Viewpoint - Nigel Ridge
The UK Absolute Return fund manager on the world of long short.
Can you start by explaining what an absolute return fund is and how it differs from more traditional, long-only funds?
In a long-only fund, where the policy is of only holding ‘long’ positions in assets and securities, most of the risk comes from exposure to the equity market, which can be volatile. An absolute return fund can take ‘short’ positions – that is, it can sell shares it does not own in the expectation that they will fall in value. These effectively reduce the equity exposure of the fund so that absolute return funds have a lower market risk. This also means they have a good chance of producing positive returns even when stock markets are falling.
How are you able to use this additional flexibility?
The fund can use ‘pair trades’, where we will take a long position in one company in a sector and a short in another because we believe that the first one will do better than the second. In addition, we can also introduce shorts where we have a negative view on a specific stock or indeed sector.
Since you took over the fund, in October 2013, performance has been good. What have been the key drivers of this?
There have been a number of factors that have been positive for the fund. We agreed with St. James’s Place a change to the mandate to allow us to take bigger positions in our highest conviction areas. While it has been challenging in recent months to make money from shorts, as most shares have risen regardless of news flow, the market environment has recently become more benign.
You have a relatively high exposure to financials. Can you explain the attractions of this sector?
While we expect interest rates to rise, we also expect global economic growth to be muted; so the trajectory should be gradual, with a peak somewhat lower than the cycles of the past. We believe that investors continue to look backwards rather than forwards and are still scarred by the global financial crisis. Time should be a healer, which should result in the financial earnings from companies being re-rated. Also, we hope that the stronger financial positions enforced by regulators should result in lower volatility, which is particularly attractive for absolute return investment. I would highlight Lloyds Bank and Paragon as great examples of shares where the valuation does not adequately reflect the potential for future growth.
Technology, utilities and telecoms are areas of lowest exposure. Why?
While the UK does have some excellent global technology companies, like ARM Holdings [the chip manufacturer], the reality is that it is a very small sector in the UK equity market. Telecoms and utilities are highly regulated, making them very difficult to short. However, the current environment of long-term low interest rates means they are highly rated versus history, making them also a risky long. Our approach is to tactically flex our position dependent upon market conditions.
In which areas do you currently have short positions?
We have maintained our short position in the food retailing sector, where we remain convinced that there are a number of pressures – namely the rise of the discount chains, the move to online sales and them growth of convenience stores – which will continue to undermine the performance of food retailers.
What is the outlook?
Interest rates will rise, which should be positive for performance, equity markets are less likely to be as constructive and more balanced liquidity should see a return to fundamentals. All three of these are positive for the absolute return sector. I also have sympathy with those who say that stock markets are looking fully valued. They have been buoyed by the accommodative monetary policies of central banks. Now that there are signs of economic improvement in the UK and the US, I am pretty confident that volatility will start to rise and equities will no longer be the one-way bet they have been in the past few years.
The information contained above, does not constitute investment advice. It is not intended to state, indicate or imply that current or past results are indicative of future results or expectations. Full advice should be taken to evaluate risks, consequences and suitability of any prospective fund or investment. Where the opinions of third parties are offered, these may not necessarily reflect those of St. James's Place.