Why is your fund a ‘fund to watch' and how could it work in an investor's portfolio?
The Defensive Defined Returns Fund, at its core, is about increasing predictability for investors, which is becoming ever more attractive as markets and politics continue to fuel uncertainty. Returns are driven by ‘defined return' investments, which are gaining traction due to their ability to pay out their agreed return providing equity indices are above predetermined barriers upon observation. These defined return investments make up our flagship strategy. However, in order to smoothen the short-term volatility in market downturns which these investments can exhibit, we have overlaid a tail risk protection strategy. This fund could serve as a useful complement to other investments in investors' alternatives allocation, as the predictable nature of the strategy's long-term returns may be a welcome change from the idiosyncratic performance of hedge funds, for example. Moreover, with the tail risk protection aiming to dampen the equity market sensitivity of the fund in times of market stress, this should provide a smoother journey in these environments, allowing investors to take advantage of the equity risk premium whilst aiming to minimise their exposure to equity market drawdowns.
Can you give an overview of the team running the fund and your investment process?
Tom May, CEO and CIO, oversees the fund's strategy and management. Tom has over two decades experience in derivatives, having been Head of European Securitised Equity Derivatives and Secondary Market Trading at Citigroup before cofounding Atlantic House in 2008. The lead fund manager is Jack Roberts, whose journey with the firm began in 2017 during a year-long work placement. Since returning in 2019, Jack has built an extensive knowledge regarding derivatives-based solutions, and is a CFA Charterholder. Tom and Jack are supported by the wider investment team in day-to-day running of the fund.
Ganchi Zhang, senior quantitative analyst, was instrumental in developing the Atlantic House hedging framework, a proprietary method of analysing the wide universe of hedging strategies and measuring their relative merits.
The fund buys government bonds as a capital base, before entering into swap contracts with major investment banks, to create the fund's defined return investments. The hedging framework is then utilised to select a diversified selection of protection strategies from the broader QIS universe. The underlying strategies and how they are blended are constantly reviewed to ensure the overall portfolio is behaving as intended.
The result is a fund of defined return investments driving more predictable returns, with a protection overlay to smoothen investor journeys in market volatility and protect the portfolio in tail events.
What do you see as the big opportunities and risks for your strategy?
The main attraction of the Fund is that it is designed to provide 5-7% p.a. in a wide range of market environments. The fund really proves its value when markets are flat or slightly falling, as here the defined return investments can still pay out their potential return in the long-term, whilst equity markets provide no or negative returns. When markets are choppy and volatile, but do not fall as much as 35% over 6 years, the defined returns investments should still pay out their potential return, and the protection overlay should smoothen the investor's journey. In particularly choppy markets the protection overlay may enhance the fund's returns further.
In rising equity markets, the fund is likely to return 5-7% p.a. with fairly low volatility. This more predictable source of return can be a welcome complement to more idiosyncratic holdings, such as hedge funds.
The fund will struggle in large, sustained market falls (35% or more over 6 years), as the defined return investments that drive returns will not mature and will lose capital in line with equity markets. The protection overlay may dampen this loss to an extent, but would cease to help if markets then settled at this lower level.
Can you identify a couple of key investment opportunities you are playing at the moment in the portfolio?
The defined return portion of the fund has exposure to autocalls, an investment that involves selling out of the money puts (akin to selling market ‘insurance'). Historical data suggests this insurance is significantly overpriced, due to large institutions like pension funds being required to hedge their portfolios against major market drawdowns, and therefore implied volatility (future volatility ‘implied' by the price of options) often being higher than realised volatility. This is known as the Volatility Risk Premium, and the fund benefits from this by selling the ‘overpriced' protection to attain higher potential returns in the defined return investments.
The protection overlay utilises quantitative investment strategies. These are rules-based indices run by investment banks, offering low-cost access to strategies that are purely data-driven and do not rely on human discretion. This allows investors to leverage the trading infrastructure of banks and be precise around managing their exposures, using strategies that would not be possible in a fund-of-funds format. As Atlantic House have ISDAs with 16 major investment banks, we are able to maximise the universe of strategies available to us. The strategies in the Defensive Defined Returns Fund aim to smooth investors' returns in short-term equity market volatility, including significant tail events.
