As the Magnificent Seven continue to power ahead, causing active managers to struggle, MLC Asset Management has taken charge of the situation through quite a unique approach. We speak with CIO Dan Farmer about the strategy.
The group of US companies known as the Magnificent Seven, including Alphabet (Google), Amazon, Apple, Meta, Microsoft, Nvidia and Tesla, have posed a serious problem for active managers.
As their valuations continued to reach new records this year, especially that of Nvidia, many active equity managers underweighted these stocks as the likelihood of a correction in stock prices increased.
This is good risk management, but unfortunately for these managers the correction never came, at least not to the extent as expected.
I think this is different in a lot of ways when you look at the Magnificent Seven. They are earning, they've got genuine earnings and their earnings are growing rapidly so they do have fundamental underpinnings to them... I would say it's not a pure bubble
Dan Farmer, Chief Investment Officer at MLC Asset Management, has been keeping a close eye on the Magnificent Seven.
“I’ve been around for a while and so you do see these periods where you get concentration and stocks running. I was well and truly around in 2000 when we had what turned out to be the dotcom bubble,” Farmer says in an interview with [i3] Insights.
“[But] I think this is different in a lot of ways when you look at the Magnificent Seven. They are earning, they’ve got genuine earnings and their earnings are growing rapidly so they do have fundamental underpinnings to them.
“Now you can argue about: How far does that extend into the future? Can that rate of growth be maintained? But I would say it’s not a pure bubble.”
He fully acknowledges this situation has made life hard for its external managers.
“It’s hard for active managers because you do have earnings, so it’s somewhat more challenging in how they address it,” he says.
Dispersion Trade
MLC Asset Management has had a stellar year in 2024.
Its largest single fund, the MLC My Super Growth Fund, delivered a return of just under 17 per cent over 12 months to December 2024.
Its highest growth option, the MLC Aggressive option, which takes a levered position on growth assets, resulting in an exposure of around 130 per cent to growth assets, returned just over 26 per cent per annum.
International equities were a big part of that return. But despite the high returns earned from international equities this year, the underweight position to the Magnificent Seven has caused a noticeable drag for many managers compared to their benchmarks.
For example, the S&P 500 Index has returned more than 28 per cent over the same period, a result that is rivalled by few equity managers.
Asset owners have responded differently to this situation.
AustralianSuper, for example, bought almost 5 million shares, worth US$570 million, in chipmaker Nvidia directly in the second quarter of this calendar year in what seems to be an effort to plug its underweight to the stock.
But Farmer has taken a different approach to the problem.
“We don’t want to undo the work that our managers are doing; we’ve got active managers there for a reason,” he says.
We don't want to undo the work that our managers are doing; we've got active managers there for a reason
Instead, he made use of MLC Asset Management’s internal derivatives capability to implement what is known as a dispersion trade.
A dispersion trade is an option strategy that looks to profit from the relative pricing differences, or dispersion, among the individual components of an underlying index or sector. Typically, the strategy involves buying options on stocks that are expected to outperform and selling options on stocks that are expected to underperform or remain stable.
In this case, MLC aims to profit from changes in correlations between the Magnificent Seven and a basket of highly uncorrelated stocks.
“We’ve got a really strong options team at MLC that’s been running for many years and we were grappling with this question: ‘Managers are underweight, the Magnificent Seven are running, what do we do?’” Farmer says.
“So we put on a dispersion trade. It’s not directional; it’s not forming a view on which direction the Magnificent Seven are going to go, but it’s effectively a call option on the Magnificent Seven performing differently than a basket that’s quite distinct from the Magnificent Seven.
“If the Magnificent Seven keep running and effectively the correlation between the Magnificent Seven and our basket keeps getting wider, we get paid and it helps hedge that gap. Likewise, if the Magnificent Seven collapse and the correlation becomes wider because the Magnificent Seven are underperforming dramatically, we get paid too.
“We don’t get paid, effectively you can lose a premium, if the correlation stays the same going forward over two years.”
The position was put on 12 months ago after rigorous scrutiny by the investment committee. It is a relatively small position, Farmer says, but it has worked out well for the fund.
“It’s a fairly modest trade but it’s in the money at the moment,” he says.
Farmer and his team have been looking at whether this type of trade can be extended to other situations as well. They haven’t implemented any other trade yet, but they have been looking at particular scenarios of interest.
“It’s a trade that can be applied to different challenges as well. Recently, we were looking at a similar trade around Trump’s election victory. We haven’t moved on that, but we were looking at effectively a deglobalisation trade. What impact will that have on other managers?” he says.
“It’s quite a unique trade, I think there’s not too many others in the market doing it, but we think it’s a really interesting way to take a non-directional, alpha protection bet.”
Takeover Offer
Insignia Financial Group, the parent company of MLC Asset Management, confirmed on Friday that it had received a takeover offer from Bain Capital to acquire all of the shares in the company at $4 each.
The offer is subject to a number of conditions, including satisfactory completion of due diligence on an exclusive basis, execution of a binding scheme implementation agreement, unanimous recommendation from the Insignia Financial Board of Directors and commitment from all directors to vote in favour of the transaction, as well as all necessary regulatory approvals.
However, on 18 December the board of Insignia rejected the offer.
“The Insignia Financial Board believes that, based on its view of the fundamental value of Insignia Financial (IFL), the Proposed Transaction does not adequately represent fair value for IFL shareholders in the context of a change of control transaction and that it is not in the best interests of IFL shareholders to engage with Bain Capital in relation to the Indicative Proposal,” the company said in a media release.
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[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.