Long / Short Fund Pensato Up In Down Market

Relative value strategy at play as market volatility provides opportunities in pricing mis-matches

Long / short European equity fund at Pensato found value in January’s volatile rock and roll market environment, delivering monthly performance near the top of their statistical range.

The Pensato Europa Absolute Value Fund was up 2.6 percent in January. In an investor letter reviewed by ValueWalk, fund management noted that “despite a volatile period for markets,” which was an understatement in the wake of an odd collapse in the price of oil, Swiss currency flash crashes, Eurozone QE undercurrents and Greek elections ushering in a threat to the economic establishment, the fund’s “portfolio risk management characteristics remain stable and well managed.”

Pensato has past noncorrelated performance attributes, as evidenced during periods of stock market declines.

Pensato: Volatility impacts various strategy types and price relationships

What the fund letter didn’t say is that during periods of volatility a long / short relative value strategy can often identify pricing inefficiencies between similarly traded products. Even if the strategy is not designed to benefit from volatility, often these strategies can drift into opportunity when the technical market environment of price dislocation and mean reversion is in place.

The fund noted an environment of “strong ‘alpha’ generation” as its short exposure was credited with being key to returns, up 2.03 percent on the month. It is the short book that is typically a drag on performance during periods of a rising market environment.  When the general stock market is down – the S&P 500 shed 3.10 percent of its value in January – the short exposure can be key to delivering noncorrelated investment performance.

Stimulus can be a tough market environment for a relative value strategy because can lift both good and bad stocks equally

Separate analysis indicates that as stimulus is withdrawn from the market environment in 2015, an event never before witnessed in history, such a noncorrelated investment approach that does not overly punish the portfolio during positive stock market environments but benefits during negative market environments could become a particularly interesting investment category to watch. Because stimulus lifts all stock market boats — it is equality minded like that — a long short strategy can find an all boats rising market environment challenging.

Win percentage negative, but is their “alpha” on display in size of win?

Pensato looks deep into their strategy and in the letter provides fascinating insight into key statistical benchmarks. “Although our net winning versus losing position ratio was modestly negative,” the letter pointed out, confirming a statistical point about the lack of value in win percentage in some strategies. “Our success ratio from an ‘alpha’ generation perspective was positive with 67 positions out of 125 contributing positive stock picking returns,” they said. “Alpha generation” is often an oblique and popularized term that is often measured by the win size dramatically exceeding loss size due to the manager’s skill.

The letter was littered with relative value language, noting that they are taking a contrarian investment thesis in semiconductors while pointing to fundamental analysis on falling earnings estimates to discussing how increased volatility may boost certain stock prospects.

It was the talk of noncorrelated investing, which is typically more interesting than the simple stock picker’s long till the cows come home methodology.