Commodities markets are often viewed predominantly through the narrow lens of energy markets, with the recent dramatic oil price volatility garnering front page headlines, bringing hefty gains for several hedge fund strategies amid the turmoil.
Commodities markets are often viewed predominantly through the narrow lens of energy markets, with the recent dramatic oil price volatility garnering front page headlines, bringing hefty gains for several hedge fund strategies amid the turmoil.
However, for Matthew Zabloski, founder and CEO of materials-focused hedge fund Delbrook Capital, the metals and mining sector provides for a broader mandate and a “much wider fairway” for commodity investment opportunities, in contrast to the comparatively narrow energy sector.
“Those oil-focused funds are narrowly investing in energy, the correlation between Brent and WTI or natural gas, where there are highly correlated equity returns,” Zabloski observes. “We have a much more interesting place to invest in, with a heck of a lot more opportunities. I can play precious metals off against the base metals, or against coal producers, or steel producers against uranium firms in Kazakhstan.”
The Vancouver-based firm’s long/short equity-focused strategy, the Delbrook Resource Opportunities Master Fund, fuses relative value, event driven and opportunistic investment approaches focusing on a broad spectrum of commodities. These range from gold, precious metals, silver, platinum and palladium, to base metals like copper and zinc, industrial metals and bulks – such iron ore and coal – along with energy metals like lithium and uranium.
Mining opportunities
Before establishing Delbrook Capital, Zabloski spent six years as a portfolio manager at Fidelity Management and Research Company in Boston, where he focused on cyclical equities such as natural resources and industrials, and was a co-founder of Boston-based investment manager CI Cambridge Advisors.
As someone who has traded metals and mining stocks for some 15 years, Zabloski admits he remains surprised by the sheer dearth of sector-specialist hedge funds in this sector.
“We’re all aware of the sector-focused hedge funds within healthcare, TMT, technology, and fintech. But virtually no-one is managing funds, on a focused-basis, purely in the materials sector,” he says.
“Materials has so much cyclical movement in it, in terms of valuation of equities and also the underlying commodities, so it always surprises me that there were few people taking a true hedge fund, long/short approach to investing in the space,” he says. “There are great opportunities here.”
Having initially run the strategy in a managed account format, an onshore version of the Delbrook Resource Opportunities Fund was rolled out in 2013, later launching as a Cayman-domiciled master fund in September 2018.
Today the strategy manages around USD50 million in assets. In 2019, its first full year of trading, the fund returned a stellar 45 per cent. Lately, though, Delbrook was left reeling by the first quarter’s market turbulence, suffering a 4.4 per cent drawdown in March, stemming predominantly from the broader equity volatility as a result of the coronavirus pandemic.
Performance has since rebounded, with April’s return estimated at more than 20 per cent. Year-to-date performance is now “pushing the high single digits”, Zabloski says.
Embracing volatility
As a hedge fund, Delbrook heartily and readily embraces the volatility that often underpins the metals market, which Zabloski says forms the foundation of its relative value trades, allowing its stock selection to shine. Volatility in materials stocks – traditionally higher on average than the wider stock market at the 30-35 per cent range – offers a “great opportunity” to make money, he adds.
“It’s the identification of a long equity versus a short equity, or a basket of long equities versus an ETF; large-cap gold equities against gold equity ETFs. Something where we can beta-adjust a basket, and we can trade it with very low net exposure, and generate strong risk-adjusted returns with a 1.5 to 2 Sharpe,” he says.
While the fund’s relative value element could be run as a standalone fund in its own right, Delbrook prefers to fuse it with event driven and opportunistic positions.
“Event driven is the second basket that we refer to, and it’s your typical opportunistic approach, which looks to position the portfolio ahead of key catalyst events, such as quarterly reports, M&A, production updates – any catalyst we think will materially move an equity valuation positively or negatively,” he explains.
As the coronavirus pandemic rocked stock markets globally during the first quarter of 2020, an assortment of hedge funds have piled into gold owing to its traditional ‘safe haven’ status, with prices surging some 12 per cent year-to-date. Among them is Elliott Management, Paul Singer’s high-profile activist firm, which has reportedly increased its bets in the asset recently.
Meanwhile, Delbrook is currently training its sights on a range of event driven opportunities stemming from the demand-supply impact as a result of the Covid-19 outbreak.
Specifically, Zabloski is anticipating a wave of corporate activity and buyouts on the horizon among precious metals producers. Large-cap gold equity stocks have tended to underinvest in their properties from an exploration standpoint over the past decade thanks to tough market conditions, forcing them to return capital to shareholders.
Zaboloski picks up the story: “The key theme here for us is these large caps having to backfill their resource base, which has depleted over the past 10 years. They don’t have time to explore for new gold or copper – they need to acquire existing resources,” he says. “So high quality gold mines and producers are likely to be acquired by large cap companies. Our focus in the precious metals space right now is these high-quality assets in geopolitically-safe jurisdictions where we see the capability for M&A.”
On the flip-side, certain short ideas are arising from firms being unable to produce any gold or copper during the ongoing coronavirus lockdown. Zabloski notes how many of these firms have no current cashflow which carries far-reaching implications for the debt and equity components of their balance sheets.
The shifting opportunity set and prevailing trading environment ultimately bodes well for performance, he believes. Despite a tough Q1, Zabloski is confident of another strong annual return for the strategy.
“Our mandate is to look at, and to know, assets globally, and then to risk opportunities accordingly. Geography and geopolitical headwinds will always have massive implications on equity performance, but we need to be positioned as the best fund, from a fundamental research and ideas-generation standpoint, globally.”
Model material
As talk turns to investor sentiment (most of Delbrook’s base are single- and multi-family offices, along with a handful of US and European institutional investors), Zabloski is eager to highlight the burgeoning investor appetite for metals, and explains why hedge funds are the ideal vehicle for exposure.
“All of a sudden, investors are asking how they can invest in this sector. It was like a light switch went on for the institutional investors. Gold is more topical.”
He says investors tended to ignore the materials sector for much of the period following the 2008 global financial crisis. Since then, the institutional capital that has been invested has tended to go into private equity structures, which Zabloski believes are wholly unsuitable for the asset class.
“We think the private equity model is wrong for materials. You’re asking people to lock up long-only capital in a very cyclical sector for a five-to-ten-year time horizon,” he says. “There’s little price transparency, little liquidity; I can’t tell you where any one of these commodities will be 10 years from now; I can’t tell you if copper is going to be five bucks or 50 cents. You do not want to invest in this sector in a long-only manner.
“Instead, the better structure with which to invest in this sector is the hedge fund structure. We can take long bets based on the fundamentals that we identify, we can hedge downside risk, and then we can take alpha-generating short bets where our research has uncovered opportunity on that side. You have something as cyclical as commodities, and you overlay it with the volatility of the equity space in commodities – that’s ideal for a true long/short hedge fund model.”
