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Key man risk looms large for long-short funds

Glenn Freeman  |  07 Aug 2019Text size  Decrease  Increase  |  
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Morningstar's downgrade of long-short funds run by Antares and Tribeca following senior stock picker departures highlights the personnel risk of such strategies.

Australian equities manager Antares Capital lost one of its star portfolio managers, Richard Dixon, last month, when he resigned after a few months of extended leave. Having headed the Antares Professional High Growth Shares fund (5851) for almost 12 years, Morningstar viewed him as a "linchpin" because of his rare skills in shorting and risk management.

Just three months earlier in April, another long-short strategy, Tribeca Alpha Plus, found itself short a portfolio manager when Sean Fenton resigned from the fund he helped launch in 2006. The departure of another integral team member just three days later, analyst Peter Moore, dealt a second blow to Tribeca.

In both cases, Morningstar downgraded the funds to negative from their previous Bronze medal ratings – reflecting the strong emphasis placed on these key personnel.

Long-short fund asset managers have a unique skillset in comparison to long-only analysts and portfolio managers, according to Morningstar manager research analyst Michael Malseed.

"It carries a greater risk when managers get things wrong,” Malseed says.

As such, the “People” metric has a higher weighting on Morningstar's overall analyst rating of such funds than for others. This is one of the five fundamental measures of success Morningstar uses to rate funds: People, Process, Parent, Performance and Price.

What are long-short funds?

Long-short equity is an investing strategy that takes long positions – holdings of actual shares – in companies that are expected to appreciate, and short positions in those tipped to decline. Holding a short position is akin to placing a bet that a share price will fall.

"Shorting tends to be catalyst-driven [by external events], rather than being influenced primarily by long-term fundamentals.

"And there are not many long-only investment managers who have experience shorting stocks," says Malseed.

In the case of the Antares fund, Dixon's role has been assumed by the former deputy portfolio manager, Nick Pashias.

While noting Pashias’s experience and obvious skill, Morningstar manager research Andrew Miles last month said his "lack of experience managing a short book fundamentally changes the investment proposition and is a risk too large to bear."

"All things considered, the change in portfolio manager has impaired the investment case and investors should seek alternatives," Miles said.

Draining a shallow pool

At Tribeca, the sudden departure of both the former portfolio manager and quantitative analyst puts too much strain on an internal talent pool that was already quite shallow, Morningstar says.

"The staff numbers on the fundamental research side were never large, and will now be more strained," said Morningstar analyst Alex Prineas – who also noted the exits came amid a protracted dip in fund performance.

"This can exacerbate client dissatisfaction [and] the $155 million retail client book is dwarfed by an institutional client book of several hundred million dollars, and institutions can redeem large sums with limited notice,” Prineas said in April.

Without entirely ruling out the potential of remaining team members regrouping and succeeding in the long run, "the upside for investors who stay is not worth the downside risk, which explains our Negative rating".

Long-short funds worth considering

Outside of these negatively rated long-short funds, a couple of others in the category still hold Morningstar medals.

Ausbil 130/30 Focus (18344) and Perpetual Share Plus L/S (9836) are rated Bronze and Silver – despite being similarly anchored by key portfolio managers.

Prineas describes the Ausbil fund as a "reasonably well-diversified portfolio", with on average 35 companies held in long positions, and 15 short at any time.

He notes that short positions employed by this manager can either be:

  • outright directional trades – where a bet is taken on the future direction of particular stocks
  • pair trades – where one company is bought and a similar company is sold
  • funding shorts – where low-returning stocks are sold to cover the cost of buying more attractive names.

High portfolio turnover, which often exceeds 300 per cent annually, is a potential risk for investors to consider, Prineas says.

"However, sector positioning will tend to reflect Ausbil’s flagship strategy," Prineas says – pointing to the materials sector as an example.

"The overall portfolio has remained consistently overweight materials, especially metals and mining as an outcome of Ausbil’s sector research."

Perpetual favourite

Perpetual Share Plus L/S is Morningstar's preferred long-short Australian equities strategy, though it was "soft-closed" in early 2018. This means existing investors can make additional contributions, but it's closed to new investors.

The portfolio manager is Anthony Aboud, who is highly regarded by Morningstar's Prineas for his short-selling ability.

The fund is one of the largest in the category, which brings some benefits, but also limits the number of companies available for shorting, Prineas says.

"For example, stocks with a market cap below $800 million are unlikely to have sufficient scale for this strategy to meaningfully short.

"Nevertheless, we think the manager’s fundamental approach is well suited to profiting from both long and short opportunities among the more-liquid mid- and large-cap Australian stocks."

is senior editor for Morningstar Australia

Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar.

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