A sector rotation manifests itself in selected equity sectors selling off and others gaining, while the overall market changes very little. While loosely correlated with the economic cycle, timing a sector rotation is “notoriously difficult”, Buhl-Nielsen told FSA.
“It is very difficult to prepare for such rotation,” he added. While fund managers can use options to protect against broad market risk, often there aren’t suitable option instruments that can be employed for sector rotation, he explained.
As sector rotations tend to reverse themselves in time, “the only way to go through them is to sit on your hands and wait”, he added. “By reacting, you could do more damage to your portfolio than by doing nothing.”
Buhl-Nielsen manages the Jupiter Europa Fund, which follows a fundamental long-short stock picking strategy, with significant use of derivatives.
During the past 18 months, the biggest drawdown the fund experienced was 8.05% in euro terms. Buhl-Nielsen attributed 5% of that drawdown to sector rotation.
The fund tends to focus on mid-cap stocks in the UK and developed European markets.
“We look for fundamentally attractive companies that ideally have strategic value, in the eyes of another company or a private equity firm,” he said. The ideal company is one whose shares increase on the fundamental merits, but which at some point gets acquired or undergoes a restructuring to release even more value.
Stock picking is exceptionally difficult in certain sectors. Banks and insurance companies, but also mining, commodity producers and biotech companies tend to be difficult to analyse, due to their complexity. “Even CEOs can’t know everything,” Buhl-Nielsen said.
The Europa fund holds around 70 long and 90 short equity positions. Because short positions tend to be more volatile, they are smaller, to minimise their overall effect on the portfolio and the risk of having to cover them at inopportune moments.
The blend of long and short positions results in the current net market exposure of around 40%, thus reducing the fund’s beta, which is around 0.37, according to FE.
While holding companies for long periods, Buhl-Nielsen employs option strategies to reduce potential drawdowns.
A typical tactic he uses is to buy a put option for a stock index in order to protect against a market downturn. He would then sell puts for selected individual stocks whose options trade at high premiums, but for which he doesn’t see an immediate upside. This allows him to offset the cost of the index option. He also uses more complex option strategies, depending on market conditions.
In principle, if done correctly, such an approach should provide some protection from market downturns at a low cost. It also tends to reduce the net market exposure on the downturns, which can reduce losses.
The fund is managed by a team of two. Buhl-Nielsen is an options specialist, and Tommy Kristoffersen is responsible for the fundamental analysis and stock picking. They rely heavily on Jupiter AM’s other asset managers for industry expertise.
While not making specific macroeconomic or sector bets, the fund has significant holdings in UK, German and Swedish real estate companies. The macroeconomic risk to such companies stemming from the rising interest rates is partially offset by holdings in banks, which should benefit from the increase.
Jupiter Europa Fund