The Warburton Global Fund delivers an annualised return since inception of +40%

Series 1 units of the Warburton Global Fund returned -29.0% in February 2018. The value of $1 invested since inception is $1.90.

Through some extremely unlucky timing, we lost -24.0% being short bonds, in a month where being short bonds was a profitable trade.

February was a volatile month for the global financial markets. Equity indexes registered large losses around the world. Government bond prices were down noticeably. The US yield curve steepened, as US Treasury bonds lost value at both shorter and longer maturities. Commodity prices generally fell. Precious and industrial metal prices were down solidly. Oil prices plunged. Prices of “battery” metals bucked the trend, with nickel up 1%, cobalt up 1% and vanadium up 2%. The AUD was down sharply versus the USD.

Considering we had anticipated the impending market correction, had put on a hedge to protect the fund and had very little equity market exposure, the Warburton Global Fund registered an unexpected month of performance. February’s return can be broken into the following components:

1. The quantitative portfolios:
   – High-conviction quantitative -2.2%
   – Diversified quantitative: -3.0%
2. The vanadium holdings: +0.2% 3. The 1st short bond trade: -12.0% 4. The 2nd short bond trade: -12.0%

Below is a step by step walkthrough of each component’s performance.

1. The Quantitative Portfolios

In the prevailing market conditions, our two quantitative portfolios performed far better than expected. We significantly outperformed our competitors who run similar quantitative strategies. Our quantitative portfolios quickly adapted to the worsening environment by reducing overall capital and duration exposure to the market. They minimised initial losses whilst also registering gains towards the end of the month, finishing down only -2.2% for the high- conviction quantitative portfolio and -3.0% for the diversified quantitative portfolio. The comparatively strong performance of our quantitative strategies demonstrates their ability to dynamically navigate all market conditions.

2. The Vanadium Holdings

We added the first stock to our vanadium holdings. The stock finished the month +7% higher than our purchase price and contributed +0.2% to our fund’s overall monthly return. Vanadium prices rose during the month while most other asset class prices fell. Our vanadium holdings provide another source of uncorrelated returns for the fund and we continue to remain positive on the underlying fundamentals that drive vanadium prices.

3. The 1st Short Bond Trade

Short bonds had been a profitable trade for us in January. The FOMC statement on the Wednesday 31st of January was hawkish, as expected, and US bond prices continued to fall, creating profits for our fund. However, what caught our attention was that since the FOMC statement was released, volatility in the US equity market had started to rise, with the VIX going from 13 on Wednesday to 17 on Friday.

We had written at length in our previous two monthly reports explaining how rising interest rates would reach an “inflection point” and cause a “regime change” that would affect the pricing of all major global asset classes. We believe the FOMC statement on the 31st of January provided the inflection point for the regime change and became the catalyst for the subsequent correction in prices of all major global asset classes.

On Friday the 2nd of February, with the VIX at 17, and well-aware that we were likely to enter a correction, we assessed the potential weak points of our portfolio and also ways that we could generate extra profit. Equity market exposure was our biggest concern, but with the VIX rising, our quantitative portfolios had already reduced our exposure to the equity markets. Additionally, our quantitative portfolios had also lowered our entire capital allocation to the wider asset markets, to a level significantly lower than our average exposure.

The most logical trade to us was to increase the size of our short bond position. We figured that if other asset prices were to fall due to rising interest rates, then the profits from a large short bond position would more than offset any potential losses in our quantitative portfolios.

The construction of the fund’s portfolio for February was therefore quite straightforward. It comprised our usual allocation to our quantitative portfolios, a large short bond position (to hedge the quantitative portfolios should yields rise (i.e. bonds fall)) and an allocation to vanadium, to profit from rising vanadium prices.

To hedge the quantitative portfolios, we had inadvertently created concentration risk in the discretionary portfolio. In hindsight, instead of taking such a large short bond position, we should have taken a smaller position and combined it with a complementary and uncorrelated long VIX futures position. The short bond position would hedge the quantitative portfolio against a longer drawn-out correction, but if assets prices were to correct faster than we anticipated, then the profit from the VIX futures would mitigate any short-term loss. Additionally, should bonds react to a sharp correction by rallying, the long VIX futures position would offset any losses from the short bonds position.

By having two smaller, uncorrelated but complementary positions, rather than one large concentrated position, we would have navigated either a sharp correction (via long VIX) or a longer drawn-out correction (via short bonds) equally as successfully.