During October the BlackPearl Masters Fund decreased 3.34%. October saw a sharp increase in volatility as equity markets around the world sold off. This was driven by several macroeconomic issues including rising US interest rates, US and China trade wars, uncertainty and political division around BREXIT in the UK and tightening credit conditions in Australia.
The ASX200 Index finished the month down 8%, the ASX Small Ordinaries was down 10% and the Hang Sang also finished down 10%. Against this backdrop the fund did relatively well to minimise losses by generating positive returns on the short side.
What was noticeable is that many of the fund’s underlying long positions were sold off due to general market movements rather than any specific company factors which means that the earnings power of these business in our view is unchanged from the previous month.
The stand out strategy for October was our volatility strategy which managed to generate a positive return by benefiting from a spike in the volatility index (VIX) which rose as equities sold off. The CBOE Volatility Index, known by its ticker symbol VIX, is a popular measure of the stock market's expectation of volatility implied by S&P 500 index options, calculated and published by the Chicago Board Options Exchange (CBOE). It is colloquially referred to as the fear index or the fear gauge.
The VIX is negatively correlated to the equity market and tends to move up as equity markets fall. By aiming to be net long the VIX, our volatility strategy allows us to generate positive returns on part of the portfolio as equity markets fall. Together with the funds underlying short positions the strategy is a good additional hedge for the fund and acts as a downside cushion in falling markets.
At a stock specific level, the fund benefited from numerous high PE short positions in the technology sector which were sold off heavily during the month with a number of these positions falling by over 30%. Additionally, the fund benefited from short positions in Celltrion Inc and Celltrion Healthcare which fell 27% and 31% respectively and in our managers opinion are likely to fall further.
Interestingly during times of market sell off institutional investors will often sell their larger high-quality business as these offer the greatest amount of short-term liquidity. As a result, on the long side the fund was impacted by several long large positions such as Alphabet and Amazon which were caught up in the tech lead sell off. The fund used this weakness to add to its large highly cash generative mega cap holdings.
Due to unfortunate timing the fund was also impacted as 3 of its small short positions became takeover targets by private equity. As the fund is a long short fund one of the costs of doing business is that occasionally some of the funds underlying short positions will become takeover targets. As these positions are generally small in nature this cost is more than covered by the overall positive returns the fund can generate on the short side over the long term.
Overall, looking forward, we continue to believe the environment for long short strategies such as ours should be favourable as higher volatility levels are likely here to stay which should present good investment opportunities for active nimble investors.