A symptom of this increase in systemic risk has been a "risk-on/off" environment, which has made genuine portfolio diversification more difficult to achieve. Markets have taken a bipolar view of the world and asset classes have either been grouped as "risk on" or "risk off", meaning that many have simply moved in tandem to waves of crisis, followed by a central bank policy response.
Given this risk-on/off environment and the way it has undermined portfolio diversification, a major challenge for investors has been to find investment options that offer genuinely uncorrelated returns, not just to other asset classes, but also to the risk-on/off trade.
Investors have also sought to balance their search for returns with a greater sensitivity to downside risk.
To address this, investors should consider selected absolute return-style funds that can generate returns through investment selection alone and that are not hostage to the market cycle.
Insight’s UK Equity Market Neutral strategy has proved a consistent and resilient performer ever since its launch in May 2005, delivering positive returns every year; returns that have demonstrated very little correlation to other asset classes and the risk-on/off trade.
Furthermore, returns from Insight’s fund have been delivered with low volatility and drawdowns. So how has the fund achieved this, despite highly stressed market conditions in recent years?
Performance of fund vs sector and cash since launch
Source: FE Analytics
Essentially, the portfolio aims to generate returns solely from stockpicking.
The managers – Andy Cawker, Iain Brown, Richard Howarth, Dave Headland and Matthew Cooke – employ a pair-trade approach, which involves matching each long or short idea with a hedging position of equal size.
By carefully selecting the hedge, managers can isolate the specific risk they wish to target in the lead stock idea and also be very precise in terms of the risks they want to minimise.
This precision can allow the managers to hedge out market direction, sector risks and other macro factors, allowing the fund’s performance to be driven primarily by stock selection.
For example, if Insight’s managers were attracted to a UK bank, they could choose to hedge a long position in the stock with an equally sized short position in the FTSE All Share index.
While this would technically create a market-neutral position by hedging out broad market direction risk, it would still leave investors exposed to general financial sector and associated industry risks.
However, if the managers were to hedge the long position in the same bank with the banking sector or other banking stocks, it would result in a pair trade purely exposed to the difference in stock-specific factors between it and other banks; broad market direction and the risk factors associated with the banking sector would be largely hedged out.
Building up the portfolio through pair-trades like this across the market allows returns to be driven by stock selection.
By taking this precise pair-trade approach, Insight’s UK Equity Market Neutral strategy has delivered returns that have been largely uncorrelated both to other assets and the risk-on/off trade.
As such, the fund could help to improve diversification levels in a broader portfolio context.
The strategy also seeks to deliver returns with low volatility, looking for positive performance on a rolling 12-month basis.
For investors who wish to tap into Insight’s manager skill but are looking to benefit potentially from significant underlying market moves, Insight also manages the BNY Mellon Absolute Return Equity Fund.
Like the market-neutral fund, this long/short strategy can generate returns from pair-trade stock selection alone.
However, it also has the potential to vary exposure to market direction, as managers can have net long exposure in periods when they expect markets to rise, but reduce that or even go short in periods when they expect markets to fall.
In other words, the fund has the potential to deliver returns from stock selection, while also harnessing tactical returns from market-direction exposure.
This may be beneficial for investors in a world where growth is near the stall rate and changes in the economic cycle – and therefore equity market direction – are likely to become more frequent.
For an in-depth look at the Insight UK Equity Market Neutral portfolio, click here.