Lonsec has released its 2010 Sector Reviews covering Australian and global long/short funds. Twelve Australian equity long/short funds were reviewed, with three attaining Lonsec’s highest rating of “Highly Recommended” – the Aviva Investors High Growth Shares Trust, Aviva Investors Long Short Equity Fund and the ING Extended Alpha Australian Share Fund.
Of the global long/short funds, 16 funds were reviewed with five attaining a ‘Highly Recommended’ rating – the Five Oceans World Fund, Platinum International Fund, Platinum Asia Fund, Platinum International Technology Fund and the MLC Platinum Global Fund.
Fund classification
Andrew Scifo, Investment Analyst with Lonsec commented on long/short fund classification.
“Although long/short funds share similar characteristics in terms of being able to hold short positions, the investment strategies implemented by each of the fund managers are diverse,” said Scifo.
“At Lonsec we classify long/short funds into two broad groups – 130/30 style or absolute return funds.”
With a 130/30 style fund, the fund typically maintains a net equity exposure close to 100% – or in other words, a market beta of 1, with the proceeds from short selling reinvested in the fund’s long positions. Short selling is primarily used to enhance overall fund returns and comes with increased market risk.
“The rationale behind a 130/30 strategy is that it allows the portfolio manager to fully implement both positive and negative views of stocks. Theoretically, the manager can add alpha by investing additional funds in their highest conviction ideas while also profiting from selling short their least attractive ideas (as opposed to simply not owning the stock),” explained Scifo.
“However, it takes a lot of skill to achieve this on a constant basis and there are additional risks associated with short selling.”
An absolute return fund may utilise a broad range of strategies including short selling, gearing, derivatives and cash to adjust the net equity position in line with the investment manager’s market outlook.
“Because of the different strategies employed, an absolute return fund may have a low correlation with traditional equity benchmarks at different stages of the economic cycle,” observed Scifo.
“The key differentiator of an absolute return style fund from a 130/30 fund is that short selling is used opportunistically and the investment manager is not compelled to maintain a short exposure within the portfolio.”
Key themes to emerge from the Sector Reviews
Level of short exposure
Given the diversity of long/short products within both the Australian and global peer groups, it is not surprising that the level of short exposures held by each fund varies from manager to manager.
“For fundamental 130/30 style funds, the level of short exposure is typically at the discretion of the portfolio manager,” said Scifo.
“With quantitative 130/30 funds, there are generally higher levels of short exposure due to the systemic ranking of stocks by the quantitative model that identifies long and short positions.”
In both the Australian and global long/short peer groups, the majority of managers were holding relatively low levels of short exposure compared to their maximum permitted levels at the time of the sector reviews.
Global quantitative funds disappointed
Quantitative strategies performed poorly over the past few years, largely as a result of extreme market volatility that has led to quantitative processes losing their predictive power.
As a result, in the global peer group, absolute return strategies performed better than their 130/30 counterparts.
High portfolio turnover
Long/short style funds tend to exhibit high portfolio turnover compared to long only funds. In the Australian long/short universe, the sector average portfolio turnover was 224% to the year ended 31 March 2010 – long only funds averaged 76% turnover.
“This impacts the tax effectiveness of Australian long/short funds,” observed Scifo.
“The higher turnover nature of this sector has implications for franking levels and for capital gains tax discount entitlements.”
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Disclaimer: This document is for the exclusive use of the person to whom it is provided by Lonsec and must not be used or relied upon by any other person. No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented in this document, which is drawn from public information not verified by Lonsec. Conclusions, ratings and advice are reasonably held at the time of completion but subject to change without notice. Lonsec assumes no obligation to update this document following publication. Except for any liability which cannot be excluded, Lonsec, its directors, employees and agents disclaim all liability for any error or inaccuracy in, or omission from, this document or any loss or damage suffered by the reader or any other person as a consequence of relying upon it.
Date: 22 July 2010
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