Wheelhouse Global Equity Income Fund added to BT Wrap and BT Panorama platforms

The flagship fund of Australian-based specialist income manager Wheelhouse Partners, the Wheelhouse Global Equity Fund, is now available to Australian retail investors through the BT Wrap and BT Panorama platforms.

The Fund is unique in that it combines a targeted 7-8% income return with ‘always-on’ tail or crash protection, designed to partially protect the portfolio during any market sell off.

Alastair MacLeod, Managing Director of Wheelhouse Partners, commented, “With equity markets approaching all-time highs and interest rates at all-time lows, the demand for strategies with an absolute return focus is increasing.

Read full article here…

‘Super-defensive equities’ may rescue struggling 60/40 portfolios

This article first appeared in Firstlinks on 24/2/21

Investors concerned about the outlook for their balanced (60% shares/40% bonds) portfolios may need to consider alternate strategies to deliver their future investment objectives.

Specifically, the reasons for including a large allocation to bonds looks particularly challenged. Aside from meagre future return expectations, the ability of bonds to meaningfully appreciate during a crisis appears impaired for the foreseeable future. When preparing for the next crisis, investors will likely need to look further than bonds for negatively-correlated exposures.

Two such exposures that should appreciate during future crises include:

  • Tail hedging – option positions that appreciate in bear markets, and
  • Unhedged foreign currency exposures – a more simplistic defensive approach, but one that has delivered a negative correlation during a crisis.

When integrated together within a global equity portfolio, these embedded features have consistently delivered a positive total portfolio return in Australian dollars during periods of peak to trough drawdown. We have coined the phrase ‘super-defensive equities’ to describe an equity strategy that includes both these negatively-correlated exposures.

Read full article here…

In addition, the charts below help to illustrate some of the points made in the article:

Firstly, when we model ‘super-defensive’ equities (which we define as 50% drawdown plus unhedged Global exposure), they really have done well in an absolute sense during acute drawdowns over time. (We’ve only been around the last 2)

Secondly, while we don’t own any bonds, our risk looks similar to a balanced portfolio. In the scattergram chart we have plotted Wheelhouse Global vs the Morningstar multi-strategy (Balanced) peer group. On a go forward basis, we would expect future returns (and risk) to look quite different for portfolios holding passive bond exposures (vs the last 3 years).

For income, option selling conditions rarely better

For investors seeking income, now may be the time to consider systematic option-selling strategies such as a BuyWrite. Current market conditions in the US have rarely been better.

Market volatility in the US (measured by the VIX Index) has hovered around 25 since May 2020, as the stock market recovery got fully underway. When an option is sold, this elevated volatility (Implied Volatility) is reflected in elevated option prices, meaning income is enhanced during these periods. Implied Volatility is a forward-looking measure of expected future volatility.

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Put-call ratio signalling red for contrarians

Options markets are exhibiting two unusual dynamics at the moment that can provide some insight on investor positioning and sentiment. For contrarians, the signals suggest the market is underprepared for disappointment on politics, virus, unemployment or anything else for that matter.

Firstly the Put-Call ratio is tracking at close to 20-year lows. This ratio references the number of put options held by investors versus call options. Investors will typically buy put options for protection and call options to express a bullish view, so when the balance changes it can reflect a change in investor sentiment and positioning.

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A miserly outlook for franking credits

As published on Livewire Markets, 14 July 2020

While all eyes have been focussed on falling dividends this year, there has been little discussion around the negative impact this will have on the franking credit benefits that are attached to these Australian yields.

Franking credits provide an important source of cash return to many eligible investors, on average accounting for around 1.65% of total return over the past 5 years.

Investors would have been particularly pleased with calendar 2019, a bumper year for franking credits with nearly 2% returned as companies boosted dividend payments ahead of the Federal election. Franking credits are calculated and paid on a fiscal year basis, however analysis of the calendar year is useful to provide some guidance on where franking credit returns are likely to head in the future.

A more miserly 2020 for franking credits

On this basis, returns from franking credits this year are likely to be far more miserly than 2019. We estimate that the calendar year to date contribution from cash dividends to shareholder return has fallen by over 40% for the 8 months to 31 August 2020, from the prior equivalent period.

Given the magnitude of the fall, a decline in franking credits is no doubt also expected. On our estimates, returns from franking credits this calendar year have only totalled 0.67% versus the 1.45% generated at the same point last year, with the percentage decline more than matching the decline in cash dividends.

The marked decline in franking benefits corresponds with the fact that the largest cuts to dollar dividends have been made to previously fully franked dividends, for the most part. The major cuts to bank dividends, which are all fully franked (except ANZ), in addition to the withdrawal of special dividends from BHP and RIO have all contributed to the material ‘shrinkage’ of the franking credit pool in 2020.

As these 6 stocks accounted for over 43% of the total cash dividend on the ASX200 in the past 12 months, and they were mostly all fully franked, the pool of fully franked dividends has declined more than the broader cash dividend generated by the ASX200 in percentage terms (as the broader index includes many stocks with partial or no franking credits attached, that did not see the same quantum of declines).

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Using global shares to break your dividend dependency

As published on Livewire Markets, 14 July 2020

Global equities are usually added to a portfolio for one reason – to increase diversification. With the Australian equity market representing only 2-3% of global equity exposure, plus very high sector concentrations in the local market, the benefits of global diversification are particularly meaningful for Australian investors.

However, leaving geographical considerations aside, how much diversification is actually being delivered at a sector and factor level? When income is the main consideration, the global equity sectors that generate the highest dividend yields are typically concentrated in the same sectors that dominate the Australian market. As a direct result, ‘going global’ may unwittingly ‘double down’ on these identical high yield sector exposures, albeit in a different geography, and thus fail to maximise the diversification benefit.

One solution to this problem is to introduce an alternate source of income that does not rely upon dividend yields. Buy-Write strategies are an established and well-proven solution to yield generation that breaks the connection with dividend dependency. Global Buy-Write strategies can offer genuine diversification at both the sector and country level as well as providing a regular income stream and an element of capital stability.

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How much risk is embedded in your income?

With interest rates at record lows, many investors are being forced into assuming greater risk in their portfolios to generate acceptable levels of income. As an example, bank term deposits are currently yielding a meagre 1.7% pa compared to the 40 year average of over 6% pa. As a consequence, investors who rely on income as a primary source of return are being forced into making more risky investment decisions to sustain their lifestyles.

Typically, retirees comprise a large portion of this ‘yield dependent’ investor class which is a cause for concern because they are often at a stage where they should be decreasing the risk in their portfolios.  There are well-documented reasons to support this such as sequencing risk, shorter investment horizons and liquidity risk to name a few. Hence, achieving the optimal mix between yield and risk in a balanced retirement portfolio has possibly never been more important.

The relationship that exists between yield and risk has been applied across a selection of major asset classes in the chart below. In the first instance, we define risk as price volatility, and secondly as the drawdown experienced during the recent market rout (ie 20 February to 23 March 2020). The relationship is consistent across both metrics.

Figure 1: How much capital volatility is embedded in your income?

 

Figure 2: How much capital drawdown risk is embedded in your income?

In the analysis above, the blue trendline plots the relationship between increased yield, and increased risk. Investments above the line represent more efficient income portfolios for the risk assumed and conversely those below the line less efficient. The returns on cash were used as an anchor point for both risk assumptions, so to make valid comparisons with a mostly ‘risk-free’ 1.7% income return on cash.

The conclusions are readily apparent, but it is worth elaborating on the details.

  • Australian Equities – In order to achieve an equivalent 6% income yield in the current environment, Australian equities (and importantly, their attached franking credit benefit), are one of the few asset classes that come close. The 5.9% gross yield assumes some level of dividend cuts during 2020, with a rebound in yields (at least from the banks) unlikely in the foreseeable future. Despite this, as their position above the blue trend line indicates, Australian equities appear to provide not only one of the highest yields, but also one of the most efficient yields when risk is considered.
  • Hybrids – Given the underlying sector exposure of many convertible issues is banking, capital values held up very well relative to the 40-50% falls seen in bank share prices during the recent drawdown. Hybrids present different risks compared to other asset classes, as in certain circumstances the issuer can decide to ‘convert’ the security to more risky equity (potentially at the worst time for the holder), plus withhold coupon payments. Both of these characteristics create additional risks relative to standard fixed income securities, and are intentionally designed to add value to the issuer during times of extreme credit stress. We believe the numbers in the above analysis understate these risks and if fully considered would move the yields below the efficiency line.
  • Australian Investment Grade Corporate Bonds – Average yield to maturity for Australian IG corporate bonds is currently returning 3.0%, significantly lower than average coupon rates of around 6%. The difference is explained by the decline in Australian interest rates which has pushed most bond prices well above par. Liquidity and breadth of market exposure are more difficult to achieve within the Australian corporate bond market, which in our view is a significant compromise for the slightly better than average yield versus risk relationship.
  • AREITs – Subsequent to the near 50% fall during the Coronavirus rout of Feb 20 – Mar 23rd, the ASX 300 AREIT Index has only partially recovered and remains down 25% year to date. The asset class was acutely exposed to the pandemic due to its high retail sector exposure and the evaporation of foot traffic. Assisted by the capital decline, the Index is currently indicating a 6% yield although we question the delivery of this yield in the 12 months ahead. The drawdown highlights the lack of diversification within the AREIT index, with the 6% yield, even if achievable, screening unfavourably relative to the risk.
  • Global Infrastructure – Along with AREITs, this sector was heavily exposed to the Coronavirus pandemic due to sudden demand destruction in global transport and electricity generation.  While low interest rates globally have typically been supportive for capital values (resulting in improved drawdown characteristics versus other equity-based asset classes), current yields of 3.5% fall well below the trendline for ‘equivalent risk’ versus other asset classes.

Conclusion

Dollar for dollar, within conventional asset classes it remains difficult to go past Australian equities in terms of yield generation for the risk assumed. Even with the high exposure to financials the yield is relatively more diversified than many other typical income sources that have a high factor concentration, plus it offers ample liquidity and includes the possibility of capital growth that is not included in the above analysis. IG Bonds and Hybrids may also play a role in terms of delivering diversified sources of ‘risk efficient’ income, however breadth, liquidity, and credit deterioration (especially for hybrids) could prevent inclusion in some portfolios.

For investors willing to venture past the more ‘conventional’ asset classes there is the Wheelhouse Global Equity Income Fund.  In this case ‘less conventional’ does not mean ‘more risk’ but rather the exact opposite.  The Wheelhouse approach delivers a materially beneficial yield for less risk when compared to conventional alternatives, with none of the liquidity, diversification, or factor dependent risks.

Wheelhouse Global Equity Income Fund

At Wheelhouse, we recognise that income is only as good as the security of the capital that is generating it. Our unique process is outcomes-focused, and seeks to deliver a real 7-8% income stream while assuming the lowest risk possible – typically around half the equity market’s risk.

Where are we different? The funds approach to income generation and capital protection is unique, and different to all conventional strategies.

  • Income – The fund is based on a diversified global portfolio of shares. Global shares are typically known for growth, but not yield. The ‘unconventional’ difference is the use of a systematic derivative overlay that coverts capital growth into a reliable 7-8% income stream.
  • Protection – The second ‘unconventional’ difference is the use of an ‘always-on’ protective hedge, that preserves capital in market drawdowns. This insurance mindset will usually cost a little income during normal times, but then deliver in spades when it is most required.

With the Fund passing its three-year milestone this month, both the yield and the risk have proven consistent across a variety of market scenarios, as evidenced in the analysis above.

Yield vs risk – or as we call it, income and protection – that’s all we do.

Source: Wheelhouse

Asset class proxies

Aust IG Bonds                           Solactive Australian Investment Grade Corporate Bond Select Index (SOLAUSIG).

Hybrids                                    Solactive Australian Hybrid Securities Index (SOLAUDHG). .

Global Infrastructure                 FTSE Global Core Infrastructure 50/50 Net Total Return Index in AUD

AREITS                                    ASX-300 AREIT Index

 

Download a copy of the article here.

Market crash highlights the value of tail-protection

What are tail risks?

Within financial markets, ‘tail risk’ events refer to rare and unpredictable events that can cause sudden sharemarket crashes. While there is a statistical definition (a greater than three standard deviation movement from the mean), in layman’s terms the price movements of the past month are a very good example of a tail risk event.

Tail risks are notoriously difficult to predict, and often fall outside of the ‘expected’ market return profile of a normal distribution. This creates a problem for many asset allocation and risk management models, which rely upon ‘normally distributed’ returns to assess and analyse expected returns. In reality – and particularly in times of crisis – these models systematically under-estimate the risk of loss, in large part to the nature of crashes which can be extremely vicious on the way down.

For example, our analysis of the MSCI World Index for the period 1970-2017 shows that observed tail risk events occurred 6-8 times more frequently than these models suggested, when based on a normal distribution.

Frequency of tail risk events for MSCI World, 1970 – 2017

Source: Wheelhouse

Furthermore, during periods of higher than average market volatility, research by Peters (2009 & 2014) suggests the risk is not 6-8 times more likely, but more than 20 times more likely!

After a 12-year period of relatively muted volatility and strong equity price gains, it does appear we are on the cusp of a period, potentially extended, of high market volatility and uncertainty.

Impact of tail risk events

There are two major impacts of tail risk events on investor outcomes.

1. Sequencing risk

Large losses, particularly in the 5-10 years immediately preceding and after retirement, can be devastating in terms of outcomes. This well-documented issue is known as sequencing risk, and is particularly relevant for retirees and pre-retirees due to the large sums of money involved; the relative lack of time that retirees have to recover from these losses; and the necessity for retirees to draw down income during these periods.

In our report The retiree and the 100-year storm we provide an example of sequencing risk in some detail.

2. Behavioural loss aversion

Compounding the sequencing risk dilemma is the behavioural finance theory of loss aversion, referring to the human preference of avoiding losses more than acquiring equivalent gains. Put simply, the pain of losing $100 is more pronounced than the joy of making $100.

Studies have shown that retirees are far more sensitive to this ‘emotional magnet’ than any other age cohort.

Well-crafted long-term investment plans can be disregarded overnight, as investors that are weighing the emotional response of a sharp loss look to move to the relative safety of cash at precisely the wrong time. However, by selling at the bottom when much of the damage has already been wrought, losses can be effectively locked in and longer-term investment outcomes more difficult to achieve.

What type of tail risk protection strategies are there?

For most people, the move to retirement should also include an increased allocation to more defensive asset classes, such as cash or fixed income. While these more defensive allocations will usually help defend capital during a tail event, in the more recent low-interest rate environment these allocations have also come with significantly diminished returns. Low interest rates, combined with increasing investor life expectancies, may actually serve to increase the likelihood of a critical failure such as a retiree outliving their savings.

Within equities, increased allocations to more defensive sectors such as utilities and consumer staples can also assist. However, there comes a point where correlations for all stocks and sectors increase, something we have witnessed in the past week or so.

An alternate solution, and one we employ systematically at Wheelhouse, is actively managed tail protection that relies on derivative overlays, and the principles of insurance. Our tail protection strategy, once engaged, physically increases in value for every move down in the market. In fact, the way our strategy is designed is that the hedge increases in value at a faster rate than the market is falling. This means that the worse the market falls, the more our hedge goes up.

As an example, one protective trade we entered in mid-February 2020 (when market conditions were benign) for $4.62 had increased in value by over 50x and was monetised for an average $248.32 in mid-March. In the current environment, hedging a portfolio is as expensive as it was at the peak of the GFC and really validates the Wheelhouse approach of having protection ‘always on’. These little ‘sleeping securities’ are expected to cost performance around 1.0-1.5% over the year, but during market stresses they increase in value exponentially. The chart below illustrates the performance of the tail hedge in the Wheelhouse Global Equity Income Fund year to date, where it has added 700 basis points year to date, and nearer 720 basis points since the market commenced its decline.

Source: Wheelhouse

Similar to insurance, tail protection needs to be managed. Trying to buy flood protection after the rain has started, or hurricane protection after the storm, is typically an expensive exercise. However, when ‘always on’ and actively managed, insurance policies put in place before the market turmoil can increase significantly in value.

In retirement, we believe many portfolios would benefit from an insurance mindset. For example, when we are young and working our primary asset is our salary, or our human capital, that we rely upon to provide for ourselves and our families. Thus it comes as no surprise that we often take out ‘income protection’ type policies to protect that human capital.

As we move into retirement, that human capital becomes financial capital, or our investments and savings. With decreased opportunity to return to work as we age, we believe our financial capital should be protected in a similar fashion – namely with tail risk protection strategies. By protecting capital, this allows income to be generated on a more stable financial base. For retirees, we believe this combination of income and protection is key.


 

This information is issued by Bennelong Funds Management Ltd (ABN 39 111 214 085, AFSL 296806) (BFML) in relation to the Wheelhouse Global Equity Income Fund. The Fund is managed by Wheelhouse Partners, a Bennelong boutique. This is general information only, and does not constitute financial, tax or legal advice or an offer or solicitation to subscribe for units in any fund of which BFML is the Trustee or Responsible Entity (Bennelong Fund). This information has been prepared without taking account of your objectives, financial situation or needs. Before acting on the information or deciding whether to acquire or hold a product, you should consider the appropriateness of the information based on your own objectives, financial situation or needs or consult a professional adviser. You should also consider the relevant Information Memorandum (IM) and or Product Disclosure Statement (PDS) which is available on the BFML website, bennelongfunds.com, or by phoning 1800 895 388 (AU) or 0800 442 304 (NZ). BFML may receive management and or performance fees from the Bennelong Funds, details of which are also set out in the current IM and or PDS. BFML and the Bennelong Funds, their affiliates and associates accept no liability for any inaccurate, incomplete or omitted information of any kind or any losses caused by using this information. All investments carry risks. There can be no assurance that any Bennelong Fund will achieve its targeted rate of return and no guarantee against loss resulting from an investment in any Bennelong Fund. Past fund performance is not indicative of future performance. Information is current as at 16 March 2020. Wheelhouse Investment Partners Pty Ltd (ABN 26 618 156 200) is a Corporate Authorised Representative of BFML.

COVID-19 crisis – the value of income and protection

The evolving COVID-19 crisis remains fluid, and all measures of risk have increased alongside the market’s fall.

At Wheelhouse, we never attempt to predict the direction of market movements. Rather, we eye the world through a consistent defensive lens that is always more concerned with downside risk, versus how much we stand to make should markets recover.

Our key objectives are to deliver a consistent 7-8% real yield, while assuming only around half the market’s risk. Our defensive approach is based on the following two investment processes that integrate to deliver a highly predictable return profile, even during market crises.

1) Income generation

Income generation has increased materially since the market drawdown commenced. In mid March, gross income generation is already over two times the usual average. This income stands between us and a loss, and forms part of our real return generation.

It’s worth highlighting that the heightened volatility in the market provides an opportunity for our systematic overlay to harvest outsized income returns. For example, one-month index options on the S&P 500 are currently generating nearly 5% in income for the month, or nearly 60% annualised return.

The Wheelhouse Global Equity Income Fund is well positioned to exploit this differentiated source of return and is systematically monetising this opportunity.

Source: Wheelhouse. Figures correct at 16 March 2020.


2) Capital protection

A unique aspect of our downside protection is our ‘always-on’ tail risk protection strategy, which is designed to engage in more acute or sudden drawdowns of typically greater than 10% in magnitude. The tail hedge is designed to reduce risk aggressively in market corrections, without the need to sell a single share. During these periods we actively manage the protection, extracting value wherever we can yet maintaining similar protective coverage of around 50-60% of the market risk.

Year to date the protective tail hedge has added 700 basis points in value, during which time we extracted over 300 basis points in cash which is added to our investors’ returns – no matter what happens next in the market.

Source: Wheelhouse. Figures correct at 16 March 2020.

 

For performance information, see our latest monthly report.

 


 

This information is issued by Bennelong Funds Management Ltd (ABN 39 111 214 085, AFSL 296806) (BFML) in relation to the Wheelhouse Global Equity Income Fund. The Fund is managed by Wheelhouse Partners, a Bennelong boutique. This is general information only, and does not constitute financial, tax or legal advice or an offer or solicitation to subscribe for units in any fund of which BFML is the Trustee or Responsible Entity (Bennelong Fund). This information has been prepared without taking account of your objectives, financial situation or needs. Before acting on the information or deciding whether to acquire or hold a product, you should consider the appropriateness of the information based on your own objectives, financial situation or needs or consult a professional adviser. You should also consider the relevant Information Memorandum (IM) and or Product Disclosure Statement (PDS) which is available on the BFML website, bennelongfunds.com, or by phoning 1800 895 388 (AU) or 0800 442 304 (NZ). BFML may receive management and or performance fees from the Bennelong Funds, details of which are also set out in the current IM and or PDS. BFML and the Bennelong Funds, their affiliates and associates accept no liability for any inaccurate, incomplete or omitted information of any kind or any losses caused by using this information. All investments carry risks. There can be no assurance that any Bennelong Fund will achieve its targeted rate of return and no guarantee against loss resulting from an investment in any Bennelong Fund. Past fund performance is not indicative of future performance. Information is current as at 16 March 2020. Wheelhouse Investment Partners Pty Ltd (ABN 26 618 156 200) is a Corporate Authorised Representative of BFML.