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Using ETFs & LICs to help with market volatility - Part 1, LICs

ETF Watch - Jan 16, 2016

2016 has certainly started with a bang. As we write this the ASX is down around 8% for the year, some advisers are telling their clients to sell everything and the most fear and panic we’ve seen for a number of years are gripping global markets. This two part series is going to look at some of the strategies and funds that can be used to protect your portfolio in these volatile times. Part 1 below focuses on Listed Investment Companies (LICs), with part 2 focusing on Exchange Traded Funds (ETFs).

1. Absolute Return LICs

Absolute return funds, a type of hedge fund, work by going ‘long’ (buying) some stocks and going ‘short’ (selling) other stocks. Their rationale being that they can pick both undervalued and overvalued companies, buy the undervalued ones and sell the overvalued ones and if things go the way they expect make a lot of money. By having a portion of their portfolio ‘short’ they are naturally protected from broad market falls, and if they’ve gone short on the right stocks, the falls in those stocks may outweigh the falls in the stocks they are long and they can have positive return, even when markets capitulate.  Some managers have approximate equal weighting to long and short positions, these are called market neutral funds, others have discretion where they can be overweight long or short positions, meaning if they pick the falls and rises correctly they can seriously outperform.

Some of our favourite absolute return LICs are:

Absolute Equity Performance Fund (AEG) – Only listed for around a month, we have written about this one before. It is Bennelong Funds Management’s first foray into LICs, and implements their successful paired trade Long/Short strategy where two similar stocks are selected, and a long position opened on one and short position on another. The performance of the fund it has been modelled on is exceptional, however the market knows this, and already the fund is trading at around a 12% premium to its NTA. There are also a number of options that will vest in about 6 months’ time, meaning further dilution once the options get excercised.

Australian Leaders Fund (ALF) – One of the oldest Absolute Return LICs, ALF went through a period of underperformance last year, seeing its price fall dramatically. Thankfully this looks to be behind them, with a recent announcement that their performance over the first 2 weeks of January is +1%, compared to -7% for the ASX 200. They have discretion over their long and short positions and are currently net short, so are really benefiting from recent falls. It seems the market hasn’t quite caught up with their turnaround with the NTA still only trading at a slight premium to the price.

Cadence Capital (CDM) – The second biggest of the Absolute Return LICs with a market cap close to $400m, CDM tends to have a long bias, however currently holds 24% of its funds in cash, helping to reduce falls, and pounce on any bargains that are sure to arise. CDM has a long history of outperformance and currently trades at about a 13% premium to its NTA, its highest premium in recent history.

PM Capital Global Opportunities Fund (PGF) – Whilst some of the other LICs mentioned have positions in global companies, this is the only fund which focused predominantly on global equities. The fund can only hold 30% of its portfolio short, and its performance hasn’t been overwhelming during its first 2 years of trade, meaning it is trading at a healthy 15% discount to its NTA.

WAM Capital (WAM) – Probably the most known of the Absolute Return LICs, WAM has a market cap of close to $1b, making it over twice the size of its nearest rival and can short sell up to 50% of its portfolio. It also has a number of years of outperformance backing it up, and after returning 25% in 2015 now trades at a premium to NTA of about 8%. WAM also has a much small sister fund called WAM Active (WAA) which has only a $36m market cap, but trades much closer to its NTA.

Wealth Defender Equities (WDE) – Employing a slightly different strategy to the Long/Short managers, WDE uses derivatives and cash to minimise the impacts of market falls. Only listing in May 2015, it has not had time to prove itself yet, but so far has slightly outperformed the market. We’re expecting this one to be more correlated to general market movements than the Long/Short funds covered. Currently WDE trades on a 11% discount to NTA.

Watermark Market Neutral Fund (WMK) – Managed by the same team behind ALF, this fund aims to have close to a 50/50 split between Long and Short positions, meaning no net position to general market movements. WMK was dogged by the same period of underperformance as ALF 6 to 9 months ago and whilst performance in 2015 was an impressive 26% before fees still trades at around a 10% discount to its NTA.

This is not an exhaustive list of Absolute Return Funds on the ASX, there are 15 in total that we cover at ETF Watch, however these are the biggest ones with the most liquidity. You can view the full list of Absolute Return LICs here.

2. Alternative Asset LICs

Most of the Australian based LICs focus on Australian and Global Equities, there are a few however which focus on other asset classes which can provide some diversification to your portfolio in times of market turmoil. We look at some of these below:

Argo Global Listed Infrastructure Limited (ALI) – Managed by the same team as big daddy of the LICs, ARGO (ARG), this fund as its title suggests focuses on global infrastructure securities, an asset class generally considered less volatile than traditional equities. To date the fund has followed the downward slope of traditional equity markets, however with only 6 months of history it is too early to determine how closely correlated ALI will be to traditional equity funds. ALI trades at about a 7% discount to NTA.

Blue Sky Alternatives Access Fund (BAF) – Generally invests in non-listed assets including private equity, real assets, real estate and hedge funds. The good news for investors is the outstanding options that existed have now expired so there will be no more dilution of NTA for shareholders. This fund may offer additional diversification for investors, without full correlation to share markets due to the unlisted nature of the holdings. There are other risks with unlisted assets however which investors must keep in mind. BAF’s price is around the same as when it listed back in June 2014, and is trading at about 7% discount to NTA.

There you have it, some of the funds that may help your portfolio deal with market volatility. We recommend you do your own research as the above analysis should not be construed as recommendations by ETF Watch. In our next post we’ll take a look at some of the ETFs that can help to cushion the blow.

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