The Upside: How liquid alts can expand your diversification opportunities

[00:00:00] Lauren Gardy: Hello, and welcome to The Upside. I'm your host, Lauren Gardy. Today we're excited to celebrate the five-year anniversary of one of Fidelity's key liquid alternative funds managed by portfolio manager, David Way. We're also marking the launch of a multi-alt solution that brings together the strategy along with other Fidelity alternatives. Today we'll reflect on the Long/Short Alternative Fund's journey and share insights into the role alternatives play within investors' portfolios. Please welcome to the show portfolio manager, Dave Way, and alternatives strategist, Brendan Sims. Dave, congratulations on five years managing the Fidelity Long/Short Alternative Fund.

[00:00:39] Dave Way: Thanks very much.

[00:00:40] Lauren Gardy: I'm hoping you can kick off our conversation today by telling our listeners about what you've done to differentiate your strategy from other peers in the industry.

[00:00:50] Dave Way: When I started the fund it was really about talking to investors about their overall portfolios and why I felt there was an opportunity to add a liquid alternative such as mine. I think the real opportunity that we've seen over the past five years that's come through in results is a solution that can help investors generate returns over time. The market goes up over time and for people to meet their financial objectives having equity exposure is often a very important part of that financial plan. At the same time the equity market periodically does have periods of volatility.

[00:01:31] The way that I try to differentiate my fund is to offer the opportunity to access this upside over time while incorporating shorting or an alternative strategy in order to help people manage those periods of downward volatility. Shorting is a very important part of offering that solution because typically if markets are declining if you're short stocks and have a part of your portfolio that is short the market you actually generate positive returns when the market is going down. What that allows you to do really is hold on to capital that you've made as the market's appreciated so that when the market turns and things get better your starting point is a much stronger position than if you were simply fully exposed to equity markets.

[00:02:18] Lauren Gardy: That's a very good point. Thank you. Brendan, could you talk to us ... of course, we've seen markets change quite significantly over the past few years, how have you seen the alternatives landscape also evolve throughout this time period?

[00:02:29] Brendan Sims: I'd start with a joke to say that the only constant is change. I think that whether we look at that through the lens of growth or value, market leadership, of course, Mag Seven is a term that likely resonates with most of the audience. We look at the spread between small-caps, large-caps, domestic or Western markets versus that of rest of the world. These trends are constantly sort of the pendulum is swinging, at times mean reverting but mean reversion can take years if not decades in some spaces. What I would say is the market is changing, it's evolving. I think it would be worthwhile to say that at the time of recording markets are at and/or around all-time highs.

[00:03:04] There are different things, whether that's sort of the P/E or the valuation side or the growth in earnings in particular, sort of top-line revenue growth, margin growth that have led markets to get to the valuation they're at today, but I think that group consensus would be that markets are expensive. When we think about the broader alternative landscape navigating through this change, liquid alternatives here in Canada are about six years old, Fidelity in particular, as well as sort of that of other solution providers, we're constantly looking what solutions can we bring forth that are within our wheelhouse of capabilities, and/or can we sort of grow and innovate to provide new capabilities to meet current market demand?

[00:03:46] At present, we are very fortunate to have Dave here with us, his fund's hitting a five-year anniversary. We have three other liquid alternatives, so four in total as far as the liquid side. We're growing out our alternative lineup. I think the runway of where we can take this lineup of underlying liquid alt and alternative building blocks, I don't really see where it ends. I think that the world continues to innovate and what investors are looking for. For example, right now income-oriented solutions are very popular among investors. Leverage solutions on existing underlying assets and building blocks are quite popular among sort of the investor crowd. There's a lot of different things that are in demand and that goes in and out of style as well.

[00:04:25] Lauren Gardy: It'll be very fascinating to see where this asset class goes in the future. Dave, you've hit quite a few very impressive growth and performance milestones on the fund. What do you think has resonated the most with your investors so far throughout your journey?

[00:04:39] Dave Way: I think when you launch a new strategy in a young sort of submarket of public equities there's really two pieces to it. One is the investment process around finding great companies that we can invest on the long side to take advantage of opportunities over time, and then really laying out the process for how I manage risk within the fund and generate that capital protection type feature when we see markets in periods of volatility. I think what's really resonated is the thing that I said on the day that I launched the fund that I wanted to achieve, which is generating returns similar or better than the market with much less volatility as a way to keep people invested over time, the fund's delivered that. I was really excited to offer that potential and now I'm sitting here at the five-year mark saying, hey, this could be a really important building block in your own financial plan and really add to your existing portfolio because in long/short investing you actually get three sources of return.

[00:05:46] Stocks going up in the portfolio over time, you can generate profits from the short side of the portfolio when those positions generate profits, typically when the market is going down. Over time you can actually generate a return that's not really correlated to the market, very diversified versus equities from picking stocks that will go up and then shorting stocks that may go down so you generate a spread. It's really three sources of returns working together kind of moving from promise of this is what I hope to deliver over time to this is what I hope to continue to deliver over time I think, is really what's resonated. It's an important part of portfolios to have something there that is diversified from all the rest of the stuff which, as individual building blocks, makes sense. Diversifying with something with lower volatility and higher returns can really make any financial plan stronger.

[00:06:45] Lauren Gardy: That's an excellent point. Did you have something to add?

[00:06:47] Brendan Sims: I'll joke and say that as a unit holder I hope that what you've delivered thus far you can continue to deliver.

[00:06:53] Dave Way: I hope so. I can't promise future performance but...

[00:06:53] Brendan Sims: It's been excellent. Consistency is something that comes to mind.

[00:06:57] Lauren Gardy: I'll echo that as well, and it sounds like your investment process is very well aligned with the needs of the end investor so that's fantastic. Brendan, let's pivot over to you and talk about the multi-alt strategy that I mentioned which, of course, Dave's fund comprises half of this. Could you talk to us about who the ideal investor is in this product?

[00:07:15] Brendan Sims: Speaking in broad language I would say this product, the Fidelity Multi-Alt Equity, is offered in ETF or mutual fund version. It would be for anyone that is looking to de-risk and/or provide diversification from what they're currently holding. Without knowing what said individual is holding we can make an inference that there's a good chance that this would be a unique building block that would be less similar than the other underlying building blocks of one's portfolio. It's a combination of our existing alt lineup. I made reference to those four underlying solutions, long/short alternative which is one of them, as well as a small allocation to digital assets. It's across those five building blocks that we've methodically combined these and really aimed to optimize across a few different fronts.

[00:07:55] Total return, of course, being important, we can't neglect returns, but we did want to focus in on the volatility profiles, the standard deviation or how much the fund would move as well as sort of the beta profile. How much does it move in relation to other markets or other building blocks? How does it move when markets move downwards? Those are things that we looked. What is max drawdown? Time under water which is when markets moved downwards how long until we eclipse that sort of previous high water mark? Those were all things that we looked at. I think what you're getting is you're getting a well-balanced product that somewhat auto rebalances and provides investors with a unique exposure that's likely not similar to some of their other holdings.

[00:08:36] Lauren Gardy: It sounds like a lot of great thought went into that behind the scenes.

[00:08:39] Brendan Sims: Absolutely, absolutely.

[00:08:41] Lauren Gardy: Dave, you talked about your product being sort of a smooth ride for investors over time but I'm curious, is there a specific market environment where your strategy would typically perform better than others?

[00:08:51] Dave Way: I think from a generating absolute returns perspective from the value of the fund increasing, certainly rising markets are supportive to that because at the end of the day the fund does have some market exposure. I think the real value of a fund in terms of helping investors stick to their financial plans when things are really tough, this is when I think a solution like this can be very helpful. We're all human so during periods where the market's declining and we're worried about our assets, we often have a desire to avoid loss. There's a very typical pattern of people who will buy high and sell low. I think as a solution to keep people invested those periods of market drawdowns are really helpful to remind people that this is a long term game. It's a long term plan for everybody and staying invested during those periods where it might feel hard psychologically ... we've talked about psychology of money by Morgan Housel, just staying invested and thinking long term is a really nice idea to have but you also need some building blocks in your portfolio to make it a lot easier.

[00:10:08] Lauren Gardy: That makes a lot of sense. Thank you for wording it that way. Brendan, over to you. I wanted to ask your opinion on active versus passive investing and how you see strategies like Dave's and other alternatives playing into this landscape.

[00:10:20] Brendan Sims: Interesting question, one that comes up all the time. I think there's room in the ring for them to both sort of duke it out, if you would, just to put a metaphor to things, or an analogy, if you would. What I would say in active or passive, there's likely room for both. I think that costs are crucial when it comes to investing and we can't kid ourselves that passive are some of the lowest priced products available. I do think that in some instances passive has a very one-directional or linear way of thinking with respect to how we're addressing indices. If you think about the S&P 500 you're simply just cap-weighting names. If you think about the bond market you're actually debt-weighting games, which essentially means you're overallocating to some of the most indebted names. You can quickly see how there might be some inherent flaws to some of how these passive indices are constructed.

[00:11:04] There are a number of different ways to jump from fully passive to fully active and everything in between. I think that as an investor on a personal front I look to play across that spectrum not just at either one of the tails. That would be how I look at it. I think that when it comes to addressing markets at all-time highs, if we look at the U.S. market, for example, you think about Meta and/or, I guess, Alphabet being categorized in comms. You think about maybe some other names like Amazon being captured in consumer discretionary. If you really bring those back to what we all think of them as, which is big tech companies, you have this driving force that is info tech and really just ... I think it was just recently the top 10 names in the index, in fact, over 40% of the index's allocation.

[00:11:50] We need to be really careful in sort of thinking about what a passive approach brings us and sort of building around that. I want to tiptoe around that question and not be too assertive. We think there's a ton of value to be added through the research that we do, whether that's upstairs on the ninth floor here in our Toronto office or leveraging our partners globally in all the research we do.

[00:12:11] Lauren Gardy: That's a great segue into my final question for Dave. Of course, Fidelity's research is one of our greatest strengths as an actively managed shop. Could you talk to us about how Fidelity's research has influenced your process?

[00:12:24] Dave Way: Absolutely. Like every other portfolio manager at Fidelity I spent a decade researching individual sectors, rotating around through different parts of the market and really spending three year periods totally immersed in a single sector. It's a wonderful training ground. Now as a fund manager I get to benefit from ... we have 40 people on the ninth floor, we've got a global analyst team of over 100, I have a dedicated short selling research team, and it's a chance for both me to mentor analysts and help them develop into the next generation of portfolio manager, as well as really get a lot of leverage on my time.

[00:13:06] Really, it takes a team to manage a fund like this, while I'm the sole decision maker on the fund a lot of the ideas that go into and leave the portfolio are driven by the work that our analyst team does every day, meeting companies, going out to see their headquarters, talking to customers, talking to suppliers. Having that deep research bench is really important to coming up with a differentiated view on what's going to happen within an industry or company, which is really critical to active management.

[00:13:36] Lauren Gardy: For sure, and you have a great company backing you here. Thank you very much for your time today, Dave and Brendan. Thank you for watching The Upside. Remember, Upside webcasts air daily so keep an eye on your inbox to not miss an invitation to the next show. If you haven't already done so sign up for The Upside newsletter. Also, we have video podcasts for both The Upside and Fidelity Connects. Just search Fidelity Canada on YouTube, Spotify or Apple Podcasts. Thanks for watching. I'm Lauren Gardy.