Boutiques Connect I Steyn Capital Management

Speaker 0:
Hello and welcome to this boutique connect session today. I'm joined by James Corin, portfolio manager at Staying Capital Management. Welcome, James. Thanks

Speaker 1:
very much, Chloe. It's very nice to be here. So

Speaker 0:
James Stay Capital's daily traded R I F Fund was recently launched, particularly in October last year. Perhaps you can take us through what prompted the launch of this fund,

Speaker 1:
certainly. So perhaps it might help to give a bit of background to the genesis of of where the fund came from. So,

Speaker 1:
um, the the the longest running strategy at Stan Capital Management is our qualified investor. Long Short Fund, which was launched in 2009 and in fact this month, is celebrating its 14th birthday.

Speaker 1:
But we're very proud of the long term track record because over that 14 years we've generated significant amounts of Alpha on both the long side and the short side of the book. So over 14 years we've generated an annualised return Netta fees of 17.3% which is about 4.3% points ahead of the market. But very importantly, we've done that by taking on significantly less risk than the market.

Speaker 1:
So to put some numbers to that. Over the 14 year period, the beta adjusted net exposure of our strategy has been around 25% or about a quarter of the market's net exposure, and this is very well illustrated. If you think back over the 10 biggest market drawdowns over the history of the fund, the strategy has actually outperformed the market significantly and nine out of those 10,

Speaker 1:
and actually generated a positive return in six out of those 10. And so if you think about the DNA of our firm and the DNA of that strategy with a big focus on downside risk mitigation, this is actually very well suited to a retail investor. And so, with this in mind and given investor demand, we made the decision to launch the Stand Capital Daily Liquidity Retail hedge fund in October last year.

Speaker 1:
And this really gives retail investors an access point into this, um, into our longest running strategy. But importantly in a vehicle that is appropriate for retail investors, so the vehicle is daily has daily liquidity. It's it's in the name, um, but also it has a much more modest minimum investment, which is appropriate for a retail investor and so as you you noted we launched the fund in October of last year.

Speaker 1:
Um, and it's available on the momentum wealth and the Alan Grey Platforms. And I'm very happy to report that, uh, from a standing start in October, the fund has grown to just shy of 100 million rand

Speaker 0:
today. OK, it's quite a significant amount of growth in such a short space of time.

Speaker 0:
But, um, perhaps you can take, uh, some of the other hedge fund strategies that you employ at stay in Capital. And where are you seeing opportunities at the moment?

Speaker 1:
Sure. So one of, um, the things that we are very focused on, particularly in the current market environment, is generating returns, but also really mitigating that downside directional market risk.

Speaker 1:
And so, you know, given the elevated amount of corporate activity that we've been seeing on the J. AC and corporate action over the last two years, one of the opportunity sets that we've really gravitated towards has been event driven or special situation type investments, and this would include things like merger arbitrage and risk arbitrage to unbundling, monetization and liquidations.

Speaker 1:
And, um so this really creates the opportunity for hedge funds to take advantage of dislocations in the market on an opportunistic basis,

Speaker 1:
but then also to really generate strong returns and also manage that downside risk. And so perhaps a good example of what exactly I'm talking about would be something like the P S G, um, unbundling and delisting which occurred, um, during the course of last year. So the management team of P s G proposed to unbundle the listed constituent parts of the P S G group and then take the rump private at 23 rand a share.

Speaker 1:
And so we took a look at this. And this is exactly the kind of arbitrage that we like because it was both, uh, very low risk and also very mispriced. So

Speaker 1:
maybe digging deeper into it, it was it was very low risk because for a start, the management team who proposed the transaction knew the assets very well. So from a due diligence perspective, there was no due diligence risk. We knew that the funding risk was very low because of the muons, um, good access to capital. From a regulatory perspective, there was very low risk because there was no competition commission issues. There were no t r p risks, which would have resulted in impediments to the deal. And finally,

Speaker 1:
um, AAA value unlock was something that the shareholders of P s G themselves had been asking for for a number of years. And so there was very low risk that the deal would be voted down, Um, in the shareholder vote.

Speaker 1:
So looking at the situation like this, what one is able to do, um, with a bigger hedge fund tool kit is to go along the P S G stock and then sort out the underlying constituent parts in a hedging ratio, which really focuses your exposure on that spread narrowing and closing on the closure of the transaction, which we had assessed as being a very low risk, um, situation.

Speaker 1:
So what that does is it concentrates your exposure and, you know, it results in a much in a much more significant return, but also removing that directional market risk. So to put some numbers to it over the course of that transaction, we generate

Speaker 1:
an internal rate of return of, uh, just under 200% on invested capital over the deal. Uh, term. So that is one. Yeah, that's one example of kind of the the kinds of situations and the ability to leverage that hedge fund experience.

Speaker 0:
And perhaps you can take us through. I know that was AAA long a long, um, strategy, but perhaps on the short side,

Speaker 1:
yeah. So obviously, one of the features of the current difficult economic environment is the fact that the difference between companies that are actually performing well and those that are experiencing fundamental weakness is really starting to diverge. And so, for

Speaker 1:
for fundamental stock pickers like ourselves and fundamental short sellers like ourselves, this is actually a really great environment to be able to capitalise on both sides of that equation. So to benefit not only from companies doing well but to take advantage of those companies that are not performing well.

Speaker 1:
And we don't normally talk about individual stock positions. The short stock positions. But a recent and timely example would be something like Transaction capital, which, um, coming into March was the second biggest short position in our hedge funds.

Speaker 1:
And so this is an example of a company where we looked at the financial statements towards the end of last year and became very concerned that the earnings quality had deteriorated significantly and that there was actually fundamental weakness lurking below the surface there, which was not fully appreciated by other investors.

Speaker 1:
And, you know, a couple of the clues that were available to investors to maybe detect this were things like one time gains in earnings or a growing receivables balance. But at the same time, the provision on those receivables was declining and the ageing was deteriorating. We also saw swirling stocks of repossessed taxis within their S a taxi business. So these were all clues that there was something, um, some fundamental weakness lurking below the surface.

Speaker 1:
So we put the short position on, um in November last year on the expectation that forward earnings would disappoint. And of course, in March, they released a trading statement revealing the extent of that fundamental weakness, and that actually resulted in a stock price decline of almost 70% from peak to trough. Now, uh, transaction capital is one nice example to to talk

Speaker 1:
talk about. But the reality is, is that over the last 14 years in our hedge fund strategy, we've maintained a short book of between 25 30 single stock shorts and have actually over that period generated an annualised alpha on the short side of 16%.

Speaker 1:
And we do that by positioning the short book around, um, anticipated earnings disappointments. And we do that by really spending a lot of time scrutinising the financial statements of companies for signs of earnings, quality, deterioration or fundamental weakness, which is either obscured or otherwise not evident on a cursory look at the financial statements.

Speaker 0:
So stay. Capital prides itself in this forensic accounting analysis, but you also apply this 15 step checklist approach. Um, for opportunities both in the long and short side. Can you take us through what you screen for briefly and, uh, when you would apply

Speaker 1:
it? Sure. I mean, so we spoke a little bit about the shorts and the port

Speaker 1:
event driven type investments. But really, our bread and butter type of investment is what we call quality value. And so what we're really looking to invest in, um, in these kinds of investments is high quality businesses that are not recognised as such, and they're not over paying for those businesses. So we have a proprietary screen,

Speaker 1:
uh, which screens for these ideas and then basically produces a set of ideas for us to research. And then we run it through this 15 step checklist, really to try and determine while the screen says that it's cheap and high quality. But now we need to dive in and really confirm that. And so the idea behind the checklist is really that airline pilots use checklists to avoid crashing the plane. So we figured that they must be on to something.

Speaker 1:
But also it's trying to optimise our return on time. It's just such an important concept in investing is we really want to spend our time researching only those high quality ideas, Um, that we are looking to invest in and exclude the rest. And so we we optimise it by spending a lot of time at the outset of those 15 steps really thinking about the business quality and you know, what are the margins like? What is the return on capital like, what is the incremental return on invested capital?

Speaker 1:
And then, at the very outset of that process, we run it through this forensic accounting, um, basically analysis, and we for a moment put on our short selling hat, and we scrutinise the application of accounting policies, principles, judgments. And we're really trying to determine. Is there anything in these earnings which, from a short selling perspective, would interest us? And if there is, we exclude it.

Speaker 0:
OK,

Speaker 0:
so what, then, is the outlook for fundamental hedge funds, particularly in the market environments that we currently find ourselves in? Sure.

Speaker 1:
I mean, this current market environment is actually an excellent environment for fundamental hedge funds. And I mentioned this dispersion between companies doing well and companies doing short and the ability to take advantage of both opportunities on the long side and the short side is really is, is, is really it's It's very fertile ground at the moment for for hedge funds with that toolkit.

Speaker 1:
But I think given the amount of global and macro uncertainty, the ability to really generate returns while minimising that directional risk is really, um, is really something that I think will become more important and is really something that hedge funds can bring to the table.

Speaker 0:
James, thank you very much for taking us through your insights. We appreciate your time.

Speaker 1:
Thanks very much. Clay