The absolute return strategy usually has a net zero equity exposure, meaning the long positions net off the short ones.
“We are finding many more short ideas, mainly in the US, in the last two years, so our position is now a bit net short,” the London-based analyst told FSA during a recent trip to Hong Kong. “The stock markets are pretty high now and there are a lot of fragilities such as political events and central bank actions.”
The US stock markets have jumped to record highs after anticipation of the newly-elected president’s proposed tax cuts and fiscal stimulus measures.
By comparison, over the past two years, the market surge was primarily attributed to those high growth stocks, notably the FANGs — Facebook, Amazon, Netflix and Google (now known as Alphabet), Kralj noted.
Now, facing a rising interest rate environment, he pointed out that not only bonds will generally perform badly, but some equities as well.
He said the strategy is to short Amazon, Netflix, and Tesla, which are considered high growth but long duration equities. “Companies that have cash flows far away in the future, like Netflix or Tesla, whose valuations depend on the cash flows they can generate in ten to twenty years’ time, could see their shares suffer if interest rates continue to rise.”
Another category to short is bond proxies – safe, quality, low growth stocks such as McDonald’s and Campbell Soup, which saw prices surge as investors chased dividend yield. They could be vulnerable.
“I think investors have mistaken the safety of the business with the safety of the share price. They can actually be dangerous if they are expensive.”
Instead, the fund takes long positions in some big oil companies, including Shell and BP, with “cheap valuations, strong balance sheets and better quality than what the market is thinking”.
Kralj noted low volatility indices, which are comprised of “safe” stocks, have outperformed the markets (Chart 1) but have recently fell out of favour (Chart 2).