UBS: Building return-oriented portfolios

Our approach going into 2016 focuses on seeking to build portfolios that are able to protect capital in an environment of elevated market volatility. This is not a market where clear strategy or beta bets should be expected to drive performance. We expect to achieve alpha-oriented results via a core-satellite approach. Manager and strategy diversification is critical in an attempt to mitigate the gap risk associated with less liquid markets and the unwinding of crowded trades. Targeted asymmetrical exposures via bespoke and coinvestments can offer positively convex outcomes to eke out excess returns without taking broad market exposure.

Tailoring exposure to highly diversified and risk-aware managers

We have evidence that our approach has worked well recently. The results are most apparent in our neutral portfolios (see table below). For example, in 2015, the majority of returns in our neutral products have come at a high level from diversifying strategies: Multi-Strategy and Relative Value. Even the Equity Hedged allocation has been a positive contributor, illustrating the advantage of tailoring the exposure to highly diversified and risk-aware managers.

The benefits of this approach are clear in a market selloff, as we had in August 2015. For example, while risk assets such as global equities and high yield were down notably that month, our neutral diversified products performed positively. Even our broad-based diversified flagship products, which take more market beta, were down by far less than one would have expected relative to the wider hedge fund universe.

In hedge fund investing, it is very difficult to disentangle the top-down from the bottom-up. While UBS Hedge Fund Solutions spends a great deal of time trying to understand the market backdrop in order to assess the fertility of different strategies, sub-strategies, and micro-strategies, at the end of the day our portfolios are largely constructed to reflect conviction in individual managers and their ability to extract potential opportunities across all asset classes.

In an uncertain environment, we have taken this approach to another level by seeking to complement core, diversified multi-manager platforms that are very factor aware and risk-controlled with a diversified collection of idiosyncratic co-investments / bespoke structures where we identify potentially positive return asymmetries.

Portfolios reflect our conviction in individual managers‘ ability to extract potential opportunities across asset classes

Looking into 2016, we expect to continue this approach. Now, we believe, is not the time to reach for return by concentrating allocations or taking more beta in portfolios.
For those investors looking to generate higher returns, we would recommend adding leverage to this risk-averse approach rather than taking more market risk (beta) in their hedge fund portfolios. However, please note that investing in a leveraged version entails more risk as well.

Author: Bruce Amlicke, Chief Investment Officer (CIO) for UBS Hedge Fund Solutions.

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