A net short stance maintained since November 2007 has enabled the SVM Highlander Fund to produce a positive year-to-date performance and to achieve estimated returns of 7 per cent in the f
A net short stance maintained since November 2007 has enabled the SVM Highlander Fund to produce a positive year-to-date performance and to achieve estimated returns of 7 per cent in the first 19 days of June, taking the estimated 2008 gain to 10 per cent, according to the fund’s manager.
In May the long book saw good contributions from Tullow Oil and Gas on successful drilling, and also Sevan Marie, Suez and Thus, according to Colin McLean, while the short book benefited from strong contributions from house-builders and banks.
These have continued to contribute lift performance in the first half of June, he says, supported by the fact that the funding problems in house-builders and mortgage banks are now more widely recognised.
The Highlander Fund’s short book is diversified and emphasises banks, general financials and cyclical services, while long positions include resources, utilities and tobacco. Even as some over-sold cyclical stocks rally, SVM believes there are still opportunities in short positions in smaller and mid cap companies where balance sheet distress is becoming more evident.
‘This has proved a testing time for long/short equity funds, with few IPOs to flatter results and many finding that the long-biased model, leveraging market direction, can be volatile when a bull market has ended,’ McLean says. ‘It is clear that the rally in bank shares from the March lows has drawn in many investors to buy banks who have failed to understand fully the sector’s problems.
He notes that for some months the Highlander Fund has held short positions in consumer sectors including retail, food retail, media and pubs, as well as in food manufacturers and house-builders. All of these are UK businesses, reflecting the overheating in the UK housing market, which SVM believes will lead to a sharp fall in consumer confidence.
Some of these shares have been supported by high dividend yields, McLean says, but SVM expects a pattern of dividend cuts already seen this in businesses ranging from Uniq in food to DSGI in electrical retail.
Many of these businesses are operationally leveraged, and the impact of slower sales will be magnified by competitive pricing and rising input costs. Food and energy costs are rising, and not all can be recovered from customers.
McLean also points out that a number of are carrying higher balance sheet debt. Buy-backs and stock tenders in recent years, combined with high levels of dividend distribution, have left a number of consumer businesses entering the slowdown with a weaker balance sheet.
SVM believes this will trigger dividend cuts and reduce scope for further buy-backs, and some companies may be forced to renegotiate banking covenants, as appeared more likely to occur with some UK house-builders in June. McLean expects weak trading combined with margin pressures and balance sheet problems to trigger further share price falls in many UK consumer businesses.
