After adding research staff recently, Ed Bosek and his portfolio management team at Beacon Light Capital has found new opportunity. After a strong third quarter – up 4.14% and 4.10% in the domestic and global funds respectively – the fund is looking to both long and short exposure to deliver performance. The S&P 500 and MSCI World Index, by contrast, were up 3.3% and 4.4%, on the quarter respectively. Get ready, as a major market environment shift is on the way, Bosek predicts.
Beacon Light Capital: Get ready for high volatility in low volatility stocks
In the wake of the US Presidential election, the tide is turning against safe haven assets, Bosek wrote in a Q3 investor letter dated 11/22/2016, a copy of which was reviewed by ValueWalk. “The bubble of boring” is about to burst, as low volatility, low growth investments, in both fixed income and the equity markets are about to experience a value adjustment, Bosek says. He founded Beacon with former Atticus Capital fund of funds manager Noam Ohana after Atticus founder Timothy Barakett shut down the nearly $3 billion firm to spend more time with his family.
While Beacon Light Capital is focused on fundamental value investing, they do have a macro viewpoint that shades their investing decisions. This comes into play when they consider the inflation outlook and factor investing.
Bosek notes that over the past two years, Low volatility as a factor has outperformed the market by a “stunning” 64% basis the J.P. Morgan U.S. Equity Risk Premium Factor Index.
What goes up also goes down, as mean reversion can have its own gravity.
“To us, it is startling how closely this bubble rivals that of the internet boom of the late 1990s, which most market observers would agree is the purest example of a bubble in their lifetime,” he wrote.
The low volatility bubble which may turn into high downside deviation volatility had logical underpinnings:
As with all bubbles, there were some legitimate underpinnings. As economic growth lagged after the financial downturn, commodity prices collapsed and inflation evaporated, prompting central banks to increasingly employ unorthodox monetary policies to help stimulate the economy. The net effect of disappointing growth and incredibly low inflation was everincreasing multiples for low beta stocks. The capital asset pricing model implies that low beta stocks are significantly more sensitive to rates moving toward zero than higher beta stocks. This dynamic of low growth businesses and indices with similar characteristics trading at higher multiples has confounded many traditional fundamental equity investors.
Beacon Light Capital loaded up on financials over the summer, sees interest rates rising
While he admits the Trump election was a surprise, he did see the move in financials and loaded up the portfolio with names that are now among the top performers.
We have been anticipating a shift in the inflation environment for several months,” he wrote, noting he repositioned the portfolio over the summer to be net long financials for the first time since 2011.
While planning the long end in financials, they also constructed a short theme across low volatility, low growth defensive stocks in sectors like telecoms, utilities, and consumer staples – all fitting in with the macroeconomic viewpoint. In fact, the fund took its first tail hedge position by purchasing puts on long-term U.S. Treasuries.
“Recent moves in the fixed income markets suggest the end of a bull market in bonds that has spanned my lifetime,” he wrote. “The risk to markets is that inflation expectations move more quickly than expected and act to counter growth.”
The fund sees rising inflation, with accompanying higher interest rates, but they think stocks could rise as a result.
The fund recognizes three concrete drivers of global inflation: US wage growth is starting to rear its head; Commodity prices have started to rise; Chinese inflation, intertwined with commodity prices, is also on the move.
“Corporate earnings are now no longer declining and posted the first year-over-year growth since 2014, and major drags to growth from inventory and government spending are now subsiding,” Bosek wrote, also thinking the “significant austerity drag of recent years is finally fading” as the Trump administration sets to gear up fiscal spending.
On the quarter longs were up 7.3% and short exposure generally subtracted to the same extent as market beta carried stocks higher. Big contributors to performance included Constellium, Ellie Mae, SBM Offshore, Kinder Morgan, Charles Schwab, and Amaya Inc., while only two positions, Seagate Technology PLC (short) and Realogy Holding Corp., detracted more than 50 basis points on the quarter.