Cbus Super has embarked on the second phase of its DAA program, extending it to include relative value trades.
Cbus Super has embarked on the second phase of its dynamic asset allocation (DAA) process and its newly appointed Head of Portfolio Construction, Justin Pascoe, has been tasked with expanding the program across asset classes and trade types.
The DAA relative value program consists of three types of investment approaches. The first category is fundamentally driven transactions, which can be both systematically or qualitatively implemented.
You can't necessarily model everything, sometimes you need to work it out qualitatively before you code it up into a systematised signal. It's probably a better way to do it – Justin Pascoe
“You can’t necessarily model everything; sometimes you need to work it out qualitatively before you code it up into a systematised signal. It’s probably a better way to do it,” Pascoe says in an interview with [i3] Insights.
The second type is technical trades that are based on statistical trends in markets, often based on pricing and volume. And finally, Cbus will look at opportunistic trades.
“It is important to look at the interaction between those different signals,” Pascoe says. “So if you get a technical signal, you want to think about the fundamentals that are driving it.
Cbus Dynamic Asset Allocation – Phase II
Source: Cbus
“A purely technical person will just go and put that trade on without necessarily understanding the drivers. We’d like to have a bit more rigour around that. What are we betting on? How are we going to make money from this transaction?”
The overall DAA program has a performance target of 25 basis points per annum on a rolling five-year basis, within a risk limit (tracking error) of 1 per cent. But while the overall size of the new relative value program is still modest, it also has some relatively conservative stop losses in place.
“At the moment, because it’s not fully scaled, we’ve got some pretty tight risk limits on. But as we build more breadth into the program we’ll be able to think about opening those up a bit because, again, you’ve got more breadth and more diversification across a number of the relative-value positions,” Pascoe says.
Relative Value
Pascoe is now looking to scale up the DAA program, expanding the number of trades across equities, bonds, currencies and commodities. This will not only allow for broader diversification, but will also help in providing a smoother ride for the overall DAA program.
“Phase one is fairly vanilla in the sense that it takes the listed asset classes that comprise the strategic asset allocation and then we tilt those from neutral to overweight or underweight in different sizes, based on what has become an increasingly systematised model framework,” he says.
“There is some qualitative overlay, but the underpinnings of it are systematic. Now, the returns from that are pretty lumpy, just because there’s not much breadth there. Phase two is all about breadth; phase two is about having a sharp knife and being able to put much more targeted views into our positions.”
And whereas phase one of the DAA program was largely focused on directional trades, in line with the broader strategic asset allocation of the fund, phase two will focus on relative-value trades that are intended to make money regardless of the direction of the broader portfolio.
For example, within equities Cbus can take views on relative values between countries, sectors and even different investment styles. Within fixed interest, the team can look at country comparisons, but also take views on the different yield curves within a country or between different fixed interest instruments.
Cbus can also compare various international currencies.
“We already do Aussie versus the currency basket of the MSCI World within phase one, that’s part of our strategic asset allocation. But if we wanted to do euro versus yen, or US dollar versus yen, that’s something we can do within phase two,” he says.
“The whole notion is that these are relative value [trades]. So, for example, if you think the NASDAQ is expensive, you can do long Japan versus the NASDAQ. And the funny thing in the long/short world is that even if NASDAQ goes up, as long as Japan goes up more, you make money, or if Japan falls, you just need NASDAQ to fall more.
“That is often hard for people to get their head around. It’s a different mindset. But the beauty of that is that it is uncorrelated with the broad directionality of the portfolio that comes from the strategic asset allocation,” he says.
Currently, Cbus has about three or four relative value positions implemented under the portfolio optimisation program, but Pascoe is aiming to expand this to 15 to 20 live positions, counting a long/short position as one position.
The fund put on several new trades this calendar year, after the investment committee gave the green light for broader delegation to the team and the use of a broader range of investment instruments.
Having the delegations, having the processes and team in place, allowed us to respond much more quickly than having to wait for a meeting the next month – Brett Chatfield
Brett Chatfield, Chief Investment Officer of Cbus, says this enabled the team to implement trades more quickly and efficiently, resulting in better performance.
“For example, a trade that we actually did put on in phase two was when the Nikkei was down around 20 per cent. The team put the trade on and then closed it the next day when it was up significantly,” he says.
In the first week of August, the Nikkei 225 Index experienced a sharp decline, partly because a rally in the Japanese yen, following a rate increase by the Bank of Japan, triggered investors to close their carry trades, which saw them selling the Japanese stocks they had bought with yen-denominated loans.
From 31 July, the Nikkei 225 Index fell from 39,102 points to 31,458 points on 5 August, a decline of almost 20 per cent.
“Having the delegations, having the processes and team in place, allowed us to respond much more quickly than having to wait for a meeting the next month,” he says.
Cbus profited from a similar trade in July when money started to rotate out of the mega-caps and into small caps, after data showed the US inflation rate seemed to have softened and speculation about rate cuts by the Federal Reserve started to circulate.
“We certainly made some money on the NASDAQ versus Russell 2000 relative value trade when you started to see a broadening of equity market performance and small caps outperforming. We took some profits pretty early on as that trade sort of worked out pretty well,” he said.
But Chatfield is quick to point out the DAA program will not descend into a form of hedge fund strategy. A key difference is the fund cannot use leverage under the DAA program, while there are strict risk controls and approval processes in place over each trade.
“The tracking error provides an overarching risk control, but there are also exposure limits across each of the markets and instruments [in place]. Because with tracking errors you’re relying on certain distributions, so those exposure limits provide you with another risk control as well,” he says.
For more information on phase one of Cbus’ DAA process, please see this August 2023 interview with Brett Chatfield.
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