A strategy for diverging equity markets

This is a partnership with Aviso Wealth.

Since the end of the 2021 “everything rally” advisors have grappled with deep divergence within equity markets. Last year the so-called “magnificent seven” drove the majority of growth on the S&P 500, while most of the market dragged. This year we have seen broader market participation across sectors, but within those sectors there have been distinct winners and losers. Perhaps the best example of which are the year-to-date performances of two semiconductor companies: Nvidia Corporation and Intel Corporation. According to Bloomberg, Nvidia Corporation is up over 90 per cent in 2024. Intel Corporation is down over 35 per cent. This seems to be an environment where advisors and clients can benefit from an approach designed for fragmented markets.

That’s the core thesis behind the NEI Long Short Equity Fund. The fund is provided by NEI Investments and sub-advised by Picton Mahoney Asset Management (“Picton Mahoney”). Picton Mahoney is an expert in alternative asset management with almost two decades of experience managing long short strategies¹. NEI is an expert in responsible investing (RI), and incorporate its proprietary RI approach into Picton Mahoney’s long short strategy in this fund. The result is a strategy designed to generate alpha from bifurcated markets with the goal of providing investors a smoother ride.

“We know from the preponderance of investor behavioural research that our response to loss is much stronger than our response to corresponding gains. So it’s really downside volatility that impacts investor sentiment,” says Jeff Bradacs, Co-Head of Equity Strategies and Head of Portfolio Management & Trading at Picton Mahoney. “I think one of the times where that was most felt by investors was in 2022, a period when the overall stock and bond markets were both down. That’s been extremely rare in the past 20 years. That made a lot of clients ask how to build better portfolios, and we’ve been there to help reduce the volatility in those portfolios.”

Bradacs presents the NEI Long Short Equity Fund as one such volatility moderating strategy. The fund is actively managed with an equity allocation primarily concentrated in North America. It has a beta exposure² to the market of roughly 0.75 and its active long short exposures are designed to drive alpha return³ on the long and short side. A beta of less than one generally mitigates downside risk when markets fall while remaining exposed to upside through actively selected long positions.

The active decisions of when to go long or short on a particular holding are dictated by Picton Mahoney’s unique asset management approach. Bradacs says that his firm does not fall into traditional style boxes. Instead, they look for fundamental change in the companies they hold. Positive fundamental change, such as a new product or new management, will inform a decision to go long. Negative fundamental change, like new regulatory risk or the decline of a key market, will inform a decision to go short.

“The fund’s long short investment process by Picton Mahoney focuses on identifying positive and negative fundamental change at the point of inflection and capturing this before it is fully priced by the market. The RI analysis by NEI complements this by extending the identification of potential change drivers to cover a longer-term horizon and a broader range of investment factors, including non-financial factors,” says Adelaide Chiu, Vice President and Head of Responsible Investing at NEI. “We expect this combined responsible investment strategy may enable the fund to better navigate non-traditional investment factors and produce higher risk-adjusted returns.”

The responsible investing approach of this fund includes security-specific analysis to eliminate exposures to weapons and tobacco and evaluate ESG considerations for other securities, as well as engaging in stewardship activities through corporate engagement and proxy voting. The RI approach is used in the evaluation of the Fund’s long positions. Because short positions are subject to higher turnover, the RI activities are not applied to any of the fund’s short positions.

Chiu cites a range of studies indicating that security analysis that considers non-traditional business issues (such as those related to environmental, social and governance factors) can positively contribute to stock selection.  For example, a company addressing these factors may exhibit lower volatility of cash flows and profitability, which impacts share price. Similar studies have found a positive correlation between a company’s management of non-financial risks and its enhanced resilience in business operations and financial performance over the longer term.

The mitigation of long-term risks complements the long short nature of this particular fund. Bradacs notes that the fund’s overall goal is to minimize a client’s exposure to volatility through the cycle while generating alpha through those longs and shorts.

Active management is crucial to the success of this strategy, especially in our current market environment. Due to central bank decision making and changes in broad market structure there has been greater stock selection opportunity. Where a decade ago equity markets were rising in relative lockstep, today’s divergent performance and whipsaw volatility allows for an active manager to differentiate themselves.

In this fund, Bradacs says, investors get the expertise of two sets of active managers. Picton Mahoney’s active long short strategy combined with NEI’s responsible investing approach can work in tandem to mitigate against volatility and help keep advisors and their clients on a more even path of returns, which we know influences better investor behaviour overall.

“It's rare to see this collaboration, which really provides a benefit to clients where you're getting two specialist firms and one fund, the benefits of NEI Investments and their expertise in responsible investing, and Picton Mahoney as specialists in alternative long short equity investing. So what this provides to Canadian investors is one fund with two different areas of expertise, two different areas of added value in one solution.”

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¹A long short equity is an investment strategy that seeks to take a long position in underpriced stocks while selling short overpriced shares. The strategy seeks to augment traditional long only investing by taking advantage of profit opportunities from securities identified as both under-valued and over-valued.

²Beta is a statistical measure of the volatility of a stock versus the overall market. A beta above 1 means a stock is more volatile than the overall market. A beta below 1 means a stock is less volatile than the overall market.

³Alpha is the excess return of an investment relative to the return of a benchmark index.

^{This material is for informational and educational purposes, and it is not intended to provide specific advice including, without limitation, investment, financial, tax or similar matters. The views expressed herein are subject to change without notice as markets change over time. Information herein is believed to be reliable, but NEI does not warrant its completeness or accuracy. Views expressed regarding a particular security, industry or market sector should not be considered an indication of trading intent of any funds managed by NEI Investments. Forward-looking statements are not guaranteed of future performance and risks and uncertainties often cause actual results to differ materially from forward-looking information or expectations. Do not place undue reliance on forward-looking information.}

^{Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated.
NEI Investments is a registered trademark of Northwest & Ethical Investments L.P. (“NEI LP”). Northwest & Ethical Investments Inc. is the general partner of NEI LP and a wholly-owned subsidiary of Aviso Wealth Inc. (“Aviso”). Aviso is the sole limited partner of the Manager. Aviso is a wholly-owned subsidiary of Aviso Wealth LP (“Aviso Wealth LP”), which in turn is owned 50% by Desjardins Financial Holding Inc. (“Desjardins”) and 50% by a limited partnership owned by the five Provincial Credit Union Centrals (the “Centrals”) and The CUMIS Group Limited.}