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Investment Committee: Arnaud Gandon, Heptagon Capital

Investment Committee: Arnaud Gandon, Heptagon Capital

Heptagon Capital's chief investment officer explains why capital preservation will be a key theme over the next five years.

'We believe it is reasonable to expect lower returns from traditional assets over the next five years given today’s low yield and high valuation environment. Starting yields for bonds and similar valuation equivalents for equities have historically been a good predictor of forward returns.

Quantitative easing and the explosion in Central Banks’ balance sheets in developed markets has created enormous feedback loops in financial markets: low yields make equities look attractive, this in return drives large flows to passive equity strategies.

Additionally, low yields also favour momentum and growth as a style, bringing volatility to the lowest level ever recorded, thereby encouraging more bond and
equity purchases.

Avoiding the assets that have benefited the most from quantitative easing (QE) (European high yield comes to mind) therefore seems a prudent strategy for considering allocation for the next five years. Investment strategies that favour assets which have lagged in the past five years may be a sensible approach to managing clients’ capital.

Against this background, Heptagon Capital’s focus is on value relative to growth as a style, a preference for emerging market equities and debt over developed ones and, importantly, active rather than passive investment styles.

Our general approach to managing multi-asset portfolios is one of agnosticism in the passive versus active debate. We believe that both can coexist happily in portfolios. However, having significant exposure either to credit or equity beta (through ETFs) nine years into a business cycle is a potentially risky proposition.

As a result, it is quite possible that active managers should make a comeback in the coming months and years, as mean reversion (i.e. quantitative tightening)
takes it course.

Most alternative strategies have undoubtedly had a difficult time in the past five years: it’s hard to look good when the S&P500 has gone up 96% in this period with so little volatility.

This performance translates into a Sharpe ratio of 1.5 (increasing to 1.8 over two years) for long-only US equities – a level that would have delighted many hedge fund managers in the previous decade.

There is little doubt that QE has had a big role to play in this difficult environment for alternative investments. We believe hedge funds may be well positioned to outperform a 60/40 allocation: risk management and low beta could very well become popular concepts again, especially should we witness significant equity corrections and a higher volatility regime.

We are also selectively allocating to private markets strategies, such as private debt and infrastructure, through closed-ended listed investment companies. We believe that this specialist market has matured a great deal over the past five years, and that there are enough high quality companies to invest in a concentrated portfolio of stocks with a high income component. Although we believe some pockets of this market are expensive today (e.g. private equity), we can still find value opportunities in companies operating in niche, capacity constrained private markets.

We do not believe that central banks have succeeded in banishing the cycle altogether. The longer the current cycle lasts, the larger the misallocation of capital will become.

Today, capital preservation feels like an unloved and old-fashioned concept: the next five years may well bring it back to its former glory.'

Email Suzie on sbliss@citywire.co.uk if you'd like to share a snapshot into your asset allocation meetings in the next Investment Committee panel.

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