Monday, December 9, 2019

Investment Insights

Personalized Medicine: Wave of the future

By Thomas A. Sternberg/William Blair Investment Management

Historically, the pharmaceutical industry has focused on developing blockbuster drugs for the masses, taking a one-size-fits-all approach. But as we’ve learned more about the role genetics play in inheriting and treating diseases, the opportunity has arisen to treat people in a more targeted way.

This is personalized medicine, which involves getting the right drug to the right patient at the right time, and there are three primary areas of focus: gene therapy, cell therapy, and gene editing.

Gene Therapy

Gene therapy modifies or replaces existing genes, paving the way to cure hereditary diseases. One gene-therapy drug, which treats a hereditary retinal condition that can lead to blindness, is available today. We expect to see at least two more gene-therapy drug approvals in the United States and Europe in 2019.

Cell Therapy

Cell therapy involves the transplantation of human cells back into the body to replace or repair damaged cells or tissue.

One of the most common forms of cell therapy used today is CAR T-cell therapy, in which cells are extracted from a patient’s body, modified in a laboratory to attack cancer cells in the blood, then reinserted into the patient’s body.

CAR T-cell has distinct advantages over other treatments, including that it’s given once and stays in the body, reducing hospitalization time and automatically treating recurrences of the cancer. There are two approved CAR T-cell drugs available today, each treating a different type of blood cancer.

Gene Editing

Lastly, gene editing gives scientists the ability to change an individual’s DNA. Genetic material is added, removed, or altered at particular locations in the genome.

Gene editing took off in 2012 with the discovery of CRISPR-Cas9 technology, which is faster, cheaper, more accurate, and more efficient than other methods.

Although it’s not quite as advanced as other gene therapy and cell therapy approaches, gene editing has a variety of applications. For example, with gene editing we could alter humans’ DNA to make them resistant to certain diseases (like malaria) or even prevent them from acquiring certain diseases (like cystic fibrosis).

Investment Implications

Personalized medicine should lead to better patient outcomes and economic outcomes, because we won’t be giving drugs to patients who might not actually benefit from them. And there are several investment implications.

First and foremost, the pharmaceutical companies that produce and sell these therapies will be watched closely, and there will be challenges along the way. There are complexities in the production, supply chain, and delivery of these drugs to patients that must be resolved, for instance. And new payment models will have to be developed, as these are very expensive but one-time therapies.

We also think there will be opportunities for investors beyond the pharmaceutical companies. For instance, there will also be a greater need for equipment and supplies in the production of these therapies and the supply chain in terms of delivering them, and there will be companion diagnostics.

It will be a fascinating area to watch unfold over the next several years, and we expect there to be opportunities for healthcare investors globally.

The views expressed herein do not constitute research, investment advice or trade recommendations, do not necessarily represent the views of William Blair nor TEXPERS, and are subject to revision over time.

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North American Investors and European Infrastructure

A solution for capital deployment, portfolio diversification and long-term cash flow visibility

By Jane Seto/DWS Group

When it comes to private infrastructure, North American institutional investors have considerable dry powder to allocate.[1] 

The North American infrastructure market is one of the largest in the world and commonly represents the first choice for domestic investors. However, opportunities in North America are concentrated in the energy sector, and may offer limited scope for portfolio diversification.[2]

The European infrastructure market, however, may offer a solution to North American investors, supporting portfolio diversification away from energy.[3] Moreover, European assets in the core/ core plus space often benefit from mature regulatory and concession frameworks, supporting long-term income visibility. In Europe, private infrastructure returns demonstrated a stable performance[4] due to several factors, including a wider portfolio diversification potential by sector and country, and a larger availability of assets in the regulated or contracted space. In addition, North American investors allocating to European infrastructure denominated in EUR may also gain a premium from currency hedging, improving return expectations further.[5] With competition concentrated at the larger end of the market in both regions, Europe also offers a wider set of opportunities in the middle market space where we observe less competition and more sensible pricing. 

North American market focused on energy

Historically, transaction opportunities in North America have been concentrated in energy-related sectors. Renewables, oil & gas and power projects accounted for about 80% of the total number of transactions achieving financial close between 2009 and 2019, with the majority of these projects in the greenfield space. At the same time, transportation deals accounted for 7% of total transactions, a level materially below the European average, where transportation accounted for over 30%.[6]

Looking at the pipeline of upcoming transaction opportunities, investors interested in accessing the North American market today may continue to find limited opportunities for portfolio diversification. Although the pipeline seems more diversified than in the past, energy-related deals should still account for 64% of the pipeline, while transportation accounts for a limited 13%.[7]

Click image to enlarge chart.

Europe: An opportunity for diversification into a mature investment environment 

Europe represents a leading global market for infrastructure investment for its market size and track record, offering opportunities that range from the mature Western European countries, to the fast growing economies of Eastern Europe.[8]

Click image to enlarge chart.

In its report: “North American Investors and European Infrastructure”, DWS’s Infrastructure team analyses how European infrastructure can be a solution for North American investors when it comes to capital deployment, portfolio diversification and long-term cash flow visibility.

To read the full report, visit

[1] Based on Preqin database as at 7 August 2019.
[2] Based on Infrastructure Journal database, as at July 2019.
[3] Based on Infrastructure Journal, as at June 2019. 
[4] Based on Preqin, “Preqin infrastructure Funds Statistics Database”, as at September 2018, Notes: Infrastructure fund of funds and secondaries have been removed.
[5] Based on DWS proprietary methodology estimating hedging costs on the basis of a three year interest rate swap differential between currency of investor domicile and currency of investment destination, as at 7 August 2019.
[6] Based on Infrastructure Journal, as at July 2019.
[7] Based on nfraNews, as at July 2019.
[8] World Economic Forum, as at August 2019. 

The views expressed in this document constitute DWS Group’s judgment at the time of issue and are subject to change. 

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Setting the Pace:
A proactive Fed helps keep the economy on track

By Seamus Smyth/Stone Harbor

“The crashes people remember, but the drivers remember the near misses.” – Mario Andretti

After strong market returns so far in 2019, it’s easy to forget where we were at this point last year. 

In late 2018, a combination of rate hikes by the U.S. Federal Reserve, an escalating trade war and slowing global growth pushed global equity and credit markets down sharply. There was real fear that a recession was imminent. 

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That sentiment started to shift in January 2019 when Fed Chairman Jay Powell announced that the Fed would be patient, patience that eventually transformed into the ongoing policy easing. Since the “Powell Pivot,” risk assets—including equities and global credit—have risen dramatically, while interest rates have plummeted. The resulting easier financial conditions have helped to buffer the U.S. economy, as growth has gradually slowed though unemployment remains low. Europe, China and the rest of the world have likewise slowed to varying degrees, but have not slipped into recession.

The Fed’s actions highlight the continued role of central banks in helping markets navigate changing conditions. We think it’s helpful to view the Fed and other central banks as pace cars—also called “safety cars”—which set the pace and position of drivers during a car race. More importantly, pace cars can intervene mid-race if the course becomes treacherous. Much like a pace car, the fed in particular has shown a willingness to take proactive actions when necessary—leading to generally favorable conditions for risk assets.

Looking at the U.S., we believe the risk of a recession remains just a risk—a higher risk than in most of the past decade, but still just a risk for now. The Fed’s actions this year seem to have steadied the U.S. economy, partially offsetting the drag from trade tensions and fading fiscal stimulus. 

Lower mortgage rates appear to be hitting the accelerator for housing, offsetting weaker areas of the economy. Consumer spending remains decent, as low unemployment and modestly firmer wage gains provide support. Those two boosts balance out the ongoing drag from manufacturing. 

Driven by a global manufacturing slowdown and the trade war, the ISM Manufacturing Index declined to 47.8 in September. We’ll continue to closely monitor incoming data, especially jobless claims, as a deterioration in the labor market would increase our concern of a tire blowout for the U.S. economy. Overall, while the data remains mixed, the Fed’s intervention during a period of potential hazard appears to have set the U.S. economy on a more stable course.

Europe, however, has slowed to an even more anemic pace: below 1 percent for the Euro area as a whole, though the slowdown has not been equally distributed across sectors or countries. The same trade tensions hurting the U.S. manufacturing sector have hit the European manufacturing sector, particularly in Germany, where manufacturing comprises a larger share of the economy. 

Germany’s PMI reading has declined sharply, while France and Spain have fallen more modestly. Eurozone core inflation remains stuck at just over 1 percent, well below the European Cental Bank’s (ECB) target of just below 2 percent. As a result, the ECB has taken new actions, including a package with even lower policy rates, more quantitative easing (QE), tiering of reserves and renewed targeted longer-term refinancing operations (TLTROs). We expect these actions will support growth; however, with rates already this low, there has been substantial pushback. In our view, the room to apply more monetary stimulus looks limited, at least in the absence of a more severe downturn. In other words, the policy nudge from the ECB looks a bit weaker than that from the Fed.

China’s economy has also slowed, though more gradually than many had feared given higher U.S. tariffs enacted over the past two years. Determined to control the pace of the economic slowdown, Chinese policymakers implemented various policy easing measures earlier in 2019, and we see evidence these measures are having an impact. As a result, recent data has been mixed. Exports to the U.S. have been down sharply, but Chinese exports to other countries have increased. Housing in China appears stable, though new starts have declined. We’re also seeing signs that Chinese policymakers are calibrating their stimulus to recent economic performance. As the situation seems to have stabilized, China has taken its foot off the gas pedal and slowed down some of its stimulus measures, in particular in the monetary/financial area with a noticeable decline in the credit impulse in recent months.

One common theme is that we believe central banks and other policymakers still have the ability to stimulate their economies, though as we’ve discussed previously, the amount of policy space varies. We expect the Fed to act swiftly if they detect recessionary dynamics. For instance, in the case of meaningful labor market deterioration—an increase in the unemployment rate of more than one or two tenths of a percentage point—we believe the Fed would rapidly move the fed funds rate back to zero. How rapidly? Perhaps over the course of two meetings, with a potential intermeeting cut. We believe the Fed would also return to offering forward guidance, and the re-initiation of explicit QE is a real possibility. Unlike in Europe, the Fed appears quite reluctant to take rates negative, for reasons both practical and political.

Europe has less monetary policy space, but potentially more usable fiscal policy space. As in the U.S., we think it would take labor market deterioration for Germany to take decisive action, but the Germans appear more willing to take such steps than in the past. China has clearly shown its ability and willingness to react aggressively to deteriorating economic conditions, though high leverage has reduced the pace of policy intervention, and policymakers are acting more cautiously than during past slowdowns. Overall, while the track will not always be smooth, our base case remains that the policy pace cars will be successful in keeping the major economy race cars on track.

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Low Volatility Investing: 

What's missing from investors' analysis?

By Nicholas Alonso/PanAgora

In the past 12 months, investor attention to low volatility strategies has increased as many strategies have handily beaten their capitalization-weighted benchmarks. While we believe there is sufficient academic evidence to suggest that, over time, there will be a positive payoff to low volatility assets; we are not so bold as to believe this payoff will be persistent at all times. Rather than chase attractive alpha, we believe investors ought to consider the benefits of adding some downside protection to their equity asset allocation via Low Volatility Equity strategies.

Will the Low Volatility Premia Continue to Pay Off?

Competing theories on why Low Volatility premia payoff leave us uncertain about the continued alpha potential for these strategies in the near future. One common explanation for the existence of the Low Volatility premia is that Low Volatility stocks are underpriced because of agency friction experienced by asset allocators who look to move away from their capitalization-weighted benchmarks. The fact that such frictions are likely to persist is an argument for the continued existence of the Low Volatility premia.[1]

Conversely, PanAgora’s CIO of Multi Asset, Dr. Edward Qian, has suggested that the performance of Low Volatility stocks typically appears strongest before Federal Reserve monetary easing decisions, which typically occur during times of stress.[2] Low Volatility alpha may thus be a harbinger for downturns in the equity market. If this is the case, the recent performance of Low Volatility strategies may be considered near its end.

Precisely because it is so difficult to forecast the continued alpha generated by these strategies, we believe that the more pertinent factor when deciding to invest in Low Volatility strategies should be downside protection.

Devil Is in the Details: How Portfolio Construction Techniques Impact Downside Protection

Low Volatility strategies seek to provide downside protection by lowering the volatility of the equity portfolio. While this seems like an obvious investment objective there are, in fact, many periods where the general collection of low volatility portfolios did not provide the expected downside protection. The reason for dispersion amongst low-volatility portfolio performance in market downturns is that low volatility is a portfolio characteristic and not solely a stock characteristic. The volatility of a portfolio depends both on the stocks idiosyncratic volatility, but also a stocks co-movement with other stocks in the portfolio. Stocks with low correlations to other stocks can lower the volatility of a portfolio 
even if that stock has a high volatility. Diversification, therefore, is an important feature that is often ignored in low volatility portfolios.
The fact that low volatility is a portfolio characteristic leads to an important observation that there are many different ways to build a low volatility portfolio that each lead to very different performance results. PanAgora has analyzed the outcomes of several low volatility portfolio construction methodologies. 

Our results show that performance of certain strategies, such as minimum variance and maximum diversification, are heavily dependent on which risk model is used as an input to the process. The variability in outcomes that result from simply changing the initial measurements of risk should give investors pause. We believe there is a better way to build low volatility portfolios. One that has shown to be robust to changes in the risk models and that leads to behaviors that are much more in line with the expectations for low-volatility investing.

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January 1995 – June 2019. Backtest begins in January 1995 due to data availability. These backtest results presented are gross of fees and are shown for illustrative purposes only. They do not represent actual trading or the impact of material economic and market factors on PanAgora’s decision-making process for an actual PanAgora client account. As with any investment, there is the possibility of profit as well as the risk of loss. Please see the disclosures at the end of this presentation. Source: PanAgora

A Path Forward: Risk Balanced Portfolio Construction

At PanAgora, we have focused the vast majority of our research efforts determining what is responsible for the unexpected results we see in different investment styles. We believe that these unexpected outcomes tend to be driven by a lack of true diversification.  

Risk balancing comes from a fundamental belief that “true” diversification is achieved by giving every investment in a portfolio an equal contribution to the risk of a portfolio.[3] We believe diversification in low volatility portfolios leads to outcomes that are both more robust and more in line the expectations of low volatility investing. Certain periods, such as Q4 2018, show that risk balanced portfolio construction may deliver on the expected outcome of low volatility portfolios, whereas other portfolio construction approaches have produced unexpected results.

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Past performance is not a guarantee of future results. Performance shown gross of fees. Please see the disclosures at the end of this presentation. Source: PanAgora

BACKTESTED PERFORMANCE: The model and hypothetical performance included in the presentation does not represent the performance of actual client portfolios. The performance is shown for illustrative purposes only.

[1] Baker, M., Bradley, B., & Wurgler, J. (2011). Benchmarks as Limits to Arbitrage: Understanding the Low-Volatility Anomaly. Financial Analysts Journal, 67(1). Retrieved from
[2] Qian, E., & Qian, W. (n.d.). The Low-Volatility Anomaly, Interest Rates, and the Canary in a Coal Mine. The Journal of Portfolio Management , 43(4), 3–12.
[3] “On the Financial Interpretation of Risk Contribution: Risk Budgets Do Add Up.” Journal of Investment Management, Vol. 4, No. 4 (2006), pp. 41-51.

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2020 Fixed Income Outlook: 

Staying positive amid the negative

By Jim Cielinski/Janus Henderson Investors

Negative rates and weak economic data paint a challenging backdrop, but there is room to be positive within Fixed Income, an asset class that can tolerate mundane conditions.

Incongruous Highs and Lows

The latter half of 2019 was full of contradictions. U.S. equities hit record highs with labor markets in robust health, yet many purchasing manager indices were in contraction territory and the Chinese economy grew at its slowest pace in 27 years. Worryingly, the U.S. yield curve inverted, with the 2s10s spread turning negative in August – historically, a harbinger of recession.

The inversion has correctly signaled a fragile global economy. Yet it also reflects why the Federal Reserve (Fed) has been swift to act, rapidly cutting rates to reverse the (overly aggressive) tightening in 2018. Central banks worldwide have mirrored the U.S. pivot: In 3Q19, 56 out of 62 rate moves were cuts, whereas in 3Q18, 27 out of 31 adjustments were hikes.

The Trade Smokescreen

We believe economic weakness in 2019 was a lagged response to earlier monetary tightening in the world’s two largest economies – the U.S. and China. With both now firmly in easing mode, we would look for some recovery. The trade war raised costs, reconfigured investment flows and exacerbated the global slowdown but did not cause it. If trade is resolved, but weak growth persists – indicating that the global slowdown is more structural than originally envisaged – expect credit spreads to widen and government bonds to rally.

The market’s consensual calm could be disturbed if the unemployment shoe drops. Consumption has been pivotal in protecting the U.S. economy in contrast with weakness in export-driven Germany. The latter’s sensitivity to fragile global growth means the European Central Bank (ECB) is expected to stay highly accommodative. New ECB president Christine Lagarde’s stark defense of negative rates suggests no departure from her predecessor’s policies. This should anchor eurozone sovereign yields around the zero bound. We expect Lagarde to repeat calls for more fiscal stimulus to assist the bank’s monetary policy; low government debt burdens in Northern Europe at a time of political angst will make these calls increasingly difficult to ignore.

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Elsewhere, policy effectiveness is struggling in China. Regional bank failures have led to tighter credit conditions, dampening the impact of policy easing. Emerging market debt – so closely linked to China’s fortunes – could become more attractive if the transmission mechanism of looser policy can gain traction.

Wage growth appears to be peaking and forward rates suggest inflation will be contained in most developed markets. We believe consensus is correct, and central bankers will continue to undershoot inflation targets. The Fed will likely make one or two additional cuts in 2020, which should bring the real rate more firmly into negative territory.

With the Fed cutting, the yield curve should steepen, offering potentially welcome news for bank margins. For insurers and pension schemes, for which the nominal level of sovereign bond yields is important, the search for yield will continue, driving investors further down the credit spectrum and out in duration, building up risk in the system. 

Click image to enlarge chart.

Active Management

The decline in rates brought forward gains in 2019, but risk-free rates measured in mere basis points in many developed markets (and negative in Europe) present a meager foundation on which to build returns. A more active investment approach will be required to identify markets where real yields persist and where central bank policy rates are expected to head lower. We are not predicting a global recession in 2020, but that does not preclude individual sector recessions (i.e., energy in 2015), and sufficiently avoiding associated spread widening will be key. 

Where we preach particular caution is toward valuations. The market is scarcely distinguishing between BBB and BB issuers in terms of cost of capital, creating little incentive for companies to retain investment-grade metrics. With both investment-grade and high-yield credit spreads encroaching on the tightest levels of the cycle, there is also little cushion should markets be hit by a shock – which may be likely in a U.S. presidential election year. 

A Focus on Fundamentals

Dispersion should remain a feature, and avoiding losses will be critical as disruption continues. The defaults in 2019, such as travel company Thomas Cook, were symptomatic of how technology and shifting consumption patterns are reshaping the world. Lending to companies that will be around tomorrow requires investors to be on the right side of change. In our view, that means monitoring both traditional metrics and what matters to future investors and consumers, including environmental, social and governance factors.

While the low real yield environment lessens default risk, we see diminishing gains from refinancing, particularly in Europe. Corporate borrowers must increasingly rely on cash flow over financial engineering to support their debt. In the U.S., the return on equity remains below the cost of equity capital, and this will continue to encourage share buybacks over capital expenditure. Bond investors will need to monitor whether proceeds from borrowing are being used for bondholder-friendly purposes or are worsening the balance sheet. 

No Repeat Offenders

The search for yield will force investors to look across the entire range of Fixed Income, and could result in increased interest in asset- and mortgage-backed securities. True, excessive mortgage debt was behind the Global Financial Crisis, but it is atypical for a sector to reoffend so soon. Unlike corporate credit, the debt build-up in this cycle has not been in U.S. mortgage credit.

The global economy is at a critical juncture, and investors should keep an eye on key signposts. Labor markets and incomes will be important corroborating indicators of recession while geopolitics and sentiment shifts will likely produce market disruption. Even at low yields, developed market sovereign bonds should continue to offer diversification to Equities, although more credit-sensitive areas would be vulnerable in an equity correction. A low-yielding world might reduce nominal returns, but it will not eliminate opportunities, except for those that refuse to adapt to the new framework.

The opinions and views expressed are as of the date published and are subject to change without notice. They are for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation to buy, sell or hold any security, investment strategy or market sector.

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Danske Bank's money-laundering scandal results in over $6 billion in investor losses

By Olav Haazen/Grant & Eisenhofer

In a series of successive disclosures over the past few years, Danske Bank, Denmark’s largest bank, admitted to a massive money-laundering scandal involving Danske’s branch in Estonia and causing CEO Thomas Borgen and other top executives to resign. These disclosures resulted in stock price declines that have wiped out almost $12.8 billion in market capital.

In February of 2018, credible news reports revealed that the bank’s top management had been part of a four-year long cover-up of large-scale money-laundering of illicit funds from Russia at the bank’s Estonian branch, which was first reported to management in December 2013 and then confirmed by the bank’s own internal audit committee in February 2014. In July 2018, Danske and several investigative news outlets reported that the money-laundering concerned at least $8 billion from which Danske had profited to the tune of more than $200 million. On Sept. 7, Danske disclosed that the scope of illegal money-laundering through Danske’s channels was closer to $150 billion, and on Sept. 19, Danske finally revealed that it actually involved a staggering $234 billion, nearly a thirty-fold increase over the already-shocking amount initially reported.

On the same day, Danske released a report of a year-long independent investigation ordered by the bank’s board of directors. The report erases any doubt that the bank’s anti-money laundering procedures ‘were manifestly insufficient and in breach of international standards as well as Estonian law’ and that the bank ignored that its non-resident customers were ‘categorized as high risk.’ The report also unambiguously states that by no later than early 2014 management knew of the problem – and that its internal controls had been manifestly inadequate – but failed to disclose it to banking regulators in Estonia and Denmark – let alone to its investors.

On March 14, 2019, the first civil damages claims against Danske were filed for over $450 million on behalf of 169 institutional investors in the City Court of Copenhagen, Denmark. In October 2019, a second wave of damages claims were filed on behalf of 64 additional institutional investors, bringing the total number of claimants in both waves to 232 investors with combined losses of nearly $800 million. The Grant & Eisenhofer (“G&E”) group of claimants alone represents 25 countries across Europe, North America, Asia and Australia and include some of the largest public pension funds in the world, and a third wave of damages claims will likely be filed in February 2020 on behalf of additional aggrieved investors.

G&E has been following the emerging story of Danske’s money laundering and continues to investigate avenues for investors to recover their losses under Danish law from Danske Bank. G&E is also investigating claims against Danske’s auditor Ernst & Young which the Danish Business Authority reported to the police on April 12, 2019, in connection with Ernst & Young's audit of Danske's annual and consolidated financial statements for 2014. Ernst & Young reportedly became aware of information that should have led it to carry out further investigations and notify the Money Laundering Secretariat, both of which it failed to do.

The views expressed herein do not constitute research, investment advice or trade recommendations, do not necessarily represent the views of Grant & Eisenhofer nor TEXPERS, and are subject to revision over time.

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Class-action settlement is noteworthy because of its size

A proposed settlement resolves claims that American Realty Capital Properties Inc., now called VEREIT, misrepresented its financial performance for fiscal year 2013 and the first two quarters of 2014.

The settlement is noteworthy for its size. According to Cornerstone Research,[1] since 1996, less than 2 percent of securities class action settlements have exceeded $1 billion.  If approved, American Realty Capital Properties (ARCP) will be the tenth largest since the Private Securities Litigation Reform Act was passed.[2]

It’s also noteworthy for the amounts contributed by defendants other than the issuer. ARCP is paying $738.5 million.  The rest – $286.5 million – is coming from AR Capital and others ($225 million); ARCP’s ex-CFO ($12.5 million); and ARCP’s auditors ($49 million).

Finally, the settlement is noteworthy because post-class distribution, it will give a basis for comparing recovery rates to class members and opt-outs.  According to InvestmentNews,[3] last year the REIT paid $175 million to 9 institutional investors – including Vanguard – that had exited the class to pursue their own claims.

Something similar happened in last year’s mega-settlement with Petrobras ($3 billion, #5 on the top 10 list). As here, the company there settled opt-out suits before resolving the class suit.  In both matters, the reduced class size likely enhanced the parties’ ability to reach resolution of the class action and given the outsized recovery, may well result in higher than average payouts to class members.

In any event, assuming the opt-out returns are significantly higher than class member recoveries, the ARCP settlement will further fuel the trend we’re seeing of large investors opting-out of high profile fraud matters.

All persons and entities that purchased or otherwise acquired the common stock, preferred stock, or debt securities of American Realty Capital Properties, Inc. or ARC Properties Operating Partnership, LP during the period between February 28, 2013 and October 29, 2014.
All persons and entities that purchased or otherwise acquired the common stock, preferred stock, or debt securities of American Realty Capital Properties, Inc. or ARC Properties Operating Partnership, LP during the period between February 28, 2013 and October 29, 2014.

  • Final Approval Hearing; January 21, 2020
  • Deadline for Objecting to Settlement: December 31, 2019
  • Claim Filing Deadline: January 23, 2020
  • Exclusion Deadline: If you did not exclude yourself after the Notice of Pendency of Class Action, you are a Class Member and cannot exclude yourself at this point.

[1] Cornerstone Research, Securities Class Action Settlements, 2018 Review & Analysis.
[2] Securities Class Action Clearinghouse, Top Ten by Largest Settlement.
[3] Bruce Kelly, Settlements at old Schorsch REIT could cost shareholders $730 million (10/13/2018).

The views expressed herein do not constitute research, investment advice or trade recommendations, do not necessarily represent the views of Financial Recovery Technologies nor TEXPERS, and are subject to revision over time.

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Are all hedge fund strategies diversifiers?

By Mark Shore/Coquest Advisors

Editor's Note: This article is an extract from a recent research presentation I gave in November 2019 Talking Hedge conference in Austin, Texas.

Introduction / Research Question
I asked two questions:

  1. In the aggregate do all hedge fund strategies offer diversification?
  2. When analyzing strategies independently, do the benefits vary?

These are interesting questions because I’ve found over the years investors frequently aggregate all hedge fund strategies into one bucket and say “I have hedge funds, I’m diversified.” 

But are all the strategies offering diversification benefits? In recent years, I’ve found investors are increasingly parsing up the strategies to determine which ones may be beneficial for their needs.

When allocating to a portfolio, an investor should consider if the allocation meets their goals. For example, is the allocation goal to extend the portfolio’s equity exposure or to increase the portfolio’s diversification? The research question is also interesting because of the growth of alternative investments. According to TEXPERS’ recent member survey, the results show on a dollar-weighted average, there is a 29 percent allocation to alternatives.[i]

  1. Static and dynamic correlations were examined. Static correlations are a snapshot, a moment in time. A correlation matrix would be an example of a static correlation. Dynamic correlations occur when a correlation changes over time (Meissner, 2014).[ii] This was studied in both strong and weak market environments to examine temporal correlation behavior. 
  2. The behavior of hedge fund strategies was examined in negative S&P 500 Index (SPX) quarters to study the diversification benefits. 
  3. SPX was regressed against hedge fund strategy indices to determine if equities can explain the movement in hedge fund strategies. The results were ranked from highest R-squared to the lowest. 
  4. This study is event agnostic as it examines correlation behavior from January 1997 to March 2018. 
The following market indices were used for this study: the S&P 500 index and BarclayHedge indices.[iii]

Correlation Risk
Correlation risk is defined as “dispersion in economic outcomes attributable to changes in realized or anticipated levels of correlation between market prices or rates.”[iv] In other words, correlations can change from the anticipated correlation level. For example, if the expected correlation is 0.3 between two investments, but may change at various moments, hence a dynamic correlation (Roll, 1988;[v] Ball & Torous, 2000[vi]).

Source: Mark Shore, Coquest Advisors; Bloomberg data. Click image to enlarge graph.

As noted in Figure 1, ranking the correlation of hedge fund strategies relative to various international equity indices, the Hedge Fund index falls right in the mix of the other indices at 0.77 correlation to SPX. This begs the question, if an investor aggregates all strategies, are they receiving diversification benefits from all hedge fund strategies?

 Source: Mark Shore, Coquest Advisors; Bloomberg data. Click image to enlarge graph.

When parsing up the hedge fund strategies and ranked by correlation, as noted in Figure 2, correlations to SPX suggest the benefits vary. For example, the Long/ Short index has a correlation of 0.68 to SPX.  Fixed Income Arbitrage, Equity Market Neutral and Managed Futures correlations are 0.39, 0.19 & -0.09 respectively as noted in Figure 3.

Source: Mark Shore, Coquest Advisors; Bloomberg data. Click image to enlarge graph.

Figure 4 demonstrates on a 3-year rolling basis the correlation behavior of the strategies. The lines in grey tend to be more positively correlated to SPX. The lines in black tend to offer more non-correlation to SPX. The blue line is the Hedge Fund index.

Source: Mark Shore, Coquest Advisors; Bloomberg data. Click image to enlarge graph.

As noted in Figure 5, during the negative 29 SPX quarters, several of the strategies are primarily negative. For a deeper understanding, the Long / Short and the Emerging Markets hedge fund indices were positive 38 percent & 34 percent of the time during the 29 negative SPX quarters. Fixed Income Arbitrage, Equity Market Neutral and Managed Futures (CTAs) were positive 66 percent, 76 percent and 48 percent of the time in the 29 negative SPX quarters. Interesting to note when CTAs were positive they averaged 4.59 percent in those quarters. When they were negative they averaged -1.65 percent.

Source: Mark Shore, Coquest Advisors; Bloomberg data. Click image to enlarge chart.

Figure 6 shows the results of regressing the SPX against the hedge fund strategies. SPX explains about 60 percent of the movement in the Hedge Fund index and 47 percent of the Long/Short movement. SPX explains Fixed Income Arbitrage, Equity Market Neutral and Managed Futures 16 percent, 3 percent, and 1 percent respectively. All of the regressions are statistically significant with the exception of CTAs because their correlation to SPX is close to zero.

Source: Mark Shore, Coquest Advisors; Bloomberg data. Click image to enlarge graph.
In summary, evidence suggests various potential portfolio benefits. An argument can be made for any of the above strategies to receive portfolio allocation. However, their allocation utility is usually goal dependent relative to the investor’s portfolio. The lower the correlation of SPX to the hedge fund strategy, the less likely SPX will explain the movement of the hedge fund strategy. 

[i] TEXPERS (March 2019). Report on the Asset Allocation And Investment Performance of Texas Public Employee Retirement Systems.
[ii] Meissner, G. (2014). Correlation risk modeling and management: an applied guide including the Basel Iii Correlation Framework: with interactive correlation models in Excel.
[iii] BarclayHedge Indices: Long Bias, Hedge Fund Index, Event Driven, Long/ Short, Emerging Markets, Technology, Distressed, Multi-Strategies, Merger Arbitrage, European Equity, Global Macro, Healthcare/ Bio, Fixed Income Arbitrage, Equity Market Neutral, & Managed Futures.
[iv] Anson, M. J. P., Chambers, D. R., Black, K. H., & Kazemi, H. (2012). CAIA Level I: an introduction to core topics in alternative investments. Hoboken: John Wiley & Sons.
[v] Roll, R. (1988). The International Crash of October 1987. Financial Analysts Journal44(5), 19–35
[vi] Ball, C. A., & Torous, W. N. (2000). Stochastic correlation across international stock markets. Journal of Empirical Finance7(3-4), 373–388.

The views expressed herein do not constitute research, investment advice or trade recommendations, do not necessarily represent the views of Coquest Advisors nor TEXPERS, and are subject to revision over time.

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