Absolute return strategies are an important skeleton key to building a resilient portfolio according to Ben Samild, deputy chief investment officer, portfolio strategy at the Future Fund.
“Absolute return strategies can provide an airbag for the things you are worried about in a cost-effective way,” says Samild who is responsible for asset allocation and portfolio construction and was previously head of alternatives.
The $245 billion Australian sovereign wealth fund has a long history of investing in absolute return strategies committing to the strategies since its formation in 2007. Historically it emphasised more macro directional strategies and now the thinking has evolved to fit more specific environments.
He says absolute return strategies have an important defensive role to play in the portfolio, as government bonds and duration lose their efficacy.
In addition the correlation benefits that Australian investors have gained from the pro-cyclical nature of the Australian dollar are changing and creating uncertainty.
“If you lose duration and currency then it is very difficult to build this portfolio with confidence and embed any level of defensiveness in it. We could pay for that protection but that gets expensive over time,” he says. “Absolutely we think a certain kind of hedge fund alternative asset has a really important part to play, it can be hard to communicate that and for stakeholders to understand that.”
The Future Fund’s absolute return strategies have traditionally been quite macro dominated, which goes back to the timing of its formation in 2007 and the opportunities that arose in 2008 as some investors withdrew money from strategies such as Bridgewater and Brevan Howard.
“It also made sense from a portfolio construction point of view, they felt and looked defensive,” Samild says. “As a young organisation with a small investment team they were also a really valuable source of information and gave us the ability to leverage the good thinking of the world’s best investors, which is another thing we try to do quite assertively. As the world develops and we go through this dramatic decline of interest rates, and strong asset returns our thinking changed.”
The fund uses absolute return strategies in a number of ways including looking for the “rare alpha pieces” but also some very specific purposes.
“Do you address things like inflation in a direct way or do something else? This is one of the areas we think you can set up some really interesting solutions where you can increase portfolio resilience without making a binary bet, and that limits the cost and increases your resilience,” Samild says. “We think alternatives have a real place in the world where risk premiums and discount rates are changing in time series and cross sectionally.”
Samild says the Future Fund uses many different strategies from quasi market making, very fast trading equity strategies to explicitly defensive strategies, reinsurance, fundamental quant, systematic macro, fixed income, commodities, convergent and divergent strategies.
“All of these are different and the class of managers are different and how much alpha we think they can put their hands on is different,” he says, which means due diligence for these managers is also different.
Samild challenges asset owners to think about their usefulness to the managers providing these alternative strategies.
“Your job as an asset allocator is to find a way to be useful to them. There is a giant international queue out the door for that capacity. Decide how comfortable you are with that alpha stream and what it means for you – and then do what you can do to be useful to that manager, that’s a really upside down thing for people to comprehend.”
Culture is key
Samild says it is the total portfolio approach that enables the Future Fund to use absolute return strategies to achieve goals rather than fill a bucket.
He says the culture is built around that one purpose and people are remunerated and judged and valued on how well they embrace that purpose, how well they collaborate and work together. This is very different from being judged on beating a benchmark.
“If the culture was about beating benchmarks there is no way we could run a hedge fund program the size of ours and the way we do it,” he says.
“You can’t run the kind of investment program we do without the culture of one portfolio in place from the beginning. That only becomes obvious when you step through the door and start living it. When you walk in the place and understand from the moment you are there, there is a degree of trust in you. And you have a project and everyone in the place is happy to make that project their project and their priority, there is no threat, you’re remunerated on the same fund return.”
Samild says instead of thinking of allocating in a pure Sharpe ratio return-focused way, which he says “is reasonably unhelpful” the culture and organisational structure means the team has the freedom to look at using the alternatives portfolio in many ways and as a skeleton key for total portfolio construction which is a “far more useful and interesting”.
“For a start hedge fund benchmarks are a mess, and if I was measured against that I’d have small allocations to some star managers and beat it every year. And I’d probably be adding to similar common factors that are in the broader portfolio and doing it in a way that is less interesting, less diversifying and less helpful to the broader purpose of the fund, and probably not sharing information with other groups the way we do that is completely natural.”