August 7, 2020 – The great stock market panic of March 2020, when each Monday we’d come into the (home) office and see stock market futures limit-down, has slowly faded from investors’ memories. Central banks worldwide have flooded the market with liquidity, easing investor consternation and leading to rapidly rebounding equities, bonds and arbitrage spreads.
Large-cap benchmark equity indices in Canada and the U.S. have recovered from being down well over -30% to be approximately flat year-to-date. However, unemployment remains troublingly high, a sad predicament driving wealth disparity to record levels as asset owners have seen security values recuperate.
The most speculative stock issues have led the market higher, and growth is seemingly the only game in town for equity investors. Securities that began the year at attractive valuations are now even more attractively valued, given their share prices have been crushed and haven’t recovered over the past few months. Stocks with the highest valuations have outperformed the most, in stark contrast to historical norms. Typically, valuations drive returns, and stocks with the lowest valuations have outperformed while those with the highest valuations have underperformed over the long-term. Valuation spreads, the difference between the most expensive and cheapest stocks, are now at their widest levels on record – even exceeding those that occurred in the 1999 tech bubble. These highly valued story stocks are balancing on a knife’s edge, and it may prove prescient to have an allocation to a long-short portfolio to capitalize when valuations snap back in-line with more fundamentally-driven levels.
Accelerate manages four alternative ETFs, each with a specific mandate:
- Accelerate Absolute Return Hedge Fund (TSX: HDGE): Long-short equity
- Accelerate Arbitrage Fund (TSX: ARB): Event-driven
- Accelerate Enhanced Canadian Benchmark Alternative Fund (TSX: ATSX): Alpha + beta
- Accelerate Private Equity Alpha Fund (TSX: ALFA): Private equity replication
HDGE’s hedged strategy, consisting of a diversified portfolio that is 110% long and 50% short, is designed to participate in the market upside while mitigating downside volatility. It has “worked” this year, as it fell a fraction of the market in the first quarter and has generated a positive return year-to-date. Nonetheless, HDGE’s main benefit is its low correlation with broad-based equity indices, a key characteristic in today’s volatile and perhaps overvalued market environment.
In July, price momentum and trend largely drove outperformance in the long book, while value hurt the short portfolio. The detailed performance of specific alternative risk premia driving HDGE’s long and short portfolios, such as value, quality, price momentum, operating momentum and trend, can be found in July’s AlphaRank Factor Performance.
ARB continues its track record of success in our seventh year of running the arbitrage strategy (the first six of which were in a private hedge fund).
I wrote our thesis on allocating a large portion of the ARB portfolio to SPAC arbitrage in the recent piece, “Heads I Win, Tails I Still Win: Low-Risk Investing With SPAC Arbitrage“. The thesis behind allocating to SPAC arbitrage is that it presents equity upside combined with the risk profile of treasury bills, meaning high upside potential with limited downside risk.
Nonetheless, it’s not a strategy that goes up every day, nor every month. In fact, while the broad markets rallied in July, the Accelerate AlphaRank SPAC Index was down about -1%. As we all know, diversification is the only free lunch in investing, and ARB continues to keep a healthy allocation to traditional merger arbitrage, along with SPAC arbitrage.
We have seen a frothy SPAC market lead to record issuance, with over $10 billion raised from 18 SPAC initial public offerings last month. Although the merger market has been lethargic since the pandemic began in early March, activity has picked up as twelve new transactions were announced in July, an activity level matching that of July of 2019.
For arbitrageurs, the more SPACs and mergers outstanding, the better. Currently, ARB is allocated to 55 SPACs, 19 strategic M&A deals and 5 LBOs.
The Canadian long-short overlay portfolio of ATSX added 0.5% of outperformance during July, bringing the year-to-date excess return above the S&P / TSX 60 to 12.4%. ATSX is up 9.9% while the benchmark is down -2.5%.
A large portion of ATSX’s outperformance came from mitigated downside during the first quarter bear market, but as seen recently, outperformance can occur in rising markets as well. As discussed in last month’s update, Canadian alternative risk premia, the systematic harvesting of factor anomalies both long and short, continues to perform beautifully within Canadian equities.
As technology and large growth stocks led the market higher in July, U.S. value stocks declined. In fact, the cheapest decile of stocks fell -0.2% over the month while the most overvalued equities rose 7.3%.
After the last growth stock bubble popped roughly twenty years ago, private equity (defined as leveraged small-cap value stocks) outperformed dramatically, registering strong positive returns as the S&P 500 declined over the subsequent three years. As they say, “history doesn’t repeat, but it often rhymes”, and 2020 is looking remarkably similar to the year 2000 with respect to setup of value vs growth stocks.
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Disclaimer: This distribution does not constitute investment, legal or tax advice. Data provided in this distribution should not be viewed as a recommendation or solicitation of an offer to buy or sell any securities or investment strategies. The information in this distribution is based on current market conditions and may fluctuate and change in the future. No representation or warranty, expressed or implied, is made on behalf of Accelerate Financial Technologies Inc. (“Accelerate”) as to the accuracy or completeness of the information contained herein. Accelerate does not accept any liability for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on all or any part of this research and any liability is expressly disclaimed. Past performance is not indicative of future results. Visit www.AccelerateShares.com for more information.