Lighthaven Capital to donate 25 per cent of performance fees to fund Covid-19 research
Traditional long/short fund Lighthaven Capital has committed to help in the fight against coronavirus by donating 25 per cent of its performance fees to fund research into Covid-19. Here, Founder and CIO Eric Cheung explains how a forward-thinking outlook is key to the firm’s investment philosophy…
Back in 2018, the warning signs that the US stock market was getting toppish were picked up on by Eric Chung, CIO and founder of San Francisco-based Lighthaven Capital Management, a traditional equity long/short fund. At the time, Chung noticed that the Shiller P/E ration of the S&P 500 was as high as it had ever been, other than during the ‘Dot Com’ boom.
“That gave us some pause and we readied ourselves in the event there was some catalyst for a downturn. One such catalyst was the US China trade war. We hedged significantly in 2018 which helped us when the market fell in Q4; we ended the year up over 26 per cent,” says Chung.
Chung’s Lighthaven strategy takes its inspiration from long-term value investors such as Peter Lynch, Philip Fisher and Charlie Munger. Since the strategy was first conceptualised in 2006, it has consistently outperformed the Eurekahedge Long Short Equities Hedge Fund Index.
“We operate a long strategy as well as a long/short strategy,” says Chung. “The long book is growth at a reasonable price where we’re looking for the next Apple or Chipotle. On the short side, we do the mirror image; shorting individual companies with declining revenues who are getting disrupted in the market and potentially have high leverage.
“We also periodically short market indices by purchasing ETFs; primarily the Russell 2000 and the S&P 500. We do this to reduce beta risk.”
Last year, the fund was short Harley Davidson and Ford and roughly 10 per cent of the portfolio was short the Russell 2000.
Going into 2020, Chung had much the same mindset as he did going into 2019 but as he explains: “What was really eye opening for us was back in January, one of our investment interns who comes from China made the case that coronavirus was serious. We started looking at daily data released by the WHO and the picture it painted was clear: this virus was spreading exponentially.”
Harley Davidson chopped
Chung says the team took the decision to increase the size of its short positions – “in some cases we doubled them” – whilst adding new short positions on companies that they thought would be impacted, such as shopping mall-based companies like Francesca’s, Express, Signet Jewellers, and Build-a-Bear Workshop.
“Also, we started purchasing companies we thought would do well in this environment. We already had a long position in DocuSign, which we increased significantly. Teladoc was already on our buy list so we went ahead and bought that stock; they are one of the most noteworthy public telemedicine companies in the US. We also increased our market shorts by adding a new market short on the S&P 500,” Chung explains.
Overall, this has helped Lighthaven lock in some good performance numbers so far this: the fund is up over 20 per cent through April.
Chung remarks that Harley Davidson was already being disrupted even before Covid-19. As such, it became one of the more meaningful short positions in the book as the effects of the global lockdown started to take effect.
“We have since closed that position because in early April I was beginning to watch the market react differently. A lot of individual shorts went to multi-year lows. However, in early April I could see a lot of speculators starting to pick up these names so I took the decision to close out all of our individual shorts.
“We have however, maintained a higher short position in stock market ETFs to reduce beta exposure in the portfolio,” he says.
2020 will be a rocky year
In the current climate, maintaining investment discipline is sacrosanct. Managers who deviate from their core investment thesis in the hope of tapping in to new sources of alpha – which have undoubtedly emerged in the last couple of months – run the risk of introducing more volatility and bigger drawdowns in to their portfolios.
At Lighthaven, Chung emphasises that the primary goal is to maximise returns on a risk-adjusted basis. “Of course investors care about the Sharpe ratio, which we keep an eye on,” explains Chung, “but what I focus on when evaluating risk is whether any decision I make could potentially cause a permanent loss of capital.
“I wasn’t comfortable closing all of our shorts in the portfolio, right now, and leaving the portfolio completely un-hedged because we anticipate 2020 to be a very rocky year.
“The two market shorts we have therefore give us a bit of ballast, although we have told investors that we will probably end up going 100 per cent long in the short to medium term to take advantage when stocks are trading at a discount.”
Covid-19 has, in many respects, introduced a new way to look at the world we live in. Entire sectors of the economy suddenly appear highly vulnerable as people reassess what is important in their lives. Aviation, tourism and the food and beverage industries have been hugely impacted and one wonders what the long-term future of aviation, in particular, will be. Who will be the winners and the losers?
Given the unprecedented nature of the lockdown in the economy, there are a lot of things yet to play out. If this were a baseball game, we’d only be in the first or second innings. We’re not out of the woods as to whether fixed income markets will be in trouble – mortgage markets, municipal bonds, corporate bonds. What will the US financial stimulus effects be on inflation and commodity prices? What will happen with US non-farm employment figures in the next few months, having fallen by 20.5 million so far?
“We know that small and medium-sized businesses across the US are suffering. We know that a lot of service industries – restaurants, airlines, shopping malls, movie theatres – are suffering. Will people even go back to eat in restaurants post the pandemic like they used to? We don’t know the psychological impact of Covid-19. There are lots of unanswered questions that will have an impact not just on the US economy, but the global economy.
“The best course of action, which is what Lighthaven is doing, is to stay focused on the impact of individual companies, while closely watching the macroeconomic picture,” comments Chung.
This is where having a long-term investment perspective helps. Right now, Lighthaven is looking to increase the size of its long positions in companies it thinks will survive, and potentially do even better in the future.
“DocuSign is the global leader in document e-signatures and they were doing well before the pandemic; I think that company will continue to do well, going forward. A lot of SaaS and wireless companies will also do well,” suggests Chung, adding that the most important metric for Lighthaven when putting on a long position is consistent growth of earnings.
“There are exceptions, DocuSign being one of them, but generally speaking we want to see a strong track record of earnings growth. There is also a qualitative factor. How likely is it that a competitor could disrupt a company’s business model? That is what I spend most of my time critically assessing.”
One industry that Chung finds particularly interesting, thematically, is video games although Lighthaven does not yet have any open positions in this industry.
“We’ve looked at Take Two, Activision and Electronic Arts but we haven’t yet taken any positions in the portfolio. We haven’t found a company that meets our rigorous investment criteria. But if I could find a small company that has an economic moat and longer term could survive competition, I would absolutely consider it,” he says.
For now, Chung and his team will continue to research companies that fit Lighthaven’s investment philosophy and wait for the right moment to increase the fund’s long bias. In the meantime, to demonstrate Lighthaven’s commitment to the ‘S’ in ESG, Chung concludes by confirming:
“Covid-19 is affecting everybody on the planet and millions may die. We are all in this together and while I’m not a doctor or a scientist, I can help to fund research, prevention and awareness.
“For that reason, we will be donating 25 per cent of our 2020 performance fee to organisations that are fighting Covid-19. I hope our example will encourage other hedge funds to do something similar.”