Some considerations at the first anniversary

The first fund managed by Plenisfer, Destination Value Total Return (“Destination Value”) , today crosses the milestone of one year of life on the market. The Fund began trading on May 4, 2020, with a EUR-hedged share class followed by the USD class launch on June 5, 2020. We are keenly aware that the performance of investments should be examined over longer time horizons than only 12 months. But still, it is an important birthday and a milestone for us as a new investment boutique.
Although ‘out of season’ for an annual letter, I believe it offers a special opportunity to reflect and share the success and the particulars of this first year with our investors and clients. From January 2022, we will move to calendar year annual letters.

Destination Value Total Return

Destination Value is managed with an internal expected return target of 8% annualized in USD terms, and a maximum volatility of 75% of the volatility of global equity markets, over a full 5-year market cycle. Given the global nature of the investable universe, we ‘think’ about the fund in dollars although we are aware that most European investors invest and will invest mainly in the class where the euro/dollar exchange risk is hedged (euro class-hedged) or in the euro class (where the exchange risk between the euro and the dollar remains open).

The 8% annualized Internal expected target should be understood as a long-term objective and not as an annual target.  Taking a longer-term view, we can visualize a line with an upward slope representing the annualized growth. The actual performance of the fund would fluctuate around this line.  In some years, it may be below that figure while, hopefully, much more often it will be above. As for the time horizon, there is no precise rule to determine its significance. Clearly, it must long enough to embrace different market phases (“bull” and “bear” markets) and, in any case, it cannot be less than 5 years.

 

Many investors asked us why 8%.

 

This is the nominal return of the US equity market (taken as a proxy for global equities) over a very long period (100+ years). Simply, we aim to deliver a result[1] in line with historical equity markets, but with less volatility. Given the current high starting point, we are aware that the return on the stock market is likely to be much lower over the next 10 years than in history.

Shiller’s so-called CAPE (cycle-adjusted price/earnings ratio) is currently 35, a level that is statistically correlated with a real return expectation for the next 10 years of just over zero. Even assuming that the very low level of interest rates justifies equity values above historical averages, and adding an expected inflation of around 2-2.5% to the real return expectations, it is difficult to expect an annualised nominal return for equities over the next 10 years much higher than 4-5%. So, the bar we have set is even more challenging!

The fund is managed with an internal target objective and not with respect to any benchmark, in line with the philosophy we set out in our first CEO letter (“Return to Investing as a Practice“). In fact, we believe that benchmark management no longer corresponds to the real needs of savers and asset owners. In a world where inflation risks are becoming more concrete (see the following letter “Investing in the Age of Financial Repression“) and most western pension systems will find it increasingly difficult to protect savings in real terms, a new way of managing money is needed. Our approach is to focus on the best opportunities available to generate consistent returns rather than traditional management versus benchmarks which seeks to minimize statistical deviation from indices (“tracking error”).

 

First Year of Performance: More than Twice the Target Return

So how did Destination Value do in its first year of life? To understand this clearly, it is important to look at both total return and the risk taken to achieve it.

 

Destination Value Total Return (Euro-H, class I)   +18,1%, volatility 5.9% 

 

Compared to the long-term objective, the fund delivered a much higher performance, both in the EUR hedged share class and the $ share class, which is only 11 months old. Just as important, volatility was much lower than that of the stock markets – about a third of the same – much less than our maximum volatility limit. By comparison, the same volatility would have been achieved by a hypothetical balanced portfolio invested 1/3 in shares and 2/3 in bonds (taking as a proxy of the ETF representative of the two asset classes globally). At this same level of volatility, the hypothetical portfolio would have made 13.5%.

Therefore, we can say that the return on the fund has been achieved by “consuming” a very small portion of the risk budget. A more technical way of saying this is that the Sharpe ratio for the period was 3.1, a very high level.

We acknowledge that since the fund’s inception the performance of the financial markets have been broadly favourable. The real test of our ability to manage downside risk could take place in a stressed market scenario. A scenario which could be dictated by two opposing risk assumptions; inflationary pressures such that central banks raise interest rates in a sudden and unexpected manner. Or a relapse of the global economy into a deflationary spiral following the exhaustion of the effects of post-pandemic monetary and fiscal stimulus. Both seem to us at the moment ‘tail’ risks, so we continue with a prudent but open approach to taking reasonable risks.

 

Performance Diversified Across All 5 Strategies, with Low Correlation

The fund’s performance was achieved thanks to positive contribution from all five of our proprietary strategies. In particular, the Compounders contributed about 50% of the total gross return, the Income, Macro and Special Situations strategies just over 20% each and the Alternative Risk Premia strategy contributed about 2%, even if it was the least correlated with the others (thus doing its job). Hedging strategies “cost” around 15% of the gross yield. This was in line with the percentage of expected return allocated ex-ante to the hedges.

Very relevant is the fact that the five strategies showed low correlation to each other, in a period in which the correlations between traditional asset classes (stocks, bonds, etc) appeared to be growing. Thus confirming the benefit of our approach to diversification: by strategies and not by asset class. For example, the Alternatives Risk Premia recorded an ex-post correlation of 32% with the Compounders, 19% with the Macro strategy and -2% with both the Special Situations and the Income strategy. This diversification effect eliminated about two thirds of gross volatility (i.e. the sum of the volatility of the strategies “standalone”).

 

Looking to the Future with a Blend of Confidence and Prudence

Whenever the stock markets hit new records, there are always observers who point their attention to the danger of valuations which are too high. The difference today is that the same observers are also pointing out the reasons why the valuations could be justifiable this time. We have already mentioned Shiller’s CAPE. But Robert Shiller himself recently said given the current level of interest rates, a high CAPE might not be a problem this time around.

Another indicator is Tobin’s Q Ratio which compares the market value with the replacement cost.  There are those who say that its current (high) level is justified by the technological changes taking place. Finally, there is the famous Warren Buffett indicator, the ratio of market capitalisation to the GDP of a country (not considering the fact that part of companies’ profits is generated by foreign activities). According to some, this indicator has lost importance and should be replaced with the ratio between market capitalisation and money (M2) to reflect the influence on the markets of the creation of liquidity by the central bank. From this point of view, the valuations of the shares would be on average with the past.

What conclusion to draw? From our point of view, it is more useful to keep ourselves prepared, with respect to different scenarios, rather than focusing on the forecasting capacity of the valuation tools. At the moment, the consensus is positioned on a scenario of high growth with contained inflation, favored by expansive fiscal and monetary policies and by the progress of vaccination plans in the USA and Europe. A positive scenario therefore for “risk assets”.

What are the risk scenarios? Between the two scenarios mentioned above (inflationary/ deflationary), we are more likely to worry about a possible surprise of inflation, and therefore of rising interest rates. If we add that the relationship between the US and China is probably subject to increasing tensions, there are all the elements not to remain “complacent” and to actively manage the choices within the portfolio and the total level of risk.

 

As a Boutique, Our Size is Our Strength

We conclude with a couple of comments on the second year of Plenisfer Investments (founded in May 2019). We experienced the adventure of starting the management of a new fund during a pandemic, with 100% of the team working from home, in virtual mode. Everything worked out for the best, and we still work with most of our people remotely. But this did not prevent a fruitful and beneficial interaction between all team members. In fact, we have not lost sight of the advantage of being a boutique, that is the possibility of always having “the whole team around the table”, even if in virtual mode.

 

We spend most of our time studying economies, sectors and societies. Trying to understand what generates the success of a business or a country. Is it repeatable success? Is it reflected in the market prices? Sometimes we have the answers, sometimes we don’t. We continue to study and discuss until we have an investment thesis that we think is reasonable and, at that point, we take action. The important thing is to maintain intellectual honesty; recognising what we know and what we don’t know.

To build a successful portfolio we do not need to “cover” the entire investable universe. But to have antennas that are able to identify and seize opportunities where they arise. And to analyze them thoroughly, always asking the question of what can go wrong.

 

We Remain Focused on Creating Value

In the first “CEO letter” we talked about our goal of building a company that brings investment activity back to its origins; formulating and trying to achieve concrete objectives  for our  investors. Our goal is to build a long-lasting investment franchise. We know that building a successful track record is a marathon, not a sprint. The first managed product got off to a good start, and new products are on the launch pad. But we are at the first mile, and the race is still long.

 

In order to be successful we must create value.

Value first and foremost for our investors, in terms of long-term net returns. Our first fund is called Destination Value for this very reason, not because we adhere to a particular ‘value’ investment philosophy (even if our nature as fundamental investors is rooted in valuations).

‘Value’ for our customers but also for colleagues, current and future who want to join this adventure. In terms of professional growth, knowledge and learning. If we manage to create value in this sense, profits will be a logical consequence of the value created. A business that does not create value for those it touches is destined to disappear over time.

 

 

Giordano Lombardo

CEO and Co-CIO

MAY 4th 2021

1 A sub-fund of Plenisfer Investments SICAV. Destination Value Total Return (I share-class, Euro-Hedged and USD) are for Institutional Investors only in Italy and France.

 

2 There is no guarantee that the objective will be achieved or to obtain a capital return.

 

3 Source: Plenisfer Investments. The sub-fund is active since May 4th, 2020. There is no guarantee to achieve similar returns in the future or to obtain a capital return. Performance is calculated based on the I share-class NAV EUR-hedged (LU2087694647), including gross dividend reinvestment, where applicable, net of fees, gross of tax. Performance references to the period May 4th, 2020 and April 30th, 2021. Returns do not consider applicable taxes.

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