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Downing launches new actively managed liquid alternatives fund aiming to deliver 7% to 10%+ per annum and positive returns in most markets. The new MGTS Downing Active Defined Return Assets Fund (‘Active Defined Returns’, the ‘Fund’), is the first fund from its new Liquid Alternatives team.
The Fund is aimed at institutional investors, Discretionary Fund Managers, IFAs and advised sophisticated individual investors, and will primarily consist of UK Government bonds and large-cap equity index options, which provide significant scalability and strong liquidity. It aims to deliver 7% to 10%+ per annum and positive returns in all markets except for a sustained equity market fall (generally more than 35%), over a period of at least six years.
The Fund is the first to be launched by the new Liquid Alternatives Team established by Downing. Collectively, the team has over 125 years of experience and sector knowledge, and includes Tony Stenning, who held senior roles at BlackRock and most recently was CEO of Atlantic House Group; Russell Catley, founder and also a former CEO of Atlantic House Group; Huw Price, a former Executive Director at Santander Asset Management, and Paul Adams, former Head of Cash Equities and Derivatives Sales, Royal Bank of Canada.
The Fund offers investors a compelling building block for multi-asset portfolios, aiming to add consistent and predictable returns, typically secured with a portfolio of UK Government bonds. The unique proposition includes a hybrid approach of using systematic derivative strategies and active management, combining liquid investments with predictable returns, and an equity like risk profile.
Investment strategy: Maximising the probability of delivering predictable defined returns across the economic cycle.
Systematic Liquid Derivatives: Systematic, derivative strategies optimise the equity risk-return profile. The Fund uses rules-based derivative strategies linked to the most liquid, large-cap global equity indices (i.e. FTSE100, S&P500) with the aim of harvesting well-proven consistent returns across a wide corridor of market conditions.
Strong security: The Fund will hold a high-quality portfolio of assets as secure collateral – typically UK Government bonds.
Active benefits: At times, rules-based, passive derivative strategies can underperform when markets move strongly – this is when specialist active management can add incremental gains by monitoring and monetising positions and applying active risk management.
Key benefits
Increased consistency and predictability of returns: Positive returns in all markets except for a sustained equity market fall of more than 35% over at least six years.
Diversification of risk: The Fund’s risk components are diversified across large, liquid equity indices, observation levels and counterparties. Secured with high-quality assets – typically UK Government bonds.
Active management: Our experienced team will actively manage the Fund and its investments to optimise risk and reward for investors.
Russell Catley, Head of Retail, Liquid Alternatives at Downing, said: “Put simply, we focus your investment risk on the probability of receiving the returns you need, not those you don’t. We target the highest probability of delivering 7% to 10%+ per annum with active management adding material incremental gains. We believe that we are building the next evolution of the proven success of Defined Returns funds
The Downing team isseeing strong demand from clients looking for alternatives to large-cap equity funds which are becoming concentrated in technology stocks, or alternatives to UK equity income funds and illiquid alternatives.”
Tony Stenning, Head of Liquid Alternatives at Downing, said: “The launch of our Active Defined Return Assets Fund is a significant milestone in the ambitious build-out of our new Liquid Alternatives strategies. It is a solution-focused fund that should deliver stable high single or low double-digit returns across a wide spectrum of equity market conditions, except for a persistent multi-year bear market. The Fund is designed to enhance balanced portfolios by providing consistent, predictable returns and is suitable for accumulation or drawdown.
“We aim to deliver a unique combination of proven systematic derivative strategies and specialist active management, and we are doing so at a very compelling fee level, below our closest competitors and in line with active ETFs.”
How the Fund is expected to perform in different markets
In bullish markets: UK Government bonds secure the capital, and the equity index options deliver a predictable 7-10%+ return per annum – giving up some less likely upside.
In neutral markets and normal market corrections: UK Government bonds secure the capital, and the index options deliver a predictable 7-10%+ return per annum.
In a sustained sell-off: if markets fall more than the cover to capital loss and do not recover for six years. Then capital is eroded 1:1 in line with the worst performing index.
The average Cover to Capital Loss is targeted at 35%: the average cover to capital loss represents the average level the Global indices within the Fund could fall before capital is at risk.
Fund key risks
Performance: Capital is at risk. Investors may not get back the full amount invested.
Liquidity: Access to capital is always subject to liquidity.
Counterparty risk: Other parties could default on the contractual obligations.
Fund Structure
UK regulated OEIC fund structure, fully UCITS compliant
Daily dealing, at published NAV
Minimum investment: £100,000
SRRI: 6 out of 7
Depositary: Bank of New York
Authorised corporate Director (‘ACD’): Margetts Fund Management Ltd.
I share-class: SEDOL: BM8J604 / ISIN: GB00BM8J6044
F share-class: SEDOL: BM8J615 / ISIN: GB00BM8J6150
Risk warning: Opinions expressed represent the views of the fund manager at the time of publication, are subject to change, and should not be interpreted as investment advice. Please refer to the latest full Prospectus and KIID before investing; your attention is drawn to the risk, fees and taxation factors contained therein. Please note that past performance is not a reliable indicator of future results. Capital is at risk. Investments and the income derived from them can fall as well as rise and investors may not get back the full amount invested. Investments in this fund should be held for the long term.
Important notice: This document is intended for professional investors and has been approved as a financial promotion in line with Section 21 of the FSMA by Downing LLP (“Downing”). This document is for information only and does not form part of a direct offer or invitation to purchase, subscribe for or dispose of securities and no reliance should be placed on it. Downing does not offer investment or tax advice or make recommendations regarding investments. Downing is a trading name of Downing LLP. Downing LLP is authorised and regulated by the Financial Conduct Authority (Firm Reference No. 545025). Registered in England and Wales (No. OC341575). Registered Office: 10 Lower Thames Street, London EC3R 6AF.
Warren Buffett famously introduced the investment world to the concept of an economic moat and has referred to it many times at shareholder meetings, talks to students, and in his annual shareholder letters. For example, the 2007 annual shareholder letter says that “a truly great business must have an enduring “moat” that protects excellent returns on invested capital. The dynamics of capitalism guarantee that competitors will repeatedly assault any business “castle” that is earning high returns. Therefore a formidable barrier…is essential for sustained success”[1]. In a series of articles published over the coming months, we plan to discuss several different categories of economic moat with reference to listed businesses, some of which we may choose to own.
Locking in customers for longer
The first category of economic moat we will take a look at is high switching costs. This refers to attributes of a product or service that make it costly for the customer to switch to an alternative, thereby increasing customer retention, and perhaps reducing marketing, sales, and administration costs too. Locking in the customer for longer may mean you can charge more, or at least discount less, as there is a reduced risk that the customer will switch to a cheaper provider. Stickier customers make for better visibility of revenues, and therefore aid planning for investment and staffing levels, and greater predictability will likely result in a higher valuation for the business.
Switching in financial services risks delays and errors
In the consumer world, there are many situations where it may be too costly in time or money to switch suppliers, and if the product or service is adequate, inertia may set in. This is often the case in financial services such as banking, investment platforms, and ISA and SIPP providers. Even if another service provider has a lower cost or a better reputation than your own, the risks of delays or errors during a move will make you think twice about switching. Of course, high switching costs work both ways: it is hard to lose customers, but hard to win new ones for the same reason. Hence, financial service providers that are actually growing net customer numbers and assets organically are doing rather well: for example, AJ Bell had platform customer numbers of 425,652 and assets under administration (AUA) of £64.1bn at the end of September 2022, compared with customer numbers of 183,213 and AUA of £46.1bn at IPO in late 2018. Those companies that don’t grow organically often end up consolidating others, which is risky, or being consolidated, which can be lucrative for the owners.
Switching software providers risks a loss of data
In the business world, switching costs are a notable feature in the software industry, and as a consumer, you can also relate to this if you think about your use of Microsoft products such as Word, Excel, or Powerpoint. Other alternatives might be cheaper, but there may be interoperability issues and there is a risk of loss of your valuable historic records. For businesses, whether their software is enterprise level (think SAP, Oracle, or Workday) or vertical market specific, the risks of a loss of back data, lack of interoperability with other systems, and the need to retrain your workforce, and possibly customers and suppliers as well, are significant barriers to change.
Retaining customers does require sustained investment
It is however vital for any software provider not to sit on their laurels but to continue investing to improve the product functionality and features. Companies that fail to keep their product refreshed can lose business eventually to a competitor offering a step-change in functionality. This seems to be happening in the enterprise space as Workday, listed in the US, is growing rapidly and apparently taking share from long-time incumbents Oracle and SAP to the benefit of its shareholders and its implementation partners, such as Kainos. Therefore, monitoring the percentage of revenues spent on research and development is important. For example, Alfa Financial Systems, a world leader in the provision of leasing software, spent £29m in 2022 on total investment in product development. This included R&D into future opportunities; development requested by customers; development of future upgrades and modules; and overhead allocated to the engineering teams, and represented 31% of revenues. Craneware, which supplies software to US hospitals to enable monitoring of costs, expensed between 15% and 20% of revenues on R&D in all but one of the last ten years. These are the costs of staying ahead.
Specialist distributors can also demonstrate high switching costs, particularly if the cost of the component or service they supply is small in relation to the value of the finished item and delivery is time-critical. For example, Diploma distributes replacement seals for the repair of earth-moving equipment in North America. The premium price for reliable delivery in a matter of hours is worth paying if the alternative is very costly downtime for an expensive piece of kit. Add in technical advice, breadth of stock, and product customisation, and customers have no incentive to switch supplier.
High switching costs are an economic moat that we see more often than some others that we will discuss in future articles. However, this moat requires regular investment rather than complacency to be sustained.
Opinions expressed represent the views of the fund manager at the time of publication, are subject to change, and should not be interpreted as investment advice. Please note that past performance is not a reliable indicator of future results. Capital is at risk.
This document is for information only and does not form part of a direct offer or invitation to purchase, subscribe for or dispose of securities and no reliance should be placed on it. Downing does not offer investment or tax advice or make recommendations regarding investments. This document contains information and analysis that is believed to be accurate at the time of publication but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Downing LLP as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. Downing is authorised and regulated by the Financial Conduct Authority (Firm Reference No. 545025). Registered in England No. OC341575. Registered Office: St Magnus House, 3 Lower Thames Street, London EC3R 6HD.
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