Excess demand
However, Borges believes there is also a problem surfacing with Ucits long/short equity funds: shorting stocks is becoming too fashionable. According to Morningstar data, European investors have invested a net amount of €52bn in long/short equity funds over the past three years, most of which cover only European companies.
In recent months, market-neutral funds have particularly gained traction, attracting net inflows of €9.6bn in the second half of 2015, and inflows are set to continue (see page 11-12 for Market Intelligence and 18-21 for Fund Selector).
“If you have a lot of people trying to generate alpha by exploiting market inefficiencies,the alpha pool has to be divided by more and more players. This will result in shrinking returns for investors,” notes Borges. “So we understand why these funds are popular. But at the same time, we must be aware returns in the future will be lower than they have been.”
As a consequence of these inflows, many long/short equity funds are growing too big. “It’s very common for these funds now to have grown from a few hundred million euros to more than €1bn. These funds have difficulty investing in small and mid caps, where there is most money to be made for long/short managers, because these markets are less efficient.”
However, one of the long/short equity funds Borges invests in is one that has seen its assets under management grow rapidly in recent years. When he made his first allocation to the Old Mutual Global Equity Absolute Return Fund in 2014, the strategy managed less than $1.4bn (€1.2bn). Although the fund now has $5.3bn under management, this is not an immediate concern.
“Being a global fund with hundreds of holdings, the capacity concerns are less pressing. But we are monitoring any alpha erosion,” he says.
Uniform mix
Borges and his team build separate portfolios for each of their clients, most of which are pension funds. But they tend to use the same set of funds for each.
“In principle, all of the portfolios we manageare invested in the same funds, whichare usually, but not always, equally weighted. The main differences between the portfolios can be attributed to asset allocation.
”The main building blocks of the portfolio, such as European equities, consist of four or five managers. Borges characterises himself as style-agnostic but this does not mean he doesn’t care about it. Quite the contrary.
“The ideal portfolio has a mix of styles. Inmost longstanding holdings is the Intrinsic Value Investors Fund.
“It is managed by a small company with only a single strategy [which nevertheless has around €2bn in AUM], which aims to invest in companies that are intrinsically undervalued. This idea has its roots in the theory provided by Benjamin Graham.
”Although the fund has been closed to new investors since 2007, it made an exception for BPI Gestão de Activos’s fund selection team when approached in 2010. “Because we made clear to them that weare long-term investors, they allowed us toinvest in the fund,” Borges says.
While the two funds have a very different approach, they are similar in the sense that their portfolios are concentrated, particularlyin the case of the Jupiter fund. “We prefer high-conviction funds. It makes it easier for the manager to be on top of his companies if he owns only 30 to 40. If he has much more than that, this becomes difficult.”
