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Trading through the turmoil: Argonaut Capital looks to maintain momentum post-lockdown

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After generating double-digit returns during the coronavirus-fuelled market downturn with short alpha bets, Argonaut Capital Partners is now building key positions in cyclical industries to take advantage of the post-lockdown recovery.

After generating double-digit returns during the coronavirus-fuelled market downturn with short alpha bets, Argonaut Capital Partners is now building key positions in cyclical industries to take advantage of the post-lockdown recovery.

The London-based equities-focused firm’s core long/short hedge fund strategy, the Argonaut Absolute Return Fund, advanced an eye-catching 23 per cent in the first quarter, trading a mix of UK, US and European equities.

Its performance was powered by the firm’s fundamental, bottom-up approach to stock selection, built around founder, CEO and CIO Barry Norris’s concept of ‘earnings surprise’.

“Essentially, we want to be long the stocks that we think will earn more than the market expects, and short those that we believe will have negative profit warnings,” explains Norris, who oversees the Argonaut Absolute Return and Argonaut European Alpha funds, as well as the Argonaut European Income Opportunities strategy.

“The one important thing that we always try to get across is that we’re trying to make money from longs and shorts, or double alpha, rather than positive or negative beta,” he says of Argonaut’s investment style. “We are very fundamental – we only take single stock positions.”

Prior to launching Argonaut, Norris managed European equities for Neptune Investment Management between 2002 and 2005, after beginning his career at Edinburgh-headquartered asset manager Baillie Gifford.

A cautious stance

Reflecting on Argonaut’s recent showing, which saw the firm’s flagship fund flourish as large swathes of the hedge fund industry’s performance plummeted, Norris tells Hedgeweek how he maintained a cautious stance on global growth estimates, which he regarded as being “overhyped” on the back of the apparent trade war resolution at the start of the year.

As cases of the novel coronavirus continued to spread outside of China during February, Norris’ view on markets grew even more bearish, a stance that would ultimately power the fund to its stellar 15 per cent March gain.

Roughly a third of Argonaut’s overall Q1 returns stemmed from its short bets, he explains, even though the firm was positioned net long overall. 

“We’ve got a pretty good record in short alpha over a long period of time, but obviously what makes this year different from previous years is that the market returns have been negative – our short alpha has translated into significant gains,” he adds. “We had a lot of shorts of paid off spectacularly well in Q1.”

As markets began to trend upwards at the end of March, the strategy maintained its momentum, taking profits predominantly from its long positions – including Amazon, Just Eat and Russian gold mining company Polyus.

Maintaining diversity

With the fund still up around 22 per cent year-to-date, the fund is now gradually increasing its net positioning, buying selected cyclical sectors on the long side and taking profits from short selling certain names, partly as a result of the rapid response by governments and central banks to the crisis.

As parts of the global economy look to tentatively re-open following the Covid-19 lockdown, hedge fund strategies of all stripes are weighing up how to trade any potential recovery.

For Argonaut, it means capitalising on certain cyclicals that remain fundamentally strong despite selling-off during Covid-19 downturn.

“We try to maintain diversity, and one the things we’ve learned over a long period of time is to avoid binary outcomes,” says Norris.

Elaborating on this point, he continues: “Even though in March we were having a great month, we realised that, at least in the short-term, asset prices often mean-revert, particularly in a bear market. We were taking profits in our shorts, but we were also thinking about what cyclical part of the market we should be adding to.”

Specifically, he zeroes in on the semiconductor industry and the UK housebuilding sector as particularly attractive bets for Argonaut’s main fund.

“Semiconductors are normally very cyclical, but during this sell-off there are more people working from home. Whether it’s video conferencing, smartphones, 5G internet – there’s a need for electronics,” he observes, adding that very few firms in the semiconductor space have had profit warnings.

“It’s also an industry that may be moving from being in a global supply chain to one where there’s a separate Chinese supply chain, and a separate US supply chain. This will inevitably lead to more semiconductor capex and more opportunities. We really like this sector.”

Meanwhile, he describes the UK housebuilding industry as “a very good business” heading into the virus downturn, before companies in the sector saw share prices halve within a month. But despite that hit, it remains a key area of the economy likely to enjoy continued government support, given both its broader importance to the UK economy, as well as being politically vital, in light of the UK population’s perennial home-owning aspirations.

“If people are going to stay at home more, it’s not then logical to think they won’t want to have their own home,” Norris observes, outlining the position idea.

He suggests that with record low interest rates of 10 basis points, the cost of buying – excluding transaction costs and stamp duty, which he says are “still too high” – remains much cheaper than renting.

“We felt it would probably be one of the first industries to go back to normality in terms of workers returning, and therefore demand would probably also come back fairly quickly,” he continues.

“There’s a debate over whether house prices will fall with more people unemployed, and whether they’d be able to afford mortgage payments.  In a normal economic situation that might be true, but in this one, with interest rates nearly zero, I don’t think there will be that many people forced to sell their house. We very much think that is a very good play on the recovery as well.”

A degree of normality

Looking at the broader macro environment, against a prevailing backdrop of central bank stimulus and government support for the broader economy, Norris describes the behaviour of the stock market in recent weeks as “quite rational”.

“The stock market is willing to be a lot more long-term than what people give it credit for, and is better able to discount some of the concerns and fears people have got about virus, compared to what they’re seeing immediately in terms of lockdown,” he observes.

“During the financial crisis it took the Federal Reserve a long time to do QE, and when they did QE they were just buying various different maturities of treasuries. Here, though, they’ve pretty much come in straight away and announced unlimited QE, and they’ve been buying high-yield bonds, municipal bonds, going all the way up the risk curve as well,” he says.

“Of course, that can’t have any stimulative effect on the real economy for people who aren’t allowed to work. But what it does do is it gives confidence in the shape of the recovery, and it means that asset prices are supported because there is essentially a buyer-of-last-resort in the market.”

He adds: “It’s a natural human emotion to extrapolate from the recent past and think it’s going to last for a long period of time, but we will inevitably return to some degree of normality.”

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