The manager of Octopus Absolute UK Equity blames poor timing in short calls for the fund’s protracted underperformance. But the long plays are helping it to outpace its benchmark again.
Back in August 2009 David Crawford was riding high in the performance tables. His fund, Octopus Absolute UK Equity, wasn’t just top of its sector but beating almost every fund. The FTSE was showing a loss of 14% over the year but Octopus was enjoying a gain of 56.9%. It was little wonder that more than £1m a day was gushing in from financial advisers. But today the fund is rock bottom, ranked 40th of the 40 funds in the Absolute Return sector. In 2010 it lost 8.6% when the average absolute return fund gained 4.4%.
To Crawford’s credit, he’s not hiding in a corner. He’s happy to talk openly and honestly about what went wrong – which might be because the fund has picked up, and over the past six months has begun to once again outpace the sector.
When I last interviewed him, in August 2009, he was concerned about over-optimism. “My main fear is that if we hit 5,000 [on the FTSE 100], many people will get sucked back into the market and from that level the risk return may be better on the short side, or simply to be in cash.” He felt that mining stocks were over-bought, and that despite the recovery in financials from their near-Armageddon lows in March 2009, there was still plenty of upside. He was long the likes of Lloyds TSB and short the miners such as Rio Tinto.
”We were too early. It cost us quite a lot of money”
In the event, the market powered through 5,000 and kept rising. And Rio Tinto was one of the biggest beneficiaries of the rebound in the world economy, especially in emerging markets. The fund turned south, losing 5.2% in October 2009, then another 4.7% the following month. In the first half of 2010, it lost money in five out of the six months. “I still think some financials have merit and have longs in two of them. But the difficulties that investors have in analysing their balance sheets means that lots of people are still avoiding them.
“We lost in the short book from September 2009 onwards. In emerging-markets facing stocks, such as mining and industrials, we felt that many stocks had gone too far too fast. That is, to a degree, now coming through, but we were too early. It cost us quite a lot of money.” He had short positions in Vedanta, Rio, and Xstrata. If you take a look at the share prices of any of them you really wouldn’t have wanted to be shorting them in September 2009. (article continues below)
Crawford blames the mistake on taking some big macro calls, and today talks a lot about focusing on stock fundamentals. He’s decided to reduce the positions in the fund, but at the same time he has moved up the market cap scale for reasons of both liquidity and value. And he has reduced the number of short positions too. “We don’t want short positions for the sake of it,” he says. “We are trying to be more focused, as we can see from the past that we have made most money from our high conviction ideas.” Ideally, he says, he sees the fund as having just 30 positions, although it’s more in the 40-50 bracket at the moment.
What’s interesting about Octopus Absolute UK Equity is that while it’s evidently one of the most volatile and racy funds in the Absolute Return sector, it’s also in some ways one of the most plain vanilla. Crawford has little interest in the sort of black-box approach that some hedge fund managers take. The ’strategies’ that other hedge fund managers take hold little interest to him. Yes, he has a ’pair’ of long BP and short Shell, but not because he was looking for a pair, but because they came up either cheap or overvalued on a fundamental basis. He either has conviction on a stock and goes long, and holds it for some while, or shorts it because he sees it as overvalued. It’s as simple as that. He’s 100% long and 30% short, giving a net 70% long position. “From that I suppose you can say that we are broadly positioned for a rising market,” he says.
In his long book, he likes Vodafone for its cash characteristics. “It has high free cash flow and I think that we’ll soon see it start to pay dividends from its Verizon business in the US, or do a share buyback. The p/e [price/earnings ratio] is still sub 12 times.” He admits it’s not quite the most exciting stock he’s ever held, but says undervaluations are less easy to spot outside the mega-caps.
“In late 2008 there were lots of stocks across the market which had fallen. Today what we see is that the large caps have been left behind in the recovery.”
BP is another big position. “I still think it could be 20% higher than where it is today.” Before the spill, it was trading at more than £6, today it is just below £5 yet the oil price has risen since then. Yes, there’s the clean-up costs, but Crawford is confident that they won’t wreck the company.
He also holds National Grid, which he reckons is a good play against inflation, and has an undervalued American business. “I think investors will be looking to protect themselves against rising inflation. Bonds don’t look attractive, cash is paying zero, so equities look the place to be.”
He has been reducing his small cap exposure, but does retain a holding in one of the stockmarket’s more peculiar companies – Horizon Acquisition. It’s a shell company set up by Hugh Osmond, an entrepreneur. It has a structure similar to Resolution, which raised just over £400m in February 2010. But it’s not after zombie life companies, but heavily-indebted corporates that it can turn around.
On the short side of the book, Netflix stands out. It’s an American business much like LoveFilm in Britain, which its fans see as the successor to Blockbuster in the film download market. “It has been a hot stock, trading on 60 times and with a $10 billion (£6.4 billion) market value. I think it is massively overvalued, given the amount of competition it faces and issues over how much it will have to pay suppliers for content.”
Investors who stuck with Crawford will be hoping he’s right. Investors have made gains in five of the past six months. There’s a 20% performance fee, but as it doesn’t pay out until underperformance has recovered, Crawford didn’t get any bonus last year. Let’s hope for both investors and Crawford that he starts earning that fee again soon.