Horseman Capital Management, the $2.5 billion fund manager whose Horseman Global fund was up 31.26% in 2008, once again has its long / short dial set for bear as they wait for a coming “capitulation.” In an August 2016 letter to investors reviewed by ValueWalk, the fund had a negative long-short ratio by 83.74% in August, resulting in down -4.94% monthly performance.  With the MSCI World index up 3% this year, and the MSCI Emerging Markets index up 12%, Horseman Global is down -1.97% year to date. But that could change rather dramatically if portfolio manager Russell Clark’s short thesis plays out.

Also see top Q3 hedge fund letters

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Horseman Capital

Horseman Capital –  Global long / short ratio mainly short

Sometimes the road of the noncorrelated manager can be lonely. As the stock market appeared to sleep-walk higher most of the summer – and bouts of stock market selling in January and July resulted in V bottom” recoveries – the plight of a long / short manager with short exposure can be tricky. The fact that Horseman Global is down low single digits year to date in the wake of strong net short exposure for most of 2016 is actually a significant accomplishment.

Clark, however, doesn’t see it this way. “After 8 months of hard work in 2016, with a few wins and a few losses, here we are with a fund that has basically gone nowhere,” he wrote to investors.

Specifically, he states:

So after 8 months of hard work in 2016, with a few wins and a few losses, here we are with a fund that has basically gone nowhere. This is a sorry state of affairs that has been repeated not only at hedge funds, but for most active fund managers. Why should investors bother giving their hard earned cash to active managers, with their higher fees and poor performance. This is a view that is gaining more and more traction in the industry. Active fund management, with hedge funds by definition being the most active, has become an area to be avoided.

His outlook is positive on the short book going forward, with REITs and consumer staples offering a nice hedge towards the bond portfolio.

There are signs that China has had some success with its policy of closing capacity in heavy industry, particularly in coal. This has made me far more nervous about commodity related shorts, and so we largely exited the remaining positions in the short book. In their place we have shorted staples and Reits. I like Reits and staples as shorts as many of them have poor financials, and tend to fall when bond yields rise, offering a nice hedge on my long treasuries positions.

Russell Clark goes the following reason (and more on it below)

The Horseman Capital flagship fund is also significantly short financials and Automobiles and Airlines. While he has confidence in his short equity exposure, he expresses a bit more trepidation for the fund’s commodity short exposure.  With this type of exposure, performance for the fund manager with only two losing years since 2001 could dramatically change if or when the equity market environment turns negative.

As talk of a December interest rate hike gains momentum, the prospects for another sell-off, particularly if the US President is Donald Trump, is likely to rise, say other analysts. Regardless of the next US President, a stock market sell-off on rate hikes is an outcome that many fund managers appear to be expecting.

Markets eventually go down, it is often a matter of timing that is the most difficult aspect of the trade, as Clark notes:

One of the curious features about long periods of outperformance of one style or another is that ultimately everyone is forced in. Sometimes this happens through capitulation by previously sceptical investors, or sometimes it happens through pure greed as fear of missing out takes over. The big question is, how close are we to that moment? I think we are indeed getting close. Goldman Sachs data on hedge funds show that top 10 positions for average hedge funds make up 70% of long positions. Longs tend to concentrate as market breadth narrows, and funds are forced into fewer and fewer winners. Total level of short interest is beginning to fall according to NYSE data. And large short biased funds have had a very tough time of it. Against this bonfire of the shorts, more and more investors are moving to passive strategies, or even structured products.

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Horseman Capital

Horseman Capital – Investment strategies, like asset classes, have cyclical performance tendencies

Investors patiently waiting for a short thesis to play out can be a testing moment. When stock market gains glisten, a noncorrelated hedge fund like Horseman Capital’s plodding along managing downside deviation doesn’t seem as sexy. In fact, it might motivate investors to move from active managers and park assets in passive approaches, which has occurred of late.

But investment styles, like asset classes, often have cyclical performance trends. The out of favor can quickly turn around and, given adjusting market dynamics, outperform:

I hear this argument more and more, and I have some sympathy for it. However it seems logical to me that a market that is heavily skewed to one area will naturally favour passive investors who remain fully invested no matter what, and when this imbalance unwinds active managers should outperform. In the TMT boom, active fund managers did their best to avoid buying overpriced stocks, but generally their underperformance became so extreme, that they either left the industry, or eventually succumbed to the madness and bought into the bubble – typically at the worse point. However, after the bubble burst active fund managers massively outperformed, at least until 2008 or 2009. However from 2009 onwards, active fund management has been going through a prolonged period of underperformance.

Clark has most of his short exposure targeted for the US, with the Euro and Japan following but a slight positive tilt towards the UK. The fund’s biggest US holdings include TJX, Costco and Burlington Stores. In terms of currency exposure the fund is long the Japanese yen and euro while short the British pound and Hong Kong dollar among other exposure.

Specifically, Horseman Capital’s PM explains the short thesis as follows:

This month losses came from the short equity portfolio, in particular from the financials, automobile and real estate sectors. The long positions were profitable, in particular oil and financial names in Brazil, and the defence and discount retailing sectors.

In the processed food sector, Campbell Soup CEO Denise Morrison recently said that she was aware of the mounting distrust of Big Food and that an increasing numbers of consumers are sceptical of the ability of large, longestablished food companies to produce genuine authentic food experiences.

According to a report by Boston Consulting Group some $18 billion in sales have shifted from large to small companies from 2009 to 2014 across all consumer packaged good categories. Consumers have been increasingly migrating to smaller, upstart brands that are often perceived as healthier and more authentic. According to another report from Rabobank the top 10 branded processed food companies in the US have lost 4% of their market share in the past five years as smaller, more innovative brands have seized the initiative.

Sales of powdered instant drinks fell 3.8% in dollar terms and about 9.5% in volume in the US last year, and sales of carbonated soft drinks fell 0.8% in dollar terms, and 1.1% in volume (source: Euromonitor), as consumers are more concerned over high sugar levels, artificial sweeteners and links to obesity. Some soda makers have replaced high fructose corn syrup with cane sugar to appeal to health conscious consumers, however this does not resolve the problem that old brands now have to contend with an increasing number of new popular drinks deemed healthier such as cold-pressed juices and coconut water.

Vita Coco, a company founded in 2004 has become the top selling coconut water brand in the US with sales over $420m worldwide. General Mills and Kellogg announced the removal of artificial colors and flavors from their cereals last year after sales fell 1% in dollar terms and 2.3% in volume. Bruce McColl, who as the chief marketer of Mars oversees Snickers chocolate bars and other brands, said “consumers aren’t out there thinking about our brands.” And however much brands may have been worth in the past, their importance may be fading. In the meantime Snack bar maker Kind inc, a company founded in New York in 2004 which produces snack bars that are gluten free, made of whole ingredients and low in sodium, saw its revenue rising to $547 million in 2015 (source: Euromonitor), making it the fastest growing snack bar brand in the US.

According to Itamar Simonson and Emanuel Rosen (authors of “Absolute Value: What Really Influences Customers in the Age of (Nearly) Perfect Information”), the original job of brands was to assure consumers about the quality of a product or service. But now customers can review products on shopping websites, talk to each other through social media and consult reviews websites. As a result brands have “a reduced role as a quality signal”. Shopping websites also make it easier for consumers to find the sort of product they like and filter out the sort they don’t. So brands are less needed as a mental shortcut. “Brand equity is simply not as valuable as it used to be”.

Consumer staple brand stocks are popular long positions at present, they pay high dividends and tend to be perceived as safe businesses with stable revenues. However sales have been declining over the past few years and net incomes maintained only by increasing prices. In the UK, according to a survey from creative communications agency Southpaw, consumers described the products they now spend less on than they did half a decade ago as ‘expensive’. Over the past few weeks we have built small short positions in consumer staple brand companies.

Will Horseman Capital be right? Only time will tell