Standard Life Investments runs one of the biggest and best performing diversified growth funds on the market. The Edinburgh-based group’s £8.6bn ($13.5bn) Global Absolute Return Strategies fund has been pulling in billions from pension funds and charities in the UK, Scandinavia and the US. It was also made available to retail investors in May 2008.
In the nine months to September 30 2010, SLI had net inflows of £6.3bn from third-party investors, of which half flowed into Gars.
The fund was launched as an internal vehicle five years ago with the short-term goal of plugging a £200m hole in the insurer’s staff pension fund. Having resolved the deficit using a “liabilities plus” investment strategy, the fund was made available to external institutional clients in June 2006.
Euan Munro, SLI’s head of multi-asset and fixed income, said that GARS “aims to succeed uncertain world through a focus is on the big moving parts of the global economy”. By exploiting inefficiencies in financial markets, the fund aims to generate annual returns of Libor plus 5% over rolling five-year periods. GARS has delivered an absolute return of 74% in the past three years, equivalent to compound annual returns of 19.9%.
About three-quarters of the money in the fund is invested through SLI’s long-only equity, credit and fixed-income desks. The remainder is held in cash, and used to underpin a derivatives overlay that permits GARS’s 22-strong asset management team to make big macro bets on everything from the future trajectory of interest rates to commodity prices.
These can also include the relative performance of diverse equity markets, such as South Korea versus Europe. They might also invest in currency pairs such as dollar/yen and dollar/euro.
The investment team is confident that Western governments, with the possible exception of Ireland’s, have done enough to shore up their banking systems and have also lowered interest rates sufficiently to ensure household and corporate debt can be repaid. But within this context, the GARS team believes that global economic recovery is going to be patchy. Munro said: We try and build portfolios that recognise that growth isn’t going to be strong enough to float all boats. So we’re looking for relative winners and build portfolios of relative value positions.”
A typical strategy blends bullishness about Korea with bearishness about Europe. GARS acquired exposure to Korean equity market growth through call options and exposure to European stock market decline through the opposite. The fund has some £800m invested in the strategy, which is partially predicated on the assumption that the Korean equity market will continue to buoyed up by a strong export sector, whose competitiveness Munro said is enhanced by the fact that Korea, unlike China, should be able to continue to maintain an artificially cheap currency without attracting Washington’s ire.
Macro funds are liable to be wrong-footed when the tectonic plates of the global economy move in unexpected ways. Many rival funds got their fingers burnt in October and November 2010 when, in line with the mantra “Don’t fight the Fed” and the expectation that QE2 would trigger a sharp fall in the US currency, they dumped dollars and bought US government debt.
Munro said GARS avoided falling into this trap.
Instead GARS bought dollars and shorted two-year Treasuries. It’s a strategy that has paid off: the dollar has since gained 7.5% versus the euro while the yield on two-year Treasuries has doubled to 60 basis points since October 2010.
Munro said “People were saying don’t fight the Fed, by which they meant sell dollars and buy the 10-year part of the yield curve. But that was actually the wrong thing to do. It was right to fight the Fed.” He believes the behaviour of many rival investors reflected the “the extreme short-termism that can come into markets”
“Fundamentally, if you step back and take a longer term view and ask how healthy is it that the biggest buyer of US debt is the issuer and how healthy is it that the second biggest buyer is their biggest exporter, China? The answer has got be to not very.”
Even though 25 per cent of GARS is invested in equities, Mr Munro says a sharp equity market correction would not be disastrous for the fund. In such a scenario, losses from the equity portion of the portfolio would be offset by gains from its Australia-versus-Japan bonds and rates position.
In pitches to potential clients, GARS frequently comes up against hedge-fund players Ruffer and Brevan Howard. However Munro pointed out that some of these players are peopled by “ex-Morgan Stanley prop traders” who utilize a prop-desk-like, high-frequency trading approach”. By contrast he said GARS likes to make “big macro calls” informed by a “highly-qualified risk expertise”.
Munro said that GARS has no intention of pitching for business from the government’s universal pension scheme, Nest. He said it would make no economic sense, since the management fees on Nest are capped at 0.3%, while GARS charges institutional investors annual management fees of 0.8%. “GARS is priced as a top-end, highly sophisticated, fancy balanced fund, and is also priced as a very, very cheap hedge fund”.
Many institutional investors, including Volkswagen UK’s default defined contribution plan — which is 50% invested in GARS — are already using GARS as a core part of their fund. Munro said the aim is now to persuade many more to follow suit. “We designed GARS as a better-quality core, an advanced balanced fund that could be at the heart of any portfolio and leave clients far less dependent on the hope that equity markets might go up.
Some investment consultants are concerned about SLI’s plan to swell GARS to ten times its current size. They fear this would compromise performance. But Munro downplays such fears. He pointed out that Pimco’s flagship bond fund has assets of $250bn adding that GARS’s investment approach is so long term, it doesn’t matter if a change of investment strategy takes several weeks execute.
“While up to now we’ve been able to implement our strategies over one to two days, it wouldn’t invalidate our investment process if it took us a fortnight to work our way into a strategy.”
While Munro acknowledges that a “perfect storm” could hit GARS’s performance he said the fund is prepared for all obvious, and not so obvious, scenarios. “It’s a highly diverse strategy, it’s less likely to go wrong in most foreseeable market conditions than a balanced fund or a heavy equity-investment strategy, there’s no particular scenario that worries me too much.”
An edited version of this article was published in the Financial Times’ FTfm section on 17 January 2011