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BlackPearl Masters Fund Newsletter February 2020

During February the fund finished down 4.8% as markets worldwide sold off aggressively in response to the outbreak of the coronavirus. While the fund was down it did manage to perform better than the overall market with two of our nine strategies managing to generate positive performance for the month.

Fund strategies that were weakest had exposure to resources and energy sectors which were the worst performing sectors during the month while the strategies that performed best and made gains had significant short exposure, substantial hedges through options or were long the VIX.

Our long short global value strategy was up for the month as it made significant gains on many of its short positions as well as gains on put options purchased to hedge the portfolio from any unforeseen events. These put options proved very valuable as they significantly increased in value due to the high velocity fall in equity prices and the increase in implied volatility which makes options more expensive.

Additionally, our volatility focused strategy also generated gains as the VIX index moved higher on the back of the high increase in expected volatility. The VIX or volatility index is an index that measures the markets expectations of the 30-day forward volatility. The index is derived using price inputs of the S&P500 index options and is generally considered a good measure of the level of risk, fear or stress in the market.

We have continued to invest in the VIX strategy as the VIX index has historically had a strong inverse relationship to the equity markets, meaning it has tended to go up during times when equities have gone down. As a result, we employ the strategy and view it as an insurance policy that we expect to perform well during times of market stress like we are experiencing now. As equities have continued to sell off in March the manager of the VIX strategy has continued to report strong performance for this strategy.

As at the time of writing we have seen the fastest market sell off in the ASX200 only surpassed by the 1987 crash. In many cases we have seen indiscriminate panic selling by investors as countries around the world move into lockdown in order to contain the virus. While there is no doubt that in the short term many companies will need to downgrade earnings, it is important to remember that the value of a business comes from the sum of all its future cash flow and not just 6-12 months of earnings.

Additionally, while we will see negative economic growth in the short term, we are seeing very positive moves by Governments around the world that are providing unpreceded stimulus packages. At the same time the world central banks are stepping in an providing enormous liquidity to capital markets by slashing interest rates and engaging in quantitative easing. Locally Australia is set to inject $189 billion into the local economy which equates to circa 10% of GDP.

At the same time, we are starting to see reports that China infections have started to slow with the majority of cases there now being imported from overseas. Furthermore, Italy has now had two days of lower reported cases and both Singapore and South Korea have done a good job in containing the virus. We see these as initial signs that the lockdowns are having a positive effect in reducing the spread of the virus and provide hope that the tough social distancing measures will begin to help reduce the transmission in other parts of the world.

While in the short-term things still may get worse before they get better it is important to remember that markets generally recover and start to climb a wall of worry while the news flow is still bad. Hence at a portfoliolevel some of our managers have begun to reduce short positions and take profits in index hedges.

At the same time many of our strategies are in the process of optimizing portfolios to gain exposure to high quality cash generative businesses in order to take advantage of the eventual recovery in equity valuations. The coronavirus is a 1 in 100-year type event and we expect that over medium to long term the situation will provide some incredible investment opportunities for patient investors.


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