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Smoother Dynamic Total Return
Dreyfus' Dynamic Total Return Fund
Interview with: Sinead Colton, Vassilis Dagioglu

Author: Ticker Magazine
Last Update: Aug 27, 8:34 AM ET
Traditionally investors have been encouraged to diversify portfolio between stocks and bonds with 60/40 allocation. Dreyfus’ Dynamic Total Return Fund takes that process further and can diversify across many asset classes to generate equity like returns. With the strong overlay of risk management tools, the fund seeks to limit downside and remains focused on delivering superior outcome to benchmarks.

“The fund is a go-anywhere, managed volatility strategy that invests across a variety of asset classes from stocks, bonds, cash, currency, and commodities.”
For example, with Greece’s situation, we had a net equity exposure of about 60%, which we reduced to 45% by the end of June by selling some equity exposure, and moving that into cash. We also had some option protection within the portfolio: puts on the S&P and TOPIX.

As July unfolded, an agreement was reached with Greece and reforms were being put through Parliament. With the additional clarity we had, we put risk back into the portfolio and it’s now closer to a 60% net equity exposure again.

Q: How many different country markets do you look at in the global equity realm?

A: Across the board we’re looking at 12 developed markets. We include emerging markets, but at an index level only, because it’s only a 4% allocation. Where we’re seeing the biggest opportunity, the most divergence, is in the developed markets, so that’s where we focus.

Q: What types of bonds do you consider?

A: Most of our tactical positioning is within government bond markets. We follow six markets: the U.S., Canada, the U.K., Germany, Japan, and Australia. We have some high-yield bonds, about a 5% exposure. Although fixed income, the characteristics align with what we view as a growth asset, essentially more equity-like in terms of the drivers and expected performance.

We can hold investment grade, but currently we don’t. Municipals really aren’t in our universe.

Q: Why look at government bonds when there are so many asset classes to consider, especially when rates are expected to rise?

A: Bonds help us diversify. We also vary our net bond exposure. Also, we believe government bonds provide diversification while providing a high degree of liquidity.

If you look at our positioning at the end of March, we had reduced government bond exposure to a net 8%. Within that we had longs and shorts: long Treasuries, long Gilts, and short German Bunds. The reason for such low exposure was because within our model, in addition to the other asset classes, we have an expected return for cash created.

Most of the time that sits in the background, providing an effective hurdle rate for investing. At the end of first-quarter of 2015, bond yields had reached such low levels that our model said expected returns of bonds were not meeting our hurdle rate. We reduced our net bond exposure to 8%, and held 32% in cash.

In second-quarter, as yields backed up in late April and May, we added to our bond exposure. Today, it’s 38%. It’s not as if we hold bonds regardless. Our model assesses whether a degree of net exposure makes sense and how much. So, despite rates/yields backing up across the board, our bond positioning performance was positive.

We’re starting to see much greater divergence across economies, and we should potentially see some tightening by the U.S. Federal Reserve this year and the Bank of England is expected to follow the U.S. But, looking more broadly, the ECB and Bank of Japan are easing, presenting an opportunity to exploit deviations across economies.

Government bonds are attractive; however, we closely monitor the degree of correlation between stocks and bonds and whether a more permanent shift from the negative correlation between stocks and bonds to neutral or slightly positive occurs.

A dramatic shift in those correlation assumptions would signify a different environment, with us potentially reassessing our positions, but given where we are today, and the environment, we see that a lot of opportunity within the bond markets.

Q: How do you determine which asset sets to include or exclude?

A: The first element for us is liquidity. We aim to ensure that all our asset classes are highly liquid, offering daily liquidity as a mutual fund. We’ve managed asset allocation strategies for over 25 years without ever gating a fund. Liquidity management is a top priority—it permeates all aspects of a portfolio. A great downside risk management strategy doesn’t help if you can’t trade the necessary instruments or asset classes.

With sufficient liquidity, the second element is to create a robust model or systematic discipline process to value that asset class, both in its own right and compared to other markets. Research and a significant history of data are required to test the signals we’re developing.

Third, we use synthetic instruments to take some leverage in the portfolio, allowing us to hold enough diversifying assets to hedge our growth asset exposures.

Typically, across the board, we hold futures, whether they’re equity or bond futures. We use some ETFs and some total-return stocks, but we prefer highly liquid instruments without much counterparty exposure.

Q: Are you open to shorting commodities in certain ways?

A: Oil is one of the biggest drivers behind our shorts in the U.K. because it’s a significant energy component in the FTSE. We implement through a commodity ETF.

Our commodity exposure is pretty small, yet we maintain flexibility to introduce more granularity to that exposure. We have a commodity strategy for institutional investors, which has the ability to short, and the energy market is an area where we’ve been significantly short, particularly because of oversupply within oil.

Q: How is your research team organized?

A: We have 26 multi-asset research analysts who hold Master’s and PhD degrees and are experts in their fields. They continually seek new ways to enhance the process, whether through an existing signal or developing new signals. A dedicated research team closely aligned to their specialization areas yet capable of cross-pollination is a significant advantage.

Working together, they develop the most effective strategies and signals within their fields. Sometimes insights from different asset classes help them consider an area they’re focused on in a slightly different light, which has proved useful.

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