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Financial Review

March 14, 2024

The ‘junk stock’ rally is heaping pressure on hedge funds


Joshua Peach

It’s been a rough start to the year for several prominent Australian hedge funds, who have missed out on the months-long rally that drove the sharemarket to record highs.

Long-short strategies operated by Totus Capital, Firetrail Investments and Sage Capital are among funds to report negative returns over the three months to the end of February, underperforming the S&P/ASX 200, which has jumped more than 9 per cent since the start of December.

The tepid returns follow hedge funds unwinding a mammoth $1 billion in short positions in the final week of February, adding to more volatility to one of the wildest earnings seasons on record.  

Australian equities have been on a tear since late October, surging as much as 15 per cent before a sharp sell-off earlier this week. The rally was sparked by growing signs that global central banks are nearing the peak of their rate increasing cycle, sending investors rushing back to risk-on assets.

However, the broad market gains caught many short sellers off guard, hitting returns across long-short strategies.

QVG was among those to buck the trend, successfully returning around 4 per cent during February, taking its three-month return to 13 per cent.

Despite the strong performance, QVG portfolio manager Josh Clark said the fund’s short positions had struggled during the rally but were offset by double-digits gains in takeover-target Altium, tech favourite WiseTech and discount jewellery retailer Lovisa.

“We definitely lost absolute dollars in shorts,” he said, noting that the fund had stemmed some of the losses by reducing its short positions in the lead up to the rally.

“Over the past six months or so we’ve been covering more short positions than we have initiated on, just because the worst seemed to be behind a lot of the existing positions we’d had.”

Looking ahead, Mr Clark said the fund had initiated several new short positions.

“We would expect the short book to grow from here. We’ve got a few ideas and want to put some more capital to work once we gain some more conviction.”

“On the long side, some of our better performers now look like their getting closer to fair value.”

Beyond the ASX, global long-short funds have also struggled. Both Fidelity’s global long-short fund and Bronte Capital global Amalthea fund recorded moderate losses in February, despite gains across most major global benchmarks.

“The pressure that was on the portfolio in December is still unfortunately upon us,” Bronte Capital chief investment officer John Hempton told investors in a letter this week.

“Junk stocks are rallying relative to quality. And that hurts us.”

Commodity crunch

Defying the drop, Munro Partners’ concentrated global growth strategy charted a 12 per cent return during the month. The fund continued to capitalise on its long-term high conviction bet on US chipmaker Nvidia, which advanced 30 per cent in February after its fourth quarter report smashed analysts’ expectation.

Other funds to ride the three-month rally to double-digit returns include hedge funds operated by Kardinia and Auscap, neither of which hold substantial short positions based on recent filings.

Hedge funds exposed to the commodity sector, however, are among the worst hit. Ausbil’s global resources fund, Paragon’s commodity-focused long-short fund and Regal’s resources long-short fund all lost more than 2 per cent in February alone and remain in the red over three months.

The funds have fallen alongside the S&P/ASX 200 Resources Index, which was down 6 per cent in February, as cratering commodity prices and rising costs pinched miners and dragged down share prices.

The losses in February have added to an already difficult 12 months for Ausbil’s global resources fund, which is now down more than 50 per cent from a year ago. The fund has been hit by a collapse in battery metals producers and explorers, amid a sustained rout in the price of lithium and nickel.

More recently, the fund told investors its long exposure to copper and uranium producers had hurt returns but said it expected lithium prices to recover going forward.

“Sentiment towards battery materials has turned positive in recent weeks, and we believe pricing is likely to trend higher,” the fund told investors this week.

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