Picton Mahoney: The Best Kept Secret in the Canadian ETF Industry

As a risk management guy, the current financial climate has my caution flags waving. With Bitcoin and the S&P 500 at all-time highs, and even gold peaking, coupled with Trump's recent re-election and ongoing tensions in the Middle East, volatility seems more a certainty than a possibility.

Now, I’m not looking to time the market—that's a fool's errand. However, for many of you who began investing during the post-2020 pandemic bull market, there’s a good chance you might have overestimated your risk tolerance, unprepared for the potential of a lost decade or severe corrections.

If this is the case, a particular lineup of ETFs could serve as a crucial hedge. They're known as liquid alternatives, or 'alts,' capable of employing short selling and derivatives to achieve their goals. The aim here is to deliver risk-adjusted returns that outperform traditional stock and bond portfolios, and provide diversification via lower correlation.

While many large fund managers like BMO and Fidelity have ventured into the alternatives space, my preference leans towards specialists with focused expertise. Enter Picton Mahoney Asset Management—a name likely unfamiliar to many retail investors, yet their lineup of alternative ETFs has been a favored tool among advisors looking to access genuine hedge fund strategies.

What is Picton Mahoney?

Picton Mahoney is a specialized asset management firm based in Canada with $11.4 billion in assets under management (AUM) and staffed by 140 employees. It has been operating for 19 years, focusing primarily on managing risk and protecting the downside through its "fortified" approach to alternative investments.

The firm's investment philosophy is influenced by the observation that shorter and sharper economic cycles could lead to greater volatility in stock and bond markets. They anticipate lower returns for stocks and bonds due to higher, more volatile inflation rates.

Picton Mahoney also notes that today, stocks and bonds may fail to provide effective diversification from one another, potentially creating "single asset" portfolios, which was a contributing factor to the underperformance of the traditional 60/40 balanced portfolio in 2022.

Picton Mahoney offers a range of investment solutions across four major categories: equity, income, merger arbitrage, and multi-asset. These solutions are available through both mutual funds and ETFs, most of which incorporate a hedge fund-like performance fee structure.

The typical fee structure includes a flat management fee of 0.95%, plus a 20% performance fee that applies only when returns exceed a 2% hurdle rate. This fee arrangement includes a perpetual high-water mark, which ensures performance fees are charged only on new profits, not on recovering losses from previous periods.

My favorite Picton Mahoney ETFs

Picton Mahoney's ETF lineup, though complex and bearing higher fees, offers unique benefits that shouldn't be overlooked. Their funds have consistently delivered competitive risk-adjusted returns with low to negligible correlation to traditional stock and bond markets, even after accounting for fees.

Consider the Picton Mahoney Fortified Market Neutral Alternative Fund (PFMN), which maintains a strategy of 100% long equity exposure paired with 100% short equity, achieving an average beta of zero. This strategy aims to reduce volatility and drawdowns significantly.

According to data from PFMN's website, since its inception, it has matched the total returns of the S&P/TSX Composite Total Return (TR) Index but with only about a quarter of the volatility and drawdowns, boasting a Sharpe ratio of 1.22 compared to the index's 0.61.

For those looking for a bit more aggression and growth in their strategy, the Picton Mahoney Fortified Long Short Alternative Fund (PFLS) employs a similar long-short strategy but with a net long bias currently at 65.06%.

This approach has outperformed the S&P/TSX Composite TR Index in terms of compound annual growth rate (CAGR) while maintaining lower standard deviation and drawdown, resulting in a superior Sharpe ratio of 1.26.

My personal favorite, and an ETF in which I invest, is the Picton Mahoney Fortified Alpha Alternative Fund (PFAA). This multi-asset strategy combines market neutral, arbitrage, special situations, momentum, value, quality, and discretionary market hedges.

While it may lag the S&P/TSX Composite TR Index in total returns, it significantly reduces standard deviation and max drawdown, showcasing a remarkable Sharpe ratio of 1.7 compared to the index's 0.43.

It’s important to note that these ETFs are not typically suited for beginner investors. They are best used by those with a high net worth, a deep understanding of alternative investments, a preference for risk-adjusted returns over total returns, an awareness of the potential impacts of high volatility and deep drawdowns, and comfort with a hedge fund-like fee structure.