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Alternative Market Briefing

Australian hedge fund bets big on asymmetric themes

Friday, August 21, 2020

amb
Kenny Arnott
B. G., Opalesque Geneva:

The Arnott Opportunities Fund (Cayman) is up 16% YTD (to August, Month-to-Date). It has annualised more than 22% since May 2013, compared to 6.9% for the MSCI, according to documents seen by Opalesque. That good fortune comes from a strong focus on asymmetric investment opportunities.

The fund went through the first months of 2020 by focusing on macro drivers for risk and opportunities. "We watched the risks of COVID unfold in January and reduced our small-cap exposure aggressively," says an Arnott presentation overviewed by Opalesque. "Then we positioned very short in our hedge book and financials into March and respected the power of liquidity the Fed provided in April. We lifted our index hedge and covered short financial positions no longer at risk."

Since February, a global total of $3.9 trillion (6.6% of global GDP) has been magically created through quantitative easing, it continues. "We are witnessing the Great Monetary Inflation (GMI), an unprecedented expansion of every form of money, unlike anything the developed world has ever seen. There is no sign of it ending, and we expect more in September. And now Congress has become an additional critical player in driving money supply with its fiscal programs. This will have long-lasting consequences that will provide plenty of pitfalls and opportunities for many years to come."

Strategy

The strategy, which started in 1999, is equity long/short with a macro overlay. The universe is global equities. The portfolio will typically have 40 to 70 positions and occasionally trade global futures and options. The strategy aims to identify trends and opportunities using value investing principles and capture price oscillations around the underlying trend using trading skills.

The investment approach centers around finding asymmetric themes; investing in the best stocks within those themes; focusing on macro drivers for risk and opportunity; and generating an asymmetric return profile.

An asymmetric return is the set of possible results of an investment strategy where the upside potential is greater than the downside risk.

"In 1990, I went to Memphis and worked for Paul Tudor Jones' uncle, Billy Dunavant. His style was to 'find asymmetric investment opportunities and when you do, bet big. And when you don't find those opportunities, don't bet'," says founder and portfolio manager Kenny Arnott. "That became the mission statement of Arnott Capital. And our results prove we have not deviated from that mission since I founded Arnott Capital in 1999."

Arnott's maximum drawdown has been -9% from high-water mark (the highest peak in value that an investment fund has reached) since 1999, vs. the market's -50%.

Mr. Arnott will present in the upcoming investor workshop webinar, The keys to asymmetric returns, on Tuesday 1st September at 10 am EST.

Themes

The current long themes are uranium, gold, "Connecting the future", Hong Kong, and agriculture. The short themes are core shorts, crowded defensive longs, August reporting season, equity index futures and puts.

In the Connecting the Future theme, the managers argue that 5G is a transformational technology that is set to drive an explosion in the internet of things. Ericsson is forecasting a 350% growth in cellular-connected devices from 2020 to 2025. This is enabled by low latency, lower power usage and higher reliability than 4G. The volume of data generation would increase from 33 Zettabytes in 2018 to over 175 Zettabytes by 2025, that is, a 530% increase in data. One should consider innovative technologies connected by 5G such as autonomous vehicles, robotic surgery, smart cities, and robotic factories.

"In this upgrade cycle, we believe the enablers, being telco operators and hardware providers, will claim increased economics, learning from their mistakes in the 3G to 4G upgrade cycle. These companies would have been unlikely to exist or be as dominant as they are today."

The Hong Kong long theses finds inspiration in "The Death of Hong Kong". Indeed, since Fortune published this article in 1995, the Hang Seng Index rose 100% from 1995 to 1997. Given geopolitical uncertainty, the managers believe the same sentiment exists at the present time. The Immigration of US-listed Chinese ADR (American depositary receipt)'s onto the Hong Kong Bourse could potentially add US$557bn of market cap to the HS Index, raising >US$30bn of capital. Recent changes in the share structures of HS Index provide for a significant revamp of the index weighting, seeing a significant increase in technology weighting of stocks to this index.

The Agriculture theme sees the agriculture sector as being uncoupled from the traditional business cycle, vital to the functioning of any country and deeply unloved by the investment community. The managers cite the ABARES (Australian Bureau of Agricultural and Resource Economics and Sciences) forecasting winter crop production of 44,520kt in winter 2020-21.

Arnott Capital is based in Sydney, Australia. Arnott's other fund, Opportunities Trust (AUD), has similar returns to that of the Cayman fund.


Related article:
5 May 2020: The Corona Fighters Report 22: Asset managers who delivered in the downturn


Upcoming webinar:

Investor Workshop: The Keys to Asymmetric Returns
Tuesday Sept 1st at 10 am EST
Details and free registration here: www.opalesque.com/webinar/

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