Alternatives reaping rewards for patient investors
The share market has finally exceeded its pre-COVID high – set back in February 2020 – and has now risen more than 60% – to 7,338 points – from its COVID-19 induced low point on 23 March, 2020.
This is an extraordinary performance by any measure, and shows the importance of staying fully invested in quality companies even when markets dive.
For stock pickers, the COVID-19 induced sell-off provided an opportunity not seen in markets since the Global Financial Crisis – for quality companies to be bought at bargain basement prices. Investors who chose wisely – based on underlying fundamentals rather than market sentiment – have done well.
But it is not plain sailing yet, and markets still remain extremely volatile – oscillating between ‘value’ and ‘growth’ on an almost daily basis.
The underlying trend remains biased towards cyclical beneficiaries such as travel and hospitality and away from the COVID-19 winners and high multiple growth stocks, such as healthcare providers and e-commerce platforms, that have come under pressure from rising bond yields.
But there is no doubt that the outlook for the Australian equity market for the second half of 2021 is positive.
Notwithstanding the current uncertainty in NSW regarding an increase in COVID-19 cases, and subsequent lockdown and stay at home orders. With vaccine supplies due to come through in large quantities as the year progresses, serious outbreaks with the resulting threat that hospitals will be overrun will become less common, as will the need for the lock downs.
This is good news for markets and for the economy. But there is more to future share market prosperity than just the re-opening stocks story.
STRONG ECONOMIC FUNDAMENTALS
Domestically, the Australian economy is on a firm footing. It is well supported by a Federal Government that is happy to undertake highly-expansionary measures, and which is willing to put near-term spending ahead of the longer-term debt consequences.
Sure, economic indicators are probably close to their peak, but this doesn’t necessarily indicate that the cycle has ended – rather just that the rate of economic improvement has slowed. And traditionally, this circumstance has provided a positive backdrop for share market outperformance.
At the same time – the global recovery is gaining momentum and becoming globally synchronized as the UK, Europe and the US recover, vaccination levels increase, and services, sectors, and borders begin to open.
While a global economic recovery will have a flow on effect on Australia, the local market is also well supported with ultra-low borrowing rates. The cash rate in Australia is now 75 basis points below its pre-COVID levels, and yet the economy is back at its highs. Business and consumer confidence is also at near record levels, despite ongoing snap lockdowns and restrictions.
Company earnings are picking up rapidly and this should continue to provide a strong tailwind for the market particularly if confidence remains robust as we expect to be the case. We are expecting strong revenue recovery across the cyclical sectors although the growth rate might have been tempered somewhat due to extended Sydney lockdown.
Rising costs will be a key focus of this reporting season, particularly on labour shortages, though we anticipate much of those input costs to alleviate from current high levels in the next 12 months. Many of the COVID winners are likely to report reasonable earnings with the latest round of lockdown, though the market is likely to look through and remain focused on the forward earnings.
While there are fears of a correction coming from some quarters – many of these are overblown and it is important for investors to remain focused on the underlying fundamentals of stronger growth, increasing earnings, low interest rates and the conviction to remain fully invested. This is particularly important while market volatility remains and is real. But this provides excellent opportunities for long/short investors to add value to share market returns.
A LONG/SHORT ADVANTAGE
A long/short equity strategy is one that allows investors to benefit in rising and falling markets. Long positions are taken in companies that are expected to outperform, while short positions can be taken to profit from negative share price movements.
In our view, an ideal diversified portfolio, would generally consist of between 60 to 70 long positions and 30 to 40 short positions. At this level, an investment manager can style agnostic – and not be distracted by talk of market rotations favouring growth or value stocks – and rather take up a broad-based industry exposure.
By short selling a range of stocks with weak investment characteristics, and reinvesting the proceeds in long positions in preferred stocks, a long/short manager can beat the index and meet investors’ return expectations.
It’s about taking a view. And for a long/short manager, it is the ability to short stocks that actually provides the freedom to buy exposure to some of those high conviction ideas.
Although many take the view that long/short managers have a high turnover, and dodge in and out of investments at a fast rate – this is not necessarily the case. Long only positions, in particular, sometimes take months – or years – before they reap investor rewards. This was particularly the case during COVID-19.
With many of these opportunities it’s just a matter of being patient and constructing a portfolio that can still deliver returns, while having the freedom to continue to pick up those underperforming businesses or high quality assets that are being left behind by the markets, for various reasons.
It is not just about the quick return. Long/short – done right – means being realistic about the return targets and timing.
Take Sydney Airport, for instance, which has recently been the subject of a high-profile takeover bid. The Tribeca Alpha Plus fund has been a holder of Sydney Airport for more than a year. It was sold down sharply at the beginning of the COVID-19 crisis – despite its solid fundamentals and strong competitive position and despite the fact that there is no doubt that eventually, travel will resume.
The fund went long on this one in April last year and the takeover didn’t come until more than a year later. By taking a buy and hold strategy – that has lasted beyond a year – we were able to buy cheap and now have a holding worth 70% more than its purchase price.
Treasury Wines is another good example. It was sold off sharply as a result of Chinese sanctions during 2020. We have held Treasury Wines since October last year. We bought in at a time when no-one wanted to touch the company, when trade war talk was at its peak, and negative news about tariffs was rife. We didn’t know when the share price would increase – but we knew there was a substantial amount of intrinsic value that hadn’t been realised. We were happy to buy, and wait until other investors came to see that value. And now we start seeing it coming through quite quickly. We have made more than 40% return on its purchase price in six months and are optimistic for its prospects.
That’s just a couple of examples but this market is full of those opportunities.
OPPORTUNITIES IN ALTERNATIVES
It’s something that advisers are increasingly recognising as well. In recent times we are seeing advisers increasing their allocation to alternatives, including long/short equity funds, as they struggle to find income and growth for clients in the more traditional asset classes.
This trend shows no sign of abating.
In a portfolio construction sense, advisers are looking beyond the traditional construct of Australian equities exposure through a portfolio of long only managers, international exposure through international managers topped off with a dash of fixed income.
Instead, we are increasingly seeing more advisers allocating into the alternative space – simply because returns are getting harder to come by in traditional asset classes. Exacerbating this is the correlation between fixed income and equity has been very positive in recent times, which means for many investors in traditional asset classes the risk of allocating capital is increasing.
So advisers are looking for, and allocating to, the alternatives space – and that includes long/ short equities.
Indeed, in recent years we have seen investment in long/short managers gaining traction with Australian investors and advisers. If you look at the top performers, it is the long/short managers that have actually been at the top of the tables, compared to simple long only managers.
That alternatives exposure also helps offset the overall risk for the whole portfolio – long/short funds are not as correlated with other asset classes. Their ability to short and to generate additional alpha, assists with this.
Especially now, when investors are being advised to settle for low or single-digit returns, the alternatives space will continue to be a more important part of the portfolio construction process, and long/short funds have a role to play in this.
Jun Bei Liu is lead portfolio manager of the Tribeca Alpha Plus fund.
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