Profiting from old economy companies

The Firetrail Absolute Return strategy has experienced a difficult few months after an extended period of outperformance. The long-short strategy, which seeks to balance its long and short positions to remove the so-called ‘market risk,’ had seen a number of stock-specific issues dragging performance lower before staging a recovery in August and September.

Portfolio manager and chief investment officer Patrick Hodgens highlighted and explained the key drivers behind the difficult August, which ultimately came down to two short positions being subject to significant and unexpected takeover offers. Specifically, Sydney Airports (ASX:SYD) which received an offer from an Australian Super-led consortium, and Altium (ASX:ALU), the offer for which has since been withdrawn.

Hodgens was quick to highlight that this is par for the course for a strategy that can have as much as 200 per cent of investor’s capital in short positions (ultimately offset by long positions). These takeover offers “don’t matter over the long-term,” suggested Hodgens, evidenced by the strategy’s consistent outperformance over rolling three-year periods.

More importantly, the strategy’s performance in both the GFC and March 2020 sell-off is shown as evidence of the neutrality of the approach from market volatility. During the GFC, at which point the strategy was being run at Macquarie, the portfolio gained 10 per cent, while the index fell by over 47. Similarly from November 2019 to June 2020, it gained 8.8 per cent, versus the index which fell 12.3 per cent over the same period.

Despite short-term volatility, performance continues to be driven by the core ‘mid-to-large’ exposure within the portfolio, adding 6 per cent over the last 12 months. Within this allocation ResMed was a standout given particular focus by the manager. A top three position in its high-conviction or long-only strategy, Firetrail sees this stock as a true global leader.

ResMed has seen a solid run of late, with its 15 million cloud connected sleep apnoea devices considered by many to be far superior to their competitors. The group has benefited from a mass recall of (its biggest competitor) Phillips’ products, with Firetrail suggesting the market share gains may be underappreciated. It highlights the ongoing impact of a recall on sales, suggesting as much as one year’s worth of selling time is spent on dealing with issues, with many customers taking the opportunity to look at an alternative. Similarly, the manager believes the market’s focus on slowing ventilator sales has hidden a “step change opportunity” for revenue and market share growth.

The fund has also benefited from a targeted exposure to broader commodity exposures including the likes of Lynas (ASX:LYC), with Newcrest (ASX: NCM) an increasing exposure on the basis that the growth opportunity in its three key assets is grossly underappreciated.

The standout on the short side is what Hodgens defined as an “old economy” company; AGL Energy (ASX: AGL). The company has recently fallen to an all-time low, paying off for Firetrail investors, who have shorted the company on numerous occasions. The manager highlights the growing ESG risk but most importantly the clear overcapacity in the national electricity market as renewable generation has grown over the last few years. The position has added 1.7 per cent to performance of the fund over the last 12 months alone. 

At present, the fund has over 220 individual positions, with Newcrest, Crown Resorts (ASX: CWN) and OZ Minerals (ASX: OZL) the highest-conviction longs. The shorts are naturally held closer to the chest. The fund is overweight cyclicals vs. defensives. showing confidence in the potential for economy recovery, with a corresponding 9 per cent overweight to value over growth.

Drew Meredith

Drew is publisher of the Inside Network's mastheads and a principal adviser at Wattle Partners.