Columbia Threadneedle’s leading UK equity long/short duo backed mid-caps to ride out Britain’s referendum on the EU. However, a prolonged, sobering cold shower followed. Mark Westwood tells Chris Sloley the chastening lessons they learned.
A sudden burst of torrential rain momentarily drenched Londoners as they trudged to the polls to vote in the EU referendum on 23 June last year.
The decision by UK voters to break ties with the EU hit the high-flying duo’s Threadneedle UK Absolute Alpha fund hard, and the aftershocks are still being felt.
Speaking just over one year on from that day, Westwood recalls the damage to his fund performance. On a one-year basis to the end of July 2017, the strategy returned 2.1% in sterling terms against a 14.9% rise by the FTSE All Share.
‘Brexit was certainly the worst couple of days of my investment career and also the fund’s performance. We lost 5% in two days which was twice as bad as our worst monthly return in six or seven years of running the fund.’
Just one month earlier their UK-domiciled strategy, which is registered for sale in eight European markets, was put into ‘containment’ after inflows breached the self-imposed £1 billion (€1.1 billion) assets limit. This coincided with a slowdown in performance, which dropped in Q1 2016 but would be greatly exacerbated by Brexit.
‘Just before Brexit we went through the barrier and decided to put the fund into containment, which meant doing no more marketing for new clients to ensure we could run it as we wanted to in a fairly tight FTSE 350 market.
‘We had outflows after Brexit for obvious reasons so we are now tentatively putting it out to clients because it is 30% smaller than it was when we needed to put the brakes on,’ London-based Westwood says.
Investors had been drawn to the fund for its strong performance and commendable drawdowns, and Westwood (pictured above right with Kinder left) says the pair were seen as offering an attractive alternative to the low-returning long-only equivalents trawling the UK equity market.
However, Westwood admits the pair wildly underestimated the market response to a surprise vote.
‘We anticipated the market might fall 10% and we had therefore set up with just 20% net long as a cautionary move. We were prepared to lose 2% of client money in a worst-case scenario. In fact, over the two days we lost more than double that and it was the scale of the fall in the long positions that surprised us.
‘We were mis-hedged on the fund,’ Westwood says. ‘We had a lot of UK mid-cap longs and quite a significant FTSE 100 index futures short position. The UK-focused stocks fell a lot further than the FTSE, which then rallied with the drop in sterling post-Brexit.’
Westwood is currently Citywire A-rated for his work in the long-only equity space, however, he is no longer rated under Citywire’s Alternative Ucits ratings, which cover this fund.
Kinder has an A rating in the Alt Ucits space due to his work on a separate UK-focused long/short fund, Threadneedle UK Extended Alpha.
Nervous investors started to bail out, but Westwood and Kinder didn’t panic. They had to meet redemptions, but they realised that hasty decisions could make things worse so they fell back on the contrarian ethos they developed when they launched the fund in 2010.
‘We were very disappointed with the performance of the fund, but we did at least sit things out over the subsequent months and wait for a more rational market to return. We dealt with it in a contrarian way.
‘An example would be our long in Derwent London, as there were concerns about property investment into central London post-Brexit and we were able to add to our holding. It had good results this year and its shares are around £30 (€33)now. So it is about being greedy and taking a longer-term perspective when others are fearful.
‘You often make the most money when you are buying into uncomfortable areas while rivals are being more short-term. We believe in owning things for a three to five-year investment horizon rather than three to five weeks.’
Despite the chastening experience of Brexit and continued sluggish performance that followed, Westwood and Kinder were reluctant to suddenly overload with macro calls and have stuck to their bottom-up approach.
‘Even if you were brave or clever enough to predict something like Donald Trump or Brexit, the actual reaction in the market is often very different. It is much easier to let stock-picking drive returns rather than focus on macro events,’ Westwood says.
Westwood and Kinder have not shifted their portfolio dramatically but they have shored up defences. The duo have cut FTSE 100 futures in exchange for single-stock shorts, and are also running a historically low level of gross exposure, which has dropped from 90% in May 2017 to 78% at the end of June.
Meanwhile, net exposure in the fund is at the low end of the pair’s 20-50% range, at 25%. ‘We are right at the bottom of the range and we have done that over the last few months as the market is hitting all-time highs.
‘We are struggling to find value investments for the long portfolio and we have been adding some new names into the short side. This reflects our view that markets are richly valued,’ he says.
Westwood believes in sticking with what you know, and so has 37 stocks in the long book compared with the usual 45-50. He is also steering clear of more global markets where some of his sector peers have gone.
For example, Janus Henderson pair Luke Newman and Ben Wallace added an ex-UK bucket to their Henderson Gartmore UK Absolute Return fund late last year to limit the impact of UK-centric events. However, Westwood sees no reason for his fund to follow suit.
‘You stick to a select band of companies you really trust to weather a tough macro backdrop. For us, it is just not a good time to be investing, wherever you are looking.
‘I am a UK-only fund manager and I have been doing this for 20 years, as has Chris, and we would much rather stick with our niche expertise. If that means running a smaller fund that’s okay because it is the size of the return to the clients that matters not the size of assets.
'So we limited the fund to £1 billion because we want to make sure we can keep the strategy nimble and close shorts when we want, as well as ensuring we can perform how we want.’
Investors are gradually returning to the fund, Westwood says, after it dipped to a low of £680 million (€747 million) in late 2016 before recovering to its current level. Westwood is open about the difficulties caused by political uncertainty but says the fund is now more structurally sound if another unpredictable event occurs.
‘The biggest lesson from Brexit is to make sure you get your hedging right as we were short large-caps versus mid-cap longs. Over the years we have realised you have to learn about the correlations between your long book and short book.
‘We would never be long airlines and short oil, that is effectively the same trade, you are double counting. They are either going to go the right way or both the wrong way. Our job should be easier going forward and as long as we keep learning from our mistakes, albeit with a few more grey hairs,’ he says.
This article originally appeared in the September edition of Citywire Selector magazine.