How can you get the best of two frustrating worlds?
This week Goldman Sachs, a US bank, published a report outlining the difficult starting point for investors today. Any investor looking to hold a portfolio of broad-based stocks and bonds will quickly succumb to “valuation frustration”, to borrow the words of the author. That is because both equities and bonds are trading, on average, at high valuations compared with historical levels. But there may be a solution.
Goldman shows that US stocks and bonds are trading near their respective highest levels in the past 100 years, and at their high point when considered together. See the chart below, where stock valuations are represented by a cyclically adjusted ratio of share prices to earnings-per-share and bond valuations are represented by the yield on the US government’s 10-year bonds (remember that the lower interest rates are, the higher bond prices will be, and the lower prospective returns from the asset class). The report goes on to suggest two scenarios that may play out and the strategy an investor in a mixed portfolio of bonds could employ under each.
The first picture painted by the report is one where valuations remain stable at their high levels, and returns are lower than the experience over the last couple decades. In this case Goldman suggests staying invested, rather than moving to cash, as securities in both asset classes will generate positive performance. The second scenario described contemplates a large drop in asset prices due to a growth and/or inflation shock. In this case the investor should adopt a high allocation to cash. The problem is knowing which scenario will play out.
We believe the Montaka long-short global equities strategy can be useful in solving the conundrum ex-ante – regardless of which of the scenarios may be realised. On the one hand Montaka remains invested in stocks in its long portfolio. It is quite concentrated among leading businesses around the world that are undervalued in the market. This portfolio provides the potential to capture positive performance in equities. On the other hand, Montaka holds a short portfolio, which offsets the overall net market exposure of the long book and results in a high effective cash position. For instance, today the net market exposure of the fund is less than 40 per cent, which means the resulting cash level is north of 60 per cent.
Moreover, Montaka does not diversify across the many thousands of stocks and bonds across the world. Instead it is invested in a couple dozen long opportunities and around three dozen short positions. So, the overall market direction means much less again to the potential for Montaka to generate returns and reduce risk.
Since inception more than three years ago, Montaka has achieved higher returns with lower risk than was available in the market. Our team strives to sustain this record each day. And we believe it is a fitting strategy and pursuit, regardless of which of the environments might eventuate.
If you would like to find out more about the Montaka Global Access Fund, please click here.