ChampionsNews: Mr Saffaf, with a market neutral alpha strategy in the PARAGON UI (DE000A1J31Z1 /DE000A1J31W8 ) you propose to generate risk-budgeted excess returns in a low interest rate world. What are the advantages of this strategy and how do you achieve market neutral alpha? Consistent, risk-controlled returns sound almost too good to be true in times of zero interest rates.
Saffaf: There is no such thing as a free lunch. We therefore need to take some risks. The question is, however, what risk one is prepared to take. Most fund concepts revolve around price forecasts, i.e. they take directional bets. We don‘t make and do not position the fund to benefit from any forecasts. Instead, we use options for complete market neutrality. Most investors are aware that options can be used as hedging instruments or as part of premium strategies of volatility funds. However options can also be an active means to generate returns because they offer an essential advantage over linear instruments like stocks or futures: options allow the construction of non-linear, i.e. curved, pay-out profiles and simultaneous long and short exposures on an underlying, something that is not possible with equities. Investors can therefore implement many asymmetric trading strategies with much more attractive risk/return profiles than those achievable with purely linear long only approaches.
Our alpha strategy bets on monthly market moves in either direction. Markets always move, both in sideways and directional environments. People frequently equate market movements with volatility. While there is a significant probability of market movements in times of strong volatility markets may also move favourably in less volatile times. Neither the DAX nor the S&P 500 index have been highly volatile of late. However the DAX mostly moved sideways in recent months and monthly moves have been relatively limited, while the upwards trend of the S&P 500 meant that prices moved quite significantly from the beginning to the end of each month. Our completely non-predictive strategy benefits from these market moves even though volatility is at a historic low.
ChampionsNews: Your options strategies focus on the DAX, the EuroStoxx50 and the S&P 500. Why have you opted for precisely these indices? Are there no other liquid markets out there that would offer worthwhile investments?
Saffaf: We select our target markets purely from a liquidity point of view. A strategy must remain flexible even with a fund volume of 500 million Euros. The three indices are the most liquid option markets in Europe and the US.
ChampionsNews: Derivatives strategies are clearly not risk-free. How do you protect the portfolio against potential losses?
Saffaf: Derivative instruments are not necessarily more risky than stocks or bonds. The use determines the amount of risk. We have rules for our sensitivity ratios and we take active measures if they reach certain thresholds. We also buy put options and, most recently, volatility calls to minimise risk.
Derivative instruments are not necessarily more risky than stocks or bondsTarek Saffaf ,
Senior Portfolio Manager Greiff capital management
ChampionsNews: Where do you currently see attractive bond investments and how is this view reflected in the portfolio?
Saffaf: We do not believe that bond markets adequately reward risks any more. We have seen over the past years that the quest for yield has led many fixed income funds to shift into credits so that credit outperformed strongly in 2017. The yields of European high yield bonds, for instance of two-year Greek bonds, trade below US treasuries. However this development cannot continue for ever. Also, credits have a strong correlation to the equity markets, which means that fixed income funds become increasingly equity-like. As a fixed income fund, we keep our exposure to high grades (with a minimum rating of A) and short maturities, accepting that returns may be negative. We then generate positive total returns via our alpha portfolio.
ChampionsNews: Do you anticipate a reversal of Europe’s interest-rate regime? Or will we have to expect low rates for a longer?
Saffaf: In Europe, any major sustained trend reversal on the rate front will only come in small steps. The first change will likely affect the quantitative easing programme while a – limited – interest-rate reversal should only materialise in the medium term. Fixed income investing will therefore remain unattractive over the next years.
Author: Tarek Saffaf and Timo Lüllau
Date of issue: 2/20/2018
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