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Tactical moves in times of volatility – Otus Capital Management

Close-up of black and white marble chess pieces on a chess board.

The crisis has tasked fund managers with navigating the period of volatility as skilfully as possible and generate additional alpha opportunities.

Andrew Gibbs, portfolio manager and founding partner at hedge fund Otus Capital Management, described the challenges in a newsletter.

The “unprecedented speed at which events in this particular crisis unfolded” allowed only the very fastest of traders to significantly alter their outcomes by action taken along the way, he wrote.

Expert Investor talked to Gibbs about how he has protected his fund in the market turmoil and other insights he has learned from the crisis so far.

Setting up put options

To stave off damage to the fund and create additional return, Gibbs told Expert Investor that he implemented two steps  – the first was setting up ‘out-of-the-money’ put options and the second buying equities in the dip.

The put options were implemented after the fund’s returns had suffered, largely because of its 17% weight in tanker stocks.

Gibbs says that Bermuda-based carrier and crude oil tanker company Frontline, for instance, fell 25% in January due to China entering its shutdown – which he saw as an early signal about the extent of the crisis.

At the end of January, they then monetised the put options.

Determining the ‘tradeable bounce’

“Since the financial crisis market participants have been almost trained by the actions of the central banks to buy the dip,” Gibbs explains.

“Whenever the market falls […] we know that central banks will come in and provide liquidity; they will shore up whatever risk is out there and allow us to move forward.”

Yet, the difficulty for Gibbs was to identify the right key indicators when a ‘tradeable bounce’, a reverse in market sentiment after a correction, would happen.

One was in the supply of liquidity, as he believes that the crisis is inherently a liquidity crisis.

“I needed to look at when the debt markets, and in particular the high-yield debt markets or the junk markets, stopped falling,” he explains, in order to time the moment when the balance will switch to more buyers than sellers.

By about 20 March he got confirmation that the tradeable bounce was reached.

Buying trend companies

Defining this point in time is crucial, Gibbs says, in order to be able to pick up companies at deeply discounted prices.

“We went specifically to look for companies with good balance sheets, because they have to be able to survive this environment and not be foreclosed by these rescue rights issues […], and companies that were exposed to themes that would benefit from the way society was likely to change as a result of what we’re currently going through,” Gibbs continues.

They identified two online pharmacies that would benefit from the new trends and added these to the portfolio: Shop Apotheke Europe, a Dutch company, and Zur Rose, a Swiss firm.

Both companies belong to trends the crisis has accelerated — a tendency to “stay at home” and the speed of “digitalisation”.

Based on his experience of covid-19 so far, Gibbs believes that this crisis “will dwarf what we saw through the financial crisis”.

“What I can tell you is the changes I’m seeing are very significant. We won’t see changes as big as this for some time.”

He adds that investors should keep in mind that “this crisis will be remembered for its savage attack on poor balance sheets”, and points to zombie companies that have built up since the financial crisis and will probably die this time.

Elena Johansson

Senior Reporter

Part of the Bonhill Group.