Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Bronte Capital bends short books to Aussie ‘crooks’
Bronte Capital CEO John Hempton believes the ASX is a target-rich environment for short sellers, and that a potentially imminent “post-bubble environment” will bring better days for the fund.
It’s been a tough few years for Bronte Capital, which – like many other hedge funds – has suffered from a period of pretty lacklustre returns relative to benchmark. Bronte’s long book is “dull, and has not kept up with the market”, and Hempton holds that Bronte has been “unable to find investments in high quality companies we would like to hold for decades at prices that we find acceptable.”
But performance has seen a turnaround in the last few months, and Hempton believes that happier days are ahead – though in this case happier days means the rapid collapse of the asset price bubble that has engulfed markets over the last decade.
What ARK founder Cathie Wood and other investors describe as an irrational bear market in “innovation stocks”, Hempton believes is simply the market following the same course it did in previous bubbles – champions falling, and money “pouring into a narrower and narrower collection of unbroken stories which continue to rise unabated.”
“This is what happened in the tech bubble where the market became very narrow indeed, led by a small coterie of nearly perfect tech stories – and where value stocks became extremely cheap. We are not there yet,” Hempton wrote. “But we hope we do get there – because the years 2000-2005 were very good years for sensible value investors – and we think we know how to play that game. We think we would perform very well in a post-bubble market.”
Of course, 2021 – despite the latter quarters seeing a turnaround in performance for Bronte – brought plenty of challenges on the short side. Like many other hedge funds who grew wary of the market after the WallStreetBets saga, Bronte shrunk its position in “any stock susceptible to a gamma squeeze to trivial levels”, with 4 basis point positions relatively common, and doubled its number of shorts for a “target rich environment”.
“The market is within a whisker of all-time highs. And yet our short-book is doing well. The retail mania has slowed. The most excessive sign of retail mania – massive investment in short-dated far-out-of-the-money options has slowed dramatically,” Hempton wrote. “We are far less scared of a gamma squeeze in one of our names than we were in February. In the past six months we have made money on our short book despite the market taking out many new highs. There is plenty of alpha there.”
And now Hempton says Bronte will bend it short books towards Australia, fed up with what he describes as fly by night operators taking advantage of Australia’s defamation laws – which are rigid, to put it lightly – and a corporate regulator that comes down harder on short sellers than their targets.
“The Australian defamation rules have a specific legislated exemption – you cannot defame a company with more than ten employees,” Hempton wrote. “But ASIC has begun legislating by regulation. If you criticize a company publicly which you have traded you can expect a regulatory inspection, thirty thousand dollars plus in legal bills and that is only if you are lucky. ASIC has taken to accompanying the Federal Police on knock-your-door down raids on completely honest short-sellers.”
Australia is a particularly rich hunting ground for “crooks” – who Hempton leaves unnamed for fear of attracting the ire of ASIC – because of its compulsory superannuation, and he believes that “millions of people will lose thousands of dollars of their superannuation to fraud.”
“We see no evidence of poor intentions at ASIC, but their actions make it less likely that corporate crime will be uncovered in Australia,” Hempton wrote. “In the past we (and a few others) fed tip-offs to ASIC – some of which have resulted in crooks going to prison. But if you tip-off the new ASIC (or the press for that matter) about a crime you are more likely to get a subpoena than a thank-you note. The consequences are obvious.”
