Archives for May 2016

The returns of GARS

This was originally published as an article in Investment Week

SLI Global Absolute Return Strategies (GARS) started life as a retail fund in May 2008 (and has become the largest retail fund in the UK market) though as a strategy available to external investors, it was launched by Standard Life in the summer of 2006. Its investment objectives are to achieve a total return of cash plus 5% (gross of fees), over rolling three-year periods, roughly consistent with the long-term returns from equities, but to deliver this with only one-third to one-half of the volatility of equities.

The team has sought to generate returns from a variety of sources, using both traditional investments in equities, bonds and real estate, as well as currencies, interest rates and volatility. Additionally it uses advanced investment strategies such as relative value and directional returns. By enhancing the number of return sources, they aim to enhance diversification and provide a smoother path of returns.

In their marketing, the team at Standard Life has distinguished between four types of return: Market Beta, Security Selection, Relative Value and Directional, labelling the first two as traditional and the latter two as advanced.

Over the period from July 2006 to the end of 2015,  GARS has generated a total gross investment return (before fund fees and costs) of 71.47% from these strategies. Since 2008 the fund has been invested in between 30 and 40 individual strategies at any one time.

Using data provided by SLI, attributing performance by individual strategy on a quarterly basis since 2006, the individual strategies were classified into each of the four types of return. A fifth type, Other, was created for this analysis,which is essentially the return generated on cash holdings.

  • Within the Market Beta classification only those strategies which appeared to involve being long a sector or market in the equity, bond or property markets were included.
  • Within Security Selection, only the strategy return for security selection provided by SLI was included. Security Selection involves going overweight some securities (relative to an index) and underweight other securities. This is an alpha return.
  • Within Relative Value only those strategies which were described as one asset type versus another; for example European vs US volatility, UK vs German short-rates, German vs French equity were included. In addition, an S&P call calendar spread and various cross-asset strategies were classified as Relative Value. Relative Value trades involve going long one asset and short an equivalent value of a second asset. Returns from Relative Value are also alpha returns with no associated market risk premium.
  • Within Directional strategies in interest rate and currency markets, strategies investing in volatility and dividends and yield curve strategies were included.
  • Within Other cash, liquid instruments and a small unexplained residual, which amounts to -0.2% over the entire period were included.

Analysis of returns by strategy type

  1. Beta returns from investment in equity markets have been reasonable overall at 8.7%. Equity market exposure cost investors heavily in 2008, but fared better in 2009 when a proportion of the 2008 losses were made back. Beta from fixed income market exposure has generated positive returns in every calendar year, with 2009 and 2012 being the strongest years thus far, totalling 20.1%. The team correctly positioned the fund in anticipation of strong performance in the corporate bond market in both of these years. Returns from occasional forays into real estate investment detracted in 2008.
  2. In the original marketing of the GARS strategy, the team’s target was for security selection to contribute about 1% per annum to the fund’s returns. However, the managers have struggled to deliver even 1% of return (0.9%) over the near-10 years since launch. It is this strategy that has been the most affected by the enormous inflows into the fund in recent years.
  3. The returns from Relative Value of 7.6% since launch are less than 1% per annum, although they have been positive in eight of the ten calendar years since launch. The negative contributions from equity and cross-asset Relative Value strategies since launch are disappointing, clearly indicating that the team has struggled to find good alpha-generating ideas in these areas. They have though had some success in Relative Value strategies in rates and bond markets and in volatility across markets.
  4. The greatest generator of returns has been from Directional trades (32.0%), and within those, from trading strategies in interest rates and yield curves (21.4%). Alongside the team’s good calls in fixed interest markets generally in the beta portion of the portfolio, these markets were very fruitful for investors from 2006 until 2011. However, since then only small returns have been generated from these strategies.
  5. Over the last three years, total returns of 7.5% from Directional strategies have been generated almost exclusively from the currency markets, nearly all of which has come from trades where the US dollar was the long position.

Analysis of returns by underlying asset class

  1. FIXED INCOME Performance attribution by strategy shows that the bulk of returns (47.2% from a total gross return of 71.5%) in GARS have come from strategies, both traditional and advanced, in the money and fixed income markets. Combining Fixed Income Beta, Rates & Bonds RV and Rates and Yield Curve Directional as Fixed Income strategies, returns here amount to almost two-thirds of the total return to investors over the period. Well-timed moves into strategies that benefitted from falling interest rates and bond yields in the second half of 2008 were particularly profitable and did much to offset the losses from equity strategies at that time. However, since Q3 2014 returns from these fixed income strategies have been negative. It may be coincidental but the timing of this change in the pattern of returns occurred when Ian Pizer, a key contributor of fixed income duration ideas to GARS, left SLI to join Aviva.
  2. EQUITIES Combining Equity Beta, Equity RV, Dividends and Security Selection as Equity strategies, returns here amount to 9.2%, which since inception is less than 1% per annum. This must be viewed as disappointing given the opportunities that have prevailed for returns from both long-only and long-short strategies over this period of time.
  3. CURRENCIES From 2013 to 2015, returns from currency strategies have formed an increasingly important part of the fund’s total returns. Prior to 2013, currency strategies had generated little in the way of returns. Almost all of the returns since 2013 have come being long the US dollar.

Conclusions

  • Over the history of the strategy to date, GARS has broadly met its long term total return target.
  • These returns have come from both advanced investment strategies (Relative Value and Directional strategies typically used in many hedge funds) and more traditional sources of market return (the Beta and Security Selection strategies). The advanced strategies have delivered 39.6% of gross returns, while the traditional strategies have delivered only 27.6% of gross returns. This dependence on advanced strategies (alongside the large gross positioning that is required to implement some of these strategies) may be surprising to investors who have not looked deeply into the GARS investment process.
  • GARS has generated its returns principally through strategies based on investment in fixed income strategies. It generated good returns from being positioned in corporate bonds in the strong markets of 2009-10 and 2012-13 and positions aimed at benefitting from lower interest rates across the yield curve. However in recent years this source of returns have dried up.
  • Equity strategies have generated only beta-type returns, with little value added from security selection or market timing.
  • In recent years, a correct call on US dollar strength has supported returns as bond and interest rate strategies have struggled to maintain performance.