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September 1, 2012

Buyside Snapshot: Banking on Equities' Return

By James Armstrong

From everything in equities to absolutely nothing. That was how big the change was for Oklahoma City-based hedge fund Covenant Global Investors. As a multi-strategy global macro fund, Covenant can invest wherever it sees opportunity, and when the market began to tank, the fund lost its taste for stocks.

Steve Shafer

"From '03 to '08, we were virtually all equity," said Steve Shafer, chief investment officer of Covenant Global. "From late '08 to about six or nine months ago, we were all credit, which is now starting to migrate back toward an equity-oriented portfolio mix."

Currently, the fund has around 20 to 25 percent of its $320 million in assets allocated to stocks. Shafer and his team of three dedicated analysts do all of the trading themselves. Most of the equities they trade are large-cap global names that are fairly liquid, but they are increasingly using algorithms when trading more illiquid small-cap stocks.

Like many institutional investors, Covenant has been slow to return to equities, but Shafer said the pendulum is swinging back toward investments in stocks. He predicts equity volumes will pick up in the future, but probably not all at once.

"I don't necessarily think it will happen as smoothly or as quickly as investors would like," Shafer said. "It will be a long, hard slog-two steps forward, one step back."

Currently equity markets are dominated by macro factors, and Shafer said that has created a disconnect between stock prices and companies' fundamentals. Eventually, stock prices will get more in line with the value of individual businesses, and that should be good for the markets and for long-term investors, he said.

In the meantime, macro events are likely to continue to whipsaw stocks around, creating opportunities for macro-oriented trading. Shafer predicts that over the next three to five years, the investors who win biggest will be those with intermediate time frames, as opposed to shorter-term or tactical traders.

While Shafer is always aware of the presence of high-frequency traders, they don't concern him too much. He feels they exacerbate volatility, but for a fund like his, that isn't necessarily a bad thing. Instead, he tries to make volatility work for him.

That's true whether he's trading stocks in the U.S. or in foreign markets. Shafer said traders have to look at the world today as one large, global fabric, and not get caught up in where a company is domiciled. He gave the example of Banco Santander, which is based in Spain but only has a fraction of its assets exposed there.

If Shafer is in a hurry to buy a foreign stock, he'll trade ADRs, but his preference is to get the stock on the exchange where it normally trades. In those cases, he'll use an outside broker to work his order throughout the day or sometimes over a week or more.

When buying international stocks, Covenant will sometimes hedge out currency risk, but other times it will choose not to do so in order to gain extra exposure to a certain currency.



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