Where are investors meant to put their money while they wait for yields and interest rates to rise? Franklin K2’s Citywire A-rated Brooks Ritchey, who manages the $1.7 billion (€1.4 billion) Franklin K2 Alternative Strategies fund, alongside David Saunders and Robert Christian, says the uncertainty in the bond market has made investors reconsider their allocations.
‘Alternative funds have become a nice addition alongside traditional bond funds. We know that cash yields in continental Europe are negative. In fact globally, in mid-December 33% of two-year treasury notes were yielding below zero.
‘A third of the world’s government bond markets are yielding below zero. The Japanese markets have experienced this for quite a while, as has continental Europe for the past few years.
‘Cash is yielding less than zero and treasury notes and sovereign bonds are yielding much below their historical averages. Meanwhile, central banks in the UK, the US and by the summer, the ECB, are all removing some sort of historical stimulus, so it really is a case of “what’s a bond investor supposed to do?”’
Ritchey says the market is constantly waiting for yields to reset higher, and even bond bulls such as Bill Gross and Michael Hasenstab, are drawing in their horns a little.
‘What can investors do while they are waiting for yields to rise and for the Fed to hike two or three times this year? What do they do while they are waiting for the ECB, which announced it was going to cut bond purchases by half?
‘What do you do while waiting for the gas tank of yields to be refilled? We are seeing inflows in our Franklin K2 Alternative Strategies fund from continental European investors, as they feel this may be a better place than cash and some sectors of the bond market right now.
‘We are not advocating selling out of bonds. That said, investors with new cash positions or coupon income from bonds should consider looking at alternative hedged strategies,’ Ritchey says.
Ritchey says long/short funds’ increasing popularity is underpinned by poor opportunities in credit markets.
‘The bond market is going through what Mohamed A. El-Erian called “a beautiful normalisation”.
‘There are currently three main choices for investors: risk assets like equities; bonds; or alternative or alpha driven assets, such as hedged strategies,’ he says.
On a risk basis, Ritchey says his team is finding the market more and more difficult as yields begin to move higher. ‘Clearly, in one of the three major assets classes, investors aren’t expecting high returns or yields.
The response from investors and the flows we are seeing indicate that people are buying into this story. As interest rates move higher, active alpha and hedge strategies tend to do a lot better, which is certainly what we have seen in the past.’
Investors have been flocking to the alternatives sector and over the past year Ritchey’s strategy has rocketed from $1.04 billion to $1.78 billion in assets under management, a $745 million increase. Ritchey partly puts this down to investors’ frustration with the bond market, but also the fact that over the past year his fund has returned 2.9% versus 2.2% from the sector’s average manager.
‘Our strategy is multi-manager and has four core buckets: equity L/S (35.63%); event driven (16.85%); relative value (34.09%); and macro CTA (13.43%). Last year all four buckets contributed positively to performance but the winner by far was L/S equity.
‘I read your last Liquid Alternatives feature, where Ufuk Boydak from Loys said L/S equity had a nice run. The story is that the active alpha cycle is back, it’s been back for about 14 or 15 months and the primary benefactors from that were the equity L/S managers.
‘However, our clients are saying that people are taking a fresh look at macro CTAs. It’s about a 13% allocation in our fund right now, but we, and perhaps other investors, are looking to be more exposed to this sector going forward.’
This article originally appeared in the February edition of the Citywire Selector magazine.