 11% over 12 months to the end of March.

There will always be an argument about fees, and value, but the old adage that quality is remembered long after cost is forgotten would seem to hold true.

On that note, have a safe, if somewhat unusual, Easter long weekend.

Hedge Clippings | Friday 03 April, 2020

"Only when the tide goes out do you discover who's been swimming naked"

Hedge Clippings is happy to credit the above quote to Warren Buffett, as, amongst all the wise words he has spoken over the years, this seems the most appropriate one for these extraordinary times. If you want more, here's a link to them courtesy of "Brainy Quote" - the only problem being you'll have to put up with a whole bunch of people advertising on the back of his wisdom.

We're not quite sure of his view on the current market, but as one of his pearls was/is "our favourite holding period is forever" we can probably guess. However, having a long-term view when markets are as volatile as they are now requires nerve, and probably a strong balance sheet to boot.

He also said, "let blockheads read what blockheads wrote", so we will leave it to the reader to decide if we qualify!

Everyone is, however, aware (we presume) that the ASX200 fell over 20% in March, with daily and intraday volatility at unprecedented levels, making the role of portfolio managers doubly difficult. As we recently wrote, these are difficult and disorderly markets, and managers that previously rode the bull markets - or as Buffett might say, rose on the flood tide - are going to be found wanting to various degrees.

That was certainly the case in February when the ASX200 fell by 8%, while the average absolute return fund on www.fundmonitors.com fell by half that amount, but with performances ranging from -30% through to +20%. On early indications March will have a similar pattern, with some already reporting falls of around 30%.

On the positive side, those managers and strategies we would expect to excel have been doing just that. Again, reports are still sparse after just three days, but Gyrostat's Absolute Return Fund rose +5.8%, while preliminary returns from the likes of Levitas (+15%), ARK (+5%), and Arnott (+7%) are hopefully an indication of those to come.

Positive is one thing, but in our view any manager protecting capital is worth looking at. So, with the ASX down almost 18% over 12 months (what a difference a couple of months make), even half that figure is something to crow about.

Meanwhile, Hedge Clippings has pleasingly seen an increase in manager "Insights" articles focusing on the potential long-term effects of the current pandemic. Included below are two worth reading - "How bad will the COVID-19 recession be" from Arminius Capital (whose author Marcel von Pfyffer admits to now knowing why he studied what he did at university), and the interestingly titled "Love in the time of COVID-19" from Delft Partners.

The latter provides the following advice: Invest, Don't Speculate; Be Patient - think long term, and finally, Diversify to spread risk.

Wise words indeed, but it takes nerve. Both Insights are worth reading, and as you can't (or shouldn't) go anywhere on the weekend, spend a little time doing so - even with a well-earned glass in hand!

Hedge Clippings | Friday 27 March, 2020

Looking at fund performances as we do at AFM is always a case of looking at things through the rear-view mirror. As such, while we receive intra-month data from some managers, the reality is that firm data is only available for many funds, if not most, on a monthly basis. So, when markets are moving as rapidly as they are now, February's performance data, while indicative, is almost ancient history. It does, however, give an indication of what's to come. In February the ASX200 Absolute Return Index returned -7.69%. Absolute return funds fell 4% - around half that amount. Market Neutral funds fell just 2.22%. However, averages can be misleading - returns across all 400+ funds ranged from -32% to +21%, with 78% outperforming the ASX and 16% providing positive returns. March will be another matter. What is apparent is that many funds and strategies which might have been underperforming in the bull market of the past few years have been providing investors with attractive risk profiles. This week we sat down (remotely of course via Zoom, so please excuse the "studio" set up) with Kristiaan Rehder from the Bennelong Kardinia Absolute Return Fund to continue our series on "Defensive Funds in a Disorderly World". You can see the interview (approx. six minutes) here. Meanwhile, regular readers of Hedge Clippings will know that we have great faith in the UK based Longview Economics and their insightful and accurate data - not only on economic matters. Longview recently started issuing a daily update of COVID-19 statistics comparing infection rates, deaths, tests performed, infections etc. If you look at the Longview data in the table below, Australia's numbers per capita compare favourably (albeit that they're 24 hours out of date) and, as per the PM's claims this afternoon, show that we're in a better position better than many countries overseas.

For the full Longview report please click here. China's numbers - if you believe them - makes it look as if they're on top of it. However, having an authoritarian system that enables them to weld up the doors of apartment blocks to prevent people's movements possibly makes that easier. Currently (based on Longview's data, so maybe 24 hours out of date), we're testing 7,018 people per million. In the US, the number is only 1,116. Our infection rate of those tested is 1%. In the US it's 18% with 942 deaths. Maybe they're only testing really sick people in the US, but in Italy the numbers are: Tested: 5,386 per million Percentage of those tested infected: 23% Deaths: 7,503 As for America, while they can throw billions (trillions?) of dollars at the problem, they can't - or Trump won't - be welding up doors to apartment blocks. Meanwhile the long-term damage to the core economy - business and personal - is and will be massive. When we mentioned to Longview's Chris Watling that our numbers (relatively speaking) were encouraging, his sage warning was that if we follow overseas trends, they'll get worse from here. How much worse remains to be seen, as the challenge for all countries has been constantly chasing the problem rather than getting ahead of it. And so, to markets: In 1987 the ASX fell 50%. In 2008 it fell by 54%. 2020 is much more serious as it affects every sector (perhaps excluding medical) massively. Qantas laid off 80%, Virgin - 90%. Retail will have to, or has already, closed. Even if the govt. is playing catch up. So, the economy in Australia has, depending on one's view, stopped, or is stopping, or will stop dead in the water. As much as the government supports businesses and households, a six-month lockdown as envisaged can only be reflected in company earnings which are tied to equity pricings.

Hedge Clippings | Friday 20 March, 2020

Hedge Clippings' first mention of the emergence of coronavirus was back at the end of January, less than 8 weeks ago. Since that time the situation has gone from concerning through to alarming, panic, and now to a change in the world as we know (or have known) it. More has probably been written and spoken on the subject of COVID-19 than any other topic since World War II - and in fact Angela Merkel, the German Chancellor even stated earlier this week that it was the greatest threat since 1945.

Last week we referred to "the curve" and the need to slow the rate of infection to allow the medical system to cope with the coming avalanche of patients. The reality is that governments, both locally and overseas, need to get ahead of the curve when implementing policy and restrictions on population movement, and social interactions, and adjust economic policy to suit - and on the run as required.

Personally we would hate to be a politician, particularly at the current time when, whatever one does, there will be those who disagree with you because they don't like you in the first place, those who think you are not moving ahead of the curve sufficiently, or those that say you're being alarmist and moving too fast.

In all reality, COVID-19 itself, and the medical, social and economic situation it brings with it, is moving so rapidly that it is almost impossible to keep pace. As we noted in last week's hedge clippings, "whatever the situation was last week, or even yesterday, the reality is that it will have changed significantly not only by next week, but by tomorrow".

That in itself was probably an understatement as the situation seems to change by the hour, or certainly by the day.

Without being alarmist, what seems clear to Hedge Clippings is that the government's approach should be "whatever it takes" and "whatever it costs". Whilst encouraging to see that the Australian Banking Association's (ABA) Anna Bligh says that all small businesses hit by the pandemic will be able to access a six-month deferral of all loan repayments, the reality is that the government is going to have to provide financial support at both the business and the household level for those whose revenues had been decimated but whose costs - even if cut to the bone - remain above their income.

How this is done structurally remains to be seen. It has been suggested that HECS type arrangements could be put in place, which just might well work. In all this, the concept of a budget surplus is probably now a further 10 years away, but in reality that's not important. Neither really is the "R" word - Recession, which as we have stated before is almost inevitable. The questions now are how long it will last, and how severe it will be.

At the current time, of course, many eyes are on equity markets and, given the extreme volatility they have been experiencing, thus the performance of funds. Today's an up day on the ASX, but that could change by close of trade, and again on Monday.

What is clear from the perspective of managed fund performance is that funds which happily benefited from the strong markets of the past couple of years, without recognising the need to invest with an eye on the future to protect investors' capital in the inevitable event that the market changes direction, have suffered.

Protection comes in all shapes and sizes, and those strategies that are inevitably performing better are those such as Long Short or Market Neutral, or those funds which can hold variable levels of cash. Those benefiting (in other words, providing positive returns) are the true alternatives such as managed futures, global macro, or long volatility funds, aside of course from fixed income and credit.

Last week we mentioned the discussion we had with Alex Pollak, CIO of the Loftus Peak Global Disruption Fund. This week we have followed that up with a brief five-minute video interview (remotely, and therefore at an appropriate distance) recorded yesterday with Alex, entitled "Defensive Investing in a Disorderly World", which you can view here.

Over the coming weeks and months Hedge Clippings will be focusing attention on the theme of "Defensive Funds in a Disorderly World", including further interviews and articles to provide investors and their advisers with insights into how these managers are thinking and implementing their investment strategies.

Given the rapidly changing world in which we now operate, these manager interviews and insights may hit your inbox more frequently than your normal weekly edition of Hedge Clippings. Depending on your situation, you may either have more time to read or view them, or less if your inbox is already overflowing with COVID-19 updates.

Whichever, in the meantime, stay safe.

Hedge Clippings | Friday 13 March, 2020

To say that we are in uncharted waters and facing a crisis of global proportions is probably not only stating the obvious, but also understating the severity of the situation. Whatever the situation was last week, or even yesterday, the reality is that it will have changed significantly (and in the short to medium term, not for the better) not only by next week, but by tomorrow.

We certainly don't profess to have any medical knowledge, or experience in crisis management - in fact one of the problems is that few politicians, or those making decisions, do either. The best they can do is throw money (and at $17.5 billion, I doubt that's even started) at the problem and then act decisively on the recommendations of those with the appropriate knowledge and experience.

In that regard we're pleased to see the advice from Australia's chief medical officer to the Prime Minister and state leaders that non-essential gatherings of more than 500 people should be cancelled has been taken forthwith. In all reality that decision probably should have been taken some days ago, but hindsight as we have always said is a wonderful thing.

If you think we are being alarmist then I suggest you read this article which we received this morning from Robert Swift of Delft Partners. The title of the article, "Act Today or You Will Die" is certainly alarmist, and we would suggest with good reason as it seems to be based on solid information and from someone who has expertise in the area.

Undoubtedly decisive decision-making and quick actions are required, and it is interesting to note that some are now praising China's response to the problem they created in the first place. The Chinese authorities certainly didn't make decisive decisions or act quickly in December when they were first warned of the outbreak of yet another virus which by all accounts emanated from a live or "wet market". By the time they did (brutally if you watched the ABC's 4Corners last Monday), it was all too late. But in reality the Chinese authorities should have acted to close ALL wet markets after previous epidemics such as SARS in 2003, which according to the World Health Organisation was "thought to be an animal virus, possibly from bats that spread to other animals (civet cats) and first infected humans in Guangdong province in 2002".

Authorities around the world, including Australia but possibly with the exception of countries such as Singapore and Taiwan (no doubt benefiting from their experience with SARS), have been playing catch up ever since.

Turning to AFM's database of actively managed funds, their performances in February (in current times certainly almost ancient history) were generally good by comparison with the market, with 16% providing positive returns, and 80% outperforming the ASX200. Depending on strategy and style, some will obviously suffer more than others, although generally we would caution against panic redemptions. The suggested timeframe for investing in a managed fund is generally 5 to 7 years, so unless one is invested in an index based ETF which will track the market (don't say we didn't warn you!) or you have a liquidity issue, it is probably worth staying the course. Obviously, some funds and strategies are more risk averse than others, and that suggestion is not intended as financial advice, be it general or personal!

From the perspective of financial markets, one would have to expect that there is further downside given that the market fell 50% in 1987, and again in 2008 in what was merely a financial crisis. Discussing the current situation earlier today with Alex Pollack of the Loftus Peak Global Disruption Fund (-1.05% in February, an outperformance of over 6.6% vs the ASX200, and 4.1% over the MSCI All Countries World Index), we concluded that the fact that many companies' share prices were already stretched from a valuation perspective in part explains the severity and rapidity of the falls to date. No doubt index selling will have hammered quality companies as well as poor ones, while any with weak balance sheets or tight margins will suffer. Those with weak balance sheets will find refinancing difficult to say the least, while those with tight margins will tip into the red simply because the reduction in their revenues will be either immediate or rapid, and will certainly outpace their ability to cut costs and overheads.

Those sectors obviously in trouble - think travel, education and tourism (Flight Centre to close 100 stores across Australia) for a start - will suffer if they haven't already, and as the days unfold will no doubt suffer more.

Many in the financial services sector (Hedge Clippings included) are fortunate enough to be able to leave their offices and work from home, avoiding crowds, public transport and the risk that close personal contact entails. Spare a thought for those that can't.

Alarmist? Quite possibly. But if Australia's chief Medical Officer has advised the PM and Premiers that gatherings of more than 500 should be cancelled, yours truly is listening.

Hedge Clippings | Friday 06 March, 2020

The market's recent chaos and panic as a result of COVID-19 has been nothing compared with that experienced in the toiletry aisles of Australian supermarkets this week. For a while it had Hedge Clippings both amazed and perplexed, and, being faced with shelves devoid of both baked beans and toilet paper (surely there can't be a connection there?) a little miffed.

Leaving aside the miffed feelings - we weren't caught short ourselves, but had to wait in a long queue amongst those who obviously were, and were seemingly expecting to be for some months or even years to come, while all we were there for was for a litre of milk and a packet of hot cross buns. However, we were perplexed as to why the nation had become so obsessed, when our understanding of COVID-19 was that it was a respiratory virus, not a gastric one.

All was explained when we recalled Maslow's "Hierarchy of Needs" which, for those not familiar, or who can't recall it, states that the basic physiological aspects that man (or woman we assume) needs for the survival of his/her body are, at times of stress, more important than others such as (in ascending order) safety, love/belonging, self-esteem and finally self-actualisation.

Recalling (actually reading) further, Maslow lists in the basic physiological list aspects which include food, clothing, air, shelter, and the homeostatic processes such as excretion!

So there we have the answer. No one was (or is, as the shelves are still bare) being irrational after all, they were merely reverting to their core hierarchy of needs which have been there since we crawled out of the swamp.

Which, based on the behaviour of some of those we witnessed, in some cases might not have been so long ago.

What has all this got to do with fund performances you might well ask? Probably not much, except that last week we mentioned the "F" word, Fear. And with good reason, as fear of the consequences of COVID-19 is clearly driving markets.

A few weeks back we referred to Chris Watling's work at Longview Economics which over time found a clear correlation between company earnings and the performance of the S&P500. Put simply, the earnings of many companies are, or are going to be, under extreme pressure and it therefore follows that so too will share prices.

With the ASX200 down almost 1,000 points since its most recent high, and the Dow off around 3,500, investors are probably being much more rational than the shoppers in the toiletry aisles of Woolworths, Coles or Aldi.

We at Hedge Clippings, however, will maintain our sense of proportion, control and decorum. Until and unless of course COVID-19 threatens the supply of a decent bottle of Pinot Noir. That's when you'll see real fear, and resulting panic.

Hedge Clippings | Friday 28 February, 2020

If reading this edition of Hedge Clippings has an element of déjà vu about it, it's probably because we wrote about the "unknown unknowns" of the coronavirus in Hedge Clippings just three weeks ago. At that stage we mentioned that the "outcome was unknown, not only from the medical perspective, but also an economic one".

As with everything to do with the coronavirus, the situation is constantly and rapidly changing  (so much so that they have even changed its name to COVID-19), although as we said at the time, the speed of progression is a known unknown.

What is becoming clear is that the economic effect is significant, and depending on how things unfold from here, it seems unlikely that China will record any growth, not only this quarter, but potentially the one beyond. Given Australia's economic dependence on China there is a strong possibility that our economy will follow suit.

Having seen markets power ahead over the past year or two based on FOMO (Fear Of Missing Out) or TINA (There Is No Alternative), the markets are now gripped simply by the "F" word - FEAR.

Fear that has driven the yield on Australian government 10-year bonds to just 0.859%, down from an already low 1.37% at the beginning of the year.

Fear that has wiped out six months of All Ordinaries' gains.

Fear that is likely to keep consumers subdued, with their hands in their pockets (or out depending on your perspective) and retailers having difficulty in keeping their heads above water.

Fear that has people wearing facemasks in the streets of Melbourne and Sydney, in spite of the fact that as yet no one has actually contracted the virus within Australia, with all known cases here resulting from returning travellers.

In reality the fear is potentially more contagious than the virus that is spreading it.

However, there are some worrying realities. Chinese car sales fell 92% in the first two weeks of February. Australia is highly leveraged to China not only from tourism and education, but also for our exports of the raw materials that feed China's now stationary mills and factories.

As yet the US seems less affected, however there is a significant caveat on that given (as previously mentioned in Hedge Clippings) the significant number of so called "Zombie" companies in the US which, having been bloated by cheap and easily available debt, use their entire free cash flow paying the interest bill. That works whilst interest rates remain low (which we expect to continue) but it won't do so if there is any slowdown in economic activity or sales.

In the short term it's highly likely that there will be a further interest rate cut when the RBA next meets, although at current levels there's a limit to how much further rates can fall. Looking further forward a couple of months, and the chances of the much vaunted budget surplus evaporating would seem inevitable.

One might even say both are highly likely to be "known knowns".

Hedge Clippings | Friday 21 February, 2020

Hedge Clippings was interested to note (not sure if "miffed" or "pleased" is correct) that he was no longer (assuming he ever was) a member of the informed public according to the Edelman trust barometer released yesterday. Basically, that's because those the survey defines as the "informed public" are tertiary educated, have top quartile income, are 25-64 years old and are relatively high consumers of news. Sadly we fail on nearly all counts, the exception being the high consumer of news (and not the fake news either). Now many of you might have already guessed that we didn't qualify as "informed", but now it has been confirmed.

Apparently the informed public now increasingly share the negative sentiments of the mass public in Australia - or in other words, we presume, the UNinformed public. So be it. Hedge Clippings is always in line with the term "hedge", or at least generally conscious of the potential for the negative to occur, albeit that we would generally like to think of ourselves as positive. Anyway, enough about us!

This week we had the good fortune to host Chris Watling of Longview Economics who presented his overview and Latest Global Macro and Market Outlook. We have quoted Longview previously, and we would consider Chris to be one of the most well informed economists we have come across - and certainly one of the most interesting and entertaining. As testimony to this, last October Longview correctly predicted the outcome of the UK General Election - and not just the overall result, but the number of seats Bojo would win by. At that time the result was anything but certain, but their prediction of a 70-90 seat majority was smack on the money - except sadly we didn't put a cent on the trade.

We digress (again). One of Watling's slides reminded us that it was Warren Buffett who quoted Aesop who in 600 BC said, "A bird in the hand is worth two in the bush".  In other words, don't take excessive risks with your capital. Meanwhile, Watling's many charts went on to prove that while there are widespread concerns about earnings ("in the LONG term, it is all about earnings") in fact since 1930 there's been a strong correlation between the US S&P500 and EPS:

Equally, he showed that over the past 39 years there's been no correlation between Earnings and Returns on a one-year outlook, and that over the VERY long term, earnings mean revert:

While over the very short term (1, 3, 5 years) there's no correlation between Valuation and Returns.
 

Most interesting was his points on listening to those he terms the "Armageddonists" such as Jim Rogers who has repeatedly forecast the end of the boom each year between 2011 and 2017. For instance, in 2011 Rogers predicted a "100% chance of crisis, worse than 2008" and so on through to 2017 when it was "the worst crash in our lifetime". For the record, the S&P500 fell 7.7% in 2011 (at least he got the direction right) and in 2015 it was down 3.3%, but for every other year it rose. We note he stopped, or wasn't quoted, predicting after 2017.

That's the history. For Longview's opinion on the future you can contact them here.

Hedge Clippings | Friday 14 February, 2020

Being the old-time romantic type, Hedge Clippings duly (and thankfully) remembered that today marks St Valentine's day, but we'd guess there's not too much kissing aboard the Coronavirus stricken Diamond Princess in Yokahama. Before we're accused of being insensitive (have you ever heard of an insensitive romantic type?) the point we're getting to is whether isolating 4,000 passengers on a ship with known cases of a highly contagious and dangerous disease was the correct strategy.

We have to admit that we wouldn't have a clue WHAT the best strategy would have been, and hindsight is a wonderful view to have, but is there a chance that by keeping all the passengers on board it is just a matter of time before more and more become infected in a somewhat gruesome version of the domino theory?

Meanwhile as our government tries to limit further cases in Australia by extending travel bans from China for non-citizens, and as noted in last week's Hedge Clippings the economic ripple is continuing. The issue is not only affecting direct imports and exports to and from China, with reports that Korean vehicle manufacturers Kia and Hyundai have had to halt car production due to the shortage of some components manufactured in China.

Maybe we're being alarmist, but it would seem that the risks associated with a longer than expected duration of the crisis are considerable - and unknown.

Also in the media this week has been the court case involving the Goldsky Ponzi fund, the founders of which managed to misappropriate large sums of money from unwitting investors. Once again hindsight can be a wonderful thing, but in this case, just like most other Ponzi schemes before (Astarra in Australia, or Bernie Madoff for example), there are some tell-tale signs, and some simple rules to follow.

One is to beware of the marketing spin, but to be fair, smart marketing to gullible or even greedy investors is just what Ponzi operators survive and thrive on. There's an old saying that if "something sounds too good to be true, then maybe it is". Famous sportspeople and other household name "brand ambassadors" should not be relied on for so-called financial advice.

So as a rule of thumb, do some basic research and due diligence. Who is the scheme's administrator, custodian or trustee? Even this can be difficult, particularly for the unsuspecting, or unsophisticated investor chasing exceptional returns. In the case of Goldsky, they falsely claimed to use Citco, a well known global fund administrator for independent pricing of assets, and reporting of returns.

The implied endorsements of industry awards aren't foolproof. Awards are frequently there for the manager's marketing purposes - and have been known to be less than reliable as an indicator of future returns.

Even relying on financial advice or paid for research isn't foolproof, as shown in the case of Shawn Richard's Astarra, which way back pre 2010 cost investors over $100 million in spite of a positive research report written by a party who also consulted to Astarra (for a fee of course), shared office space, and sat on the investment committee of the advisory group (AIOFP) which just happened to be the main distribution channel for the fund.

For the whole sorry tale click here. Suffice to say Astarra was paying advisors high commissions, and lending money to the associated dealer groups. For the record (excuse the pun), Richards was sentenced to 3 years in the slammer.

While on the subject of advisors (and no connection with the above) an excellent and interesting piece of research from Mark Hoven's Adviser Ratings summarising the changes to the advisor landscape in 2019 entitled "Musical Chairs", the key findings of which showed adviser numbers fell 4,378 (-15.6%), three out of every five advisers are now privately licenced, 21% of the industry is now made up of "Micro-licensees" of 10 advisers or less, and that 30% of the entire industry has been on the move (ceased or switched) in some form or another in 2019.

(And finally, for the pedantic types who noticed the varied spelling of the word advisor/adviser, the dictionary allows both.)