Picton Mahoney Fortified Alpha Alternative Fund | PFAA.TO ETF Review

Imagine a fund that leveraged three of its best alternative in house strategies, which are uncorrelated to both market beta equity and aggregate bond markets, in a way that added potential alpha return streams to enhance performance while additionally hedging against risk?

Well, fortunately for Canadian ETF investors a new fund from Picton Mahoney offers just that.

Enter the room ticker $PFAA.TO.

Picton Mahoney Alpha Alternative fund is in my opinion the most interesting ETF to come down the TSX pipeline this year.

If I’m being perfectly honest it has been a lacklustre year for ETF releases.

It seems as though product creation has mostly been focussed on FOMO type concentrated products that were all of the rage in 2021.

Last year’s “concentrated bets” strategies are entering the market at specifically the wrong time given the current economic environment.

METAVERSE this. Aggregate bond that.

Hearing about the release of PFAA.TO, which combines Picton Mahoney’s market neutral equity, special situations credit and merger arbitrage strategies into one neat multi-strategy package, was the most exciting and surprising ETF news I’ve received all year.

So why am I so excited about this fund?

Well, we’re going to explore that thoroughly in this review of Picton Mahoney Fortified Alpha Alternative Fund.

Picton Mahoney Fortified Alpha Alternative Fund Review

Stacking white rocks on top of each other overlooking the beach
Source: Pixabay

PFAA.TO ETF Review

Hey guys! Here is the part where I mention I’m a travel vlogger! This ETF review is entirely for entertainment purposes only. There could be considerable errors in the data I gathered. This is not financial advice. Do your own due diligence and research. Consult with a financial advisor. 

Picton Mahoney = Alternative Investing Strategy Specialist

Having familiarized myself with the entire roster of Picton Mahoney funds, some which date back to 2005, I’ve come to realize they put Pacman to shame when it comes to gobbling up Sharpe ratios for buffet breakfast versus the benchmark they’re tracking.

This has been the case in any which direction I’ve looked.

Active extensions equity.

Long-short equity.

Market-Neutral equity.

Fixed Income Alternatives.

Merger Arbitrage.

Special Situations Credit.

When it comes to utilizing leverage, hedging and fortification strategies to produce higher risk adjusted rates of returns, I’ve only noticed outstanding results from Picton Mahoney irregardless of the given mandate.


Video Source: Picton Mahoney Absolute Alpha Strategy from Picton Mahoney Asset Management on Vimeo.

Picton Mahoney Fortified Alpha Alternative ETF Holdings & Info

Well then, let’s pop open the hood to see what we’ve got in terms of goodies in this new alternative fund.

Modelled after Picton Mahoney’s Absolute Alpha mutual fund, PFAA offers investors an expanded canvas portfolio featuring market neutral, special situations credit and merger arbitrage as its primary strategies along with value, momentum, quality, discretionary hedges and tail risk strategies as its secondary layer of diversifiers.

Picton Mahoney Absolute Alpha Fund Allocation
Source: Picton Mahoney

When we add up the sum of its parts we’ve got a fund that offers investors a GROSS 372% canvas with 247.46% long versus -125.39% short for an overall net exposure of 122.07% NET at the mutual fund absolute alpha level.

For the ETF version we can likely expect something close to the 250 to 300% gross range.

Given that this is ultimately a fund of funds multi-strategy approach to diversification it makes sense for us to break things down individually component by component to better understand the product as a whole.


Video Source: Picton Mahoney Market Neutral Strategy from Picton Mahoney Asset Management on Vimeo.

Market Neutral Equity Strategy

One of the alternative strategies Picton Mahoney has been deploying the longest has been its market neutral equity mandate.

Dating back to 2006 for Class F, we’re able to see clearly how well this defensive equity strategy has performed.

Spoiler alert.

It’s been outstanding.

Picton Mahoney Market Neutral Strategy Performance
Source: Picton Mahoney

With a 5.02% average annualized performance since its inception it has offered investors stability with a Sharpe Ratio of 0.79 and Standard Deviation of only 4.72%.

Compare that over the same period of time versus the highly volatile S&P TSX Composite index which offered returns of 6.76% with 17.04% RISK and a Sharpe Ratio of 0.40.

Picton Mahoney Market Neutral Annual Returns, Standard Deviation and Sharpe Ratio
Source: Picton Mahoney

Moreover, the Picton Mahoney market neutral equity strategy had 14/15 positive years!

That’s a success rate of 93.33%!

How about the TSX over the same period of time?

11/15 positive years for only a 73.33% success rate.

Picton Mahoney Market Neutral Allocation and Exposure
Source: Picton Mahoney

The overall market neutral strategy is 180% GROSS and 10% NET going 95.68% long and -86.11% short.

Okay, that’s all swell and over the moon but why would investors want to consider a market neutral strategy in the first place?

As the most defensive of all long-short equity strategies, a market-neutral mandate attempts to profit from both increasing and decreasing prices in the financial markets.

On the long-side of the equation it seeks out stocks with strong factor profiles (value, momentum, quality, etc) while shorting those with that are overpriced with unattractive fundamentals.

Basically, Shitcos.

Seeking absolute rather than relative returns, a market neutral equity strategy hedges to zero delta.

The diversification benefit for investors is an uncorrelated strategy compared to general stock and bond markets.


Video Source: Picton Mahoney Special Situations Strategy from Picton Mahoney Asset Management on Vimeo.

Special Situations Credit Strategy

Equally forming the backbone of the fortified absolute alpha alternative fund is the special situations credit strategy.

As an event driven credit investing strategy it seeks to maximize total returns while mitigating losses utilizing shorting and other hedging strategies.

What reaches the special situations radar of opportunity?

Specifically, news of an acquisition, regulatory changes or bond refinancing are some of the event driven situations that warrant attention.

A bottoms up analysis would determine whether to go long/short the “special credit situation” with a goal of creating equity like returns with less risk (hedging interest rate risk, currency risk, liquidity risk and credit risk).

How has the Picton Mahoney Special Situations Credit strategy performed?

Picton Mahoney Special Situations Credit Performance
Source: Picton Mahoney

From a returns standpoint what you notice is Picton Mahoney’s Special Situations fund has absolutely crushed its benchmark by 640 basis points (7.76% versus 1.36%).

Picton Mahoney Special Situations Return and Risk Analysis
Source: Picton Mahoney

Furthermore, it has provided considerably better risk management by clocking in a standard deviation of 5.97% versus 6.58%.

With returns considerably higher than risk it’s not surprising the strategy has a Sharpe ratio > 1 (1.16).

Picton Mahoney Special Situations Exposure and Allocation
Source: Picton Mahoney

Finally, we have a view of its long/short mandate by going Gross 168.02% (long 126.97% & short -41.06%) for a NET coverage of 85.91%.

Video Source: Picton Mahoney Merger Arbitrage Strategy from Picton Mahoney Asset Management on Vimeo.

Merger Arbitrage Strategy

Last but certainly not least it’s time to cover the fund’s Merger Arbitrage strategy.

What is Merger Arbitrage?

It’s a hedge fund strategy that involves simultaneously purchasing and selling the stock of two merging companies.

The primary goal is to take advantage of the uncertainty of the deal by acquiring it below its acquisition price.

In an “investing legends” interview with Julian Klymochko, I covered merger arbitrage and SPAC investing in more detail.

Picton Mahoney Merger Arbitrage Performance
Source: Picton Mahoney

Since its inception the Picton Mahoney Arbitrage Fund has returned 5.05% average annual performance.

Picton Mahoney Merger Arbitrage Return and Risk Analysis
Source: Picton Mahoney

More impressive is how the volatility has been managed with this strategy with a standard deviation of 3.75%.

It’s once again a Sharpe Ratio monster clocking in at an impressive 1.13.

Additional Alternative Strategies

The Fortified Alpha Alternatives Fund additionally layers on a number of different “diversified diversifiers” for good measure.

  1. Value
  2. Momentum
  3. Quality
  4. Discretionary Hedges
  5. Tail Risk Strategy

By seeking research supported factor exposure to value, momentum and quality strategies while adding further fortification with discretionary hedges and tail risk insurance we’re seeing the full range of multi-strategy diversification this fund provides.

Whole Is Greater Than The Sum Of Its Parts

So what’s the big picture with this fund when you put it altogether?

In my opinion, it is that the whole is greater than the sum of its parts.

If you were to cobble together the individual strategies being offered in this fund you’d need numerous ETFs to accomplish that task.

Instead, the fortified absolute alpha alternative ETF provides investors with three core alternative strategies that are uncorrelated to broad equity and bond markets and a smattering of secondary style premia as additional diversified diversifiers.

Given the ETF’s gross exposure of roughly 300% and net 125%, I would expect for the fund to long-term offer investors equity-like returns with less than half (possibly a third or a quarter) of the volatility.

PFAA.TO ETF Pros and Cons

Pros and Cons thumbs up and thumbs down
Source: Pixabay

Pros

  1. Multi-strategy plus multi-asset class approach to diversification within the alternative sleeve of your portfolio
  2. An all-in-one alternative strategy to diversify a 60/40 portfolio capable of enhancing risk adjusted returns
  3. The utilization of leverage, hedging and tail risk strategies to provide an attractive returns meets volatility profile
  4. Tremendous potential building block for those seeking a multi-strategy all-weather portfolio
  5. Access to sophisticated “high level” strategies that until recently were only available to institutional investors
  6. Chance to support boutique level creativity in the investing space as opposed to the big banks and giant ETF providers in Canada
  7. A very reasonable management fee of 0.95 given the many layers of strategies included in the fund

Cons

  1. Boglehead style of investors obsessed with fees versus pursuing more efficient and strategically diversified portfolios might run for the hills when considering the management fee of 0.95 and performances fees of 2/20.
  2. Tracking error given that alternative strategies will not follow “industry standard” benchmarks and investors need to be fully prepared for that in advance

Potential Portfolio Solutions

Here comes the fun part.

How does ticker PFAA.TO potentially fit into a portfolio?

I think there are a number of options for it to be a core alternative holding for Canadian investors.

Let’s explore those.

All Weather / Risk Parity Portfolio

For those seeking a maximally diversified portfolio, that is ready to tackle every economic regime thrown its way, could consider the following asset allocation.

40% UPAR
30% PFAA.TO
30% HRAA.TO

Here you’d be utilizing UPAR as the long-only backbone of your all-weather plus risk parity strategy with 168% net exposure to global equities (35%), Long-Term Treasury (49%), TIPs (49%) and Gold/Commodities (35%).

Picton Mahoney Absolute Alpha Alternative at 30% would layer on uncorrelated strategies such as market neutral, merger arbitrage and special situation credit along with additional diversifiers.

Finally, Horizons Adaptive Asset Allocation would further enhance diversification benefits of the portfolio by providing a systematic global macro program offering trend-following and other managed futures strategies such as carry and seasonality.

Overall, you’d have a multi-strategy portfolio that puts a milquetoast 60/40 to shame from a diversification standpoint.

Multi-Factor Portfolio

For those interested more in pursuing equity factors as the primary puzzle piece of the portfolio the following portfolio would be something to consider.

10% VVL.TO
10% VMO.TO
10% VVO.TO
10% PZW.TO
10% ZGQ.TO
30% HARB.TO
20% PFAA.TO

What we end up here is with a 50/30/20 portfolio of 50% factor equities, 30% tactical bonds and 20% multi-strategy alternatives.

For equity strategies you’d have 10% slices of globally diversified exposure to value, momentum, minimum volatility, size (small/mid-cap) and quality.

The 30% absolute return bond fund would provide long/short hedging strategies.

Finally, 20% allocated to Picton Mahoney Fortified Alpha Alternative ETF would layer on all of the alternative strategies we’ve discussed at length in this article.

Diversify A 60/40 Portfolio

Last but not least for those investors committed firmly to the milquetoast 60/40 portfolio an alternative sleeve could be carved out with PFAA.TO.

You would go from 60/40 to 50/30/20 with only two funds.

80% ZBAL.TO
20% PFAA.TO

BMO all-in-one asset allocation fund would provide you with your globally diversified 60/40 exposure to market-cap weighted equities and aggregate bonds whereas PFAA.TO would provide an all-in-one multi-strategy alternative sleeve solution.

Nomadic Samuel admiring the views of Mount Washington while visiting Vancouver Island, British Columbia, Canada
Nomadic Samuel admiring the views of Mount Washington while visiting Vancouver Island, British Columbia, Canada

Nomadic Samuel Final Thoughts

Does Picton Mahoney Fortified Alpha Alternative make it into my portfolio?

Absolutely.

At this point, it should be rather obvious that I’m extremely impressed with the fund from a diversification standpoint.

It offers everything I’m looking for when I’m seeking out an alternative sleeve ETF solution.

Firstly, its multi-strategy approach provides me with a collection of uncorrelated mandates that I’d otherwise have to cobble together as individual funds.

Secondly, it utilizes leverage, hedging and tail-risk strategies to enhance risk adjusted returns in a way that will fortify my portfolio while making it considerably more efficient.

Thirdly, it allows me to pursue “other” alternative strategies within my expanded canvas portfolio such as dedicated trend-following and other managed futures macro strategies to further diversify my diversifiers.

Fourthly, given that I’m using portable beta strategies such as WisdomTree 90/60 equity/bond and UPAR (168% exposure to stocks/bonds/alternatives) I’m creating space for alternative strategies within my portfolio without sacrificing real-estate to traditional long only equity/bond/gold/commodity asset classes.

At the end of the day diversification is your only free lunch in investing and instead of shaving down traditional asset classes to make room for an alternative sleeve, I’ve instead expanded my canvas to layer on as many multi-strategy alternative mandates as possible.

Because of my equal parts stocks/bonds/alternatives approach to portfolio construction, I’ve had numerous strategies within my portfolio conspire in my favour during 2022 during the extremely rare event of when stocks and bonds are down at the same time.

Is this the right approach for you?

That is entirely up for you to decide.

However, I’m going to close by saying I greatly appreciate that we’re now at a stage where “in the know” retail DIY investors (such as myself) have the opportunity to build efficient portfolios that rival the Yale Endowment model and Sovereign Wealth funds of the world.

That to me is amazing.

And I thank Picton Mahoney for providing a building block that allows me to achieve that goal.

That’s all I’ve got for now.

Ciao!

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