Cowardly lions and absolute returns

Bull or bear? Smart investors generally tailor their strategies to take advantage of the particular characteristics of these phases of the economic cycle. But what if the market is in neither bull nor bear phase?

Richard Gosnell, CIO of Taquanta Asset Managers Quants operation believes that is the situation right now. He maintains that we could well be in the throes of what author Vitaliy Katsenelson refers to as a "cowardly lion" or "range-bound" equity market.

In his book "Active Value Investing: Making Money in Range-Bound Markets", Katsenelson defines range-bound markets as those characterised by roller-coaster volatility in which money invested in the beginning of the cycle will have very low real return gains by the end of the cycle. The term "cowardly lion" is Katsenelson pet name for range-bound markets in which, he says, "bursts of occasionally bravery lead to stock appreciation, but which are ultimately overrun by fear that leads to a subsequent descent."

Katsenelson says that over the last 200 years, every full-blown, long-lasting bull market (such as experienced in the US from 1982 - 2000) was followed by a range-bound (cowardly lion) market that lasted about 15 years. But within these long-lasting range-bound markets are several mini bull and bear mini-cycles that last a few months to a couple of years.

Gosnell says a similar pattern is evident in South Africa. From 1960 to mid 1969, there was a bull run of just over nine years with the index rising by around 20% in real terms per annum. This was followed by 34 years of cowardly lion conditions - short bursts of bears and bulls with an overall real return of just 3% per annum throughout the period. Then a bull phase kicked in mid 2003 and over the next 4,5 years - to October 2007 - there was a compound increase of 311% (37% per annum).

However, Gosnell warns, there is every indication that we have entered into a range-bound market. Investment experts like George Soros, Paul Volker and Richard Bernstein have highlighted that the current market conditions represent a distinct break from the bull market of the past few years.

"The key now, for investors, is to adopt strategies that will see them through this 'stagnant' market phase relatively comfortably," he says.

"For those investors who truly want security and certainty, Absolute Return Funds that incorporate a large proportion of assets that will give positive returns in all markets are the way to go."

Taquanta Asset Managers has taken this approach with its Absolute Return offerings by adopting a 'cash plus' strategy: this strategy offers expectations of returns of money market plus 2% (or more depending on the mandate) with a slight increase in volatility above cash. The funds include a quantitative active value tilted stock picking strategy with the bulk of the equity market risk hedged out.

"In range-bound equity markets, we expect the money market (cash) to provide a return of only slightly less than equities but with considerably less risk. When this is boosted with our quants stock picking and other related strategies, we anticipate producing an attractive real return at low risk. As we go deeper into cowardly lion territory, that could be just what the investment doctor ordered," Gosnell concludes.