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Argonaut’s Norris explains Q1 fund underperformance

28 April 2017

FE Alpha Manager Barry Norris talks through the challenges faced by the FP Argonaut Absolute Return fund during the first quarter of the year.

By Rob Langston,

News editor, FE Trustnet

Barry Norris, lead manager of FP Argonaut Absolute Return, says he may consider adapting his shorting strategy for the current market environment after the fund dropped to a loss during the first quarter.

The FE Alpha Manager noted that the long/short fund fell by 3.4 per cent during the first quarter of the year compared with a 1.02 per cent gain for the average IA Targeted Absolute Return sector fund.

Performance of fund vs sector during Q1 2017

  

Source: FE Analytics

He said: “If you look at attribution more than 100 per cent of the loss was caused by the short book. The short book is essential to the product in delivering non-correlated returns but it’s very difficult at the moment to deliver short alpha.

“The long book delivered positive returns but not as positive as the market return overall.”

First quarter losses follow a difficult 2016 for the £137m, one crown-rated fund when it recorded a 26.2 per cent loss.

The fund is managed using the manager’s “earnings surprise” investment process, which aims to identify companies with significant upside or downside potential.

Norris said: “The short book despite receiving earnings downgrades continues to be a drag on performance, but the existence of a short book is necessary for the low market correlation.”

The fund manager hinted that underperformance of the shorting strategy could prompt a rethink of how it is constructed.

He said: “Outside of the earnings season, stockpicking was drowned out by rapid sector rotation based on correlation to bond market which in turn were based on political position rather than economic.

“In order to adapt the process for the current market environment we certainly think that post-earnings season, where there seems to be more of a connection to fundamentals, we could look just to run a short book based predominantly on lower growth rather than a bigger net [position].

“Certainly that way as well we would take more modest sector bets. I think that when the environment for shorting been so difficult in terms of being rewarded, we can certainly better manage any drag on performance.”


Despite the underperformance of the fund during the first quarter, it did enjoy some success in both its long and short books, said Norris (pictured).

Contributors to performance in the long portfolio were Danish wind turbines company Vestas Wind Systems, Swedish cosmetics firm Oriflame, and Russian airline Aeroflot. On the short side Norwegian Air Shuttle, UK firm Standard Life and Marine Harvest were the best performers.

Detractors from performance included salmon farmers Norway Royal Salmon and Grieg Seafood and French miner Eramet on the long side. London-listed silver miner Fresnillo, German energy firm E.On and French satellite provider Eutelsat on the short side.

He said: “There are no huge winners or losers in terms of stock specific but if you look at the fundamentals in the long book and the short book the process is based around being long stocks with potential for earnings upgrades and being short stocks with potential for earnings downgrade."

Norris added: “One of the frustrations in the market at the moment is that normally there has been a greater synchronisation between upgrade/downgrade share price performance.

“That’s why the strategy has worked pretty well over a number of years. But we’re continuing to see this disconnect between sync of upgrades and share price performance.”

Despite some of the challenges under current market conditions, Norris says he is still finding opportunities on both the long and short side.

He said: “The biggest net long position is in financial and industrials. We’ve recently added shorts in materials offsetting longs a bit more in sector. It’s a reflection of the fact that the momentum in commodities seems to have peaked.”

Another short area identified by Norris is the consumer discretionary where the fund has recently taken a bet against jewellery company Pandora.

He said: “Pandora was a company had been long from 2012 to relatively recently. Our view on stock has changed 180 degrees.

“The main problem with this company at the moment is momentum slowing everywhere.

“All along been view of company that bracelets and charms have very high fashion risk and that fashion risk will fade over time.

“Whenever get slowdown in sales momentum reflected a lot more in retailers where there is less fashion risk.

The fund manager said the catalyst in terms of a slowdown is in US mall traffic where footfall has slowed. He also highlighted a restructure of its sales reporting in the US where a significant part of its business is in franchised stores.


Norris also noted that internet search enquiries for Pandora – quite highly correlated to sales - had also fallen.

“It’s not an expensive stock but the problem is it will always trade on like-for-like sales, as that slows will cause significant derating in what has been a very popular stock for investors today,” he said.

Another recent short position is in Bank Norwegian, where Norris feels that strong growth in the sector has been fuelled by fast lending standards.

He said the bull case for the stock is that non-performing loans (NPL) in Norway are easier to enforce than in the rest of the Europe, but warns that default ratio reporting usually follows 12-18 months after the loans have turned bad.

He said: “When it reports NPL ratio always reporting loans turned sour hey 18months ago rather than loans today. The faster they grow more the ratio will be flattered by higher assets sand lower NPLs. Conversely, if growth slows the NPL ratio goes up.”

Norris said regulatory pressures in Norway are likely to slow top-line growth and force it to expand elsewhere so the NPL ratio doesn’t spike up.

He said: “We generally think earnings are at risk because the company is not provisioning for lending.

“The final question mark on stock is that the CEO who managed the business for a number of years retired in January and as far as we can work out he sold all his shares. This is small position at the moment but think outlook will get worse going forward.”

Performance of fund vs sector over 3yrs

  

Source: FE Analytics

Over three years the fund has lost 9.78 per cent compared to a 7.41 per cent gain for the average sector fund.

The fund has an ongoing charge figure (OCF) of 1 per cent, as at 15 February.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.