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Central bank market distortions. How do they affect the fund?

Updated: Feb 14, 2023

Central banks, especially the Fed, always influence financial markets. Recently, they have been distorting financial markets. Ultra-easy monetary policies have resulted in extreme asset price inflation. Put simply, there is too much money chasing too few investment opportunities.

Sovereign bond yields have fallen sharply and the risk-parity trade is being undermined. Further, with inflation concerns driving market sentiment, there is more likely to be a positive correlation between bond and equity prices. According to Bloomberg: “Ray Dalio’s $138 billion asset manager has tweaked its version of the strategy by moving into alternatives to conventional bonds as yields hit historic lows” (September 2020).

Cash is also no longer a safe harbour. Negative real yields and currency debasement resulting from central bank financing of government debt underpin the “cash is trash” mantra.

This market backdrop is favourable for OQFM’s Asia Absolute Alpha Fund. The fund’s relatively low risk profile and focus on market neutrality potentially represents a favourable alternative to sovereign bonds and cash.

Further, recent central bank bond purchases were a key driver of the relative outperformance of growth over value in 2020 with significant declines in bond yields providing justification for the extreme valuations assigned to growth stocks. This has set the scene for the strong performance of value factors and stronger positive correlations between value and momentum factors. The outperformance won’t be in a straight line – there will continue to be short term value/growth gyrations – but as discussed in the previous discussion point, these can also be exploited using the Fund’s non-systematic rebalancing process.

In short, the central bank market distortions present a challenge for many investors but provide a favourable backdrop for the Fund’s investment process and investment appeal.

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