This article was originally posted on ValueWalk.com by Mark Melin. See the end of this article for additional insight and commentary.
Balyasny Asset Management is a study in portfolio management nuance. In the $12.6 billion hedge fund’s most recent letter to investors, first reported by Business Insider, the hedge fund subtly spoke to a particular strategy and mathematical mindset that is becoming increasingly influential. The holy grail is not about a choice between a quantitative strategy or a fundamental value approach; success is found in their integration into a portfolio. One component that is increasingly important in determine market value is passive investing vehicles, which Balyasny says should be factored into the importance of earnings release numbers.
Balyasny applies a macro portfolio risk management approach as well as executing a variety of value strategies
Dmitry Balyasny is the founder, chief investment officer and managing partner at one of the more successful hedge funds at delivering a coveted noncorrelated returns stream.
To operate in such a world requires a keen sense managing talented humans and overlaying their work with a macro portfolio risk management strategy outlook.
Looking at Balyasny’s portfolio management process through several interviews and examination of their investor letters, the portfolio management picture in some ways reveals a structure like Bridgewater’s macro management process.
Much like some of the big-picture portfolio management concepts Bridgewater uses – beta adjustments and volatility targeting based on macro outlook – Balyasny’s approach to dialing up and down macro risk exposure was similarly evident prior to the market crash of August 2015.
This top level macro market environment analysis comes as the hedge fund also employs what is considered a brilliant team of strategists in major financial centers around the world. Unlike the macro portfolio overlay that dialed up and down leverage relative to US Federal Reserve modeling before quantitative easing was being lifted, these value managers focus on idiosyncratic stock issues through a more Bill Ackman-like approach. They want to find value, long or short, that can move the needle. While the performance of late has been muted — both Balyasny funds are close to break even on the year — the fund manages many long-term investments and the cost of risk overlays is not always known.
Balyasny combines macro risk management with fundamental value approaches
Ackman doesn’t so much rely on macro analysis to determine risk hedges. He once told me they don’t use hedging techniques but rather the short exposure in the portfolio are pure individual value plays.
What Balyasny does is combine both the pure value approach with a macro risk hedge strategy. And this points to how the fund manager doesn’t think one strategy is better than the other, but rather Dmitry Balyasny is more the conductor of an orchestra that is blending a number of finely tuned instruments.
This is evident from the recent letter to investors in how they evaluate their recent integration of quantitative trading with their traditionally more fundamentally-focused value identification team:
Some of our worst trades are caused by an over-reliance on data without a variant fundamental view (e.g., a short position in a fundamentally challenged business with deteriorating current data where results come in close enough in light of low expectations to cause a big squeeze).
On the flip side, some of our best trades have been when our teams identify some fundamental inflection in a business that has not been picked up yet in the data. Each approach can be successful on its own if practiced by a top team, but combining the two will lead to the best results
Fund managers with a risk management outlook often recognize how non-economic market players impact price discovery
Identifying fund managers who have a macro outlook on the world and utilize global portfolio risk management themes can be ascertained through various methods. One is recognizing their macro market supply and demand belief system while considering how the balance of power between market forces plays out relative to price discovery.
Balyasny, for its part, notes the increase in non-economic market participation – recognizing this is a key sign of a market-based thinker – and then converts the beta impact analysis into a macro market outlook. In this case, the indiscriminate impact ETFs have on individual stock prices is in his scope:
Day-to-day action is very ETF-driven. While this action won’t change the ultimate valuation of individual companies, it will increase short-term correlations. Portfolio construction needs to be tight and tilts need to be very well managed to navigate these powerful flows. This makes catalysts, earnings, and other events extremely important to play — and play correctly — because that is when dispersion is most likely to occur.
Balyasny translates market force knowledge to how this impacts the relative importance of earnings reports as a stock price catalyst. From a mathematical standpoint, it’s a macro machine driven by one big formula – one that is currently locked inside the head of Dmitry Balyasny — overlayed on talented individual value managers.
Insight / Analysis / Opinion:
I have watched BAM grow significantly and have a reasonably good understanding of their portfolio overlay method and it definitely has noncorrelated components. They are currently integrating a new quant unit and their thinking is strong by recognizing that quant formulas might be best when integrated with fundamental logic.