Making money in falling markets

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By Nick Downing CEO, Chief Investment Officer

Nassim Taleb developed the now famous “black swan theory” to explain “the disproportionate role of high-profile, hard-to-predict, and rare events that are beyond the realm of normal expectations”. These events are extreme outliers and have a severe impact. Interestingly, according to Taleb, the Covid pandemic was not a black swan event, as it was expected with a high level of certainty that a global pandemic would eventually take place. The Covid pandemic was instead, a “gray rhino”, a term introduced by Michele Wucker, in her book “The Gray Rhino: How to recognise and act on the obvious dangers we ignore.” Unlike black swans, gray rhinos are highly probably, high impact, yet neglected threats.

Investment portfolios need to protect against black swans and gray rhinos. Taleb’s advice is not to attempt to predict events which are unpredictable, but to build robustness against potential negative events. It could be argued that surging inflation, rising interest rates and quantitative tightening are not gray rhinos as the threats have not been neglected, but the label is still relevant, to the extent that these risks have not yet been amply discounted in bond, credit and equity markets.

BH Macro Limited, listed on the London Stock Exchange in 2007, is the only way for investors to access the award-winning Brevan Howard master fund, one of the world’s leading global macro absolute return investment vehicles. BH Macro provides protection against market disruption. The managers use a black swan approach to investing, rewarding investors in the event of rising volatility in financial markets and providing a solid counterbalance to any portfolio. The managers limit losses by buying rather than underwriting option structures, which tend to be far out of the money and therefore very cheap. Gains can be impressive during heightened volatility. When the market environment is not suitable, losses are limited to the price of the “cheap” out of the money options, providing investors with little downside risk.

The track record is exceptional, producing an annualised net asset value (NAV) per share return of 9.33% (GBP) since its listing in 2007. Since then, positive monthly returns have been produced in 17 of the 20 worst months for the S&P 500 index. The strongest gains tend to be when markets are under stress. During the Global Financial Crisis in 2008 and 2009, BH Macro returned 23.25% and 18.0%, and then 12.34% during the European sovereign debt crisis in 2011. As markets corrected in 2018 due to rising US interest rates and quantitative tightening, BH Macro gained by 12.43%, and when Covid struck in 2020, investors were rewarded with a 28.09% return. In the year to end May, BH Macro has already increased its NAV per share by 14.34%. By contrast the MSCI All Country World Index has dropped by 17.91%. Bond markets, the traditional counterweight in balanced portfolios, have not fared much better. The iShares International Treasury Bond ETF has lost 17.86% year-to-date.

During years when there is little volatility, for instance the period from 2012 to 2017, returns have been pedestrian, ranging from a loss of 4.35% to a gain of 5.79%. However, the managers have extended the range of asset classes they trade, to generate more exciting returns in low volatility years. This entails peripheral exposure to equity, credit, commodity and digital assets.

The main strategies remain interest rate and foreign exchange markets, which this year have generated 95% of returns. The rate book is positioned to make money from rising US Treasury bonds, providing investors with protection from inflation and interest rates, the biggest threats today. There is currently 6x leverage to movement in the US 10-year Treasury bond yield and 4x leverage to rises gin the US 2-year Treasury yield. BH Macro forms a cornerstone and proven risk diversifier in our clients’ portfolios. Its share price and its NAV do not always move in synch and like other closed-end investment companies, there is always the possibility that the share could trade at a widening discount to NAV. Investors should therefore be careful when investing privately and rather consult one of our wealth managers.

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• All writers’ opinions are their own and do not constitute investment recommendations or financial advice. Speaking to a qualified wealth and investment professional is crucial before making financial decisions.
• ‘Overberg Asset Management (Pty) Ltd. is an authorised financial services provider: 783’

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