Shorting COVID winners as traditional businesses rebound

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Perpetual

Perpetual Asset Management

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Portfolio managers Anthony Aboud and Sean Roger on why the Perpetual SHARE-PLUS Long-Short Fund sees a lot of COVID changes as transitory rather than permanent and has the short book to back up this view.

Could you start by introducing yourselves?

My name's Anthony Aboud. I'm the lead portfolio manager of the SHARE-PLUS Fund. I've been at Perpetual for nine years.

My name's Sean Roger, I'm the deputy portfolio manager of the Perpetual SHARE-PLUS Long-Short Fund. I've been at Perpetual for eight years.

What makes the SHARE-PLUS Long-Short Fund unique?

The SHARE-PLUS Long-Short Fund at its core is very similar to a lot of other Perpetual funds in so far as it invests in ASX-listed companies. It has two unique quirks though. One is it can invest up to 20% globally, which it has in the past and done very successfully. And the other quirk is that it has got an ability to short stocks, so bet that those companies can go down.

How does that work in practice?

What we want to try and do with this is leverage our big analyst team. Not only to make investments on the up, but to actually find companies where we think are overvalued or have structural issues facing it, and we can make money and generate alpha for our unit holders on the down as well. Shorting has been pretty tough over the last few years, but we're starting to really see some really good opportunities of companies where the share prices are representing some speculative excesses. And we think there's some really good alpha to be generated on the short book.

And that means embracing volatility?

For an active manager like us, we love volatility. It was tough at the time when we saw the market fall 36% in a couple of weeks. However, you’ve got to take advantage of these opportunities to find really good investment ideas. And we did that. The whole team really focused on not worrying about the short term but looking mid cycle. Let's look over what the earnings are going to look like in three-year’s time and then also still focus on the forensic accounting to make sure that the balance sheets are fine, that the company does not need to raise equity in a dilutive nature. And we found some really great ideas, whether it be companies like AP Eagers, Crown, the banks, or even McMillan Shakespeare. These are companies which had halved but we found great opportunity to buy them when everyone else was selling

What were some of the lessons from COVID?

There has been a lot of focus on the COVID winners or companies that have benefited from changes in consumer behaviour or the lockdowns associated with COVID. There's clearly been an acceleration in some of the structural shifts during this period, whether that's the consumers purchasing from retail shifting to online or people working from home. The market's taking quite a strong view on some of these and any of the companies that are exposed to those trends have been the COVID winners, they're bought at any price, and they've wanted to get exposure to.

How have you made the most of the opportunities?

We found a bit of opportunity through really focusing our attention on trying to unpick whether these trends are in fact structural or whether they just transitory movements. Where we've seen, I guess, a bit of a difference, in our opinion versus the markets, we've put on some exposures there. Especially on the short side, some of these COVID winners have been high-flyers. We've viewed a lot of the benefits they’ve had as being more one-off than permanent. So, we've put on a number of positions on in the short book to reflect that view.

Where do you stand on inflation?

It's the big debate of the day, the big inflation debate. Is it permanent? Is it transitory? It's hard to know. I mean, we've got a bit of a unique aspect here because we as a group get to speak to hundreds of CEOs within Australia, so we're always asking them. Across the board, they are seeing more than just pockets of inflationary pressures, whether it be scarcity of assets or just outright inflation. What started as just being a couple of pockets like in Western Australian labour or shipping rates has really become a little bit more broad-based. We feel that, potentially, there's a little bit more longevity to this inflationary scare, just from the fact that we are seeing the fiscal dominance of governments all around the world, or the Western world especially, are happy to build up fiscal deficits to stimulate the economy with virtually no one really pushing back against them. We can see this being a multi-year phenomenon.

How can the Fund benefit from this reflationary trend?

What's interesting here is it's only been one-way traffic for the last 40 years, so far as it's been really a bond bull market and we've seen disinflation or deflation for that period of time. We haven't really seen many fund managers run money during an inflationary or increasing interest rate environment. So, it's going to be very interesting. Can we make money from that? I think on the long side, absolutely. From a reflationary perspective, commodities generally do very, very well. Cyclicals definitely in the early stage of a reflationary cycle should do extremely well. And we feel that in the financial sector, we feel that there's some good opportunities as the banks and insurance companies can invest there and generate a yield in their assets side of their book.

What other companies or sectors meet this brief?

The other places we're seeing good opportunity is a recovery in some of the sectors which were hit by COVID. Whether it be Event or Qantas, et cetera. They're the sort of the opportunities that we see. On the other side of the coin, we feel that long duration assets, whether it be bonds or equities, suffer in an increasing interest rate environment. When I'm talking about long duration, I'm talking about companies which may not make any money today, but there's promise of money to be made in 10 or 15 years. In the zero-interest-rate world, they're worth a lot. But as interest rates start to increase, those companies come under a lot of pressure. And we typically don't own those companies or are short.

Can you take us through an example of where you are looking to short?

There's a lot of leverage in speculation in markets today. You don't have to look further than the US where you've seen a $350 billion increase in the level of margin loans in the market, a doubling in the number of Robin Hood accounts or a four-fold increase in the number of unprofitable tech companies that are listed. In that environment, we see a lot of opportunities to short companies where the market's more focused on a narrative as opposed to long-term fundamental drivers. One particular area where we see a lot of opportunity at the moment is in the e-commerce space. These group of companies were obviously very big beneficiaries during the COVID period. Sales are very elevated due to consumers shifting their purchasing patterns from retailers to online, given that they were locked at home and not able to go outside. They also saw big increases in their margins during this period. There was limited stock availability, so they didn't need to discount and they didn't need to cut prices at all, because the goods were just flying out the door.

The share prices of these companies reacted very strongly accordingly. Some of them were up three to four times during this period, which suggested to us that the market viewed them as better businesses coming out the other side of COVID. This may be the case and there's arguments to suggest it will. You've had that acceleration in the shift from retail to online purchasing and these businesses have had a massive increase in the number of customer accounts that they've got. So, there's reasons to suggest they may be better businesses. We take a more cautious approach, and we think that some of the benefits they had during 2020 will prove to be transitory, but we also see some risks on the horizon in terms of increased competition for them online. You've had a lot of traditional retail businesses had their focus turned to the online space and you've seen Wesfarmers, Woolworths, and even Amazon really ramp up their investments in more recent times.

We think this will negatively impact the e-commerce players in one key way and that is the cost of their customer acquisition. We view that as the online rent, they're not paying rent for storefronts, but they do need to pay to acquire new customers and as competition increases, the price they've got to pay to Google, and these companies we think will also increase. So, whilst we see they've clearly been beneficiaries in the short-term, we see some risks rising that over the long-term they may in fact face more competition than what they had pre COVID. Given the share prices are still elevated, we see some really good opportunity to make some money on the short side there and we've got that exposure in the fund.

 

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This information has been prepared by Perpetual Investment Management Limited (PIML) ABN 18 000 866 535, AFSL 234426. It is general information only and is not intended to provide you with financial advice or take into account your objectives, financial situation or needs. You should consider, with a financial adviser, whether the information is suitable for your circumstances. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. The information is believed to be accurate at the time of compilation and is provided in good faith. This document may contain information contributed by third parties. PIML does not warrant the accuracy or completeness of any information contributed by a third party. Any views expressed in this document are opinions of the author at the time of writing and do not constitute a recommendation to act. This information, including any assumptions and conclusions is not intended to be a comprehensive statement of relevant practice or law that is often complex and can change.

The product disclosure statement (PDS) for the Perpetual SHARE-PLUS Long-Short Fund, issued by PIML, should be considered before deciding whether to acquire or hold units in the Fund. The PDS can be obtained by calling 1800 022 033 or visiting our website www.perpetual.com.au. No company in the Perpetual Group (Perpetual Limited ABN 86 000 431 827 and its subsidiaries) guarantees the performance of any fund or the return of an investor's capital. Total returns shown for the Perpetual SHARE-PLUS Long-Short Fund have been calculated using exit prices after taking into account all of PIML's ongoing fees and assuming reinvestment of distributions. No allowance has been made for taxation. Past performance is not indicative of future performances.