Mangrove Partners finished 2019 down -9.4% despite a return of +5.1% in the month of December, according to a hedge fund letter to investors update seen by ValueWalk. The firm blamed the disappointing returns on costs from hedging, coal investments, disappointing energy longs and a lack of exposure to growth stocks.
Mangrove’s Nathaniel August said in his fourth-quarter letter that they are now working on finding new shorts and are evaluating a number of new ideas that appear promising. December’s gains came mostly from gains in the long portfolio, although losses in the fund’s short book detracted from those gains.
Review of Mangrove Partners's 2019 results
August describes 2019 as "a disappointing year on both relative and absolute bases," adding that even though it would be easy to blame their short positions for the problems, they believe their long book presented the real problems. Shorts were down 5.8% for the year, which vastly outperformed the 31.5% that would have been recorded if shorting the S&P 500. The fund's long positions gained just 2.4%, lagging far behind the S&P. The fund's CDS hedges detracted another 5% of net asset value.
He said the main reason the fund underperformed in 2019 was its "near complete lack of exposure to growth stocks," which outperformed value by 7.8%, based on the difference in returns between the Russell 2000's growth and value sections. He also said they have always been more comfortable with value stocks because they are usually "less exposed to rapid technological change and obsolescence." However, this strategy didn't work last year and has resulted in long periods of underperformance, including the last decade.
Problems with oil, gas, shipping and coal stocks
August also said the fund held large positions in oil and gas stocks. Mangrove Partners's average exposure to exploration and production companies in 2019 was 32%. At the beginning of last year, August and his team believed that the industry was at its lowest multiple ever. However, even though WTI oil prices climbed 34% last year, the median small-cap exploration and production company tumbled 26% during the year.
He noted that many companies experienced operational problems, but others, including Frontera, Bonanza Creek and PDC Energy posted results that were at or above their guidance. Thus, it's clear that the negative performance in these companies was the result of additional multiple compression. E&P stocks cost Mangrove Partners 7% of its net asset value.
Mangrove Partners was also hit by its investments in private shipping companies. August described the underperformance as "truly puzzling," adding that shipping rates were strong and improving last year. He specifically mentioned Capesize, which averaged $22,185 per day in the fourth quarter, compared to $15,829 per day in the fourth quarter of 2018. He also said spreads between high sulfur and low sulfur fuel oil also seem to be much higher than expected, which should provide another advantage to the fund's fleet, but valuations for its ships declined, subtracting 2.7% of net asset value.
Mangrove Partners hit by commodity declines
The fund's coal investments subtracted 6.1% in 2019, and August said they made "analytical errors" in the operations of the two biggest positions. Both companies had higher costs and lower volumes than what they had expected. Mangrove was also hurt by commodity price declines, which were exacerbated by restrictions on Chinese imports that had a negative impact on prices during the fourth quarter.
He estimates that about half the losses in their coal holdings came from commodity price declines, while the other half came from operational challenges. He believes coal demand outside the U.S. is still growing because of new power plants and steel blast furnaces in India and China. Further, he said there isn't much new supply, and already existing minds are still depleting. Thus, he expects prices will return to levels they must be at to motivate mining companies to invest in new mines.