- 31 dec.Vector 2021 Annual Review
- 15 okt.Q3 Review
- 17 aug.Chinese crackdowns
- 22 jul.Vector 2021 Semi-Annual Review
- 25 jun.Why we still like value
- 25 mei'Transitory' Inflation
- 22 apr.Reversal to the mean?
- 17 mrt.Vector's take on sustainable finance
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- 19 feb.David versus Goliath: An analysis of 2020 stock market performance
- 30 dec.Vector 2020 Annual Review
- 20 nov.Factor momentum
- 20 okt.How will the US elections influence your portfolio?
- 25 sep.Are better times for quant investing on the horizon?
- 26 aug.Fama/French going through its biggest drawdown since 1963
- 17 jul.Vector 2020 Semi-Annual Review
- 25 jun.A Look At Post-Corona Market Valuations
- 25 meiUnprecedented times call for unprecedented measures...
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- 31 dec.Vector 2019 Annual Review
- 17 dec.Fama/French going through its second biggest drawdown since 1963
- 15 nov.The Alpha Lifecycle
- 16 okt.Vector 2019 Q3 Review
- 10 sep.A new prospectus
- 14 aug.Market Review: July
- 10 jul.Vector 2019 Semi-annual Review
- 14 jun.Are factor premia disappearing?
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- 12 apr.Market recovery: sense or sentiment?
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- 31 dec.Vector 2018 Annual Review
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- 18 jul.Vector 2018 Semi-annual Review
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- 02 mrt.Vector wins Morningstar Germany and Belgium Awards!
- 22 feb.Vector Flexible wins De Tijd/L'Echo Awards for the third year in a row!
- 16 feb.Navigator wins Morningstar France Award!
Decomposing Vector Flexible's stellar 2022
15 mrt. 2023
After having a solid recovery around the turn of the year, markets fell a little in February. Global equity ended the month about 0.5% lower. March, however, is proving to be an entirely different story, with most of year-to-date gains being wiped out as the time of writing… In a times of market turmoil like these a flexible mandate is very useful as we can adapt the portfolio’s exposure to lower or increase the risk dynamically.
In this article we will address a question we got a few times recently and which shows that investors are not completely familiar with the way Vector Flexible operates: “how did you lose just 0.3% in 2022, while most of your competitors recorded double digit losses?” In order to answer this question, we will briefly discuss the mechanisms behind the fund and show the return decomposition of last year. Basically, the return of Flexible consists of 3 large building blocks:
- The Market Beta ~ exposure to the benchmark: In Vector Flexible’s case, we have about a unit exposure to the MSCI All Countries. Put differently, without hedging any risk we would be running a similar risk as the market/our benchmark – just like we do with Vector Navigator, our pure global equity fund.
- Stock Picking/ allocation component: Since our funds are actively managed, we will always deviate from the benchmark. Either because we take active bets on sectors or regions or because we select the right/wrong companies within a sector or region.
- Hedging: Every Flexible fund tends to (actively) hedge its exposure to the market. Out portfolio is fully invested and on top of that we use future contracts on the MSCI World to hedge our exposure to the global markets. We hedge at least 25% of the market risk, but can increase this to 100% in a worst-case scenario. The use of futures allows us to reap the full benefit of the stock selection model (i.e., alpha on 100% of the portfolio as it is fully invested in equity), while still being able to dynamically adjust the risk level (Beta) for market events. The use of futures as a hedging mechanism was a big win for us in 2022 as these derivatives have next to no duration risk. This means that we did not suffer from the huge increase in interest rates like many colleagues did who tend to manage their equity exposure with a bond portfolio, which has inherent interest rate risk.
Using these three components, we can perfectly recreate the ‘theoretical return’ Vector Flexible has earned over any period. For instance, during the second week of April the MSCI World recorded a return of -0.83%, while the MSCI All Countries lost 0.77%. Our selection, proxied by Vector Navigator, fell by 0.37% during the week. We hedged away 45.77% of the market risk during this week. We can approximately recreate the return of Vector Flexible by using some simple calculations:
Return (Flexible) = Beta (MSCI ACWI) +/- Stock Picking effect +/- Hedging
Beta = 1 * -0.77% = -0.77%
Stock picking = -0.37% - (-0.77%) = +0.40%
Hedging = -45.77% * -0.83% = +0.38%
This brings the theoretical return of Vector Flexible to the simple sum of -0.77% + 0.40% +0.38% = 0.01%. Well, if you would check the returns, Flexible actually lost about 9 bps during that week. Are our calculations wrong? Not really, the difference is due to the cut-off of the futures pricing not perfectly aligning with the market return on any given day, but this ‘error’ is then offset the next day. If we do this calculation on a weekly basis, the sum of these theoretical returns adds up to -0.25% for 2022, which is rather close the -0.30% Flexible actually recorded. We can plot this graphically as well:
This decomposition shows that the excess return over a unit market exposure was earned in about equal parts by the stock picking and hedging components. The hedging return can in theory be split up even further by looking at how we deviated from the base hedge (25%). Put differently, how did we ‘time’ the market by increasing the protection of the fund when the markets fell with respect to the base hedge. In 2022 we dynamically changed the hedge a couple of times, hedging away up to 60% of market risk at a given point based on the model and investment committee meetings. This dynamic exposure earned us an additional 3.1% during the year, which is about half of the total hedging return earned in 2022.
We hope that this article on how Flexible's internal organs function helps you understand the fund a bit better, but we always remain open for any further questions you might have.
Werner, Thierry & Nils