In Part 2, we looked at the conclusion of Alex’s thesis and how his investment strategy performed. Now we explore what Alex would have done if given a few more weeks as an investment horizon as he had detailed separately his thought process at the time.
Answering this question under the assumption that he was allowed up to four different instruments in the portfolio, had no access to borrowing or repo facilities, and can only allocate capital to equity, debt, and cash, Alex cited four key dates that would impact the future of his portfolio allocation: 6th July Federal Open Market Committee (FOMC), 7th July jobless claims, 13th July CPI month on month and year on year (US), 20th July CPI (UK). Given the continuing bearish macro-outlook, Alex again took a defensive / hedged position with a target return of 0-0.25%.
Firstly, he would close his positions in ProShares Short QQQ; Invesco DB Agriculture Fund and the UK Gilt 0.125% Jan31st 2023, leaving only cash. This left him with the opportunity to take a more defensive position as markets were expected to become even more volatile.
Secondly, he would increase allocation in his GBP time deposit by £11.154 million to equal £41.154 million total. This will generate a 1.1% per annum annualised return, thus generating 9 basis points of income over the 3 weeks.
Thirdly, he would purchase 20 million GBP in Horizon Kinetics Inflation Beneficiaries ETF. “This ETF invests in companies, both US and foreign, that benefit from rising prices. This is based on the hypothesis that inflation will remain high for the short term, which will be seen in the July 13th CPI announcement.”
Fourthly, he would buy 20 million GBP of KraneShares Global Carbon Strategy ETF. “This is benchmarked to IHS Markit’s Global Carbon Index and tracks the most traded carbon credit futures contracts by offering coverage of cap-and-trade carbon allowances.” Essentially, the fund invests in businesses that are actively working towards reducing their carbon footprint or providing solutions to address climate change. Investors can support and potentially benefit from the growth of these companies and projects that are focused on improving the natural environment. Alex justifies this by pointing to the war in Ukraine, which has a global energy shortage and high oil prices. The war has caused “some countries looking to burn fossil fuels (coal) rather than the Natural gas usually supplied from Russia. This is shown by the projected 3% rise of US coal production in 2022 (S&P Global, 2022). Countries and their energy companies may therefore seek to offset CO2 emissions by buying carbon credits. This investment position would likely remain beyond the 3-week investment horizon.”
Lastly, he would buy 20 million worth of GBP US dollar time deposit. This refers to a deposit that cannot be withdrawn for a specific period of time that is denominated in both British pounds (GBP) and US dollars (USD) with a value of 20 million GBP. In this case, the deposit is held in both currencies simultaneously.
This time deposit yields 1.54% annually and increases the portfolio's exposure to USD. 60% of the portfolio has now been allocated in USD. Any US rate hikes will likely continue to strengthen the USD as it is expected that the Fed may raise rates the same or more than other central banks. As Alex is a Sterling investor, with 60% in USD, the rest of the portfolio would remain in GBP as a partial hedge to this FX risk.
We’ve now looked at how his portfolio would have looked at the end of the extension period with the changes he made:
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As we can see, Alex was within his target return range with a return of 0.12%. He performed slightly below the equity market, with his shares of KraneShares Global Carbon Strategy ETF being responsible for all his losses but his portfolio has significantly less portfolio volatility than the benchmark. This is further shown through the sensitivity of the portfolio, which is measured by beta adjusted. Beta adjusted shows the P&L impact of applicable assets affected by a hypothetical change in the benchmark. For example, if the FTSE 100 goes up 10%, Alex’s portfolio goes up by 4.1%.
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Overall, Alex’s defensive / hedged strategy proved stable and successful in a volatile market.
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