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Now is the time for Variable Beta

The role of Variable Beta funds

In periods of negative returns such as the Great Depression, Japan in the late 80’s, the dot-com bubble and the GFC, Variable Beta long-short equity funds aim to provide investors with increased capital protection.

A Fund that has the ability to hold variable levels of cash and short sell equities or indices can cushion the fall by being less than 100% exposed to equity risk, and can generate positive returns from short selling. Over an equity cycle of rising and falling share prices, the variable beta manager seeks to produce a superior risk-adjusted return for investors by reducing downside volatility and participating in upward momentum when presented. Essentially providing less volatile investment returns.

The current state of play

In response to the GFC (remember November 2007) accommodative monetary and fiscal policy was rolled out across the US, Europe, Japan and China - triggering the long sustained equity bull market we are currently experiencing. Since March 2009, the S&P 500 has risen 269.8%. This abnormally long upward trajectory for US shares has also been associated with relatively low volatility.

 US Equity Market Performance

Intervention by central banks and the resultant buying of government bonds has exerted an unprecedented downward bias on both long and short term interest rates in developed economies. Traditional ‘risk free’ long term (10 Year) government bond interest rates have fallen to such low levels that investors are now seeking alternative sources of yield. Low interest rates, excess liquidity, rising property values, recovering economic growth and accelerating corporate profit growth, has prompted strong inflows into ETFs and other passive equity funds.

The Great Unwind

The smooth upward ride that equity investors have enjoyed since March 2009 is now being challenged by the synchronised unwinding of a number of factors that previously supported the equity bull market, namely:

  • excess liquidity from the ending of quantitative easing
  • the environment of low volatility in equity returns
  • low interest rates as the US Federal Reserve embarks on a tightening path
  • mispriced risk as Central Banks’ distorting activity stops holding down interest rates at artificially low levels
  • a transitioning from ‘growth without inflation’ to ‘growth with inflation’
  • China’s tilting of economic growth towards domestic consumption and away from a reliance on exports is reducing the over-supply in export sectors (ie. Steel) and generating some producer price inflation

US Equity Market Performance

While we believe the equity rally could continue, driven by the persistence of a number of positive factors, the conditions for any bull market will eventually deteriorate.  There are many other examples over the last 40 years of 50% plus equity corrections ranging from the US dot-com bubble to emerging markets such as China, Indonesia, Thailand and Korea. Given the significant equity holdings that have been acquired by ETFs and passive index funds in the last decade, an extended period of outflows from these investment structures is likely to be an environment that sees a significant market correction. 

Why now is the time for Variable Beta?

Being long into overtime with this bull market, and if history is to teach us anything, now would be the time to ensure that all portfolios have a portion allocated to a Variable Beta/Long Short investment strategy. Applied hypothetically to the above not-so-distant events a Variable Beta approach would have provided investors greater capital protection via the manager being able to hold cash and take short equity positions. Most importantly, Variable Beta long-short managers have the ability to act quickly when market conditions change which is particularly useful in the current environment. 


Article supplied by Mark Newman CIO and co-founder, K2 Asset Management.

For more information on the above please contact your Partners Wealth Group advisor directly or on 1800 333 143.

This information is general in nature and is provided by Partners Wealth Group. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information.


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