What an upside downside year!

January 31, 2023

The global reopening headlined markets in 2021. The S&P500completed its best three-year stretch since 1999. Locally, the FTSE/JSEsaw its best performance since 2009,when it returned 29.2% in total returns.Being positioned in long-only portfolios was an uncomplicated choice when picking an investment vehicle. 2022,however, was quite the roller coaster
ride. While markets reopened positively,tensions in Russia and Ukraine put the market on the back foot. Concerns around interest rate hikes based on rising inflation caused uncertainty to escalate.As increased, diverging market views began to emerge worldwide,fuel led by growing recession concerns,markets were under pressure, and long-only investors did not enjoy the same returns they may have in the recent past.

So, the question is, what to do with all this volatility? Firstly, volatility does not always have to pose a threat to investments. Experienced hedge fund managers have become close friends with upward and downward fluctuations. Hedge fund managers have designed portfolios that can take advantage of market deviations and generate return seven when the market is on its way down.

Traditionally, balanced mandates have given investors the flexibility to diversify risk away using bond and cash instruments. But, if your concern is not just about making excess returns but about protecting your wealth, a look at downside deviation when making investments decisions becomes key. Downside deviation can assist investors in calculating the downside risk on returns below a minimum threshold. Looking at 2022 as of 30 November 2022 (at the time of writing this article), the FTSE/JSE Capped SWIX All Share TR ZAR 7.4%;South African Multi-Asset portfolios, on the other hand, returned 1.6%, 1.0%, and 0.9% for the ASISA South African Multi-Asset Low, Medium, and High Equity funds on average, while the Laurium Long short Prescient RI Hedge Fund (“LongShort”) and Laurium Prescient MarketNeutral RI Hedge Fund (“Market Neutral”)have nearly doubled these returns at17.9% and 13.6% respectively year to date.

So, how was this done? We can turn to the upside/downside capture ratios of the funds.

As per Morningstar: “Upside/downside capture ratio shows you whether a given fund has outperformed – gained more or lost less than – a broad market benchmark during periods of market strength and weakness, and if so, by how much. Upside capture ratios for funds are calculated by taking the fund’s monthly return during months when the benchmark had a positive return and dividing it by the benchmark return during that same month. Downside capture
ratios are calculated by taking the fund’s monthly return during the periods of negative benchmark performance and dividing it by the benchmark return.

Figure 1: Upside and Downside Capture Ratios vs. Multi-Asset portfolios

“An upside capture ratio over100 indicates a fund has generally outperformed the benchmark during periods of positive returns for the benchmark. Meanwhile, a downside capture ratio of less than 100 indicates that a fund has lost less than its benchmark in periods when the benchmark has been in the red. If a fund generates positive returns, however, while the benchmark declines, the fund’s downside capture ratio will be negative (meaning it has moved in the opposite direction of the benchmark).”

Figure 2: Laurium Long Short Prescient Fund vs. FTSE/JSE Capped SWIX TR since inception 1 Aug 2008 – 30 Nov 2022

Multi-Asset portfolios, while having the ability to diversify risk, were not able to reduce the downside risk as our hedge funds have done. Our Long Short and Market Neutral funds have captured 36.6% and 0.4% upside of the markets when moving up. Although this may not seem to be shooting the lights out, the notable point is that when the market has been trending downward this year, these funds have managed to generate positive returns with downside deviations of -47.6% and -77.2% for the Long Short and Market Neutral funds, respectively.

In comparison, multi-asset portfolios had positive downside capture ratios of 28.1%, 42.4% and 51.4%, indicating that although the funds could protect capital with declines less than the broader market during these negative periods, hedge funds in fact generated positive returns during these times. Hedge Funds are now more broadly accessible, with several LISPs offering a selection of approved established hedge funds on their platforms. If you are interested
in adding a great diversifier to your portfolios, offering equity-like net returns at lower volatility or elevated returns at market-like volatility, then please contact your preferred LISP consultants to access our hedge funds. The Laurium Long Short and Laurium Market Neutral Funds are both daily priced with daily liquidity.

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