It is not normal practice to provide intra-month updates on performance. However, given the quantum and pace of movement in the market over the last couple of weeks, these are not normal times, and we felt it prudent to provide investors with an update on how the strategy has been performing and how the portfolio has been positioned in the face of market wide declines.
In January we warned of the inherent risk that existed in the market. Historic risk adjusted returns were at extreme highs and history tells us that this is unsustainable. To normalize, future returns needed to moderate or fall, volatility needed to increase or we needed see a combination of lower returns and higher volatility.
The long term risk adjusted return for the S&P/ASX 200 Accumulation Index is 0.25. However, the Index’s risk adjusted return peaked at 3.2 in November 2019. To put this into perspective the one year risk adjusted return for the Index has only been as high on five occasions over the last forty years. Those five occasions were:
Below we update the chart we presented in January. The one year Sharpe Ratio has dropped from 3.2 in November to -0.25 (as at 9 March 2020). Note, these steep declines have also followed those periods when risk adjusted returns were at positive extremes.
Now we are not market timers and we did not foresee the coronavirus, but it has been the ‘Black Swan’ event made famous by Nassim Taleb’s 2008 book on the impact of the highly improbable. The coronavirus has been the prick that has burst the bull market.
Nor can we make predictions about the timing about when markets will recover. It is too early to determine the full impact the virus will have globally on economies and markets. Put simply nobody knows the potential impact. Whilst this uncertainty remains prevalent in investor’s minds, lower interest rates, fiscal stimulus and cheaper market valuations are likely to take a back seat. Yes, the market is 19% cheaper than two weeks ago, but the impact on earnings is yet to be fully understood. This provides the potential for further disappointment as investors discount potential risks.
Since the market peak on the 20th February we have seen the index down some 19%. In comparison the drawdown on the Fund has been limited to just 2%. Note we are not immune to the threat of a drawdown, but ideally it is contained.
We have also seen a rapid and steep increase in three month market volatility from 11% to 20%. In the same period the volatility for the Fund has remained firmly below 10% despite the markets change in perceived risk.
Over the cycle we expect the return stream from the strategy to be uncorrelated to that of the equities market. Note, that does not mean as a market neutral strategy we will make money in up markets and down markets, month in and month out. Rather over the cycle and as trends develop we expect to produce a return stream irrespective of market direction.
In times of stress where outcomes are unknown, our focus becomes one of capital preservation.
We will not pick turning points in the market, but we will participate in clearly defined and extended relative trends, be they positive or negative. Experience indicates that a weak global macro view, economic shocks from bush fires and COVID-19, combined with fear and panic selling can lead to an environment where one should focus on capital preservation. It is not an environment of adding to positions in the expectation of an immediate rebound. It is an environment of preserving capital until the implications of a global pandemic on the economy and markets are more clearly defined through price evolution.
Accordingly we remain defensively positioned.
We would emphasize that our strategy is not designed to be an investor’s only exposure to the equities market.
Rather we view our strategy as an alternative return stream uncorrelated to the return from equities (and for that matter other asset classes). We seek to provide returns between 5% and 10% over cash over the long term, with volatility outcomes significantly less than that of the broader equities market. Additionally we view our strategy as forming a component of a diversified portfolio where investors can achieve enhanced risk adjusted returns by exchanging some equity beta for an uncorrelated exposure.
Month to date the Fund is +1.89% versus the S&P/ASX 200 Accumulation Index -10.09%. In an environment that that is inherently volatile and prone to large drawdowns, it is pleasing the strategy has performed exactly as it is expected to behave.
Equus Point Capital
10 March 2020
The material contained in this communication (and all its attachments) has been prepared by Equus Point Capital Pty Ltd. Equus Point Capital is a Corporate Authorised Representative of Prodigy Investment Partners Limited AFSL No. 466173 (“Prodigy”).
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Equus Point Capital and Prodigy believe that the information and advice (if any) contained herein is correct at the time of compilation. However, Equus Point Capital and Prodigy make no representation or warranty that it is accurate, complete, reliable or up to date, nor does Equus Point Capital or Prodigy accept any obligation to correct or update the opinions (if any) in it. The opinions (if any) expressed are subject to change without notice. Equus Point Capital and Prodigy do not accepts any liability whatsoever for any direct, indirect, consequential or other loss arising from any use of the material contained in this communication.
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 ASX All Ordinaries Accumulation Index for period from Dec 1980 to Apr 2000 and S&P/ASX 200 Accumulation Index from Apr 2000 to Dec 2019.