Jeff Bradacs, CFA, Portfolio Manager, Picton Mahoney Asset Management joins Pierre Daillie to discuss how a market neutral strategy can help keep Mr. Market quiet, especially in today’s economy and market that is transitioning from a high-growth, early-cycle recovery stage to a slower-growth, mid-cycle environment. Jeff breaks down how a market neutral strategy generates returns through stock selection, where he and his team are finding opportunities and what they see in the macro environment.
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Jeff is a Portfolio Manager at Picton Mahoney Asset Management, specializing in Canadian Equities. Prior to joining Picton Mahoney, Jeff was Vice President and Senior Portfolio Manager at BMO Global Asset Management where he was lead portfolio manager for Canadian Large Cap Equity portfolios, managing over six billion dollars in assets under management.
Prior to that he spend over a decade at Manulife Asset Management joining as an analyst and progressing to managing director and portfolio manager with responsibility for Canadian equity portfolios, managed with a blend of fundamental and quantitative analysis.
Jeff is CFA charter holder, and has an Honors B Admin from the Richard Ivey School of Business at Western University.[00:00:59] Announcement/Disclaimer: This is the Insight is Capital Podcast.
The views and opinions expressed in this podcast are those of the individual guests, and do not necessarily reflect the official policy or position of advisoranalyst.com or of our guests.
This broadcast is meant to be for informational purposes only. Nothing discussed in this broadcast is intended to be considered as advice.[00:01:18] Pierre Daillie: Jeff, welcome to the show. It’s great to have you. [00:01:21] Jeff Bradacs: Thanks Pierre, it’s great to connect. [00:01:23] Pierre Daillie: So, Jeff, to kick things off, um, tell us more about Picton Mahoney Asset Management. [00:01:30] Jeff Bradacs: Yeah, that’s, it’s a great place to start.
Uh, for those listening in that aren’t familiar with Picton Mahoney Asset Management, we are founded over 15 years ago, and we currently manage today over around 10 billion in assets, for both retail and institutional clients.
We’re an independent asset manager, meaning we’re not a subsidiary or division of a, a larger financial institution. Instead, we’re a hundred percent employee-owned, and very much believe in alignment alongside our clients with senior investment professionals investing in our funds alongside clients.
Uh, we’ll talk today about one of our strategies, but we manage a number of strategies across equities, fixed income, and multi-asset. And a common thread between them is a focus in on risk adjusted returns, and also helping our clients reach their financial goals with greater certainty.[00:02:23] Pierre Daillie: Jeff, tell us about your role, uh, your background. I know I, I covered some of that, and, um, but maybe you could provide some color on that, and, and, uh, also why you joined Picton Mahoney Asset Management. [00:02:36] Jeff Bradacs: Yep. My role is as a portfolio manager on a number of the equity solutions, and long-short strategies. I work alongside Dave Picton. What we’re gonna talk about today is our Market Neutral.
As you mentioned, with my background, I’ve been managing at least for about 17 years. And this journey as an investor has led me through different disciplines. Uh, I’ve managed portfolios before that were predominantly fundamental driven. You can think of meeting with companies, industry analysis, site visits and building models-
… to find profitable investments. And I’ve also managed portfolios over my time that are very quantitative in nature. Using mathematics, statistics to find profitable investments.
And, what insight I’ve gathered as an investor is there is strength in both. And, as an investor, I could build better portfolios if I combine them in a portfolio.
And that’s really what led me to the team at Picton Mahoney Asset Management, is very much an alignment in this belief. At Picton Mahoney Asset Management on the Equity Solutions, we focus in on a style that’s unique called ‘fundamental change’. And we also believe in leveraging both fundamental analysis, and quantitative analysis to build portfolios.
And we gain significant insight when you have different edges, looking at companies from different vantage points. And we see a lot of power when they confirm each other. So, when they both say buy, we see that’s significantly powerful.
So that’s a bit about my background, also what led me and really what differentiates Picton Mahoney Asset Management.[00:04:07] Pierre Daillie: What is the Market Neutral Strategy, and how does it work? [00:04:10] Jeff Bradacs: Uh, great question. As I anticipate, there’s people listening in that have heard this term market neutral… maybe have an idea, not, not fully clear, uh, what it is, how it’s managed… and why it’s important for clients’ portfolios as a solution.
So, I, I’ll break it down, and from a… a very high level, a Market Neutral is an alternative solution. Now, when a lot of people hear alternatives, they think of different asset classes, than traditional stocks, equities, or boughts. Things like infrastructure, private equity.
And those are alternatives. But what are also alternatives is how a solution is managed. And in the case of Market Neutral, that takes traditional equity stocks, and manage those differently to provide a, a different outcome for investors.
Now, the objective of our Market Neutral portfolio is to manage those equities to provide a positive return stream for clients, irrespective of the market direction. Or, for other words, neutral to the direction of equity markets. And over the 15 years we’ve managing this solution, through great financial crisis, through the pandemic, that’s been our objective. Now, how it works, and we build a portfolio, you’d think of the portfolio in some ways, two halves.
On one side we buy companies, go long companies where we see positive fundamental change. On the other side, we short stocks, and we short those companies with negative change. We bring it together within a portfolio, and through risk management, what we want to ensure is that portfolio for our clients, the exposure to equity markets is close to zero. Or, technical term, beta close to zero.
Now, why this matters within the portfolio context, is if you can add a solution like Market Neutral to your equities and your fixed income, and you can add a market solution that’s not correlated with either, what is can do is improve the overall quality of returns for clients.
So, there’s some background on Market Neutral and how it works, and also how it fits within a client’s portfolio.[00:06:28] Pierre Daillie: Right, so you, you’d be… you’d have your base strategy… uh, which, let’s say it’s traditional 60-40… um, and then, and then in order to complement that, you’d be adding Market Neutral to add to the overall incremental expected return over the long term, uh, irrespective of how the, the base strategy does… [ [00:06:51] Jeff Bradacs: Correct.. [00:06:52] Pierre Daillie: So, wh-, what challenges do you think investors are facing in the current environment? [00:06:58] Jeff Bradacs: Two concerns we hear from investors, and… are, one is inflation and the surge of inflation. And the other is we’ve had this surge in economic growth and we’re, we’re now in that deceleration phase, and that, that’s causing some jitters in the market.
So, maybe I could expand on each of those in a little more detail. I’ll, I’ll start with inflation, and it, it’s something we debate at Picton Mahoney, and I’ll tell you both sides of really the coin on the debate.
On one side… uh, inflation is higher and here to stay higher. It really centers around the massive monetary creation and fiscal stimulus this cycle. And just to give some context for listeners, uh, it starts with monetary stimulus. As a result of the pandemic, across the globe central banks flooded the system. Essentially they wanted to ensure that this pandemic, global pandemic didn’t turn into a global liquidity crisis, like we saw with 2008.
As a result, the Fed for example, put in six trillion dollars into the economy. That’s a massive number.
The equivalent of 30% of GDP. Also, the government stepped in with fiscal stimulus across the globe. For example, in the US, five trillion dollars was added. And to give you just the data point, uh, in the US, 90% of US citizens received checks in the mail. $1400 per individual, so-
… stepping back and thinking the average family of two adults, two children… that’s $5600, a meaningful amount.
And, for the debate on those that inflation’s here to stay is that, that liquidity is now causing inflation in the system. Equivalent to over 50% of GDP, fiscal and monetary.
Also they’ll point to is that wages are not starting to increase. And that’s really the key driver of sustained inflation, is that higher prices lead to higher wages, and that virtuous cycle.
So, that’s the one side of the coin. On the other side of the debate… is, it, stepping back, and acknowledging that we haven’t had inflation for over 25 years prior to this. And that’s because there are some large deflationary tailwinds. Things like demographics.
Things like technology. Amazon, that aids price discovery, and deflationary in force. And also globalization. And s-, some may argue globalization’s decreased after the last regime of the US, but it’s still here.
Also, on the temporary side of inflation debate, is that there’s been a surge of goods in CPI. And it’s been driven by a narrow basket of goods that consumers are purchasing.
For me, for example, I haven’t traveled for a couple of years for leisure, or been to a sporting event or concert. But, like many people, I’ve done a home renovation, others concentrated purchases in cars. I’ve heard a story of someone selling a boat for more money than they bought it 15 years ago.[Laughs]
That’s, that’s clearly not a sustainable trend, and capital will solve supply chains, and there’ll be more boats produced.[00:10:00] Pierre Daillie: Yeah, the, the same thing’s happening with, uh, cars too, right? I mean, with, with, uh, foreign cars… you know, I think Audi in particular… uh, the, the, um, buyouts on the backends of leases are, are now fetching, you know, $10,000, $15,000 premiums… because, because of the shortage of vehicles.
Yeah,[00:10:20] Jeff Bradacs: we’re seeing that flare-
… with vehicles.
And that, that would ar-, feed into the argument that it’s temporary, is… next year-
… we’re gonna be laughing, those surged used auto prices where they were up over 30%. And as capital’s deployed in the supply chain, more automobiles will be produced, and that’s gonna be a deflationary headwind.
Now, as I, we debate it, uh, we don’t see the inflation picture today derailing the equity markets, but the key debate is… mid-next year, where is inflation.
As we start lapping those comps, is it still here at high? And are we starting to see that initial high wages that have brought people back to the workforce… is it continuing the higher wages.
I would say, if we do have inflation mid-next year, then that could challenge the equity market, because it means policy makers, the FED, need to play catch up.
Jeff, do you see[00:11:11] Pierre Daillie: an other challenges, uh, that, you know, in terms of headwinds that investors are facing today? [00:11:17] Jeff Bradacs: Yeah, the, the second challenge… uh, that advisors, and g-, generally the market are facing is we’ve had this, this surge in economic growth. A-, and now we’re in this deceleration phase. And that, that’s causing some jitters in the market, and some volatility.
And, if I just back it up, the surge in economic growth is happening as we went from closed economies due to the pandemic to reopening. And we saw a massive surge, and measures like PMIs, measures of economic growth, reached 40 year highs earlier this year.
And now we’re on that deceleration phase.
A-, and that gives some volatility for investors if, as to how far the economic growth falls.. Now, typically when we have this, kind of, switch in early to mid-cycle, it’s usually a question of demand. Has the consumer run out of gas? I don’t believe that to be the case this, it’s more driven by the supply side.
On the consumer side, given that we’ve had massive fiscal stimulus, it means that for the first time in a recession in the US, consumer notional incomes actually grew during a recession. So, the consumer’s coming out of this recession from the pandemic in great shape. Also business balance sheets are in great shape.
So, the slow down’s really driven by the supply chain, a-, and there’s a multitude of reasons on the supply side. One goes back to a year and a half ago in March, many factories were forced to shut due to the pandemic for, for safety of their employees, or also maybe just uncertainty of demand [inaudible 00:12:46]. Demand has surged back, and it’s, it means that inventories to sales are at 40 year low.
So, we’re seeing that slowdown today, uh, driven by supply, but it also means that we have a nice tailwind to the economy in rebuilding inventories. Rebuilding the supply chains will be a nice tailwind in rebuilding the inventory cycle.
So, that’s one concerns, and I think that’s causing some volatility in the market. You might now see it on the headline index level . But, below the index level, there’s been a lot of volatility this year. Uh 60% of Canadian-US companies corrected 10%. And-
… one third of TSX companies corrected 20%. So, so that’s a lot of volatility out there.
And, you’ve probably heard the term, uh, Mr Market before. Uh, r-, coined by Benjamin [Gare 00:13:56]. And of that… irrational behavior of the market going from fear to greed.
And, as we transition through this period, we could probably see more volatility, as the market some days are fear, or declining, going through deceleration, to greed. In, in the case of our solution, uh, we take out that Mr Market in the noise for investors. We try to produce a return with much less volatility.[00:14:07] Pierre Daillie: I had an interesting conversation with, uh, another, um… uh, PM CIO, and, and one of the points he made that was really interesting in that, is that when we had, while we had… in terms of the equity market, while we had a scarcity of growth last year, because of the collapse in the economy, growth stocks, which are high duration… uh, in nature, performed ex-, exceptionally well, as we know, in hindsight now.
Um… but then in the face of recovery, of the reopening trade that happened in the Fall with the election, and then subsequently the vaccine news, the reopening trade reignited value stocks… for example. And, and so… it’s interesting to see, you know, how, how an inflationary outlook could be, uh, one that leads to higher interest rates potentially, uh, over the next couple of years. And… how that, how that plays between value and growth, or value and momentum… uh, stocks. And, and so there’s o-, there, there seems to be, uh, this incipient shift in the regime of the market… and, and, and what happens next, and, and how that affects stocks.
But that’s probably the nice thing about the Market Neutral strategy that we’re talking about today, is that it, it, it… it, um… performs… in a way that’s very different than, than the general outlook for, for either… growth stocks, or value stocks.[00:15:42] Jeff Bradacs: Great point you make, too, and also with… the change in regimes, and potentially, if inflation does persist, what that means for portfolios.
And, I would agree, uh… when I, when we look at portfolios out there, um… we think there’s a lot more rate risk in portfolios than maybe clients perceive. And what I mean by, for example, is, a portfolio that may feel diversified on the surface, maybe a client’s portfolio that’s investment bonds, dividend stocks, and then their favorite tech stocks, may feel very diversified.
But… there’s a large interest rate risk there, across those three components, and if we do have higher inflation, it is persistent, that could be a challenge for investors, ’cause that unintended interest risk in portfolios.
Uh, turning to our portfolio as you mentioned, uh-
… we’re neutral to the market. But within our positioning today, we also do have a positive tilt towards commodities. And-
… commodities historically have been nice diversifiers in inflationary environments.
And, one, one, one commodity we really like is copper. Not only is it a, it’s a nice hedge for us in our portfolio, but the cyclical outlook for copper’s aligned, and there’s some nice secular, uh, kickers there.
And just to elaborate, it’s kind of followed the boom and bust cycle copper. If I go back to the early 2000s, uh, China came into the world. Uh… copper companies started raising capital, and they started building mines, it usually takes five to seven years to build a copper mine. And they built these mines, and they came on right at the wrong time. 2008, 9, 10, right as the financial crisis hit.
As you can imagine, they, they flooded the market with capacity, and the last decade, copper companies have been starved for capital, and haven’t built mines. Meanwhile, demands coming back, and then copper also has that secular story of decarbonization. Uh, things like wind, that’s massively copper-intensive, and things like electric vehicles, where an electric vehicle is four times copper-intensive than I.C.E. Car, int-, internal combustion-
So, I think in a portfolio that’s structured, to your comments also, is it’s important to have diversifiers in a portfolio to prepare you for those [inaudible 00:18:14], and if inflation persists, having something in your portfolio that will act differently to protect it, protect your portfolio.[00:18:07] Pierre Daillie: Yeah, I just, to add to your point about copper, and, and, uh, electric vehicles… um… I think the, the, uh, last number that I read was that it takes 56 pounds of copper… for one electrical vehicle.
Yeah.[00:18:22] Jeff Bradacs: … it’s four times as intensive. [crosstalk 00:18:38]
And then we also have to build that grid, to, to power the cars, whether that’s at home, whether charging stations-[00:18:29] Pierre Daillie: Right. [00:18:29] Jeff Bradacs: … so… a massive long term demand driver for copper.
So, Jeff, where does Market Neutral fit in investor portfolios?
Great question. Where we’re seeing our clients use Market Neutral, there’s a couple specific areas. One is for clients with too much cash. Maybe they’ve had cash come in the last two years… uh, concerned with the pandemic, they’re concerned with valuations. And they’re looking to deploy that cash to get a return, but… they don’t wanna add equity risks to their portfolio.
So, they’re looking to Market Neutral to get a positive return, but not add to equity market risk.
The second area we’re seeing clients use Market Neutral as a solution is an alternative for fixed income. Uh, and so, low rate environment. It’s a challenge for fixed income. So, they’re looking to Market Neutral to get a return, but not add rate exposure to the portfolio.
And I would say, kind of the last area, as we’re finding more and more clients stepping back… looking at their portfolio, and in many cases looking at the traditional investments, maybe 60-40, or along that lines, and while it’s served out extremely well in the past, maybe challenge going forward. Challenge to get returns, also challenge to be diversified, and they’re stepping back, looking at those building blocks, seeing if they have the right building blocks.
And looking to Market Neutral as an alternative to add to their building blocks, to build better portfolios.[00:20:01] Pierre Daillie: Where can investors learn more about the Market Neutral strategy, and Picton Mahoney Asset Management? [00:20:06] Jeff Bradacs: Yeah, for more information on Picton Mahoney Asset Management, and our strategies, you can refer to our website at pictonmahoney.com, or reach out to one of our sales consultants for more information. [00:20:19] Pierre Daillie: Jeff, thank you so much for your incredibly valuable time and insight. [00:20:24] Jeff Bradacs: Thanks Pierre, good to connect with you.
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