Podcast: Is Hedged Equity a Cure for Volatility?
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We created the strategy in 2008 and then had to prove out its capital preservation nature immediately. In our latest podcast, Alger Chief Investment Officer Dan Chung discusses why a hedged equity strategy may be the sensible choice for investors concerned with high market volatility.

ALEX BERNSTEIN: Hello, I'm Alex Bernstein and you're listening to The Alger Podcast: Investing in Growth and Change.  Across the globe, everyone everywhere is now coming to terms with the “new normal” of life under the weight of the coronavirus.  For anxious U.S. investors – which is pretty much everybody these days – uncertainty and extreme volatility in the markets has led to concerns about what types of investment vehicles are safe or even productive.  One possible answer may be a hedged equity strategy.  Also known as “long-short” strategies, these are portfolios that invest in long-only stocks while also maintaining a “hedge” of equity shorts.  Alger’s hedged equity strategy is called Dynamic Opportunities.  The strategy was created with an eye for effectively navigating volatile markets. Here with me today, to discuss how he and his team manage Alger’s hedged equity strategy, is one of the original architects of the Dynamic Opportunities, Alger Chief Investment Officer Dan Chung.  Dan, thanks so much for joining me this afternoon.

DAN CHUNG: Thanks, Alex.   

ALEX: So, Dan, can you start by just describing what exactly a hedged equity strategy is?

DAN: So, a hedged equity strategy is a portfolio that invests on the long side in high quality growth stocks. So, our long side positions are very much a reflection of the best ideas across all of Alger’s traditional long strategies.  But the hedged equity part of it is that we also implement shorts of multiple kinds.  First, we look for companies that have deteriorating fundamentals, weakening market positions, and which we believe are overvalued.  And we do short against those kinds of companies.  They offer our output of the kind of work that we do on our long only side.  

Secondly, we also implement shorts to simply protect against the downside of the market or of a particular sector, which we may fundamentally buy out of favor or we think is going through changes that will undermine the fundamentals of an industry.  So those can be sector shorts, or they can be market shorts, again, to protect against the downside in either the market or the sectors.  And most importantly, the overall strategy attempts to maintain a pretty balanced approach to the overall markets.  In other words, we’re not looking in this strategy to beat the S&P 500 by a significant margin on the upside through the use of leverage or anything risky.

Quite the opposite.  We’re trying to dampen the volatility of a long only strategy, hopefully produce half or less than half of the volatility of the S&P 500.  But meanwhile, through both the use of hedging shorts and also high quality long investing, we’re hoping to produce long term returns for our shareholders that are attractive in somewhere in between, if you will, the low returning strategies like bonds and below the S&P 500.

ALEX: I realized when we were preparing for this interview, that you created the composite version of this portfolio, the Dynamic Returns strategy, around the time of the last financial crisis, twelve years ago.  But in fact, you actually created that portfolio before that crisis occurred.  Is that accurate? 

DAN: Actually, the strategy was originally created out of high-level discussions amongst Alger shareholders.  But up until about 12 years ago those strategies were only long only strategies.  So, the real impetus for this was about creating an offering that represented less volatility, more opportunistic returns, accepting that they would likely be lower returns than our long only strategies, but in particular wanting to have a strategy that was capital preservation first.  

So very downside protected, built to weather storms.  And I’ll note, we did this looking at the asset allocation plans of many of our best partners in the business.  So private wealth managers, family financial advisors where many, of course, have diversified their clients wisely into other asset classes.  So, we were looking to create a strategy that was appropriate to a very conservative capital preservation first, then opportunistic returns, but nevertheless what we thought would be attractive returns long term relative to, in particular, your standard bond portfolios that were available  

ALEX: And then, pretty much as soon as you created it, the financial crisis did happen.  Did that crisis inform anything you were doing with the fund at that time?

DAN: Yes.  So, our timing wasn’t particularly good.  We created it, as you picked up, right in the middle of ’08 so we had to prove out the conservative nature, capital preservation nature of the strategy immediately.  We had a very successful 2008 with the strategy.  And we were not anticipating the extreme swings in the market at the time.  As I said, we were really just trying to create a long-term capital preservation-oriented strategy for our clients, who in particular wanted to, again, reduce the volatility of long only strategies and also have a strategy that was capital preservation sort of as its first mandate.  

Nevertheless, I’ll note the strategy is still an equity long/short strategy and we are targeting producing attractive, we believe, long-term returns and trying to be opportunistic when markets are volatile, as we’re experiencing today and as we experienced in the financial crisis.  And if you went back, you’d see that the portfolio did perform quite well not only during the crisis but coming out of it.

ALEX: When you created it, did you ever anticipate market swings that would be as extreme as what we’re experiencing today?

DAN: Well, to be fair, the Alger firm, which is now 56 years in existence, has weathered many market selloffs of stock.  In my tenure in particular, the bursting of the internet bubble, as well as 9/11 and the ensuing recessions in bear market, as well as, of course, the great financial crisis itself in ’08 and ’09.  And there have been some small and intermediate corrections along the way.  So I would say that we were not anticipating any particular market corrections, but we certainly designed the portfolio and managed the portfolio every day to be able to withstand crises, to be able to be opportunistic and take advantage of opportunities that have been presented, but all with the mind that our first mandate is capital preservation for our clients.

ALEX: Dan, can you describe some of the subtle things that you’re doing today with the strategy, in the wake of the current markets?

DAN: So, what we’re doing with Alger, and our advantage really as fundamental investors, is that we have a large team now.  Basically, as large as it’s ever been and as strong as it’s ever been.  We have roughly 55 portfolio managers and analysts scouring the markets, watching sectors, as well as understanding and analyzing the individual fundamentals of every company that we follow.  And we’re looking for opportunities to make additions to companies that we believe not only will weather the storm, but whose stock prices now are overly discounting their future and, therefore, offering very attractive risk/reward opportunities.  But at the same time, we’re still maintaining, particularly with this portfolio, a conservative stance about the overall exposure we want to take.  

So, for example, we’re still maintaining low gross exposure and net exposure that is quite, quite low relative to the market.  So, we’re using the market volatility to add selectively in individual sectors or individual stocks that we identify.  But at the same time, we are maintaining a relatively conservative position as the fund has been designed to do and has done for many years.

ALEX: Can you give us an example of a particular long that’s stood out for you during this period?

DAN: Sure.  So, first of all, one of the most innovative sectors in the U.S. is the health care sector.  Because there are companies there that are, of course, on the frontlines of fighting Covid-19.  In particular I want to note telemedicine.  The ability for doctors to communicate with their patients via video conference telemedicine.  This is a highly efficient way of delivering medicine for millions of people.  It’s receiving a huge acceleration in usage.  

In the U.S. regulatory restrictions on how doctors communicate have been lifted so that telemedicine can be accelerated.  This is great not only for the patients’ ability to see doctors and nurses, but also for doctors and nurses not to have to expose themselves to so many people that, of course, may be sick, but many who are not.  So, telemedicine is a great example.  Of course, many companies are working on finding a vaccine or a cure for this.  So, there are some leading companies.  Again, we were fortunate to be invested in one of them simply because it has a very innovative platform for drug discovery that is actually in trials already.  Can  it be a possible vaccine for this?  And what we like about their platform is they believe their platform could show accelerated drug discovery based on modeling a disease, creating and designing a drug based on their platform to target it.  And we’ll see.  

And then finally I'll note health care services.  We have long been a fan of some of the most innovative testing companies.  Often these testing companies are targeted in the cancer arena, but we’ve been fortunate also to be invested in companies that are targeting other kinds of testing, including infectious diseases and the flu and viruses.  

Another sector where Alger has been historically strong and focused is, of course, the e-commerce sector.  And what I’ll note there simply is some of the leading companies are actually, I would say, on the front line of supporting Americans today.  So, if you think about, of course, leading e-commerce companies that deliver goods and products, including food, to your home, this is taking a big positive surge as people are sheltering in place or working from home, entertainment services, streaming services to entertain and inform U.S. all while we’re basically spending more time at home and not traveling.  

There’s a tremendous surge in streaming activity in online gaming.  In order to meet that capacity and handle that increase in traffic there are a lot of infrastructure companies in the technology sector that provide critical technology.  We’ve been very fortunate to have already been invested in these sectors and following them for a long time.  And in recent terms we have increased our position sizes in some of those sectors.

ALEX: Can you give us some examples of shorts you’ve been keeping an eye on?  

DAN: So, on the short side of the portfolio, we, look for industries that are structurally challenged to grow.  Societal or, in particular, digital trends that are positive for some are negative for others.  Some of our most successful shorts have been within the real estate sector, and particular amongst the shopping malls.  We’ve long been watching the growth of e-commerce and how it’s increasingly spread across sectors within the consumer shopping areas, as well as among the different demographics in the American population and abroad.  

The negative result has been we’ve also understood that America has way more shopping mall square feet per person than almost any other country in the world.  We believe we have too many shopping malls and they’re too big given how many people we have.  With e-commerce, these shopping malls have been struggling and we have been short many of them, in particular many that are either over leveraged or are in particularly poor locations. There are, of course, shopping malls that are in great locations and will remain vibrant places for people to shop and other activities, but we see many that are struggling, and we’ve been short quite a few of them.

In the consumer discretionary sector, there are companies that built their business model based on having as many stores as possible across the country or even the world.  Some of these business models are struggling with their own inability to have adjusted their product offerings in terms of the design, value, taste, variety to the rising millennial consumer, as opposed to the fading baby boomer consumer. 

The biggest effect for consumer discretionary right now is the changing demographics of the consumer themselves and what their preferences and tastes are.  And so, there are a lot of old world consumer discretionary brands whether it’s in furniture, retailing, or products, brands, that are not in favor with the Millennials and are particularly hard hit during this period.  And we’re not so confident that they’ll necessarily come back because their fundamentals prior to this in our view were either weak or deteriorating.  

There’s an array of consumer discretionary companies that we’ve made some adjustments to positions as this market unfolded.  I would note, for example, casinos in China and in the U.S.  We think it’s going to take quite a while for consumers to come back to these businesses, as they’re highly discretionary and also are conducted in exactly the kind of environment the consumers may not want to go back to very quickly, i.e., crowded, close confined quarters, and also often requiring travel.  So, we added some shorts in those areas, if you will, tactically.

ALEX: Thank you, Dan.  I’d like to ask, regardless of the extreme market volatility that we’re seeing today, do you think a long/short strategy belongs in an investor’s portfolio?

DAN: I do.  I believe that a long/short portfolio really makes sense as a way to dampen the volatility of long only strategies, which I think they should also be invested in, but still produce returns that I believe will be superior to many bond portfolios.  

My greatest concern is that many investors are overinvested in cash and in bond portfolios.  And I’ll note that the collapse in interest rates has been very good for near-term returns on government bond portfolios, but when we get past this crisis, and we will get past it, and interest rates start to rise again, we believe whatever return or gains they just recently made will reverse quite quickly in the bond portfolios.  So, I think it’s actually really important for investors to have a strategy that will be positively correlated with equity markets, but have much less volatility than them, and also can be opportunistic about individual stock opportunities.  

So, I think long/short hedge strategy products belong  right in between cash, bonds, long/short hedge equity, and then long only equity in my view.  

Not all companies are alike within an industry.  These are the times that test who is really the best or best prepared, and also sometimes who perhaps has been caught off guard or has made mistakes.  And we believe, only in active fundamental management with a deep research team that can even attempt to sort out who might be the new winners and who might be a new loser in not only the marketplace, but in what might be a changed industry landscape as we come out of this crisis.  

ALEX: Dan, any final thoughts?

DAN: So, while we’re not trying to predict when the market recovers or when the bottom is, we are very active at Alger in identifying key opportunities on the long side that we think when this crisis passes will provide exceptional upside returns, and perhaps currently are offering minimal downside risks.  

ALEX: Dan, thanks so much for your time this afternoon.

DAN: Thanks, Alex.

ALEX: And thank you for listening.  For more information on Alger Dynamic Opportunities and for our latest insights on the current markets, please visit www.alger.com. 

Click here for more information on Dynamic Opportunities Strategy.



The views expressed are the views of Fred Alger Management, LLC (“FAM”) and Alger Management Ltd. (together with their affiliated entities “Alger”) as of March, 2020. Alger has used sources of information which it believes to be reliable; however, this publication is not intended to be and does not constitute investment advice. These views are subject to change at any time and may not represent the views of all portfolio management teams. These views should not be interpreted as a guarantee the future performance of the markets, any security, or any funds managed by Alger. 

Risk Disclosures:  Investing in the stock market involves risks and may not be suitable for all investors. Growth stocks tend to be more volatile than other stocks as their prices tend to be higher in relation to their companies’ earnings and may be more sensitive to market, political, and economic developments. A significant portion of assets will be invested in technology and healthcare companies, which may be significantly affected by competition, innovation, regulation, and product obsolescence, and may be more volatile than the securities of other companies.   Short sales could increase market exposure, magnifying losses and increasing volatility. Active trading may increase transaction costs, brokerage commissions, and taxes, which can lower the return on investment. Past performance is not indicative of future performance. Investors whose reference currency differs from that in which the underlying assets are invested may be subject to exchange rate movements that alter the value of their investments.

Short selling is a technique used by investors who try to profit from the falling price of a stock. It is the act of borrowing a security from a broker and selling it, with the understanding that it must later be bought back and returned to the broker. In order to engage in a short sale, an arrangement is made with a broker to borrow the security being sold short. In order to close out its short position, the security will be replaced by purchasing the security at the price prevailing at the time of replacement. A loss will be incurred if the price of the security sold short has increased since the time of the short sale and may experience a gain if the price has decreased since the short sale.

Gross exposure equals the value of both a fund's long positions and short positions. Net exposure equals the value of the long positions less its short positions.

S&P 500®: An index of large company stocks considered to be representative of the U.S. stock market.

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