Back in December, Stephen Roberts was feeling quite confident about the markets.
Not only had he positioned his Horseman European Select Fund portfolio to run roughly 107 percent net long, Roberts told clients he was using a recent sell-off in emerging markets and commodities to add about 20 percent to his personal position in the strategy.
As it turns out, this was not a good decision. The long-short equity hedge fund, managed by London-based Horseman Capital Management, went on to lose money in seven of the first eight months of this year. At the end of August, it had plummeted more than 33 percent for the year, making it one of the worst-performing hedge funds this year.
Including a loss in December 2015, the fund has lost money eight of the past nine months. As a result, the strategy’s assets — which include those in the fund — have nearly halved, to just $562 million from more than $1 billion at the beginning of the year.
Horseman European Select should not be confused with Horseman Global Fund, Horseman Capital Management’s wildly successful multistrategy fund, which has been among the best performers over the past few years despite running significantly net short for most of the time. That fund, managed by Russell Clark, is down 1.7 percent or so this year through September 21.
A look at Horseman European’s month-to-month moves — as detailed in its monthly letters to clients — provides an interesting insight into how the fund sank so swiftly, tried to react to losses and revamped its portfolio in an effort to turn things around. In Horseman’s case, all it did was stem the decline, not reverse it.
At the beginning of the year, Horseman European — which aims to invest 75 percent of its assets in European equities, both long and short — was heavily long a variety of global banks. They accounted for all of the fund’s top ten holdings, which accounted for roughly half of the fund’s net asset value. However, the fund lost 16.8 percent in January amid the global market’s wider sell-off.
“The storm that is currently passing through global financial markets resulted in your fund’s economically sensitive bank holdings having a substantial drawdown,” Horseman told investors in its January 2016 letter. “Unlike 2007/8 we believe that this storm will not result in any permanent damage and will pass without affecting the future earnings power of your holdings.”
However, Horseman European lost another 8.3 percent in February. Remember, 2016 started off very rough for stock investors, with the markets tumbling until they abruptly reversed course in mid-February. Many other fund managers who were highly exposed to other sectors like technology and Internet stocks, or to stocks that were the targets of activist investors, were also hurt badly.
In its February report, Horseman told investors it remained confident in its long positions, especially its bank stocks. “We feel strongly that the stock markets’ current concerns will not affect the future earnings power to anywhere near the extent that has been reflected in the recent stock price falls. This should result in the current losses in the fund being transient rather than permanent,” the letter stated.
Alas, the fund lost another 1.2 percent or so in March. The manager then decided to shift course, lamenting the fund’s inability to monetize the European Central Bank’s latest easing efforts. Horseman told clients it planned to liquidate much of the fund’s long exposure and “probably” move to a net short equity position.
Sure enough, Horseman European was just 28 percent long, 50 percent short, for a net short exposure of 22 percent by the end of April. But the fund still lost more than 6 percent that month. Horseman explained that the fund was repositioned to benefit from slower economic growth “and a more entrenched deflationary period.”
Its long portfolio mostly consisted of what the fund called “businesses whose innovations are deflationary and are causing huge disruption across the industries in which they operate,” such as Alphabet, Apple and Tesla Motors. It also initiated long positions in the world’s top three lithium producers, “as global battery consumption is set to quintuple over the next ten years,” the letter said.
Meanwhile, Horseman shorted the commodity sector and reinstated its short bets against oil companies, especially after many of them enjoyed sharp rallies. Horseman also said it was building a short book in the European industrial goods sector, geared toward companies that are exposed to China. Altogether, Horseman European had more than 70 short positions and ten or so long positions.
By the following month, it further boosted its short book, betting against companies that it deemed to be victims of disruptive technology advances or beneficiaries of easy credit, such as autos, big-box retailers, aircraft makers and aircraft leasers. It also started ramping up its long exposure to gold-related stocks.
This revamping partly helped in June, when the fund returned more than 6 percent. But that proved to be Horseman European’s only profitable month of the year.
After the June Brexit vote, Horseman added to its gold positions, which accounted for 24 percent of assets by the end of the month. By the end of August, the fund was 63 percent net short, and five of its top ten long positions were gold-related equities, including the top two. It was also short banks.
This huge reversal of bets only exacerbated Horseman European’s losses, however. The fund dropped another 5.9 percent in August.
“Whilst investors who have bought into the equity markets at the February lows have made some strong gains we believe these gains could be quickly dissipated as the fundamentals required to sustain future economic growth are now moving in the opposite direction,” Horseman wrote in the August letter.
In the meantime, those investors are probably up, and Horseman is in a deep hole.
