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Investing in Liquid Alternatives –
Our Pure Strategies
Investors’ Insight
Harcourt Investment Consulting
For institutional investors only
Content
3 Executive Summary
The quest for diversification and absolute returns
4 History
From the script to the creation of the Pure Strategies
5 Pure Strategies
The making of the Pure Strategies
6 Creating robust portfolios with Liquid Alternatives
8 How can you invest?
9 Conclusion
Cost-efficient, transparent and liquid
10
Management
Our Pure Strategies team
2 Liquid Alternatives
Executive Summary
The quest for diversification
and absolute returns
Since the outbreak of the financial crisis in 2008, the
world’s biggest central banks have flooded the financial
markets with liquidity, paving the way for the current
­market environment marked by low interest rates. As a
consequence, large investors such as insurance companies
and pension funds have found it increasingly difficult to
reach their investment goals and are looking for additional
ways to make good on their promises to clients 1. This has
involved a search for alternative risk premia – strategies
that can deliver suitable risk-adjusted returns by investing
in a range of uncorrelated asset classes. Until recently,
these highly sophisticated investment strategies have only
been available to a very limited circle of “smart money”
in­vestors such as hedge funds and university endowments.
While these strategy-related risk premia have generated
substantial above-average returns since the early 1990s,
they have come at a considerable cost in the form of high
fees, a lack of transparency and illiquidity. The ensuing
­significant changes in the product landscape have set the
stage for so-called “liquid alternative strategies”. These
formerly exclusive strategies are now widely available as
regulated mutual investment funds with all their associated
benefits, resulting in additional investment oppor­tunities
for institutional and private investors alike.
Our Pure Strategies – your benefits at a glance
We offer access to absolute “hedge-fund-style” re­
turns while being significantly more cost-efficient,
offering full transparency under the UCITS IV frame­
work with daily liquidity/NAV data.
Our investment philosophy is based on our syste­matic, well-researched and rules-based investment
approach.
We focus on robust, liquid alternative strategies
that perform well in different market environments
and provide downside protection during times of
crisis due to proven diversification benefits.
Strategy-specific, “pure” risk premia are comple­
mentary to traditional risk premia from equities and
bonds, for example, thereby enhancing a portfolio’s
overall risk-return profile.
Four dedicated portfolio managers with a combined
investment experience of nearly 60 years, proven
track records, and four European Hedge Fund Review
(HFR) performance awards.
Our liquid alternative strategies open up access to alternative risk premia which have previously only been available to some of the most sophisticated “smart money” investors. Furthermore, we can offer exposure through a
systematic investment approach within a regulated UCITS IV mutual fund structure.
1
Euromoney (2013): Insight – Financial repression hits pension funds, heaping on liability risks.
Liquid Alternatives 3
History
From the script to the creation of
the Pure Strategies
In 1952, Harry Markowitz’s seminal paper “Portfolio Selection”2 marked the financial industry’s academic ­starting
point for the concept of diversification, providing the principal blueprint for protecting portfolios against large
drawdowns for decades. However, the stock-market crash
in 1987 and the bursting of the “IT bubble” at the turn
of the millennium highlighted serious practical flaws in this
widely-held concept, as several usually only slightly correlated (or even uncorrelated) asset classes suddenly declined
in unison. Investors who had relied on protection through
diversification were left sitting with heavy losses. Consequently, the concept of diversification was broadened to
include various developed and emerging markets. How­
ever, it took the financial crisis of 2008 to spur investors
into seriously looking for alternative ways to improve their
risk-reward ratios.
Until then, these investment approaches were only familiar
to the most sophisticated “smart money” investors, par­
ticularly university endowments, large private foundations,
and well-known hedge funds (see chart 1). Alterna­tive risk
premia, as opposed to traditional risk premia that stem from
individual asset classes such as equities and bonds, are derived from investment strategies backed by solid ­academic
research, aiming at above-average, risk-adjusted returns
over a risk-free rate. Offered through hedge-fund struc­tures, these products promised excess returns, or “alpha”
in market speak, but often came at a high price in the form
of ­elevated fees, low transparency and almost no regulation. Additio­nally, many hedge funds were structured with
long lock-up and notice periods leading to illiquidity.
Increased investor demand for alternative investment strategies have paved the way for the introduction of “liquid
­alternative strategies” or so-called ’40 Act Funds 3 in the
USA. These funds owe their name to the Investment Company Act of 1940, introduced after the crash of 1929 and
the ensuing Great Depression. The initial goal was to boost
investors’ confidence in US mutual funds by setting clear
standards for investment companies – a framework governing the mutual-funds industry to this day. ’40 Act Funds,
while employing very similar strategies as hedge funds,
manage to do so with all the advantages of tradi­tional
­mutual investment funds. Against this background, wellknown consultancies and service providers in the ­financial
industry such as McKinsey 4 and SEI 5 have forecast a rapid
increase in the size of assets under management and the
available number of mutual investment funds up to 2020.
At Vontobel, we have developed three types of liquid alter­
native strategies, which we call Pure Strategies.
Chart 1: Liquid Alternatives as a replacement for hedge funds
Verifiable prices
Highly liquid, exchange-traded assets,
daily pricing
Examples
Managed Futures/CTAs
Global Macro
Long/Short Equity
Equity Market Neutral
Liquid Alternatives can be
viewed as a substitute for
hedge funds
Non-traditional Bond
Event Driven: Merger Arbitrage
Relative Value
Non exchange-traded assets,
monthly pricing
Event Driven: Distressed Securities
Private Equity
Real Estate
Markowitz, Harry M. (1952): Portfolio Selection, The Journal of Finance, Vol. 7, No. 1, pp. 77–91.
Rouwenhorst, K. Geert (2014): The origins of mutual funds, Yale ICF Working Paper No. 04–48.
McKinsey & Company, Financial Services Practice (2014): The Trillion-Dollar Convergence: Capturing the Next Wave of Growth in Alternative Investments.
5
SEI (2013): The Retail Phenomenon: What enterprising private fund managers need to know.
2
3
4
4 Liquid Alternatives
Pure Strategies
Finally putting it all together –
The making of the Pure Strategies
In 1997, William Fung and David Hsieh put forward the
idea that risk and return characteristics can be structured
dependent on trading strategies rather than on the se­
lection of asset classes 6. In developing our Pure Strategies
we have performed extensive research on over 20 different strategy-specific risk premia. Through this empirical
research we have identified three strategies that yield
the most attractive and ­robust returns in benign market
regimes as well as during periods of stress. These are momentum, value and volatility. As chart 2 shows, these
three strategies fulfil our two main criteria − diversification
Chart 2: All strategies meet our two main criteria
High
Illiquidity
Momentum
Diversification
Volatility*
FX Carry
Value
Convertible
Arbitrage
Merger
Arbitrage
Low
Low
Robustness in Periods of Stress
* Tail risk-hedged volatility strategy
6
High
and robustness − particularly well. Other prominent and
widely employed approaches such as merger and convertible arbitrage or foreign-exchange carry fail to do so on
one or several counts.
The term “pure strategies” means that each individual
strategy aims to capture the essence of the specific in­­vestment concept while simultaneously hedging against
­systematic market or so-called “beta” risk. Moreover,
each strategy invests in a variety of different markets and
underlying instruments globally to enable us to move in
a well-diversified investment universe while keeping the
corre­lation with generally employed hedge-fund strategies low. Investors thus gain access to attractive and ­­
u­n­ique risk-return profiles with downside protection. In the
Hedge Fund Research (HFR) universe, Pure Momentum
is classified as Macro: Systematic Diversified, Pure Dividend as Equity Hedge: Fundamental Value, and Pure Premium as Relative Value: Volatility.
The following overview (see charts on page 7) provides
a detailed description of each of the three strategies and
their payoff profiles. In these charts, the horizontal axis
denotes the price development of the underlying market,
while the vertical axis shows the respective gain (section
above the horizontal axis) or loss (section below the horizontal axis) of the strategy at a given price level.
Fung, William/Hsieh, David A. (1997): Empirical Characteristics of Dynamic Hedging Strategies: The Case of Hedge Funds, Review of Financial Studies 10.
Liquid Alternatives 5
Pure Strategies
Creating robust portfolios
with Liquid Alternatives
Pure Momentum – systematically exploiting both
upward and d
­ ownward trends
This strategy is designed to benefit from two types of momentum in the global financial markets. “Time series momentum” reflects risk premia arising from a systematic
participation in strong medium-term uptrends as well as
in downtrends (usually between 20 days and 12 months).
It involves investing globally in about 40 of the most liquid ­financial instruments such as widely-traded equity,
fixed-income, and currency futures. This first sub-strategy of Pure Momentum will tend to perform best in markets with strong price trends, either positive or negative.
In sideways markets with frequent, short-lived trends, the
so-called “whipsaw effect” sets in, resulting in a number
of break-even trades or minor losses. This can be offset
by the ­second sub-strategy called “cross-sectional momentum”, which is used to systematically identify stocks
that show persistent relative fundamental strength compared with their domestic markets. Under this sub-strategy, we take long positions in a basket of stocks leveraging our in-house emerging-markets expertise. Any outperformance relative to the respective index will be locked
in by hedging against general market and currency risk
through short index and currency futures or forward contracts. In sum, our Pure Momentum strategy is unique
in the investment landscape in that it combines two nearly uncorrelated sub-strategies. It can deliver additional
diversification benefits with signi­ficant upside potential
in positive and negative-return environments, providing
protection to investors with a “long” bias. The corresponding payoff diagram in chart 3 is ­referred to as a
“long straddle” profile.
Pure Dividend – “quality” dividend stocks with
dynamic beta hedge
This strategy is designed to profit from regularly earned
dividends and focuses on “high-quality” stocks of com­
panies with a strong dividend history, stable earnings,
cash flows, and solid balance sheets. It systematically
­selects stocks in the global equity markets with a focus
on maximising dividend income. In the current low-yield
environment, dividend income can pass for a higher-­
yielding substitute for regularly earned interest payments
from a typical fixed-­income fund, replacing duration and
credit risk by tightly controlled equity market risk. The
long equity ­holdings are then balanced by a short position
in corresponding equity indices in order to extract this
6 Liquid Alternatives
high-­quality dividend premium, achieved through short
futures positions and a proprietary downtrend model,
thereby lowering the portfolio’s exposure to general
­market risk. However, this short index exposure will be
flexed to allow some market beta in positive equity-return
environments. The payoff diagram in chart 4 shows the
well-known ­profile of a “long call”.
Pure Premium – collecting premia that resemble
insurers’ income
This strategy is designed to benefit from systematically
earning option premiums that are similar to an insurance
company’s premium income from numerous small insurance policies. It is well-diversified across regions (US,
Europe, Japan) and asset classes, investing in a universe
of only the most liquid equity, government-bond, and
foreign-exchange markets. The sale of at-the-money
options results in a so-called “short straddle” payoff,
i. e. a V-shaped profile turned upside down with no initial
downside protection. In order to mitigate possible losses,
risks are addressed through buying options far below
and far above the current market price (out-of-the money) or, in other words, by “cutting off” both the left and
right tails of the short-straddle profile. Around 10 percent
to 20 percent of the option premia received from selling
the at-­the-money straddle is typically spent on buying the
out-of-the money call and put options, a situation exemplified by the “wings” of the below “butterfly” profile.
Thus, the resulting position is short volatility with a limited
expected maximum loss. The corresponding payoff diagram in chart 5, named according to its shape, yields a
“butterfly” profile. This strategy is designed to provide
diversification to long-straddle return profiles such as the
Pure Momentum Strategy by generating its strongest returns in sideways markets and consequently yields lower or
negative returns in strong directional market environments.
Combination of all three strategies leads to significant
­diversification benefits
The merits of each of the three strategies on a stand-alone
basis are plain to see: they boast a distinct payoff profile
with limited downside, making them complementary to
traditional portfolios with mainly equities and bonds. One
additional significant benefit, however, comes into play
when all three strategies are combined to form a mixed
portfolio that offers the prospect of performing reasonably well in almost any market environment. In addition,
um
Chart 3: Pure Momentum – Payoff Long Straddle
Profit
Price falling
Price rising
Loss
Collect risk premium
Limited downside
Chart 4: Pure Dividend – Payoff Long Call
Profit
Price rising
Price falling
Price rising
Loss
Limited downside
Limited downside
Collect risk premium
Chart 5: Pure Premium – Payoff Butterfly
Profit
Price rising
Price rising
Price falling
we believe the combination of all three strategies can
provide the advantage of substantial diversification benefits not only in terms of markets and instruments, but
Profit
also with respect to periods of both low and high market
volatility. In general, one can distinguish six market en­
vironments: uptrends, sideways markets, and downtrends,
with each regime showing either high or low levels of
­volatility. In a given regime, one or two strategies might
Price falling
Price rising
lead
to a flat or slightly negative performance, which
could be offset or often overcompensated by the relatively strong performance of the remaining one or two
Loss
strategies.
Limited downside
Limited dow
Collect risk premium
Looking
at equity markets
from a trend perspective, for
example, Pure Momentum is designed to perform well in
either strong uptrends or downtrends, since the underlying algorithm will alert the portfolio manager to go either
long or short. Pure Dividend will perform relatively well
in sideways markets and even better during uptrends, alProfit
lowing the portfolio manager to achieve high dividend in­
come and potentially additional price gains. Pure Premium,
which only aims to collect option premia in quiet markets,
will perform negatively when markets move substantially.
In sum, investors can expect to benefit considerably from
rising
Price
falling
strong
uptrends, incur only moderate losses in Price
stable
markets, and profit reasonably from falling equity markets.
Looking at equities from a volatility perspective with asLoss
sumed low levels of volatility, investors can expect to incur moderate losses in Pure Momentum, achieve a flat to
Limited
downside
Collect risk premium
slightly
positive performance
in Pure Dividend, and profit
strongly in Pure Premium.
Based on our own extensive research, including 10 years
of backtesting from 2003 until 2013, we find that an equal
weighting of all three strategies yields an annual return
of 7.20 percent with 4.35 percent volatility. These results,
based on a monthly rebalancing and inclusive of bid-ask
spreads and fees, show considerable improvements compared to the strategies on a stand-alone basis and allow
­investors to achieve a better risk-reward ratio.
Loss
Limited downside
Price falling
Collect risk premium
Liquid Alternatives 7
Pure Strategies
How can you invest?
Vontobel liquid alternative funds are managed by our
Harcourt specialists. In the European Union, they are
­regulated under the UCITS IV Directive, which ensures
a ­greater degree of safety with full transparency, high
levels of ­liquidity, and strict leverage limits.
Alternatively, institutional clients and high-net-worth in­
dividuals can also invest in an AIFMD structure. It is more
flexible than a UCITS fund and the weights of the indivi­
dual Pure Strategies in this structure can vary considerably
over time.
Vontobel Fund –
Pure Momentum Strategy
Vontobel Fund –
Pure Dividend Strategy
Vontobel Fund –
Pure Premium Strategy
Target
LIBOR + 300 to + 500
basis points
LIBOR + 300 to + 500
basis points
LIBOR + 300 to + 500
basis points
Instruments
Equities, Bonds, Futures,
FX Forwards*
Equities, Bonds, Futures,
FX Forwards*
Options, Bonds,
FX Forwards*
Portfolio Manager
Dr Jan Viebig, CFA
Dr Martin Tschunko, CFA
Dr Martin Tschunko, CFA
Benchmark
3 months US dollar LIBOR
3 months US dollar LIBOR
3 months US dollar LIBOR
Fees
0.75 % Management Fee
(institutional)
0.75 % Management Fee
(institutional)
0.75 % Management Fee
(institutional)
10 % Performance Fee
UCITS IV (Luxembourg)
UCITS IV (Luxembourg)
10 % Performance Fee
UCITS IV (Luxembourg)
HFR Strategy
Classification
Macro:
Systematic Diversified
Equity Hedge:
Fundamental Value
Relative Value:
Volatility
ISIN
LU0971938195 (USD-I)
LU0971937205 (USD-I)
LU0971938864 (USD-I)
* Additional instruments possible at a later stage
8 Liquid Alternatives
Conclusion
Cost-efficient, transparent and liquid
Since 2008, central banks’ unprecedented liquidity injections have restored trust in the financial system, yet they
have simultaneously led to ­additional challenges for investors and savers. This boost to liquidity has enabled markets
to shrug off fundamental ­economic data, thus leading to
­significant r­ eturns from traditional risk premia. Although
these benign conditions may continue for some time, va­
luations are likely to come under pressure at some stage,
and prudent i­n­vestors with a long-term focus should start
preparing themselves for this scenario. A diversified investment ­approach across different asset classes, combi­ning
robust “price-­agnostic” momentum strategies and fully
hedged dividend and option premium-generating strategies, ­provides a cost-efficient, transparent, and flexible
solution to mitigate this risk – not only for sophisticated investors, but also for the investing public.
Liquid Alternatives 9
Management
Our Pure Strategies team
Portfolio Management
Dr Jan Viebig, CFA
Head of Alternative Investments
Lead PM of VF – Pure Momentum
Strategy
Dr Martin Tschunko, CFA
Head of Liquid Alternative Strategies
Lead PM of VF – Pure Dividend
Strategy and Pure Premium Strategy
Head of Emerging-Markets Equities,
Credit Suisse
Quantitative Trader, focus on
volatility strategies, Man Group
PM Multi Asset Class,
SAIL Advisors Ltd.
PM Long/Short-Equity and
Absolute Return, DWS
PM Global Long/Short-Equity,
Deutsche Bank
PM Fixed Income, HSBC and
Nomura
Paul Nicholson, CFA
Lead PM of VF – Absolute
Return Bond
Risk Management
Dr Philipp Kallerhoff
PM Absolute Return Bond/
Liquid Alternatives
Dr Matthias Kurmann
Analyst
Thomas Carrier
Risk Management
PM Equity and Fixed Income,
Centrade Capital Management
Quantitative Analyst Private Equity,
Capital Dynamics
Due Diligence Officer Europe,
Olympia Capital Management
Quantitative Analyst Multi
Asset Class, Landesbank Berlin
Quantitative Analyst,
Olympus Capital Management
Credit Analyst, JP Morgan
Our team has 60 years of investment experience and has won four European Hedge Fund Review Performance Awards.
10 Liquid Alternatives
Important legal notice
This document is for information purposes only and nothing contained in this document should constitute a solicitation, or offer, or recommendation,
to buy or sell any investment instruments, to effect any transactions, or to conclude any legal act of any kind whatsoever. Prospective investors must
rely on their own examination of the legal, taxation, financial and other consequences of an investment in the funds, including the merits of investing
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Before entering into an agreement in respect of an investment referred to in this document, you should consult your own professional and/or investment advisers as to its suitability for you. The value of investments and the income from them may go down as well as up and investors may not get
back the amount originally invested. Past performance is not a guide to current or future performance. Performance data does not take account of
commission or costs charged when units are issued or redeemed. An investment in a sub-fund of the Vontobel Fund carries various risks which are
­explained in the sales prospectus. In particular, we wish to draw your attention to the following risks: Investments in the securities of emerging-market
countries may exhibit considerable price volatility and – in addition to the unpredictable social, political and economic environment – may also be
­subject to general operating and regulatory conditions that differ from the standards commonly found in industrialised countries. The currencies of
emerging-market countries may exhibit wider fluctuations. Investments in riskier, higher-yielding bonds are generally considered to be more specu­
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Liquid Alternatives 11
Harcourt Investment Consulting AG
Gotthardstrasse 43, CH-8022 Zurich
Telephone +41 (0)58 283 62 00
[email protected]
www.harcourt.ch