Dr Christian Baylis of Fortlake Asset Management has made the top 50 ’Tomorrow’s Titans’ best up-and-comers on the global hedge fund circuit. Baylis is Chief Investment Officer and generates returns using the most liquid parts of the fixed income market.
The UK-based Hedge Fund Journal announced its Top 50 overnight with just seven ‘Titans’ coming from the Asia region.
It is a huge honour for Baylis to make the list and vindication of all the hard work he has put in, to date.
The report highlights portfolio managers who are already leading managers in distinctive strategies – or close to becoming leading managers – with promising performance, the potential to grow assets, and in some cases with scope to further develop their strategies as they grow.
Nominations come from the Hedge Fund Journal’s network of readers, subscribers and contacts, including: pension funds; family offices; endowments; foundations; funds of funds; private banks and wealth managers; insurance companies; prime brokers; administrators; custodians; depositaries; law firms; accountancy firms; exchanges; technology providers, and others.
Baylis’ vision for Fortlake is to create an alternative fixed income solution for both the Australian market and global fixed income, which generates alpha from multiple angles: “If you are siloed into one asset class like plain vanilla cash bonds and tied into one market, there is one degree of freedom. We are pulling more levers: we have multiple markets and instruments to choose from, which creates at least 30 sources of alpha, of which many are not correlated. The interposing philosophy considers relationships between all value buckets, including rates, inflation and credit, blending all value drivers. We see other fixed income and credit teams being much more siloed by asset class,” says Baylis.
Note: Alpha is the measure of the performance of a portfolio after adjusting for risk. Alpha is calculated by comparing the volatility of the portfolio and comparing it to some benchmark. The alpha is the excess return of the portfolio over the benchmark.
“We have had a very bearish inflation stance, well above consensus, since the firm started. We took the view that inflation was far from transitory, as it starts to permeate the psyche and ratchet up expectations. Covid wiped inventory clean while enforced savings created pent-up demand, and more money was printed over 18 months in the pandemic than in the prior 10 years. Less labour migration, China lockdowns, supply chain issues and the Russian invasion create a perfect storm. Anticipatory inflation is already seen in the consumer psyche, and this could lead to wage-price spirals,” says Baylis.
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Directionally, the inflation thematic has been a good call for Fortlake.
After a unique pandemic, with an isolated and totally variant outcome, it is really dangerous to get excited about forecasts. Rather than rely on mean reversion, it is better to be much more dynamic on monetary policy, like delta hedging a position. In a situation like this, we use Monte Carlo simulations rather than relying on a past viewpoint. We also employ risk-based forecasting.
Baylis takes the view that basing monetary policy on a central base case path is risky given the huge errors entailed in estimating the natural rates of unemployment and inflation and the long- and variable-time lags before monetary policy takes effect. Therefore, it is better to iteratively adjust policy – and investment strategies – in response to events.
Baylis sees consumer preferences for sustainability as one source of inflation, and he does not think it will be easy for central banks to engineer a soft landing. He sees a high risk of central banks making policy errors, with negative outcomes for inflation, the economy, or both. He draws some parallels between 2022 and the 1970s and sees no reason why inflation could not go higher, given the very large bounds of uncertainty: “UK inflation calculated using the 1970s methodology would already be in the teens. Real interest rates are deeply negative, by 7% in the US and 4% in Australia. Europe is still stimulating the economy despite inflation. It has real interest rates of minus 8.6%, more than 10% below the neutral rate of 2.5%. Recession or slower growth is mathematically a higher probability since we have brought forward future consumption”.
Baylis does not however necessarily expect a stagflation scenario of recession and inflation but rather foresees slower economic growth combined with inflation as most likely, as inflation itself is already starting to dent demand in the economy.
Meanwhile, central banks do not have much ammunition to stimulate the economy. “Previous crises were easier to deal with because they were all disinflationary, whereas the current situation is inflationary, with real interest rates already well into negative territory,” says Baylis. The financial market impacts of the economic environment could also be exaggerated due to a reversal of central banks’ role, from captive buyers to forced sellers of financial assets.
“In developed markets, they have gone from being non-commercial buyers with a huge impact on rates, inflation and credit, to effectively being non-commercial sellers,” says Baylis. In emerging markets, some of which have huge pools of capital, geopolitics adds another dimension where fear of potential sanctions could encourage divestment of western assets that might be vulnerable to freezes or confiscation for political reasons.
“The US freezing of foreign currency reserves makes it harder to fund current account, fiscal and trade deficits. Sovereigns and wealthy individuals in emerging market countries may think twice about buying US Treasuries if their security depends on Western ideology,” says Baylis. These forces are already driving up risk premiums and dispersion thereof, especially for sovereign spreads in Europe.
Fortlake’s distinctive risk management approach demands that incremental risk taking needs to improve forecast risk-adjusted returns. “This means we normally get less busy as the Sharpe goes up. Running a Sharpe of 4 sets a very high bar for any new trades, but in June 2022 the opportunity set is compelling. There has been a huge repricing and total recalibration of interest rate risk by 5 or 6 standard deviations. Credit spreads and their volatility have also doubled. Sharpe opportunities are now much greater. The sandpit is full of toys at the moment,” says Baylis.
Fortlake’s investor base was wholly Australian on day one, but now 60% is from outside Australasia, and Fortlake is in contention for allocations to its comingled funds and customized strategies.
One other Australian made the list, Omkar Joshi, Founder at Opal Capital Management, who trades an equity market neutral strategy. For more information visit here.
