Tan, who is an investment companies analyst at the investment services firm, has grown increasingly concerned about the state of the market due to huge amounts of central bank intervention, high starting valuations and widespread complacency within the investor community.Though he does hold a number of higher risk trusts such as Aberdeen Latin American Income and BlackRock World Mining IT in his portfolio, he has been upping exposure to BH Macro, which uses a hedge fund strategy, due to the uncorrelated nature of its returns.
He also expects it to be one of the only winners when the market crashes; which is likely to be an imminent event in his opinion.
“The problem with making predictions is that although you may have a view, timing is critical and so I fully appreciate I may be early on this, but now feels like the time to be taking money off the table,” Tan (pictured) said.
“The major concern is, of course, valuations.”
“Just look at the yields on high yield bonds; junk bonds have never been so hotly bid for. German bunds are also at record lows. The yields on two-year bunds recently dropped into negative territory which shows people are so cautious they are happy to lose money on an absolute basis just so they have some form of protection.”
“It’s also about the fact we have watched the equity market go up in an almost straight line for five years. I think there is very limited scope for it to go any further and from these levels the risk is very much to the downside.”
Performance of indices over 5yrs
Source: FE Analytics
Tan’s colleague, Monica Tepes, has warned FE Trustnet on numerous occasions that the UK market is a near its top.
However, Tan’s major concern is that, despite several fund managers upping their cash weightings recently, very few investors are worried about a possible correction.
Though there are growing macroeconomic headwinds, the biggest risk is that the large majority of investors are becoming too complacent about future returns, according to Tan, who warns that crashes only occur when people aren’t prepared for them.
“The indicator everyone puts out is the VIX, which is around 12 at the moment. It’s not a great indicator for when markets will correct, but it is a good indicator of market complacency and at the moment, it shows that everyone is very comfortable.”
Given his concerns, Tan has turned to BH Macro, which sits in the IT Hedge Fund sector and has total assets of more than £2bn.
“It’s meant to be an uncorrelated investment. It is an absolute return fund, so it typically does well when everything else is collapsing,” Tan explained.
“The strategy is almost Darwinian as it is survival of the fittest. They have 60 to 70 traders across 10 desks. If a trader does well they are given more cash, if they do badly they get less and if they do really badly they are rewarded with a boot out the door.”
“All of these traders are incentivised and they are all looking for each ‘nook and cranny’ for opportunities. This should mean that returns should be totally uncorrelated to other asset classes.”
BH Macro, which invests across global fixed income, equity, commodity and derivative markets, was launched in April 2007. According to FE Analytics, it has returned 118.6 per cent over that time. As a point of comparison, the MSCI AC World index has returned less than half that amount.
Performance of trust vs sector and index since Apr 2007
Source: FE Analytics
As Tan points out, those returns have been uncorrelated to other asset classes and due to the BH Macro‘s various strategies, it has thrived in falling markets.
Our data shows that in the crash year of 2008 when global equities fell 20 per cent, the closed-ended fund returned 28.36 per cent. It was a similar situation in 2011 when the eurozone crisis almost reached breaking point.
Our data shows that BH Macro spiked when equity markets plummeted that year.
Performance of trust and fund vs index in 2011
Source: FE Analytics
It is very difficult for investors to find open-ended funds that have performed in a similar manner as while the large majority have been able to defend capital when markets have fallen, they have tended to deliver a small positive return.
The most popular portfolio in the IMA Targeted Absolute Return sector, the £20bn Standard Life GARS fund, returned 2.64 per cent in 2011, for example.
BH Macro’s performance has been far more lacklustre over the last year or so, however, as it is down 3.5 per cent year to date.
Tan says investors should fully expect the trust to underperform when markets are buoyant and because of that, the discount to NAV tends to widen. However, he says that on its current discount of 5 per cent, the closed-ended fund looks very good value.
“With the exception of 2008 when the discount moved out to 20 per cent – for no real reason in my opinion because the NAV was performing well – the discount has tended to be well supported at 5 per cent,” Tan explained.
He added: “Once again, because equity markets have been going up, people have thought, ‘why am I holding something like BH Macro? I should be buying something that is in fashion’.However, those periods never last too long.”
Tan’s only concern about the Guernsey-domiciled trust is its charges. Due to its very active approach and as each trader is incentivised to outperform, BH Macro has ongoing charges plus a performance fee of 2.62 per cent.
However, he says investors would be wrong to avoid it because of its cost as it is well positioned to perform when the market eventually “collapses”.
