Julian Robertson, the founder of fund management company Tiger Management and a pioneer of the hedge fund industry, died on Aug 23, survived by a generation of successful investor proteges also known as his “cubs”.
One of them is Jay Raffaldini, Managing Director and Head of Investment Specialists at O'Connor, UBS, who now manages US$45 billion ($62.8 billion) in hedge fund assets for clients globally — making his team one of the largest hedge fund investors in the world.
Speaking at a private UBS event on Aug 26, Raffaldini says: “What made Julian [Robertson] such a successful investor was whenever he had a great idea, he would always say, ‘Give me something to hedge against it’.”
“What that means is if you wanted to buy one stock, that’s great; but if you buy a stock that’s unhedged, how much of your success is Beta versus Alpha — and Julian was all about Alpha, which is what made him brilliant,” Raffaldini continues.
Much of this investment philosophy is reflected in the O’Connor Hedge Fund, a multi-strategy hedge fund manager within UBS Asset Management, whose approach is firmly rooted in relative value investing and state-of-the-art risk management capabilities.
Head of the O’Connor unit’s Asia-Pacific business John Bradshaw, speaking at the same event, says that his 12-person team, based across Shanghai, Hong Kong and Singapore, manages capital allocations from both its flagship multi-strategy Alpha fund as well as a standalone China long/short fund.
Bradshaw says that in total, the team has about US$2.2 billion of gross exposure across the region. “The key element is that we put together a portfolio with long stock positions and short stock positions, and we’re looking to identify situations where we’re going to see our long positions relatively outperform our short positions,” he explains.
Regime shift requires ‘brutal’ adjustment
The way Raffaldini sees it, investors are viewing the economic environment of 2022 in “two distinct phases”, with the first half of the year featuring a macroeconomic “regime shift” with inflation rates and currencies facing repricing.
In that period, directional bets dominated the general investing profile, he says. But Raffaldini believes that since the beginning
of July, investors have recognised that they were at the ending point of the “regime shift”, and consequently, non-directional strategies like relative value have returned to take precedence in term profiles.
“Many investors have piled into strategies that made money in the past, which is not uncommon, but the issue is how else to move forward,” he says, noting that the traditional model of distributing a portfolio across 60% equities allocation and 40% fixed income, which many investors have adopted, is having a “horrible” year.
Raffaldini notes that the 60/40 model was adopted in 1980, the beginning of the bull market in financial assets. He believes that if the traditional portfolio were to be redeveloped today, it would probably look “radically different”, but investors are so “married” to the 60/40 model of investing that making a significant change would be akin to a “miracle”.
Agreeing with this “behavioural” observation is Bradshaw, who adds that it is a similar situation for investors who are “stuck long” in China and do not want to sell to consolidate their losses. “When I look at it from a trading perspective, when I have a position and my thesis has suddenly been challenged because of external environmental changes, we have to be brutal — just accept that something has changed and pivot to something new,” he says.
Bradshaw believes that the investment landscape has reached a crossroads, not just with China but also other strategies, and investors must decide where their future lies — whether they are going to “revert” to old methods or choose to go down a “different path”.
Relative value investing
To that end, the focus of the O’Connor fund is to have a “low correlation” to broader equity markets and other indices, and as a result is “agnostic” to what the broader market is doing, as well as to capture the “exceptional Alpha opportunity” it has identified in China, says Bradshaw.
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He believes that the fund has performed relatively strongly this year, considering its Shanghai team’s “very conservative” view on
the economic outlook. “As such, we’ve been very defensively positioned — we have actually been running a net short position over the course of this year, so we have benefitted somewhat from the correction,” he says.
“But really, the essence of our strategy is to leverage the insight we get from our research team onshore in China, where they can actually [go around] and do due diligence, visiting factories and meeting with management, which is what we are really trying to isolate,” adds Bradshaw. He says that his team is not “targeting” to have a strong view on which direction it thinks the market is heading.
Bradshaw notes that China’s consumer price index (CPI) was 2.7% in July, compared with 8.5% in the US. According to him, one of the main reasons for this “different backdrop” is the US government’s “extreme” response to the pandemic, which “sowed the seeds” for the inflationary environment it is now experiencing, compared to China’s vastly different response.
He adds that the CPIs of the two countries are structured differently, with shelter and transport more heavily weighted in the US, whereas China is focused on food and clothing. “We do expect inflation in China to pick up a bit and probably be in the 3.5% to 4% range,” he says, and that China will also be impacted by higher rates of inflation and an economic slowdown.
“Naturally, China would see lower demand for exports, which is obviously going to be another headwind,” says Bradshaw. “But remember, China does have a lot of policy options to try and support economic growth, although if inflation does tick upwards, that could curtail the People’s Bank of China (PBOC) somewhat in terms of further monetary easing.”
“The volatility created by [Beijing’s] regulatory changes last summer was very difficult to navigate and understand, which is why it’s really important to follow policy direction very closely when we look at investing in China — not just at the PBOC but also across other areas of government,” he adds, noting that the last 12 to 18 months have created a “difficult environment” for investors.
In order to hedge against unexpected movements in China, Bradshaw explains that the O’Connor fund needs to “move quickly”. “If I’ve learned anything from investing in Asia for 20 years, it is that unexpected things happen all the time. I generally like to have convexity in my portfolio, which means that I have options or derivative strategies to help manage the volatility of our returns and provide protection in that book,” he says, admitting that this is an advantage for hedge funds compared with mutual funds, long-only institutions and individual investors.
Alpha opportunities aplenty in China
Historically, investors have taken a “long bias” in their approach to investing in China, considering its “amazing secular growth story” in the past decade — but investing in China should not “just be about Beta”, advises Bradshaw.
With recent regulatory changes, the uncertain future of the Chinese market looms large, offering “structural Alpha opportunities” that the O’Connor fund has identified.
To him, there are several areas in which the China market “ticks the boxes” for the fund. He believes that the market is “very inefficient”, with relatively low sell-side research coverage compared to other regional markets and the global market, instead featuring higher retail participation that lends to greater momentum shifts.
“We all know retail investors like to chase things on the way up and then panic out on the way down. So if you have a disciplined investment process, you can spot where there are massive deviations from our perceived fair value,” he explains.
Next, liquidity in the China market has also “picked up massively” over the past couple of years, says Bradshaw. He points out that when O’Connor launched its China long/short product in September 2021, it was offered with daily liquidity to investors to show how confident the team was in the liquidity of its portfolio.
Finally, institutional participation in the Chinese market from international institutions and hedge funds, in comparison with the overall market, is relatively low. “That means that there is some degree of cushioning during risk-off periods because there’s not so much impact on the broader market,” he says.
These elements put together, Bradshaw believes, makes for a “fantastic opportunity” for disciplined relative value, long/short strategies on which funds, such as O’Connor, aim to capitalise.
Raffaldini concludes that China has now become the O’Connor fund’s “highest conviction”, considering the alignment of these factors. “For us, looking at the Alpha oppor- tunities in China — and it is all about Alpha — there has been no precedent in any other market at this level for years,” he says.
Clearly, Robertson’s spirit lives on.