With market dispersion near historic highs, we have rarely been so positive in the last two decades about the prospects for both the long and short sides of our portfolio.
When investors ask what is different about our approach to long investments, it is that we look for undervalued, owneroperated businesses where management teams earn more from the stock they own than the compensation they are paid. We believe this creates a solid alignment of incentives. We also do our company analysis with a longer investment horizon than most, typically three years, but we’ll occasionally hold positions much longer. Our approach often leads us to under-followed, out-of-favour, publicly listed companies.
For the short part of the portfolio by contrast, we look for two specific company profiles: either young companies with unproven business models, or mature, over-leveraged firms that are likely to need restructuring and often facing highly specific headwinds. To express these positions in the portfolio, the Fund almost exclusively uses single-name put options. These offer the advantage of capping the downside risk while offering positive leverage and a tool to manage volatility. This uncommon approach to shorting allows us to build positions in areas of the market that many other short-focused funds cannot.
From ‘junk’ to opportunity
In the first half of 2023, we saw both a resurgence in mega-cap momentum and a sharp ‘junk’ rally in lower-quality stocks following their downturn in 2022. As investors began broadly anticipating a peak in the rate cycle, many covered their short positions in the highly leveraged companies that came under pressure in 2022 and early 2023. Between them, these forces drained capital from higherquality small and mid-caps, creating both a challenge and opportunity for us.
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