Chris Huang

Christopher Huang, Investment Analyst at Zenith says “It is commonly held that long/short funds are as, or less risky than the market. While we certainly believe that quality long/short funds improve an investor’s risk/return profile relative to investing in the index, we do caution investors to understand and be comfortable with the notion of both net and gross exposure. We caution that market risk (net exposure) is not the only risk that investors should be cognisant of. Gross exposure (i.e. exposure to the manager’s stock picking skills) is also of paramount importance.” In Zenith’s 2013 Australian Long/Short Sector Report, we discuss the notion of whether long/short funds are more or less risky than the market.

“Active extension and variable beta funds have had solid returns in generally favourable equity market conditions over the past 12 months. Many of the funds we have reviewed in this sector have kept pace with the Australian equity market in the year to March 2013, with active extension funds benefiting more from the equity market rally than variable beta funds.”

“Many of the active extension funds we have reviewed have maintained close to 100% net market exposures which have allowed them to achieve returns close to that of the Australian equity market. In comparison, variable beta funds have generally struggled to outperform the market as their net exposures have been relatively low. Despite this, we continue to highly rate these type of funds as they have demonstrated a good track record of preserving capital in poorer market conditions.”

Huang also added, “We are also seeing an increasing number of funds taking advantage from shorting mining, mining services and energy related stocks which have performed poorly. This has aided in generating alpha. In this market environment, we believe that there are benefits of including both active extension and variable beta Australian long/short equity funds in an investor’s portfolio, as it allows investors in these funds to benefit from selecting companies likely to rise and fall in value (long and short positions respectively).”

Zenith’s approved Australian long/short equity funds (equally weighted), including active extension and variable beta funds, returned 16.3% relative to the market (S&P/ASX 300 Accumulation Index) return of 19.2% in the year to March 2013. Broken down by investment style, active extension funds returned 19%, which performed better than variable beta funds which delivered 12%. While returns achieved by the Zenith approved Australian long/short equity funds (equally weighted) were lower than the market, these funds achieved it with less risk, as measured by Standard Deviation (9.3% p.a. vs. 11.6% p.a. for the market) in the year to March 2013. By investment style, Standard Deviation for active extension funds for the year to March 2013 was 11.7% p.a. and 6.1% p.a. for variable beta funds over the same period.

From an initial universe of 35 Australian long/short equity products, 6 funds were rated “Highly Recommended”, 9 funds were rated “Recommended”, no funds were rated “Approved” and 20 funds were “Not Approved”.

Zenith’s complete Recommended List for the Australian Long/Short Equity Sector, broken out by investment style, is shown below:

Active Extension Funds (i.e. 130/30)

• BlackRock Australian Equity Opportunities Fund (MAL0072AU) – Highly Recommended
• BlackRock Wholesale Australian Share Fund (PWA0823AU) – Highly Recommended
• Perpetual Wholesale Share-Plus Long-Short Fund (PER0072AU) – Highly Recommended
• Regal Long Short Australian Equity Fund (AMR0006AU) – Highly Recommended
• AMP Capital Australian Equity Opportunities Fund (AMP1783AU) – Recommended
• Antares High Growth Shares Fund (PPL0106AU) – Recommended
• Arnhem Long Short Australian Equity Fund (ARO0019AU) – Recommended
• Ausbil Investment Trust – Active Extension Fund – Retail (AAP0008AU) – Recommended
• Grant Samuel Tribeca Alpha Plus Fund (ETL0069AU) – Recommended

• Bennelong Kardinia Absolute Return Fund (BFL0010AU) – Highly Recommended
• Perpetual Pure Equity Alpha Fund (PER0668AU) – Highly Recommended
• Evergreen Australian Equities Return Fund (EVG0001AU) – Recommended
• K2 Australian Absolute Return Fund (KAM0101AU) – Recommended
• PM Capital Australian Opportunities Fund (PMC0101AU) – Recommended
• WaveStone Wholesale Australian Equity Long/Short Fund (HOW0053AU) – Recommended

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Daniel Liptak said, “The FRM Sigma Fund provides an efficient use of cash tied to a strong risk management and research process which Zenith views as an excellent approach to investing into systematic managed futures programs (commonly referred to as CTA’s). Accordingly Zenith has awarded the FRM Sigma Alpha Fund as Highly Recommended.”

The events of 2008 and the associated liquidity crises brought to sharp relief some of the unintended risks assumed when investing in hedge funds and CTA’s. These risks include:

• lack of transparency;
• liquidity mismatch;
• model based pricing; and
• a lack of separation of the investment team and the back office;

Daniel Liptak continued, “FRM Sigma provides a response to the above issues and it does so by investing in thoroughly researched trading programs through an internal managed account platform.”

“Where an underlying manager is unable to work with a managed account FRM will only invest if a single investor fund is created for it. Such a structure provides FRM the alibility to independently manage risk, cash and pricing of the underlying securities.”

Liptak added, “This approach clearly removes the underlying managers from noninvestment risks. The added value of this approach is that FRM can efficiently use nominal leverage to target return and volatility outcomes associated with single strategy funds.”

“In contrast, however, to single manager funds FRM Sigma provides diversification benefits; as it invests across different strategies which can react differently to market shocks.”

Daniel Liptak concluded, “CTA’s are currently in high demand, but as with all strategies there are risks. Zenith maintains that the FRM structure and the investment process should provide investors with an attractive opportunity to capture returns from CTA funds and navigate some of the downside risks.”

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Zenith Investment Partners Pty Ltd (Zenith) Investment Analyst Steven Tang has announced the completion of the 2010 Fixed Income Sector Review and confirmed that from an initial group of 91 fixed interest funds, 7 were rated HIGHLY RECOMMENDED and 12 were rated RECOMMENDED.

In addition to being added to the Zenith Recommended List these 19 Funds are also candidates for client model portfolios.

The key changes to the Recommended List post the review include the addition of 5 new funds across various categories as well as upgrades for 2 existing funds. The 19 funds that were rated Recommended or above are shown below:

Australian Fixed Interest – Bonds

• Australian Unity Vianova Strategic Fixed Interest Trust (Recommended)
• Legg Mason Australian Bond Trust *NEW* (Recommended)
• Tyndall Australian Bond Fund (Highly Recommended)
• Vanguard Australian Fixed Interest Index Fund (Recommended)

Australian Fixed Interest – Corporate Debt

• Macquarie Income Opportunities Fund (Highly Recommended)

Australian Fixed Interest – Specialist

• Goldman Sachs JBWere Core Plus Australian Fixed Interest Fund (Highly Recommended)
• Perennial Tactical Income Fund (Recommended) International Fixed Interest – Bonds
• Advance International Fixed Income Multi-Blend Fund *UPGRADE* (Highly Recommended)
• EQT PIMCO Wholesale Global Bond Fund (Recommended)
• Vanguard International Fixed Interest Index Fund *NEW* (Recommended)

International Fixed Interest – Corporate Debt

• Colonial First State Wholesale Global Credit Income Fund (Highly Recommended)
• Bentham Global Income Fund (Recommended)
• Bentham Syndicated Loan Fund *NEW* (Recommended)

Diversified Fixed Interest

• Colonial First State Wholesale Diversified Fixed Interest (Recommended)
• EQT PIMCO Wholesale Diversified Fixed Interest Fund *NEW* (Recommended)
• Macquarie Diversified Fixed Interest Fund (Highly Recommended)
• MLC Diversified Debt Fund *NEW* (Recommended)
• Schroder Fixed Income Fund *UPGRADE* (Highly Recommended)
• Vanguard Index Diversified Bond Fund (Recommended)

Last year’s Fixed Interest Sector Report focused on the changing nature of Bond Indices and the effects this could have on future performance of fixed interest portfolios as well as the importance of maintaining Strategic Asset Allocation.

While these topics remain relevant today, this year Zenith chose to address some investor concerns, specifically whether to use diversified fixed interest funds or specialist sector funds and the veracity of the ‘Bond Bubble’ claims.”

The last few years have been a roller coaster ride for investment markets and investors alike. During this period many investors were understandably disappointed with the performance of their investments, particularly those they thought were defensive.

Unfortunately, many products labelled as diversified fixed income funds were among these defensive investments that failed to deliver on expectations.

Following this disappointing period it’s not surprising that many investors questioned their fixed income allocations. The natural question became ‘if the diversified offerings had failed to deliver on expectations would it be better to segregate the fixed income allocation and allocate to specialist managers?’

In response, Steven Tang offered the following insight, “While a simple portfolio construction exercise, in which mandates are separated and return data over the past few years is used, lends credence to the intuitive appeal of this idea (based on the presumption that these specialised managers have superior skills within their more defined mandates), the outcome is highly dependent on the investor making the correct initial and ongoing asset allocation decision.”

Although it’s simple in hindsight it’s historically a very difficult task to execute successfully and can dramatically change the outcome. Performance over the past few years by diversified fixed income managers has been more a reflection of their strategic benchmarks than their lack of skill in this area.

Given the changing fixed income landscape these managers remain better placed to exploit the diverse range of opportunity sets, alleviating investors of the complex asset allocation decision.

It’s for this reason that Zenith’s Recommended List and fixed interest portfolio exposures remain biased to Diversified Fixed Interest Funds.”

In reference to the debate concerning the existence and threat of a ‘Bond Bubble’ in the US Treasury market Steven Tang observed that using the typical definition of a ‘Bubble’, i.e. irrational market behaviour driven by speculative mania, it’s unlikely that the US Treasury market represents a ‘Bubble’.

Unlike other financial markets, investors know exactly what returns they will receive if they hold until maturity (assuming no defaults). Additionally, short-term gains are likely to be very modest given current yields. More likely investors are looking for a safe haven for their savings given their torrid experiences of the last few years and the current uncertainty in global financial markets.

Steven Tang concluded, “Nevertheless, it’s definitely possible that investors could face a capital loss as bond yields rise. However, while they may not remain at their current lows, it’s difficult to see a near term catalyst for a rapid rise in yields which would result in large investor losses.”

“In the future, US growth may surprise on the upside, the US Federal Reserve may maintain its loose monetary policy for far too long, creating massive inflationary pressures, or demand for US Treasuries could dissipate making US Treasuries an appalling long-term investment.

“But not in the near-term.”

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Chris Saunders, Wilson HTM Head of Financial Advisory said “We selected Zenith based on the rigour of their research process; marketplace reputation for diligence and service – and most importantly, Zenith’s understanding of Wilson HTM’s unique internal research requirements.”

BDO Wealth Management in Melbourne, and I-Group Financial based in Brisbane and Newcastle, have also recently confirmed Zenith as the provider of their external research.

Furthermore, Melbourne based DFS Portfolio Solutions has appointed Zenith to its Investment Advisory Board to complement its internal investment process.

Commenting on Zenith’s success and client growth John Nicoll, Zenith National Sales Manager, said “There continues to be a significant shift back to the need for tighter, high quality approved product lists based on advice driven support that understands the individual requirements of each adviser group business.”

“The impact of the GFC and a reversion back to risk focussed processes has been beneficial to our business. Fortunately, this has been the model we have always delivered at Zenith, and continue to do so.”

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The first sector reviewed focuses on Market Neutral and will be followed in the near future by CTA / Global Macro, Long / Short Domestic Equities, Long / Short Global Equities, Event Driven, Multi Strategy, Fund of Hedge Funds and Fixed Income.

Commenting on the Market Neutral Sector review, Daniel Liptak said, “Currently significant risk in diversified portfolios arises from equities exposure and this is due to the assumption that over the long run equities outperform. The purpose of the Zenith Market Neutral Sector Report is not to dissect such an assumption, but rather highlight that a significant portion of that equity risk is on the downside.”

“Any investment allocation decision that ignores the consequences of risk and the associated long-term drag on compound returns is deficient. Zenith advocates an investment approach that is designed to minimise this exposure risk.”

The events of 2008 and the subsequent period created an opportunity for the Zenith Hedge Fund Review Team to rationally review the benefits of alternative investments.

“The objections (to hedge fund investments) that were voiced by many commentators regarding liquidity, transparency and leverage are clearly being addressed by the industry,” added Daniel Liptak.

“The negative impact of draw-downs from traditional equities and the affect on long-term compounding is a concern for all investors. Australian market neutral funds have over the last 5 years captured all the upside of the Australian All Ordinaries but importantly did not participate in the downside.”

Zenith’s composite index of approved market neutral funds has delivered a cumulative return of 105%, net of fees, since July 2005.

Over the same period the Australian All Ordinaries Equity Index has returned to investors only 2.24% (gross of fees).

Zenith Investment Partners, Director and Co-founder David Smythe further notes, “Zenith affirms that market neutral funds, when combined with long only equity funds can significantly reduce volatility of the portfolio and simultaneously increase the expected return over the longer term.”

On the issue of fees, David Smythe states that while it is true hedge funds do charge higher fees they are in fact not higher than those charged by benchmark aware managers on the active portion of their portfolios.

There is a compelling argument to suggest that hedge fund managers are charging less for alpha than benchmark aware funds.

“Zenith contends that the focus on fees in the benchmark aware space is therefore warranted – but also notes that any discussion on fees should be undertaken with reference to alpha, not just the headline fee rate,” said David Smythe.

Post review of the Market Neutral sector Zenith’s Approved Listed funds were:

Commenting on the successful establishment of Zenith’s Hedge Fund Review Team David Smythe confirmed that the national research provider is targeting a segment of the research market that currently is not being well serviced.

“There is a “middle market” comprising Private Banks, Family Offices, Self Managed Super Funds and Small Institutions that are demanding specialist consulting services on innovative alternative investments that are not currently being serviced by the large asset consultants or by the research houses.”

“Zenith has therefore sought to extend its coverage, particularly in the Alternatives space for the benefit of not only this target market but also for our existing clients who are interested in more in-depth coverage of Hedge Funds,” concluded David Smythe.

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The models, which operate under a managed investment scheme structure, are actively managed by Zenith on behalf of clients to ensure that the funds held in the portfolios and their weightings remain optimal over time.

Each model portfolio contains 8 – 15 of Zenith’s highest rated managed funds, with five risk profiles on offer (i.e. Conservative, Moderate, Balanced, Growth and High Growth).

Announcing the launch of the Zenith model portfolios, Zenith Associate Director Glen Franklin said, “The Zenith model portfolios provide a unique one-stop solution for advisers where they can have their client portfolios managed by Zenith’s highly experienced Adviser Services team, whilst at the same time drastically reducing the typical administrative requirements associated with making changes to client portfolios.”

“In addition, the underlying Linear Managed Account platform is a cutting edge, fully functioning administration platform that provides detailed portfolio valuations, portfolio performance and tax reporting for the client, with a pricing structure that is significantly lower than the major wraps”.

Linear Asset Management’s Managing Director Chris Hipkin added, “Zenith’s model portfolios will allow the wider financial planner network to utilise Zenith’s expertise in providing quality research.”

“Zenith’s strategic alliance with the Linear Managed Account platform will enable greater efficiency and functionality for advisers by highly researched diversified, multi-manager model portfolios, this is a great value add for clients”.

Some of the key benefits of the Zenith model portfolios are:

• Zenith model portfolios operate under a managed investment scheme structure. Therefore any portfolio changes can be made in a timely and efficient manner, without the need for individual Statements of Advice (SOA) and lengthy delays.
• Combined with the Linear Managed Account structure, Zenith’s model portfolios have the potential to revolutionise an advisers business from an efficiency and compliance perspective.
• All models are actively managed by the Zenith Adviser Services team, a team of professional investment analysts dedicated to the delivery of optimum portfolio construction.
• The multi-manager structure of the Zenith models enables Zenith to select what it considers to be “best-of-breed” funds for each asset class. This contrasts with single manager diversified funds where all asset classes are managed by a single funds management organisation that may not possess strong capabilities across all of these asset classes.
• Zenith’s five separate risk profile offerings ensure there is a Zenith model portfolio on offer to suit the risk appetite of most investors.
• Unlike a traditional multi-manager unit trust, the Managed Account structure used for the Zenith model portfolios ensures that clients retain the ownership of each of the underlying managed funds held within the model portfolio. Via the Linear Managed Account platform, clients can clearly see their unit holding in each underlying managed fund, as well as each fund’s individual performance.
• Quarterly reporting is provided, highlighting which underlying funds have been the key drivers of performance and providing a useful source of information for adviser discussions with their clients.

“Zenith has established and enviable reputation and track record within the financial services industry for innovation, consistency and service – and this has provided the solid foundation for client growth / retention.”

“The launch of Zenith’s model portfolios on the Linear Managed Account Platform will provide advisers an excellent facility and service to facilitate the attainment of their clients’ wealth creation and financial goals,” concluded Glen Franklin.

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