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New SA Retail Hedge Fund

Assett TV host Chloé Mulder is joined by James Corkin, Portfolio Manager, Steyn Capital Management to talk us through the new SA Retail Hedge Fund.

Transcript

Interviewer:
Hello and welcome to this boutique connect session. Today I’m joined by James Corin, portfolio manager at Steyn Capital Management. Welcome, James.

James Corkin:
Thanks very much, Chloé. It’s very nice to be here.

Interviewer:
So, James, Steyn Capital Management’s daily traded RIF Fund was recently launched, particularly in October last year. Perhaps you can take us through what prompted the launch of this fund.

Certainly. Perhaps it might help to give a bit of background to the genesis of where the fund came from.

The longest running strategy at Steyn Capital Management is our qualified investor Long Short Fund, which was launched in 2009 and in fact this month, is celebrating its 14th birthday.

And we’re very proud of the long-term track record because over those 14 years we’ve generated significant amounts of Alpha on both the long side and the short side of the book. So over 14 years we’ve generated an annualised return Net fees of 17.3% which is about 4.3% points ahead of the market. But very importantly, we’ve done that by taking on significantly less risk than the market.

So to put some numbers to that. Over the 14-year period, the beta adjusted net exposure of our strategy has been around 25% or about a quarter of the market’s net exposure, and this is very well illustrated. If you think back over the 10 biggest market drawdowns over the history of the fund, the strategy has actually outperformed the market significantly in nine out of those 10, and actually generated a positive return in six out of those 10. And, so, if you think about the DNA of our firm and the DNA of that strategy with a big focus on downside risk mitigation, this is actually very well suited to a retail investor. And so, with this in mind and given investor demand, we made the decision to launch the Steyn Capital Daily Liquidity Retail hedge fund in October last year.

And this really gives retail investors an access point into our longest running strategy. But importantly in a vehicle that is appropriate for retail investors, so the vehicle has daily liquidity. It’s in the name, of course, but also it has a much more modest minimum investment, which is appropriate for a retail investor and so as you noted we launched the fund in October of last year.

It is available on the momentum wealth and the Alan Grey Platforms. And I’m very happy to report that from a standing start in October, the fund has grown to just shy of 100 million Rand.

Hedge Fund Strategies

Interviewer:
OK, it’s quite a significant amount of growth in such a short space of time. But perhaps you can explain some of the other hedge fund strategies that you employ at Steyn Capital Management. And where are you seeing opportunities at the moment?

Sure. So one of the things that we are very focused on, particularly in the current market environment, is generating returns, but also really mitigating that downside directional market risk.

And so, given the elevated amount of corporate activity that we’ve been seeing on the JSE and corporate action over the last two years, one of the opportunity sets that we’ve really gravitated towards has been event driven or special situation type investments, and this would include things like merger arbitrage and risk arbitrage to unbundling, monetization and liquidations.

So, this really creates the opportunity for hedge funds to take advantage of dislocations in the market on an opportunistic basis, but then also to really generate strong returns and also manage that downside risk. And so perhaps a good example of what exactly I’m talking about would be something like the PSG, unbundling and delisting which occurred during the course of last year. So the management team of PSG proposed to unbundle the listed constituent parts of the PSG group and then take the rump private at 23 Rand a share.

And so we took a look at this. And this is exactly the kind of arbitrage that we like because it was both very low risk and also very mispriced. So, digging deeper into it, it was it very low risk because for a start, the management team who proposed the transaction knew the assets very well. From a due diligence perspective, there was no due diligence risk. We knew that the funding risk was very low because of the Moutons, good access to capital. From a regulatory perspective, there was very low risk because there were no competition commission issues. There were no TRP risks, which would have resulted in impediments to the deal. And finally, a value unlock was something that the shareholders of PSG themselves had been asking for a number of years. And so there was very low risk that the deal would be voted down in the shareholder vote.

Looking at the situation like this, what one is able to do, with a bigger hedge fund tool kit, is to go along the PSG stock and then sort out the underlying constituent parts in a hedging ratio, which really focuses your exposure on that spread narrowing and closing on the closure of the transaction, which we had assessed as being a very low risk situation.

So, what that does is it concentrates your exposure, and it results in a much more significant return, but also removes that directional market risk. So, to put some numbers to it over the course of that transaction, we generate an internal rate of return of just under 200% on invested capital over the deal term. So that is one example of kind of the kinds of situations and the ability to leverage that hedge fund experience.

Short Strategy

Interviewer:
And perhaps you can take us through it. I know that was a long strategy, but perhaps on the short side.

So obviously, one of the features of the current difficult economic environment is the fact that the difference between companies that are actually performing well and those that are experiencing fundamental weakness is really starting to diverge. And so, for fundamental stock pickers like us and fundamental short sellers like ourselves, this is actually a really great environment to be able to capitalise on both sides of that equation. So to benefit not only from companies doing well but to take advantage of those companies that are not performing well.

And we don’t normally talk about individual stock positions,  or rather short stock positions. But a recent and timely example would be something like Transaction capital, which, coming into March was the second biggest short position in our hedge funds.

This is an example of a company where we looked at the financial statements towards the end of last year and became very concerned that the earnings quality had deteriorated significantly and that there was actually fundamental weakness lurking below the surface there, which was not fully appreciated by other investors.

And, you know, a couple of the clues that were available to investors to maybe detect this were things like one-time gains in earnings or a growing receivables balance. But at the same time, the provision on those receivables was declining and the ageing was deteriorating. We also saw swelling stocks of repossessed taxis within their SA taxi business. So these were all clues that there was something, some fundamental weakness lurking below the surface.

So we put the short position on in November last year on the expectation that forward earnings would disappoint. And of course, in March, they released a trading statement revealing the extent of that fundamental weakness, and that actually resulted in a stock price decline of almost 70% from peak to trough.

Now Transaction Capital is one nice example to talk about. But the reality is that over the last 14 years in our hedge fund strategy, we’ve maintained a short book of between 25 to 30 single stock shorts and have actually over that period generated an annualised alpha on the short side of 16%.

And we do that by positioning the short book around anticipated earnings disappointments. And we do that by really spending a lot of time scrutinising the financial statements of companies for signs of earnings, quality, deterioration or fundamental weakness, which is either obscured or otherwise not evident on a cursory look at the financial statements.

15-Steps Check-List

Interviewer:
So Steyn Capital Management prides itself in this forensic accounting analysis, but you also apply this 15-step checklist approach for opportunities both in the long and short side. Can you take us through what you screen for briefly and when you would apply it.

Sure. I mean, so we spoke a little bit about the shorts and the port event driven type investments. But really, our bread and butter type of investment is what we call quality value. What we’re really looking to invest in in these kinds of investments is high quality businesses that are not recognised as such, and then not overpaying for those businesses. So we have a proprietary screen which screens for these ideas and then basically produces a set of ideas for us to research. And then we run it through this 15-step checklist, really to try and determine that while the screen says that it’s cheap and high quality, but now we need to dive in and really confirm that. And so the idea behind the checklist is really similar to airline pilot checklists to avoid crashing the plane. We figured that they must be on to something.

But also it’s trying to optimise our return on time. It’s just such an important concept in investing is we really want to spend our time researching only those high quality ideas that we are looking to invest in and exclude the rest. We optimise it by spending a lot of time at the outset of those 15 steps really thinking about the business quality and what are the margins like. What is the return on capital like, what is the incremental return on invested capital?

And then, at the very outset of that process, we run it through this forensic accounting, basically analysis, and we for a moment put on our short selling hat, and we scrutinise the application of accounting policies, principles, judgments. And we’re really trying to determine if there is anything in these earnings which, from a short selling perspective, would interest us? And if there is, we exclude it.

Market Environment Outlook

Interviewer:
So what then, is the outlook for fundamental hedge funds, particularly in the market environments that we currently find ourselves in?

This current market environment is actually an excellent environment for fundamental hedge funds. And I mentioned this dispersion between companies doing well and companies doing short and the ability to take advantage of both opportunities on the long side and the short side really is very fertile ground at the moment for hedge funds with that toolkit.

But I think given the amount of global and macro uncertainty, the ability to really generate returns while minimising that directional risk is really something that I think will become more important and is really something that hedge funds can bring to the table.

Interviewer:
James, thank you very much for taking us through your insights. We appreciate your time.

James Corkin:
Thanks very much.

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