Jittery investors are generally spooked by the financial and currency crisis in Turkey. Robert Citrone of Discovery Capital Management is not.
His volatile macro hedge fund, Discovery Global Opportunity Fund, has been short Turkey across asset classes. In the second quarter, the fund made money betting against equities, particularly financials, as well as against its currency, the Lira, according to Discovery’s second-quarter letter, obtained by Institutional Investor.
This indicates that the fund has most likely benefitted from the currency’s collapse in recent days given that shorting Turkey continued to be one of its key themes heading into the third quarter. After posting a paltry 0.27 percent gain in July, Discovery was up 6.66 percent for the first week and a half of August alone, through Friday August 10, according to an investor in the fund. As a result, the fund, which lost 9.8 percent in the first quarter, is roughly flat for the year.
“The worsening political situation in Turkey became more acute in the second quarter, as [President Recep Tayyip] Erdogan won the election on June 24 (as expected) and has taken further steps to consolidate his power,” Citrone told clients in the letter.
He added that since the election, Erdogan abolished the role of Prime Minister, expanded his power and began “exerting his influence” over the Turkish central bank. Noting also the country’s current account deficit and fiscal deficit, Citrone added, “We believe that Turkey is among the EM (emerging markets) countries most vulnerable to a rising interest rate environment and a stronger dollar.”
However, one trade that has most likely fared even better for Discovery is its continued short bet on Italy.
The fund’s negative bet on the Italian fixed income and equities markets drove gains in the second quarter — when the fund rose 4.68 percent — even though the markets reversed course somewhat in June, according to the letter.
One investor who was on a recent conference call hosted by Discovery believes the fund has made a lot of money this month shorting Italian 10-year bonds. Discovery declined to comment.
Citrone became concerned about Italy’s political stability following the March 4 elections, which highlighted a majority support for anti-establishment parties on both the left and right.
“For nearly three months following the elections, the populist parties on both the right and the left had been in negotiations on government formation, and their inability to find common political ground led many market participants to write off the likelihood of their success,” he added in the letter.
Citrone thinks subsequent developments and tensions related to forming a coalition government highlights “inevitable tensions between the European establishment and populist forces,” according to the letter.
“The political situation in Europe, led by the political disruption in Italy, is one of the largest risks global financial markets face, in our view, and this theme remains a high conviction idea in the portfolio,” Citrone told clients.
Discovery’s 12-page second quarter letter in general provides a rare insight into the positioning of the fund headed by Tiger Cub Citrone, who pursues macro and long-short equity strategies, combining a macro, top-down view with bottom-up fundamental analysis.
At the start of the third quarter, Citrone said Discovery’s key themes were shorting Italy, Turkey and South Africa; U.S. special situations; and long global technology companies, including pre-IPO positions.
The fund continues to be long equities in India and long Argentina “across asset classes,” but Citrone added it has reduced its risk allocation to each.
Discovery also continues to be long energy companies, mostly in the U.S., citing what it believes to be tight global supply. It is also short “select global consumer products and traditional retail companies.”
Citrone appears to be growing more concerned about the financial markets in general.
“While we started the quarter with constructive positioning in equities, largely driven by our longs in technology and longs in energy, we anticipate that our portfolios will be postured increasingly defensively into the third and fourth quarters of 2018,” Citrone said in the letter.
Noting the geopolitical risk in Italy and other parts of Europe, the mid-term elections in the U.S., “the Trump administration’s America First policy,” trade tensions, protectionism, and “soured” diplomatic relations with key European allies, among other reasons, Citrone warned: “We are growing more concerned about a broad and potentially significant correction in markets, with Italy and Europe the likely catalyst for such a sell off.”
