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Capitalising on ongoing volatility and exceeds R1bn rand

At a time when global equities - including South Africa - are looking overbought spurred by historically low interest rates, global market volatility looks set to continue.

Only recently Bloomberg quoted a report by New York-based Bespoke Investment Group which found that despite the VIX (or Chicago Board Options Exchange Volatility Index) having dropped by almost half during the past month - its fastest drop since Black Monday in 1987 - it remains considerably higher than its 20-year average.

The VIX, often referred to as the fear index, is a popular measure of the market's expectation of volatility over the next 30-day period.

The net result is that many local retail and institutional investors are likely to have put their long-term strategies on hold.

Amid the financial crisis, Metropolitan Asset Managers (MetAM) launched the Metropolitan Income Plus Fund. The fund, which exceeded R1 billion assets under management in July this year, is specifically structured to mitigate risk with the key objective of producing absolute returns regardless of stock market trends.

While the fund seeks to outperform the STEFI composite benchmark on a consistent basis, the fund manager targets a CPI + 4 return. Last year the fund generated a CPI + 6% return and a CPI + 8% return in 2008.

Fund manager and head of Hybrid & Structured Investments at MetAM, Brandon Quinn (Pictured above), says the fund is managed around three core principles designed to achieve the core objectives.

The first is liquidity. Approximately half of the fund is invested in cash or cash equivalents. This enables the fund to capitalise quickly on market opportunities - particularly mispriced assets and other opportunities that occur more frequently under volatile or uncertain conditions. To mitigate risk, every investment has a clear exit strategy - ensuring risk parameters are quantified upfront.

Says Quinn, "A risk budget is calculated per strategy, to both monitor and direct our investment activities. I look for investments that meet both the return objectives and risk budget constraints."

Secondly, while most collective investment schemes target return on assets, the Metropolitan Income Plus Fund targets return on capital (risk capital employed), which serves to ensure that investors' funds are optimally allocated on a risk-adjusted basis. In a nutshell, the market risk inherent in each investment is modelled and quantified.

The risk associated with each investment is then offset against the total risk budget allocated to the fund. This risk budget is a measure of the fund's risk capital.

As a consequence, says Quinn, the risk of each investment consumes a commensurate amount of risk capital. The risk appetite of the fund is therefore aligned with the risk / return relationship of the investments and risk-adjusted returns become a factor of the risk capital utilised.

Thirdly, while investment pundits traditionally target long-term performance, the Metropolitan Income Plus Fund has challenged this philosophy under volatile conditions by only targeting short-term performance.

Quinn says under the current market environment it's extremely difficult to predict where the next bubble or the next credit default will be. We feel that short-term targets with a foreseeable horizon are the best way to mitigate risk in the current market."

Unlike other funds like absolute return funds, the Metropolitan Income Plus Fund does not target rolling returns over a longer period of say three to five years. Instead it focuses on short-term performance of less than a year.

There's a specific reason for this according to Quinn. While there are certainly many cases where a long-term investment horizon makes perfect sense, long-term assets may be prone to short-term market volatility (currently the case), which could be extremely negative for a person about to retire.

Generally, traditional investment strategies have a longer-term focus disregarding the impact of short-term liquidity risks. This fund adopts a multi-asset class investment approach with a short-term pay-off objective, minimising the negative impact of market volatility and improving the opportunity to participate in multiple opportunities as the economic tides ebb and flow.

"With this discipline", says Quinn, "we are able to better focus on generating income from successive high yield short-term assets and capital gains in a broad investment universe, including interest rate derivatives, credit, commodities, currency and equity derivatives by exploiting short-term pricing anomalies both within and between asset classes."

And the fund strategy is paying dividends. Since inception the fund has outperformed its benchmark, local equities and money market investments by some margin.

Quinn believes that if the volatility in global financial markets ensues, alternative strategies will become more popular because they are often designed to exploit opportunities or "gaps" in the market.