Diversification, good research and some liquidity to pounce on opportunities are key as institutional investors chase the holy grail of beating fixed income returns via alternative, absolute return-style strategies.
East Lodge Capital chief executive and chief investment officer Alistair Lumsden said the London-based alternatives firm focuses on structured credit and takes both long and short exposures, depending on the macro environment and credit fundamentals.
Speaking at the 2017 Conexus Financial Absolute Returns Conference, Lumsden displayed a chart showing residential mortgage-backed securities in the UK – in which East Lodge invests – using loans from 2007, before the financial crisis. The value of the underlying collateral was $746 million and his team issued $570 million of securities against that.
Following 34 per cent house price appreciation in the UK, this property pool would today be worth a billion pounds, giving a loan-to-value ratio of 57 per cent, he said.
“Put another way, if you were to assume everybody behaved in an average way, we could take a housing market decline of 43 per cent before we would take any loss to the underlying structure.”
Not everyone behaves in an average way but this structure is more than able to withstand defaults from a small percentage of borrowers, Lumsden said. And it has a low correlation to equities.
Liquid strategies
Lumsden made his comments during a panel discussion titled “Blending alternatives to Create an Absolute Return”.
The session was chaired by Cambridge Associates head of hedge funds for Australia and New Zealand, Travis Schoenleber.
“Today we are eight or nine years into a bull [run] in equities markets,” Schoenleber said. “All of us are thinking about absolute returns and about how to build defense in the portfolios, while still trying to get that holy grail of earning returns higher than fixed income.”
Schoenleber asked Sunsuper portfolio manager Bruce Tomlinson what he was doing to construct an optimal portfolio.
Tomlinson heads up Sunsuper’s liquid and diversification strategies, which he established in 2007. The program has been active in credit markets, taking advantage of bank deleveraging since the financial crisis, owing largely to extra regulation, he said.
Tomlinson explained that he uses a bottom-up strategy. With about 50 per cent of capital in closed-end vehicles for roughly the last five years, about 15 per cent of capital is coming back every year, he said.
“So together with the tremendous cash flow Sunsuper has, we have a fair bit of capital to invest,” Tomlinson said. “I’m always thinking about what’s a good opportunity now; we’ve always got money to invest, and that does focus the mind.
“The bottom line is we have a ton of diversification, lots of different investments all over the world, and…we are looking at our betas all the time…but we are not going to invest in anything that has a ton of listed market risk.”
At the moment, between 5 per cent and 5.5 per cent, or about $2.2 billion, of the total $45 billion Sunsuper portfolio is invested in liquid alternatives, he said.
Willis Towers Watson senior investment consultant Aongus O’Gorman said liquid alternative strategies, or liquid diversifying strategies, deliver a positive return within the portfolio with limited economic sensitivity.
“Allocation size…has to be meaningful,” O’Gorman said. “Lots of managers at 5 per cent is not really worth the effort. So…our kind of model portfolio we want to talk about 10 per cent.”
Conexus Financial is the publisher of Investment Magazine, top1000funds, and Professional Planner. For details on upcoming events, visit conexusfinancial.com.au/events.
