I first wrote about construction of an idiot’s market neutral fund about a year ago here and I further addressed the controversy of why the technique may work here. For the year 2008, this hypothetical strategy was down -0.7%. These returns are roughly in line with the HFRX Equity Market Neutral Index return of -1.2%. (Recall that this strategy goes long 5 Morningstar top rated, low cost and no-load large cap growth funds and 5 top rated value funds, called the smart fund sample, while shorting the S&P 500 Spyder (SPY) against the long positions.)
2008 was a tumultuous year and these returns are not bad considering the market environment the strategy had to contend with. The strategy had a good first half as the mid-year update showed that returns to June 30 was 3.5%. Given that the average annual turnover of the long portfolio was about 50% per annum, it was virtually impossible for any manager, even with good foresight, to outperform the market both in the first half and the second half of 2008. He would have had to be long the inflation bet in the first half and then switch to a low-beta bet in the second half. Indeed, the consensus sample of 20 large cap blend funds from the top mutual fund complexes, which usually perform in line with the market, underperformed by about 5% in 2008.
This strategy has also shown remarkably low turnover. Of the 10 funds in the portfolio, the strategy kept all of the growth funds and turned over only 3 of the value funds. Two value funds were taken out for style drift and only one was taken out for performance reasons.
What are smart funds doing now?
I reverse engineered the macro exposures of the smart fund sample, as well as the exposures of the consensus funds, and looked for significant differences. Smart funds show a surprising level of defensiveness considering the number of well-known investors who have turned bullish in the last few months.
As the chart below shows, the estimate beta of the smart fund investors is significantly lower than the consensus:
Analyzing the exposure by sector, smart funds are underweight Financials:
...and Energy:
While smart funds are overweight traditionally defensive sectors such as Consumer Staples:
…and Health Care:
Surprising defensive readings
I find these readings surprising given the bullishness shown by investors like Ken Heebner (see his record here), John Neff, Warren Buffett, the ValueLine Survey, and many others too numerous to name. After all, the annual turnover of the smart fund sample is about 50% (as is the consensus fund sample) and these funds really don’t turn their portfolios around on a dime. So if these managers see value in the market, I would expect that they would start to be raising their beta exposures now.
No comments:
Post a Comment