Ask a Fund Manager
The Motley Fool chats with fund managers so that you can get an insight into how the professionals think. In part two of this edition, we're rejoined by Kristiaan Rehder, portfolio manager of the Bennelong Kardinia Absolute Return Fund.
The Motley Fool: The high inflation and rising interest rate environment of 2022 presents ASX investors with a very different picture than 2021. Has strategy changed this year?
Kristiaan Rehder: Our strategy hasn't changed at all. Our investment process has stayed the same since inception back in 2006.
But we do have a heightened focus on our short book, which has provided very strong returns this year.
MF: What do you look for when you're considering shorting ASX shares?
KR: We treat our short book as a profit centre. There are many fund managers out there who use their short book as hedge to their long book. That's not what we do. Our shorts have to be profitable in their own right.
So, we use the same investment process for our longs as we do with our shorts, but for the shorts it's that process in reverse. For shorts, we're looking for companies that have weak balance sheets, weak management teams, poor earnings quality, low returns, small or shrinking industries, and are trading at unattractive valuations.
Shorting is a difficult business as you're fighting so many different factors.
Markets tend to go up over the long term; research houses tend to publish supportive research, often acting as cheerleaders for companies; and management are incentivised to talk up their story.
So, it's not for everybody. If you want to successfully short companies, you must know your facts. You need to have a lot of patience. And it can be a lonely experience.
MF: Has the outlook for shorting ASX shares changed with the re-emergence of inflation?
KR: The next five years could be very different from the previous five years we've just experienced, where shorting could really come into its own. Previously each hiccup from the pandemic all the way back to the GFC has been met with central banks coming to the market's rescue.
This time around, the one big difference is inflation. And central banks have been very hardnosed in ensuring that interest rates are going higher and inflation is removed from the system.
So, this time around, we don't think there will be life jackets thrown out by central banks anytime soon. Until they get inflation under control, we think markets are going to continue coming under pressure.
Which provides a very interesting environment for shorting ASX shares.
MF: Are there any specific short investments on the ASX you can share with us?
KR: One long-standing short of ours is Adbri Ltd (ASX: ABC). It's a cement, lime and concrete producer for the building and construction industries.
Its earnings have been impacted by flooding and rain. And the wet weather is forecast to persist. Labour and energy costs continue to rise, which is leading to a margin squeeze. Returns are under pressure from increasing competition in the New South Wales and Queensland markets. And finally, cement is a very carbon-intensive industry. We estimate around 6% to 7% of global emissions comes from the cement industry.
The short has done exceptionally well. Adbri's down around 50% this calendar year.
MF: What is your current exposure to the market?
KR: Our exposure to the market is currently around 65% net long. But it hasn't always been like that. We've only recently lifted this from a market neutral position, after the market drew down in September.
The reason we did that is we wanted to take advantage of the improved risk-reward balance that was on offer. We believe the rally we've seen so far this month, which might persist in the short term, is a bear market rally. We don't believe the bottom has been seen.
Investors have to be very mindful that positioning is extremely bearish at present. Bank of America Corp (NYSE: BAC) publishes a survey, for decades now, and it highlights where investors are positioned. Across sectors and also across asset classes.
It really illustrates how conservatively positioned investors are right now. It's, in fact, at extreme levels. And whenever you get in a situation where investors are positioned in one direction, markets tend to surprise everyone by moving in the opposite direction.
MF: How do you see the ASX and US markets evolving over the coming months?
KR: Valuations have compressed over the last nine months, but we think earnings forecasts are too high going into calendar year 2023. If you look at US earnings forecasts, earnings are expected to rise 8% next year and a further 9% in calendar year 2024. But we're starting to see corporate earnings roll over in the US.
There was a very disappointing result recently by FedEx Corporation (NYSE: FDX). It missed its earnings by 30%. Its share price sold off 20% shortly thereafter. I think that's a very important signpost for global growth because of the industry it's in, the handling and distribution of goods and its reach across the globe,
In addition, we've also had Dow Inc (NYSE: DOW), Nike Inc (NYSE: NKE), and Carnival Corp (NYSE: CCL) in the US report disappointing results.
In Australia, we're right now in AGM season. And we've recently seen profit downgrades by Magellan Financial Group Ltd (ASX: MFG), St Barbara Ltd (ASX: SBM), Appen Ltd (ASX: APX), Adbri, and Costa Group Holdings Ltd (ASX: CGC), just to name a few.
But so far, earnings have held up much better in Australia than we have seen overseas. Perhaps the earnings downgrades are still ahead of us. We would expect our net exposure will likely come down early in the new year.
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Tune in tomorrow for part three of our interview, where Kristiaan Rehder unveils three S&P/ASX 200 Index (ASX: XJO) shares he's confidently long on. If you missed part one, you can find that here.
(You can find out more about the Bennelong Kardinia Absolute Return Fund here.)
