Spotting an opportunity in recession

This week's news that the S&P made about 18 per cent in four days, the largest four-day gain since the Great Depression, is a "told you so" opportunity for those voicing the wisdom of averaging-in to the public markets at a time of immense volatility.

Of all the "selling in a recession" opportunities averaging-in (buying regularly rather than investing one-off lumps of capital) is the most commonly dished-out advice. Averaging-in is just a buying process that helps spread pricing and reduces the risk of buying the highest (worst) price. The conundrum would be averaging into what?

This week's focus is on four buying considerations for the more aggressive investor. A template for buying in a crisis on the assumption that the shrewd aggressor (and not the fool) recognises that current market conditions are opportunities to change an individual's relative wealth.

Idea Number one comes from Gordian Gaeta, a renowned local risk-manager promoting Q Basis. In a nutshell, this would be aimed at sophisticated and professional investors on the basis that few others will know what he is talking about. Yes, it's complicated. But, with a rolling 12 month return of plus 300 per cent (year to date + 288 per cent); together with an astounding plus 70 per cent for October (worst drawdown minus 29 per cent); many will think "so what if I don't understand it, I don't understand heart surgery either".

Classic

With many portfolios on the operating table, this is what Q-Basis does (dumbed down). It is a classic hedge fund, a trading hedge fund. Where "hedge" means you do one thing with some of the money and a polar opposite with some of the rest. Secondly, it relies on artificial intelligence. When you consider that human sentiment has a lot to answer for, Gaeta seems to have more faith in the cold fact-based logic of a calculator rather than human intuition.

Q basis invests into every conceivable public market: shares; commodities anything with a future; it could be called a "Futures Fund". Across these markets one of four "modules" will be activated: The Long Term Trend (steadily rising markets); the Counter Trend (break-outs); the Intra-Day Trend and Error Correlation. One of these modules will always be "in play" so the fund is always invested, or as Gaeta states: "it never misses an opportunity".

The key point is that the whole fund is based on formulas and therefore one trend will always be in action. It makes the fund "non-judgmental" says Gaeta, "the fund will not make judgments on markets but make money from judgments the markets make. It has no bias."

Investors looking at the probability issues would need to be aware that Gaeta reckons the fund assumes two thirds of the trades will lose, but be "stopped" on losing above 0.4 per cent. The wins provide fivefold returns which more than offset for the stopped losses.

Idea Number Two is that championed by Arch Fund Managers. The risk-return performances of these funds are stunning. Experienced investors will be familiar with the South-Easterly drift of equity and hedge indices (where performance is the X/vertical axis, and risk is the Y/horizontal axis). As the performance world has drifted South Easterly, Arch funds have maintained a steady North Westerly bearing putting performance-distance between them and the pack. It justifies Arch's marketing spiel as providing "Structural Alpha".

Real assets

What are they doing? "We believe in real assets," says Robin Farrell. With Farrell's Arch Fund universe all hovering in positive territory for the year and since inception, it is worth for more semi-experienced investors to understand what "real assets" mean. Farrell's team, while not unaffected by financial meltdown, would be indifferent to market meltdown.

"There has been a grave public reaction to economic crisis," says Farrell in pointing out that while public markets are exposed to public sentiment, his "real assets" belong to private companies unaffected by public market pricing.

This in itself is a sound diversification play.

A good example of the "real" aspect of Farrell's interests is his current interest in shipping. Take one ship of value X. Finance that ship to add-in say a second hull to improve both its future value to X-Plus and increase its income potential. In the process, Farrell's funds are positioned as lenders at something like 5 to 7 per cent over LIBOR and as Private Equity investors secured by something like 120 per cent of the value. Arch performance is nailed to the mast!

Idea Number Three relates to Distressed Investment. The thing about "distress" is that there is of course little in the way of past performance. A good distressed purchase would be an asset that was once valuable and highly likely to be valuable again.

The concept-sale and the quality of the manager are therefore more important than past performance. The range of distressed assets likely to surface over the next few months are likely to be as wide and as exciting as has ever existed. At one level we can see the Sovereign Wealth Funds eyeing illiquid companies whose fundamental business remains strong. Layman "Distressed Opportunities" will follow shortly.

Idea Number Four is not so much novel and timely as "all weather". This is one for the inexperienced investor as well as core holdings for everyone. Much covered in this space: multi-manager; multi-asset portfolios. Russell's established a trend; big brands such as HSBC and Fidelity are recent believers. Having tried and succeeded with boutiques such as RMB, I remain a believer in boutiques and their ability to find boutique and superior performance.

The writer is Chairman of Financial Partners and Mondial