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Volatility meets private equity

02 April 2007

The FTSE 100's roller coaster ride so far this year - with highs close to the peaks of 2000, alongside frequent sell-offs - raises the question whether absolute returns are boosted by recent volatility as well as the march of private equity looking to buy household names.

As you can read in any investment publication in any week, a good fund manager will make money in any market through his stockpicking super-skills. So of course managers view volatility, such as has been seen this year, as an opportunity rather than a problem.

Alistair Hodgeson manages client portfolios for Piling and Co. “Volatility is good for certain types of investors,” he comments.

“Those who can make money from the market going in the other direction – i.e the hedge funds – and for investors looking for value because when the market takes a dive, it provides opportunity.”

When the market briefly touched 6,000 points two weeks back those who had been “gutsy and patient” did well, adds Hodgeson. “I’m long-only when picking my own equities, so volatility like that helps people like me,” he says.

A good absolute return fund will benefit from hedging against its holdings going down. New Star’s Paul Craig, who runs the Diversified Absolute Return fund, hedges by using ten different strategies.

Historically the fund invested in zeros, the quasi fixed income shares of splits. While zeros still form half of the portfolio, Craig diversifies, aiming for a Libor +3% yield.

“Absolute returns means many things to many people and products offer different levels of return,” he says. “We consider this fund a low risk product.”

The fund has given a total return of 1% on a bid-to-bid basis since the start of the year, having doubled returns on UK zeros with its diversifiers which can include hedge, property and private equity funds and equities.

“I like the private equity funds strategy because of the due diligence done prior to the investment, the team of people making investments and the fact that they’re people who can instill change,” says Craig.

A number of private equity bids, for companies such as Sainsburys, Alliance Boots, Whitbread and Wolseley, are also being keenly watched.

“I have bought all of the private equity plays but for Alliance Boots and Whitbread,” says Hodgeson, “but it’s difficult to know which fund managers have them. We will see in a quarter’s time or so when all the deals have gone through who has benefited.”

Sonja Schemmann, global equities manager at Schroder, points out that private equity activity and that of corporates looking to support their growth for the future may act against each other to create volatility.

“We will have these two opposing elements this year that will influence capital markets in opposite directions and will hence create volatility,” she comments.

Another key element for this year will be the expected slowdown in the US.

“We got a very good impression of the opposing two elements over recent weeks,” Schemmann continues. “News on sub prime mortgages, non-durable goods orders and the unwinding of the carry trade have spooked the market, whereas a new flood of takeover rumours have supported it. These developments have led to a massive spike in volatility in equity markets, currencies and commodities.”

The current situation is no surprise for managers, some of whom have been waiting for two years for this period of volatility. Hodgeson reckons on a lot more to come and Schemmann points out that cyclically, it is to be expected: “I am optimistic overall for equity markets,” she comments. “But given we are in the cycle things won't be as straightforward as they were in 2006 or 2005."

2 April 2007

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