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Dealing in absolutes

10 MINUTES WITH…BEN WALLACE

Gartmore launched its UK absolute return fund for Ben Wallace in April 2009 based on his Octanis hedge fund, with Luke Newman joining later that year to co-run the vehicle.

The pair had worked together at Deutsche in the late 1990s, with Newman subsequently moving to F&C for several years where he managed long-short products.

Key for the transition of the Octanis fund into a retail offering was the fact it has always kept leverage relatively low and used contracts for difference when shorting – allowing the managers to run a single strategy for the onshore and offshore portfolios.

Newman says the funds are basic equity long/short with a large-cap bias and that flexi-bility helped maintain performance when liquidity fell out of the market in 2008 – Octanis was up by about 30 per cent over the year.

“We are also prepared to be net-short when appropriate, whereas some of the other absolute return funds out there tend to be market-neutral,” he says.

“Our range is -30 per cent to 75 per cent net exposure and being net-short throughout most of 2008 obviously helped our positive return.”

One further differentiating factor from peers is that Newman and Wallace are prepared to take individual stock positions on the short book rather than just short-selling the index. This means the short side of the balance sheet is a genuine profit generator, according to the managers, and also reduces volatility where index futures tend not to.

Looking at recent portfolio activity, the managers moved the portfolio from net-short to net-long in March 2009, which Newman says was an easier decision to get right from a stockpicking rather than top-down perspective.

“Sentiment was almost uniformly negative but we were seeing opportunities in many heavily leveraged stocks to refinance and identified an inflection point, particularly as many valuations were distressed,” he says.

The pair ran net-long until the end of last year, introducing more beta in various consumer-facing areas such as financials and housebuilders.

However, they recognised this was a finite trading opportunity and have been more cautious in 2010, with net exposure ranging from -5 per cent to 30 per cent and the long book largely focused on stable defensive names.

“Our long exposure currently looks like an equity income fund and we are finding value in the same kind of areas as our colleague Dan Roberts – in unleveraged pharmaceuticals and utilities with strong balance sheets,” says Newman.

“On the short side, we have identified opportunities in the opposite kind of company, those with too much leverage that have been forced into risky rights issues this year.”

This has largely focused on various domestic-facing stocks but the manager also notes some shorting potential in utilities, with many business models built up in the easy credit era of the last decade.

Another key shorting area is companies exposed to UK Government expenditure, with the team turning bearish on these in light of the Government’s austerity package to cut public deficits.

In terms of gross exposure – the amount of capital deployed in the market – the managers have kept this below 100 per cent since the start of 2008, meaning they have effectively been sitting on cash.

This was in stark contrast to earlier years on Octanis when gross exposure was as high as 200 per cent.

“Our aim is to produce double-digit absolute returns whether the market is rising or falling and volatility determines how much capital we need to deploy to meet that target,” says Newman.

“Before the credit crunch, market volatility had fallen to fairly low levels so we needed more capital at work between 2005-07 but gross exposure has subsequently dropped away.”

Over the summer, however, the managers say volatility has fallen slightly and there are signs that stockpicking may start to be rewarded again, so they have slowly begun adding to the gross position.

For the rest of the year Newman expects markets to remain range-bound, with support for valuations from M&A activity but a cap on returns with debt issued largely unresolved.

“Many investors seem to be looking for signs the market is returning to a 2003-07 period, led by mid and small caps and driven by easy credit, but we see this as unlikely,” he says.

“Our view is that the coming period will be more like the mid-1990s when larger firms with strong balance sheets led the way, so we are focusing on stocks such as AstraZeneca, Vodafone and Centrica.”

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