Pronounced points of macro inflection, holding a number of historic winning trades and avoiding picking from the bottom of bear markets led to the underperformance of FP Argonaut Absolute Return in 2016, according to manager Barry Norris (pictured). 
The FE Alpha Manager, who has run the fund since its launch in 2009, says last year presented a series of unique challenges for active managers irrespective of views on market direction.
Not only this, he points out that two of his long-term investments were subject to takeover bids unexpectedly blocked by the US government.
“’F*ck You 2016…a look back on the worst year ever’ is the title of a best-selling book, currently sold out on Amazon UK. These are sentiments with which many in the active fund management industry will share, unless you manage a commodity fund or a value strategy, in which case it was a welcome relief (perhaps vindication) after years of purgatory,” he wrote in his latest blog post at the end of last year.
“Generally, the more active the manager the worse the year. Mr. Market has made a fool out of us: for me it has been the most challenging year in the 16 years in which I have been running money.”
Norris explains that he looks for stocks which are likely to significantly surprise to the upside or downside, holding appropriately long or short positions in each.
This indeed worked well for the manager up until the end of 2015, given the £227m fund outperformed its MSCI Europe ex UK benchmark by 19.88 percentage points since launch with a total return of 114.86 per cent.
Performance of fund vs sector and benchmark since launch to 2016
Source: FE Analytics
Since the start of 2016, however, the fund has lost 25.63 per cent compared to its benchmark’s return of 19.4 per cent. It was also the worst-performing fund in 2016 within the entire Investment Association universe. FP Argonaut is not the only fund in the IA Targeted Absolute Return sector to fare badly over the course of the year though, as explored in an article published yesterday.
“There are in general two risks to the process: we fail to execute in the individual stock analysis in the identification of surprise, or earnings surprise stops being rewarded in the short-term owing to macro events that have the potential to radically change the future economic environment for stocks, rendering ‘bottom-up’ stock analysis (temporarily) backward looking and irrelevant,” Norris explained.
“We have always identified these macro-economic inflection points as the greatest risk to the success of our strategy, when the recent past can no longer be extrapolated as a guide to the future.”
“Previously, I would have identified 2008 and 2009, years of obscene macro volatility, as the most challenging. But even in these turbulent years, once the nettle of macro inflection had been grasped, stock picking became relatively straightforward. 2016 has presented a multiple of these macro inflection points, some of which may transpire not actually to be inflection points at all.”
In terms of whether the manager was too confident that previous fundamental trends would carry over into 2016, he admits that selling the winners of 2015 and buying the hardest-hit stocks would have benefitted the portfolio.
That said, he argues that the theory of mean reversion and contrarianism doesn’t always benefit the end investor.
“Although we have often had strong macro views at various points over the last decade we have never been wedded to an inflexible macro view that leads to dangerous ‘forever trades’,” Norris continued.
“The difficulty in 2016, however, has been to establish whether the macro facts have really changed, and if they have only changed temporarily is this an investment opportunity or an investment trap?”
“In other words, the process can cope with macro inflection points but only when they can be identified in a timely manner and endure long enough to be an investment opportunity.”
The manager points out the significant and inexplicable uptick in commodity prices, which sparked surprise reflation in the global economy.
Performance of index over 1yr
Source: FE Analytics
However, he believes a bull market is signified by a medium-term outlook on corporate profits in addition to price momentum and, as such, rarely picks the bottom of bear markets, instead waiting for confirmation that price momentum can be sustained through an inflection point in profits.
“A subsequent chapter [of “F*ck You 2016…a look back on the worst year ever”] focuses on ‘Politics and Politicians’ largely bemoaning Brexit and Trump. If the active fund management industry has had a poor year, then the science of electoral polling (psephology) has been equally discredited,” he said.
“For investors to pre-empt electoral outcomes, which to conventional wisdom seem remote, and change their portfolios in anticipation of such outcomes looks inspired in hindsight but somewhat less so on the balance of probability.”
“Moreover, whilst those who have championed Trump as a game changer have so far been rewarded, such has been the capricious nature of markets that the Brexit referendum (and the defeat for the Italian political elite in its referendum) has so far at least had minimal impact on risk appetite, despite lingering uncertainties.”
“There’s certainly a risk that the market has overestimated the future effectiveness of Trump in the US and underestimated the potential negative economic effects of anti-establishment politics in Europe.”
While cyclical and financial stocks have performed strongly and ‘bond proxies’ have underperformed, Norris warns that – excluding the US – 10-year government bond yields have simply retraced their downward movement since March.
What’s more, he says many economies (again excluding the US) are yet to offer the prospect of fiscal stimulus.
“Whilst it is certainly possible (even probable) we have seen the top of the bond market, it is debatable whether bond yields will continue to benignly grind higher on the back of stronger global growth,” the manager noted.
Performance of indices since 2016
Source: FE Analytics
“Moreover, the moves in eurozone banks witnessed over the previous few months – which has not yet been supported by a similar improvement in the outlook for profitability - would seem to imply a much more rapid return to economic normality in the eurozone than either its politics or economic outlook would necessarily support.”
“Will economic growth really be strong enough for the ECB to exit QE and embark on raising its deposit base without causing another eurozone economic and sovereign crisis?”
Overall, the manager says 2016 has been “uniquely challenging” for his investment process given the high number of macro inflection points. Not only this, takeover bids on two stocks from his 46 long positions were blocked by the US government, which has further hindered the performance of the fund.
“As we look forward to 2017, we can draw comfort from an investment process which, by and large, has served our unit holders well for more than a decade. However, a return to a more predictable political and economic environment would certainly make for higher conviction stock selection,” he concluded.
“My experience of equity markets is that periods of high risk tolerance that are not backed up by rising corporate profits normally fail to endure.”
“However, if there is any lesson from 2016 which can be extrapolated it is that when politics seems at its most malign, a way is normally found for at least a pragmatic economic muddle through. 2016 has proven that we and our strategy are not infallible, but sticking to our process always gives us our best chance of future success.”