Money managers under the microscope
Taking care of your hedges
Insight director of UK equities Andy Cawker, manager of a long-short Ucits III fund, tells me he has been changing the way his fund hedges its market exposure as market conditions change.
His Absolute Insight UK Equity Market Neutral fund, which uses pairs trades to produce a largely market neutral portfolio, has shifted from hedging mostly against the index two years ago to now hedging predominantly against individual stocks.
Why? And why does it matter?
Well, it’s a good reflection of market conditions.
In summer of 2007, just before the onset of the subprime mortgage crisis, M&A activity, and more importantly M&A rumours, were at a peak. It seemed like almost any company that was trading poorly could become a target for private equity funds — then at the height of their power — and the share price could actually rise.
So hedging against individual stocks is a bit risky. You could rightly identify that a company will trade poorly yet lose out on the short. So hedging against the index was the path Cawker took.
Roll on 18 months and the world has changed. The subprime crisis has turned into the credit crisis, which has turned into a recession. Suddenly companies that aren’t as good as they were cracked up to be in the boom times are found out, producing great opportunities to short individual stocks.
Moreover, forced selling and dumping of lines of stocks has led to wide differences — often unwarranted – in the pricing of stocks within the same sector, giving managers more opportunity for a pairs trade.
Roll forward to today and many of those dispersions of valuations have been ironed out, often by hedge funds. But there are still, says Cawker, opportunities to go short stocks that may be long-term losers and buy the long-term winners.