Dear friends,
We spoke with Daniel Johnson and Matt Moran, managers for the River Road Long-Short Equity strategy which is incorporated in Aston River Road Long-Short (
ARLSX). Mike Mayhew, one of the Partners at Aston Asset, was also in on the call to answer questions about the fund's mechanics. About 60 people joined in.
The highlights, for me, were:
the fund's strategy is sensible and straightforward, which means there aren't a lot of moving parts and there's not a lot of conceptual complexity. The fund's stock market exposure can run from 10 - 90% long, with an average in the 50-70% range. The guys measure their portfolio's discount to fair value; if their favorite stocks sell at a less than 80% of fair value, they increase exposure. The long portfolio is compact (15-30), driven by an absolute value discipline, and emphasizes high quality firms that they can hold for the long term. The short portfolio (20-40 names) is stocked with poorly managed firms with a combination of a bad business model and a dying industry whose stock is overpriced and does not show positive price momentum. That is, they "get out of the way of moving trains" and won't short stocks that show positive price movements.
the fund grew from $8M to $207M in a year, with a strategy capacity in the $1B - 1.5B range. They anticipate substantial additional growth, which should lower expenses a little (and might improve tax efficiency - my note, not theirs). Because they started the year with such a small asset base, the expense numbers are exaggerated; expenses might have been 5% of assets back when they were tiny, but that's no longer the case.
the vogue for dividend-paying stocks drove valuations sharply higher and so some of the stocks they short pay high diviends; that increases the fund's expenses because they've got to repay those dividends but the managers believe that the shorts will turn out to be profitable even so.
the guys have no client other than the fund, don't expect ever to have one, hope to manage the fund until they retire and they have 100% of their liquid net worth in it.
their target is "sleep-at-night equity exposure," which translates to a maximum drawdown (their worst-case market event) of no more than 10-15%. They've been particularly appalled by long/short funds that suffered drawdowns in the 20-25% range which is, they say, not consistent with why folks buy such funds.
they've got the highest Sharpe ratio of any L/S fund, their longs beat the market by 900 bps, their shorts beat the inverse of the market by 1100 bps and they've kept volatility to about 40% of the market's while capturing 70% of its total returns.
A lot of the Q&A focused on the fund's short portfolio and a little on the current state of the market. The guys note that they tend to generate ideas (they keep a watchlist of no more than 40 names) by paging through Value Line. They focus on fundamentals (let's call it "reality") rather than just valuation numbers in assembling their portfolio. They point out that sometimes fundamentally rotten firms manage to make their numbers (e.g., dividend yield or cash flow) look good but, at the same time, the reality is that it's a poorly managed firm in a failing industry. On the flip side, sometimes firms in special situations (spinoffs or those emerging from bankruptcy) will have little analyst coverage and odd numbers but still be fundamentally great bargains. The fact that they need to find two or three new ideas, rather than thirty or sixty, allows them to look more carefully and think more broadly. That turns out to be profitable.
If other folks have stuff to add, I'd be grateful for their commentary.
An mp3 of the call is available on Chorus Call's servers now, and it will migrate to the Observer's by month's end.
David
Two apologies. In the middle of my introductory comments, there was some freakish noise that sounded like an electric pencil sharpener. I'm guessing it was the HVAC system switching to night-time mode but I don't really know. And I had a typo in the reminder: we mentioned 7-8 Eastern about six times then slipped and called it 7-8 Central once. (Nuts.) Apologies to anyone excluded by the goof.
