Sean Fenton is the Founder and Chief Investment Officer at Sage Capital, an Australian equity long short fund manager. Sage Capital has been nominated for the Rising Star category in the Zenith Fund Manager of the Year Awards 2021.
GH: Sage invests a little bit differently with a 'market neutral' fund that aims to generate returns independently of the direction of the overall market. It balances long and short positions, while your equity fund can also short stocks. Have the last 12 months of strong equity markets been particularly difficult for shorting?
SF: When we think about shorting, we're not necessarily just looking for stocks that might go down or fall in absolute value. Because we're a long/short fund, anything that we short is essentially reinvested back into the longs. With our absolute return fund or market neutral fund, the longs and shorts are balanced so that our stock selection drives returns.
In our equity plus fund, when we’re shorting, we’re actually taking extra-long positions. We might be 30% short but we’re 130% long. That means the decision on shorting comes down not just to stocks that are falling but stocks that are underperforming the index. That's the key to generating active returns.
In any market, a whole range of stocks are underperforming and some are outperforming and our focus in shorting is on finding underperforming stocks. So while the market has been rising strongly, it's still been a great environment for active management with some things going up and some going down.
GH: In your equity plus fund, are you able to measure how much of your return has come from your longs and how much from your shorts?
SF: We've been running Sage Capital for a couple of years but long/short funds for over 20 years. Over the long period of time, it’s fairly even. In the last year, the longs were doing better than the shorts as the market was really running and the shorts were funding the long activities. That started to turn around more recently with the shorts adding more value in the process as well.
GH: You wrote an article in Firstlinks about central banks dominating financial markets and reducing the efficacy of pricing signals on stocks. Is this central bank activity making stock picking more difficult?
SF: In some ways, it’s more difficult but it’s also opening opportunities. It’s certainly something you need to take into account in building portfolios. The role of central banks with big QE programmes and negative real rates is manifested across the world. Everything from the value of your house to crypto currencies and non-fungible tokens. It’s intriguing that the value of office properties has been rising despite leasing falls and vacancies. P/E ratios have gone stratospheric in many cases, so you've got to be aware of that as a risk. You can’t simply fight and say stocks are really expensive because bond yields are very low, driving that dynamic.
It is driving a poor allocation of resources across the economy and we're going to pay the price for that in low growth. But in terms of stock selection, it's a risk and we try to be neutral to that thematic. One day, maybe not too far in the future, central banks may change tack in both winding back asset purchases and actually increasing interest rates, and that will drive a new dynamic.
GH: We’ve all needed to recalibrate what we think is reasonable value in a whole range of assets.
SF: Yes, I've gone from thinking a P/E over 20 times is expensive to now that's cheap, and you've got to be over 50 times to raise the eyebrows.
GH: Are there other big market trends that you're backing at the moment?
SF: We’ve been going short iron ore as the price had become so elevated and the market wasn't particularly tight as Vale in Brazil was gradually coming back and normalising. Then China was starting to peak out as well, and now we're seeing a new dynamic where China's policy focus is more on common prosperity. They also want to reduce their carbon intensity and wind back steel production. Another dynamic is Evergrande, one of the largest property developers essentially approaching bankruptcy, so we’re seeing the property cycle roll over.
On the positive side, coming out of reporting season, insurance globally and domestically is strong with more pricing power for companies. Global business insurance is seeing double-digit increases. It’s good for QBE and to a lesser extent IAG and Suncorp. There’s some concern about business interruption but we see some long opportunities through the insurance cycle.
GH: Have you got a couple of stocks in your portfolio that you're most confident that the market is under appreciating, where it's frustrating that you see the value but the market doesn't?
SF: Yeah, that's the bane of every investor, the stuff that the market doesn't appreciate. You've got to be careful that you're not just marching to your own tune. You don't want to sit there for years waiting for everyone else to realise that you're right.
One that’s like that at the moment is South32, it’s really done nothing for a long time. It's gone through a transformation and now has an interesting mix with a premium aluminum exposure but also metallurgical coal and manganese. Aluminium has been very strong lately. They're generating massive free cash flow and they're in more of an ascendancy.
GH: Any industrial stock, perhaps a value stock left behind in the growth story?
SF: An interesting turnaround is Incitec Pivot, which had a whole litany of woes on the operational side, but we look at what's happening globally, with price strength in wheat and corn and increased plantings and use of fertilisers. Some missing parts are now sorted out, but the stock’s been largely ignored and put on the sidelines. So, if they can show some operational stability, with a lower Aussie dollar, we see a potential value play and a turnaround opportunity. Although Hurricane Ida just rolled over one of their plants…
GH: What about the one that got away, the stock you look at each day that was on your radar but it didn't quite reach your price?
SF: We continually reassess and don’t let things get away too much but one stock where we sat on the sidelines for too long is Xero. It's a company that has a unique product, a global rollout story with accounting software in the cloud space. But it's never really generated much profit as it's continued to invest in growth, on traditional metrics it’s always looks ridiculously expensive. We eventually took a position but it’s one that we watched for a while.
GH: And is there one which you sold too soon, that has just kept running?
SF: James Hardie is one where we had a much bigger position a year ago. It's done very well to move higher, but we've taken profit along the way. We don't regret it but it’s hard to buy back in once you have sold.
GH: Do you ever make a trade-off between income and capital growth, where you feel your portfolio needs income, but you might not get the price gain?
SF: We make holistic decisions looking at total return, with capital growth and income combined although there are different drivers. We split the market into different groups and in the growth group, there’s not a lot of income being generated, it really is capital return. Whereas we've got another grouping, which we call yield, which is full of banks, where valuations are more important. And we have defensives including infrastructure and utilities, and income generation is given more weighting in those areas. But we're always looking at the trade off with capital growth.
GH: Can you give us some insights into your business, where the flows are coming from, any plans for listed vehicle?
SF: We've really been focused on the retail and wholesale market through independent financial adviser groups, we're available on a range of platforms, and we're getting good flows across different dealer groups. We don't have any short-term plans for a listed fund but it's something that we will look at to broaden that access channel. We're not big fans of LICs so a listed open-ended structure that provides liquidity without the NTA discounts has more promise. We're also setting up a structure for offshore investors.
The full unedited interview with Sean is included in this week's edition of our podcast, Wealth of Experience.
Graham Hand is Managing Editor of Firstlinks.
Sean Fenton is Chief Investment Officer and Founder of Sage Capital. This interview contains general information only and does not consider the circumstances of any investor.
Sage Capital is an investment manager partner of Channel Capital, a sponsor of Firstlinks. For more articles and papers from Channel Capital and partners, click here.