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The past several months have demonstrated the benefits of investments uncorrelated to the public markets. As such, never before have low beta or alternative strategies – sometimes called “anti-beta” – been more in vogue.
“Bonds haven’t provided that cushion to volatility in stocks, so the question for many has been, ‘What else can be done?’” says Lois Gregson, senior exchange-traded fund (ETF) analyst at FactSet Research Systems Inc. in St. Louis.
Anti-beta, or alternative strategy, funds potentially fill that need for portfolios, which often consist mostly of long equities and fixed-income positions that have been routed simultaneously by high inflation and fast-rising interest rates.
Notably, interest has jumped in funds like the long-running AGFiQ U.S. Market Neutral Anti-Beta ETF BTAL-A and its Canadian-dollar hedged version, QBTL-T, launched in 2019. The only funds of their kind with “anti-beta” in their name, the ETFs experienced a 100 per cent increase year-over-year in assets under management, as recently noted during AGF’s third-quarter earnings conference call.
“Equities are great for creating wealth, but consistently, every five to 10 years, they experience a large drawdown, and the anti-beta fund aims to help mitigate that,” says Bill DeRoche, chief investment officer at AGF Investments LLC and portfolio manager of the anti-beta fund in Boston.
Indeed, the ETF has performed well, up about 19 per cent year-to-date, versus a global balanced portfolio fund like Vanguard Balanced ETF Portfolio VBAL-T, down about 10 per cent.
A long-short fund, AGFiQ U.S. Market Neutral Anti-Beta ETF launched in the U.S. in 2011, seeking to capture a market anomaly often cited in academic journals that “low-beta, or low-volatility securities, tend to do better than high-beta, high-volatility securities on a risk-adjusted basis,” Mr. DeRoche says.
To do this, the ETF sifts through about 1,000 U.S. equities separating them into low-beta or low-volatility and high-beta or high-volatility baskets. It then invests in the lowest quintile beta stocks from each sector – 200 in all – as its long allocation, and then it short sells the highest quintile beta stocks from each sector.
In turn, the ETF misses out on some upside of the broader U.S. market (beta), although it has some exposure through its long, low-beta positions. More important, it reduces downside exposure because it shorts stocks with the highest beta that often fall more in value than the broader market.
“So, when the market is up 10 per cent, for example, this fund is expected to be down about 4 per cent,” Mr. DeRoche explains.
“But you can think of that as the cost of the insurance that will pay off when the market is down 10 per cent, and the fund will be up about 8.5 per cent.”
One challenge with these strategies is the drag on portfolio performance during bull markets. Consider AGFiQ U.S. Market Neutral Anti-Beta CAD-Hedged ETF, which was down almost 13 and about 8 per cent in 2020 and 2021, respectively. More long-term, money invested in U.S.-listed AGFiQ U.S. Market Neutral Anti-Beta ETF in Sept. 2011 would be down 14 per cent today.
Still, Mr. DeRoche notes the fund is designed to reduce volatility associated with higher beta portfolio holdings.
“If you’re concerned about a recession or rising interest rates, this complements core investments,” he says.
How much should you allocate?
Indeed, a good argument can be made for an increased allocation today more than ever, says Mike Philbrick, chief executive officer of ReSolve Asset Management Inc. in Toronto, which provides alternative strategy solutions.
“The challenge today is creating value in what could be a prolonged era of inflation volatility,” says Mr. Philbrick, whose firm is a subadvisor for Horizons ReSolve Adaptive Asset Allocation ETF HRAA-T, a liquid alternative ETF.
Previous to late last year, when this became a concern, markets were generally characterized by high liquidity, global growth and benign inflation – and stocks and bonds were largely uncorrelated.
“So, a portfolio of stocks and bonds climbed the ladder of profitability offsetting each other’s volatility,” he adds.
That changed amid high inflation in which both asset classes fell together.
Mr. Philbrick further notes long-term market history reveals these assets move in correlation more commonly than “the goldilocks environment” of the past decade in which they were uncorrelated.
“That’s why we’re seeing these products considered more today,” he says.
The challenge, though, is determining which anti-beta strategies are suitable and then figuring out how much “portfolio real estate they should take up.”
Rob Tétrault, portfolio manager with Tétrault Wealth Advisory Group at CG Wealth Management in Winnipeg, has been using alternatives for several years, allocating about 30 to 40 per cent of portfolios to these strategies.
“We try to emulate what pension funds have been doing,” he says.
At the same time, a significant portion of his equity portfolio holds low-beta stocks due to their superior risk-adjusted performance.
“But you can’t avoid the high-beta stocks completely,” he adds. Otherwise, clients miss out on much of the benefit of growth markets.
Still, decorrelation is critical in markets like the ones we’re seeing today, he says. Yet, rather than using liquid alts like AGF’s offering, his client portfolios hold individual allocations to private equity, debt, real estate, farmland, and even music royalties.
“These essentially have a beta of zero – completely de-correlated from markets – which is kind of the holy grail,” he says.
Still, not all clients have sufficient net worth to access these investments; nor do all advisors have access to them either.
For them, funds like AGF’s or Simplify Interest Rate Hedge ETF PFIX-A – up more than 65 per cent this year – may be of interest given their ease of access and low management fees, says Ms. Gregson of FactSet Research Systems.
“A true hedge fund often requires a more significant investment with longer holding periods,” she says.
“With an ETF, I don’t know if it’s good or bad, but you have more flexibility to move in or out quickly.”
Still, the challenge remains of selecting the right strategy, allocating sufficient portfolio capital to provide that buoying effect, and making this decision with the future in mind rather than based on past performance.
“There is a real danger in being too backward-looking,” Ms. Gregson says. “You have to consider what’s going to happen in the future and then determine whether that strategy could be of actual benefit.”
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