Recently Aneet Chachra, Portfolio Manager on the Multi Strategy and Global Diversified Risk Premia strategies, spoke with Raul Pangaiban, host of ValueWalk’s “ValueTalks” podcast. Following is an excerpt from the conversation, in which Chachra discussed his investment approach, the opportunities that are being created in the “flow world” regime and why he believes the current environment is a favorable backdrop for alternative strategies.
How would you describe your investment approach? How do you invest and how do you generate your ideas?
I think we're very different from most other investors. There's lots of electronic market making firms and high frequency trading firms and though those firms typically have a pretty short holding period, less than one day. Then lots of investors do a lot of research on exactly which assets they want to buy and they're looking to hold for, many months and ideally, years. What we do falls in the middle so most of our trades are between one day to three months.
What we are doing is looking for opportunities where there's buying or selling flows that are temporarily moving prices and where we think we understand why those flows exist and why it's happening. Now, I know that's going to sound sort of vague, so let me give an actual example. Last year, there were lots of companies that were losing money due to COVID and they needed to sell stock to fix their balance sheet. Now because it's dilutive and typically they need to transact quickly, shares are offered at a discount. And in that case, we know why the shares are available and we can model out a price where we're willing to provide capital. So it's a win/win for both of us: A company raises the money it needs and we get a discount for taking a risk that things would suddenly get worse.
How do you define risk and how do you manage it?
The firm has a really strong risk team and they do all the standard models and reports. They're tracking our position limits and credit exposure and risk metrics and I can tell you that the risk team is pretty proactive. They will certainly step in if we even get close to the line. But I can also tell you that, as a manager, the risks that I worry about most are actually coming from outside the model.
Last year, we obviously had no idea COVID was coming but we were concerned that there could be a sudden volatility shock. So we had put in some protective positions in place that we thought would benefit from volatility spike. And then later on during the peak of COVID in March, you know we began to see a real risk that markets could get temporarily shut down. We had to think about that. How are we going to manage our hedges, especially our option positions, if that did happen? So we definitely, we want to be cognizant of what risks are there both in our model and outside.
You talked about flows. How do you generate those ideas?
Ideas we get they come from very different places, but they're about three main sources. The first one is we have a long history of data and models for different assets. We're tracking markets around the world and that lets us quickly know when a particular price is looking interesting to us. And then the second way is I read a lot to find ideas, not just research but also blogs and Twitter and I listen to a lot of podcasts, too. And then finally, we have good relationships with a number of banks and sometimes for various reasons, banks need to offload a particular risk and they'll contact us. So they know we can look at a fairly complicated product, we can make a decision on whether we're interested and we can price out at what price we're willing to take on this risk from a bank.
And then what are alternative strategies?
So most individual investors, they look at stocks and bonds. I think we can all agree that stocks have done well over the long run, but there's been a lot of volatility along the way especially when there's economic stress. Bonds have also performed well, but I think we can agree that with 10-year yields at even at 1.35% today, it's going to be pretty difficult for bonds mathematically for them to match their historical returns.
Now institutions do have a lot more options available to them, like private equity or venture capital. If you can get access to a top tier firm in those areas, then their historical record has been pretty good. But with all these traditional alternative strategies, you need to tie up capital for a long time.
Now what we're trying to do is a different kind of alternative investing. We're targeting absolute returns but without having to lock up money for years. And the reason I think this is important is, one of my pet peeves is this view that stocks get sold during crisis periods because people or funds are being irrational. Like if stocks only go up, then why doesn't everybody just buy and hold? But when you look carefully at flows, what you'll see is that quite often, the selling is being forced in some way. So for example, they are volatility targeting funds and they must sell when volatility goes up.
Or often people have bought stocks using margin or they've sold options or they need to meet spending needs. An example of this is capital calls. If you're an institution and you've invested in private equity or venture capital like we were discussing earlier, during crisis periods, your partners will want to put money into work and they're going to ask for the commitments that you've made. They're going to ask for you to send them the money that you promised.
Now, if you're running an institution, you now need to raise cash. Compared to most investments you know, stocks are relatively quick and easy to sell. The stock market’s open every weekday, the bid ask spread that you seek is generally pretty tight and you can settle the trade in two days. Now, if you compare this to something like real estate, like if you want to sell your house, you're going to pay a 5% commission and it's probably going to take you months to find a buyer and close the deal. So the direct costs that you see when you're selling stocks is pretty low, but there is a hidden cost that you don't see.
You know on average if you're selling stocks when volatility is really high, you're probably getting a worse price for it. Those stocks have a volatility discount so stocks have a liquidity discount during the crisis. But then traditional alternatives like private equity or venture capital or real estate, you basically can’t sell at all when markets are stressed. Instead, our alternatives, we're targeting absolute uncorrelated returns but without getting into illiquid investments.
How can liquid alternative strategies be used during periods of market stress?
So during periods of market stress you know, going back to the point we were discussing is you may not have enough cash holdings to meet the spending commitments that you have. And you can’t get out of your traditional alternative investments like private equity or venture capital or real estate. And then if you're selling stocks, you're selling them at a big discount. So it makes sense to hold things like bonds or liquid alternatives that you can exit during a crisis period without taking a big price hit.
Another article that you wrote was Welcome to the Flow World. Can you tell me more about the article and why this is a favorable backdrop for alternative strategies?
I think that money flows are the dominant driver of market moves right now. And then that's why we're calling this regime flow world. And the reason is that a lot of the traditional factors that push markets are pretty much on autopilot. Monetary policy, I think we can all agree that the Federal Reserve is pretty unlikely to raise rates anytime soon. Now fiscal policy, certainly the exact size and scope of stimulus is yet to be decided but I think we can, we all broadly we can agree on what the new US government will do.
And finally, the vaccine rollout is happening reasonably quickly. It now looks like any American who wants a vaccine should be able to get one by the summer. What this is doing is it puts almost everybody into the same boat. Stocks look pretty expensive on most valuation measures, but they are attractive if interest rates stay low. And what that’s doing is that there's not a lot of conviction that people don't think that they're buying stocks necessarily because the valuations are really attractive. But on the other hand, they think that they're being forced into stocks.
The most important message I have for everyone is that money flows matter. If you're an investor, you need to at least be aware of what flows are happening in your sector or the assets that you're interested in and perhaps they provide temporary dislocations and opportunities that this flow world is creating. I also strongly believe that it's important to be different. You don't want to be running a completely fixed and predictable strategy. There's a line that predictable gets hacked. Instead if you can blend data with tactics, you can adapt to different market conditions while a back test will be too slow to adjust. I think we can agree that computers are much better at studying lots of data but humans are better at recognizing change. COVID is a good example of this. It wasn't in anyone's model, but we've all adapted to a new world.
So my closing thought is, can you figure out where you can add human skills on top of a computer model? The combination of both is almost always going to be better than just humans or computers alone.
Janus Henderson is not affiliated with ValueWalk or The Hidden Value Stocks Newsletter.
This document is intended for the use of investment consultants and other institutional/professional investors only, and is not directed at private individuals.