equus point capital market neutral fund · the fund returned -3.71% after fees for the month. stock...

Equus Point Capital Market Neutral Fund Performance Update 31 March 2020

Equus Point Capital Pty Ltd is a Corporate Authorised Representative (001266997) of Prodigy Investment Partners Limited (AFSL 466173).

Commentary

The Fund returned -3.71% after fees for the month.

Stock selection generated -3.41% alpha for the month, with longs returning -4.00% alpha and shorts +0.59% alpha, whilst our beta positioning contributed -0.23% alpha.

In an environment where extreme intra-day and daily volatility was 3-4x recent norms and the S&P/ASX 200 Accumulation Index down 20.6% for the month and off 28.4% from its February high, capital preservation remains the focus.

Three key issues need to be addressed in order for the market to find meaningful support and for volatility to abate:

1. Monetary stimulus 2. Fiscal stimulus 3. Public health

During March we witnessed the dislocation in global bond markets where yields increased rather than decreased as per the common view that the flight to safety warrants lower, not higher, bond yields. This forced the Fed and central banks to unleash record monetary support with low (effectively zero) cash rates and quantitative easing to force bond yields lower and ensure the functioning of global credit markets. Essentially doing “whatever it takes” to avoid the liquidity and solvency issues that typified the GFC. The RBA has also joined this QE band wagon targeting 0.25% on three year bonds.

Given the Australian economy is some $1.9 trillion in size and leading economist estimates of a 10% decline in second quarter GDP, a fiscal stimulus package of some $211b and counting appears on face value to be appropriate. Perhaps rather than being a stimulus package it should be more appropriately described as a disaster recovery package, designed to bridge the pre and post crisis economy.

Obviously the situation remains fluid and no one knows if the economic impact will be V shaped or U shaped, or indeed the dreaded L shape. But we know the economy was fundamentally sound going into the crisis. This is not a liquidity crisis like the GFC. Rather it is a sharp

demand based shock to the economy that should recover given the right conditions. The pace of that recovery, and the required disaster relief, remain unknowns.

Fundamentally the level of Australian government debt to GDP was 41% going into this crisis, which compares favourably to other G20 nations. On this basis providing initial support equivalent to 10% of GDP appears to be something we can afford, especially when yields are at historical lows.

Of course one has to ask who will buy this unprecedented issue of government bonds? There simply is not enough capital to absorb the Australian issuance along with every other government fiscal stimulus, so the RBA and central banks will be forced to take on this government debt.

In the longer term questions will be raised about how do we pay for this extraordinary support? One suspects that either taxes will need to be increased and/or we see a re-emergence of inflation.

With central bank and government support already announced (although the final extent of that support remains unknown) the final factor in determining the outlook for the economy and markets are the public health implications of COVID-19.

At the time of writing, domestically we are starting to see a reduction in the number of new cases and this is encouraging, but vigilance will be required to ensure this trend remains intact. One must also be cognizant of the threat of further flair ups (the Spanish Flu of 2018-19 experienced three waves). Ultimately the only viable long-term solution to the pandemic is the development

0%

50%

100%

150%

200%

250%

G20 Government Debt to GDP Ratio

Net Returns 1m 3m 6m 1yr Incept pa Risk Characteristics Equus Point Capital -3.71% -2.74% -6.49% -6.71% -2.88% Volatility 8.86% S&P/ASX 200 Accum -20.65% -23.10% -22.57% -14.42% -3.94% Beta -0.04 Cash 0.04% 0.16% 0.35% 0.97% 1.09% Correlation to S&P/ASX 200 -0.09 Excess v Cash -3.74% -2.90% -6.84% -7.68% -3.97% Sharpe Ratio -0.45



of a vaccine and health experts warn this is 12-18 months away. In the interim widespread testing and tracing will be required to ensure any flare ups are identified and limited.

And of course we don’t know what it will mean to come out of ‘hibernation’. Social distancing, or at least social awareness, will likely see a gradual reopening of the economy. Some businesses will fail while others will take time to recover. Working remotely for many may have an ongoing impact on work practices and productivity. And changes to consumer behavior may cause lasting impacts to travel, ocean cruising, airlines, cinemas and shopping centres among other industries.

Market Risks and Valuations

In January we alluded to the inherent elevated risks to the market given risk adjusted returns were at positive extremes and the market was being driven higher by increased valuation multiples and not through changes in earnings. We update those risk adjusted returns given the 30% decline in the market to provide a reassessment of risks.

With the rapid decrease in the market and increase in volatility, the risk adjusted return for the market (i.e. the Sharpe Ratio) has gone from north of 3.0 in November 2019 to -0.7 as at end of March 2020. If history is a guide in times of extreme dislocation risk adjusted returns can fall to as low as -2.0 before markets recover. By way of example previous extreme lows include:

March 1982 as the economy entered recession

Dec 1990 prior the recession later that year

Feb 2003 during the bottom of the economic slowdown brought about by the tech bust and the impact of 9/11

Nov 2008 prior to the bottoming of the economic slowdown during the GFC

For risk adjusted returns to reach extreme negative levels we need to see further declines in the index or a

moderation in underlying volatility. Historically volatility has tended to fall first as markets bottom. History also tells us that future returns are likely to be above average when risk adjusted returns are at negative extremes.

We can also view the market through the prism of the earnings yield on equities (the inverse of the price to earnings ratio) versus risk free rates and implications for the change in earnings from the shock to the market. A high equity yield premium implies investors are seeking a higher degree of comfort to compensate for the additional risk of putting funds towards equity assets.

What we have seen over the last six weeks has been a rebasing of price. The equity yield premium (the difference between the earnings yield on equities and the risk free rate) has gone from 4.8 to 7.0 (which is consistent with the peak during the GFC). Note, since the recovery out of the GFC the equity yield premium has ranged between 3 and 5.

Whilst we have experienced the impact on prices, we are yet to see the impact on earnings. We know earnings will be impacted as companies experience a loss in headline revenue, try to manage costs and are forced to restore balance sheets through dilutive capital raisings. We would also expect companies to delay, reduce and cancel dividends to reflect these lower earnings. During the GFC the impact on earnings per share was a decrease of 40% across the market and a 30% decrease in dividends.

To give a sense of the sensitivity of the equity yield premium and the impact on earnings, the following table provides three broad scenarios:

1. A worst case scenario akin to a GFC type event where earnings decrease across the market by 40% and the equity yield premium reaches 7.0.

2. A moderate scenario where recession type event decreases earnings by 20% and the equity yield premium is 5.5.

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

S&P ASX 200 Index Sharpe Ratio

-40%

-20%

0%

20%

40%

60%

-4.0 -2.0 0.0 2.0 4.0 6.0

Futu

re 1

Yea

r R

etu

rns

Sharpe Ratio

Sharpe Ratios & Future 1 Year Returns

Low Sharpe Ratios High Sharpe Ratios



3. A best case scenario or shallow event where earnings decrease only 10% and the equity yield premium is 4.0 on the expectation of a quick recovery.

GFC Recession Shallow

Risk Free Rate 0.50% 0.75% 1.00%

Equity Yield Premium 7.0% 5.5% 4.0%

Change in Earnings -40% -20% -10%

Implied Index 3127 5003 7035

Implied PE 13.3 16.0 20.0

Implied Up/Down side1 -40% -4% 36%

Now bear in mind we are not market strategists, but we do attempt to consider a range of measures that provide a sense of market dynamics and risks. It is not an exact science. The scenarios are merely what we view as ‘reasonable’ at this time given there are so many unknowns as to the true impact of the shock to businesses and the market.

The following chart furthers that sensitivity by mapping changes in the equity yield premium and changes in earnings for the market.

Fund Performance over the Month

Whilst we avoided the excess declines of the market during March, we were not immune. The 3.7% decline was however tempered by our overall reduction in exposure over the month as market volatility spiked and prices collapsed. The dislocation in global bond markets where yields failed to act as a safe haven and actually increased during the month before central bank intervention saw interest rate sensitive stocks impacted negatively. This included REIT’s which are traditionally seen as lower beta and lower volatility exposures. It is now apparent with social awareness and changes in consumer behavior that REIT’s, in particular those with shopping centre exposure, are particularly impacted.

1 S&P/ASX 200 Index 5067 as at 3 April 2020.

Gold is also often seen as a safe haven in times of stress. However market dislocation during the month in the face of portfolio rebalancing and (one suspects) margin calls on leveraged players, saw gold price decreases as investors sought immediate liquidity, irrespective of fundamentals and safe haven status.

Our deliberate attempt to remove the impact of market movements (i.e. beta) from the strategy’s return stream does provide downside protection in the event of large market declines like March, as demonstrated in the chart below.

Portfolio Positioning

With respect to how the strategy may behave in a rapidly altered environment we would reiterate the following points.

1. Firstly, as a market neutral strategy we deliberately attempt to remove the impact of the market from the return stream.

2. Secondly, when market volatility and underlying stock volatility spike, our strategy will naturally reduce exposures to maintain a more stable effective risk level.

3. Lastly in times of stress where outcomes are unknown, our focus becomes one of capital preservation.

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. Fortunately this is precisely the behavior that the strategy is designed to reflect.

Accordingly we retain our defensive positioning.

3,000

4,000

5,000

6,000

7,000

8,000

9,000

Equity Premium v Change in Earnings Sensitivity

Earnings Fall 0% Earnings Fall 10%

Earnings Fall 20% Earnings Fall 30%

Earnings Fall 40%

-25%

-20%

-15%

-10%

-5%

0%

5%

S&P/ASX 200 Largest Negative Monthly Returns*

XJOAI Return Portfolio Return *June 2000 to Mar 2020

March 2020



Net Monthly Performance

Gross Monthly Performance

Asset Positions Weight Contrib Alpha

Long 62 60.15% -23.60% -4.00%

Short 0 0.00% 3.89% 0.59%

Futures -65.81% 16.08% -0.23%

Cash 39.85% 0.01% 0.01%

62 100.00% -3.62% -3.62%

Cash

0.04%

Excess

-3.66%

Exposure and Gross Monthly Alpha

Sector Name Long Weight

Short Weight

Active Weight

Alpha Contrib

Energy 1.5% 0.0% 1.5% -0.64%

Materials 6.4% 0.0% 6.4% -1.65%

Industrials 4.1% 0.0% 4.1% -0.53%

Cons Disc 3.2% 0.0% 3.2% 0.47%

Cons Staples 2.7% 0.0% 2.7% 0.34%

Health Care 15.7% 0.0% 15.7% 2.43%

Financials 19.3% 0.0% 19.3% -4.92%

Info Tech 4.0% 0.0% 4.0% 0.95%

Comm Serv 2.9% 0.0% 2.9% 0.09%

Utilities 0.4% 0.0% 0.4% 0.05%

Stock Total 60.2% 0.0% 60.2% -3.41%

Futures -65.8% -0.23%

Cash 39.8% 0.01%

Total 100.0% -3.62%

Net Exposure 60.2% Gross Exposure excluding Futures 60.2% Gross Exposure including Futures 126.0%

Major Alpha Contributors

Name Weight Contrib Alpha

Top Five Contributors Fisher & Paykel H. 4.77% 0.65% 1.10%

ResMed Inc. 3.56% -0.01% 0.73%

Xero Ltd 2.62% -0.27% 0.72%

Coles Group 0.00% 0.23% 0.50%

Nextdc Limited 1.32% 0.22% 0.35%

Bottom Five Contributors National Storage 0.70% -0.67% -0.46%

Silver Lake Resource 1.34% -0.46% -0.49%

Charter Hall Group 0.67% -0.94% -0.52%

Ingenia Group 2.25% -1.28% -0.91%

Credit Corp Group 0.61% -1.87% -1.17%

0%

5%

10%

15%

20%

25%

Sector Exposure

Long Weight Short Weight

-6.0%

-5.0%

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

Sector Alpha

Long Alpha Short Alpha

0

5

10

15

20

25

Positions

Long Positions Short Positions

Net Returns 1m 3m 6m 1yr Incept pa Risk Characteristics Equus Point Capital -3.71% -2.74% -6.49% -6.71% -2.88% Volatility 8.86% S&P/ASX 200 Accum -20.65% -23.10% -22.57% -14.42% -3.94% Beta -0.04 Cash 0.04% 0.16% 0.35% 0.97% 1.09% Correlation to S&P/ASX 200 -0.09 Excess v Cash -3.74% -2.90% -6.84% -7.68% -3.97% Sharpe Ratio -0.45


Disclaimer and Disclosure Equity Trustees Limited (‘EQT’) (ABN 46 004 031 298 AFSL 240975) is the Responsible Entity for the Equus Point Capital Market Neutral Fund. The material contained in this communication (and all its attachments) is general information only and has been prepared by Equus Point Capital (“EPC”), a Corporate Authorised Representative of Prodigy Investment Partners Limited (“Prodigy”), AFSL 466173. It is not intended to take the place of professional advice and you should not act on any recommendation (if any) made in this communication without first consulting your investment advisor in order to ascertain whether the recommendation (if any) is appropriate, having regard to your investment objectives, financial situation and particular needs. Nothing in this communication shall be construed as a solicitation to buy or sell a security or to engage in or refrain from engaging in any transaction. EPC and Prodigy believe that the information and advice (if any) contained herein is correct at the time of compilation. However, EPC Prodigy and EQT provide no representation or warranty that it is accurate, complete, reliable or up to date, nor does EPC, Prodigy or EQT accept any obligation to correct or update the opinions (if any) in it. The opinions (if any) expressed are subject to change without notice. EPC, Prodigy and EQT do not accept any liability whatsoever for any direct, indirect, consequential or other loss arising from any use of the material contained in this communication. This communication may refer to the past performance of a person, entity or financial product. Past performance is not a reliable indicator of future performance. Investors should obtain the relevant product disclosure statement and consider it before making any decision to invest.

Investment Manager Equus Point Capital is a boutique fund manager focused on producing meaningful risk adjusted returns from the Australian equities market. Equus Point was founded in 2017 in partnership with Prodigy Investment Partners. Equus Point’s investment process is systematic, designed to produce a return stream irrespective of market direction over the long term, with low volatility and uncorrelated to traditional asset classes.

Fund Objective To deliver absolute returns above the RBA Official Cash Rate over a rolling five-year period, with low volatility and a low correlation to traditional asset classes.

Investment Philosophy Equus Point uses a systematic approach to investing, seeking to harvest meaningful risk adjusted returns from behavioural biases in the Australian equities market. The strategy uses both long and short positions coupled with index futures to achieve a market neutral portfolio that seeks to produce positive returns irrespective of equity market direction and uncorrelated to traditional assets. Equus Point’s robust risk management approach limits to portfolio’s beta positioning, portfolio volatility, individual stock positioning, and long and short portfolio positioning. The Fund employs a proprietary systematic investment process. The Fund invest exclusively in Australian equities and equity derivatives. We believe in the following:

In the short to medium term behavioural biases of investors can influence stock prices leading to both momentum and reversion effects. Momentum is where stocks with positive historical returns tend to be rewarded with a continuation of positive returns, and stocks with negative historical returns tend to underperform with a continuation of negative returns. Reversion is where stock prices initially overshoot before returning to a perceived fair value.

Meaningful risk adjusted returns can be achieved through a portfolio of both long and short positions seeking to harvest positive and negative momentum.

Managing the risks of the potential for stock price reversion, stock volatility, portfolio volatility and beta exposure are a core part of the investment process.

Market neutral positioning between long and short portfolios is ensured through the use of index futures to offset residual beta risks.

Combining the above dynamics with acceptable leverage delivers a portfolio that is designed to provide superior risk adjusted returns through market cycles.

Benefits of the Fund 1. A systematic strategy with a disciplined focus on

risk management. 2. Attractive risk adjusted returns over the long term. 3. Low volatility return stream uncorrelated to

traditional asset classes over a rolling five year time frame.

4. Expected to preserve capital in volatile and negative equity markets.

Key Attributes APIR Code ETL5256AU Benchmark RBA Official Cash Rate Investment Objective To deliver absolute

returns of 5% above the RBA Official Cash Rate over a rolling five year period

Management Fee 1.20% Performance Fee 20% over benchmark plus

Management Fee Redemption/Liquidity Daily Buy/Sell Spread +/-0.35% Entry/Exit Fees Nil Distributions Half Yearly Inception 30 Nov 18 Investment Manager Prodigy Investment

Partners Sub Investment Manager Equus Point Capital Trustee Equity Trustees Limited Prime Broker Morgan Stanley Administrator RBC Investor Services Further information: www.equuspointcapital.com Phone (03) 9909 2680

http://www.equuspointcapital.com/

equus point capital market neutral fund · the fund returned -3.71% after fees for the month. stock...

Documents