From mainstream to niche: How energy specialist hedge fund HITE is thriving with bearish carbon outlook

Coal powered power station

Established in 2004, HITE Hedge Asset Management is an alpha-focused energy specialist hedge fund firm which trades a range of energy-related securities throughout the entire carbon value chain.

The Quincy, Massachusetts-based outfit’s approach comprises two main strategies: a long-running market neutral, pure alpha-focused, relative value product, which represents around 80 per cent of the firm’s total AUM of USD500 million, and a newer thematic, its short carbon strategy, which launched in 2018.

James Jampel, the firm’s founder, managing partner and co-CIO, and Matt Niblack, co-CIO, believe the fossil fuel industry is in a process of devolving from mainstream to niche, a perspective which underpins the broader investment philosophy at HITE.

“Dirty energy is a declining business,” Jampel tells Hedgeweek. “It’s a much smaller part of the indices now. There are fewer and fewer younger people coming out of business school wanting to be fossil energy analysts. There are whole swathes of investors who don’t want to be invested in this.”

Tools of the trade

The firm’s core strategy was initially founded as an arbitrage fund of master limited partnerships (MLPs), a publicly-traded niche in the US energy market, its origins partly reflecting Jampel’s background in management consulting and private equity.

By 2007, the firm’s assets had grown to USD60 million, before the global financial crisis struck and a wave of redemptions pulled HITE’s AUM down to under USD20 million by early 2009.

Despite that setback, the 2008 crash offered strong relative value trading opportunities in energy, recalls Jampel, which helped drive positive gains during 2009, with assets reaching USD125 million by 2012.

The original market neutral strategy has since expanded beyond master limited partnerships to focus on what Jampel describes as “the entire ‘dirty energy’ carbon value chain” – from exploration and production names through services companies to retail stocks.

“We don’t really provide any energy exposure directly. We use energy securities, both credit and equity, to help generate alpha.  We are arbitrageurs, and we use energy securities as our tools,” he explains.

“We have a covenant with our investors, that exists to this day, that we will not grow so large as to jeopardise our ability to deliver the alpha that we had promised.”

‘The core of what we do’

As interest in ESG (environmental, social and governance) and responsible investing has flourished among hedge funds in recent years, energy remained an unloved sector by many.

But just how did a group of long-term energy market specialists come to end up taking a decisive stance against the very industry where they had built their careers and reputations?

“We began to think a lot about why energy had been such a bad investment since 2010,” Jampel recalls of short carbon strategy’s origins.

“We looked at the overall sector. Is it based on commodities? Yes. Is it highly competitive? Yes. Is it capital intensive? Yes. Is the demand outlook good or bad? Bad. What is the commodity’s supply outlook – scarce or plentiful? Plentiful. Is there a presence of opaque foreign forces in the market? Yes. When we looked at the sector, everything about it came up negative.”

By 2018, Jampel and his team knew they wanted to create something new and different, which formed the basis of the HITE Carbon Offset strategy.

“We decided that we would still short the most overvalued and vulnerable names in the carbon value chain at all times. But with the new product, we would replace our carbon-related long book with a quant-based market hedge,” he says of the strategy.

“The bet would then become that carbon, or dirty energy, would underperform the market over time. There was a long discussion of whether the long book should be tilted towards renewables. But we decided to stick to what we knew: dirty energy, and hedge it with a quant-based market hedge.”

HITE’s short carbon fund, which manages around USD117 million in assets today, utilises a series of quantitative models identifying which securities on the long side, excluding carbon, are best able to hedge volatility out of short positions.

“This would allow us to offer this kind of short carbon exposure without taking market risk,” he says.  “It really is about shorting both equity and credit in the energy space and hedging it with non-energy credit and non-energy equity on the long side. That is the core of what we do.”

The approach has garnered solid returns for HITE. An investor letter seen by Hedgeweek shows the Carbon Offset strategy gained more than 22 per cent in the first half of 2020, and is annualising close to 20 per cent since its June 2018 launch.

Poll positions

Looking ahead, Jampel is resolute that this markedly bearish stance on the future of energy will continue to pay off, observing how a victory for Joe Biden in the forthcoming US presidential election will have a major impact on the sector.

“Our book is positioned to profit, just by its very nature, should Biden win,” he says of the approaching November poll. “Out of all the industries out there, energy is singularly vulnerable to a Biden presidency because it has no friends anymore, unlike pharma or tech, which have helped us during this virus.”

He adds: “If Biden gets in it, there’s never going to be another significant piece of fossil energy infrastructure built in the United States again.  Why would there ever be another pipeline, for instance?”

As the interview draws to a close, Jampel reflects on what sets HITE’s investment style apart from other asset managers within this sector. 

“If you want exposure to the decarbonisation trend, you can either go long the winners or short the losers,” he observes.

“Other hedge fund managers traditionally might have had a market neutral long/short product, and then a long-only fund. But we do the opposite. Shorting the losers plays into our strengths as a firm.”