Lansdowne Partners’ decision this week to shut its flagship hedge fund has dealt a big blow to a key strategy — equity long/short — that is already struggling to find losers in stimulus-soaked markets.
The move by the Mayfair-based fund, whose now-famous bet against Northern Rock in 2007 yielded millions of pounds in profits, marks a major retreat by an industry pioneer. It also highlights how tough life has become in the years since the financial crisis for managers trying to pick out overpriced stocks during a seemingly unstoppable bull run.
“It is much harder to see opportunities in the short book, either in terms of generating specific value or as a hedging offset to the long investments,” wrote Peter Davies and Jonathon Regis, managers of the Lansdowne Developed Markets fund, in a letter to investors this week.
Ivan Cosovic, founder of data group Breakout Point, which tracks short selling activity, described the closure as a “significant development”, given that Lansdowne has been one of the most active shorters for many years. Short selling involves investors borrowing shares and then selling them, hoping to buy them back later for less and pocketing the difference.
The fund declined to comment.
Lansdowne’s problems reflect the wider challenges facing the $830bn-in-assets equity long/short hedge fund sector.
Like many firms, Lansdowne’s investment thesis had been that quantitative easing had fuelled a misallocation of capital to poorer quality companies. Its managers believed that these stocks would eventually founder as competition hit already-expensive share prices, according to investor letters reviewed by the Financial Times.
Ultra-low financing costs were bound to rise eventually, Lansdowne reasoned, hurting those companies that had relied on cheap money to survive. As recently as last year, the firm’s leadership wrote that the opportunities for shorting were “immense”.
Instead, a decade-long bull market fuelled by trillions of dollars of quantitative easing has lifted all boats. Stocks with strong sales but meagre profits have often done well, while managers focused on a stock’s valuation, using traditional metrics such as price-to-book value, have largely been left frustrated.
Lansdowne’s managers were “amazed”, they wrote at the turn of this year, by the strong performance of US consumer-facing companies such as restaurants and food retailers, despite the threat from online competition.
Last year, the firm admitted to investors that its short bets had not beaten the market in aggregate since 2008.
“There is zero concrete evidence that hedge fund stock pickers have been able to consistently generate short-side alpha over the past decade,” said Andrew Beer, managing member at US investment firm Dynamic Beta Investments, using industry jargon for market-beating returns.
Russell Clark at Russell Clark Investment Management, who ran huge short bets on stocks relative to his long positions for much of the past eight years, recently told the FT he could have “just bought bonds or shorted commodities and be done with it”, rather than bet against stocks.
Analysts say that strains on long/short strategies have been exacerbated by the coronavirus crisis. While many companies have struggled as economies have shut down, central banks have responded by slashing interest rates and injecting yet more stimulus, handing a lifeline to weaker businesses.
As recently as April, Mr Davies and Mr Regis were highlighting opportunities to bet against lossmaking tech stocks and suppliers to the airline sector. They gave two reasons for the sudden turnround in their letter this week.
First, while there are likely to be bumps in the economic recovery, they said, “it is hard to imagine operating conditions which will stress business-models more than those witnessed in recent months”. Secondly, they said, near-zero interest rates are making it hard to determine appropriate valuations or to assess the riskiness of taking a position.
It has not all been gloom for short-sellers. UK and US hedge funds, including Marshall Wace and TCI, recently made more than €1bn in a week between them from bets against German fintech Wirecard.
Bruce Harington, head of long-short strategies at Stenham Asset Management, said that the collapse of the Dax 30 firm “shows there is still money to be made from shorts.”
Meanwhile, some in the industry believe Lansdowne’s performance has suffered because of its long positions, rather than its shorts.
The fund’s bets on airlines were hit in the coronavirus crisis, while its wagers on UK stocks did not do well in the wake of Brexit. The Developed Markets Long-Only fund, which Lansdowne is now focusing on, has lagged behind the MSCI World index since its launch in 2012 to the end of March this year.
“The real problem appears to be long-side stock selection,” said Dynamic Beta’s Mr Beer.
Additional reporting by Paul Murphy