6 Feb 2015 - Hedge Clippings

Expect the unexpected!

A few years ago there was a rush of newspeak around the known knowns, and known unknowns, and unknown unknowns. It was all a little confusing (especially when written like that) and mainly emanated out of US military and political circles, particularly Donald Rumsfield. Thankfully, here at least, the fad passed. But it did make us think about the unexpected, and the old market adage to expect the unexpected.

To be fair the market has seen a fair number of expectations come to pass over the past 12 months, including the well telegraphed end of QE in the US, the inevitability of the ECB's own stimulus program, and although not universally expected, a slowdown in the growth of China's economy.

However there have also been some unexpected and significant market moves over the past six months: Few, if any expected the Swiss to remove the cap on their currency which resulted in the Swiss Franc jumping 15% overnight. Few expected the price of oil to halve. Equally three months ago few would have expected a rally in the Australian equity market of 10% in just eleven days this early in the new year.

But then few were expecting a rate cut of 0.25% in February either, whilst now the expectation is for a cut of a further 0.25% in the next few months. To put the market's rise of 10% in context, the ASX200 (excluding dividends) only rose 1.4% in the whole of 2014, so there'll finally be some happy investors around, particularly those focusing on stocks within the yield theme such as Telstra and the banks.

The question for local investors is whether this can continue, or is this as good as it gets? A further rate cut, and a weaker A$ will no doubt fuel the rally further, but one wonders how long OPEC will continue to pump oil at these levels, and therefore subsidise the price of petrol. However, the opposite side of the cause of the rate cut is falling consumer and business confidence, neither of which will have been improved by the current state of play within the government in Canberra.

We have repeatedly warned that sooner or later interest rates WILL increase, certainly from their near zero or negative levels overseas, whereupon there's likely to be outflows from equity markets. When, or by how much is not known, but when it does occur we suspect it will be a case of expect the expected.

Which I suppose brings us back to hedge funds, and their core purpose of avoiding risk and the danger of the unexpected. Taken over a range of periods equity hedge funds have consistently outperformed the ASX200 Accumulation index.  Over 2014 they returned 7.6% (vs ASX200 5.61%); annualised over five years 8.84% (vs ASX200 6.75%) and over ten years, 9.71% (vs ASX200 7.55%). Over each time frame that's an excess return of over 2%, which over ten years would leave investors 22% better off. Most importantly this has been achieved with around half the volatility and drawdown of the equity market.

There's no doubt a clever line in there somewhere about hedge funds and the unknown unknowns, but as we noted at the beginning thankfully that fad has passed.

Specific results received this week include the following PERFORMANCE UPDATES:

KIS Asia Long Short Fund returned 0.26% during December and 4.76% for 2014 with a volatility of 2.72%.

Chris
CEO, AUSTRALIAN FUND MONITORS

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