Interview with Michael Brookes, Fund Manager of the St Helens Ailsa Long Short Fund

  1. How did you determine your strategy?

    We have a long history of investing for absolute returns in the Australian market.

    The Australian market is characterised by a traditional long-only bias of investing. We believe that this has created an opportunity for a long/short strategy to succeed.

    Stocks with attractive investment characteristics tend to outperform for long periods, while stocks with poor valuations and management will still be owned by traditional funds giving an opportunity to short.

    The short to medium volatility and mispricing of individual stock is high, providing opportunities for long short strategies.

  2. How do you execute the strategy?

    Active management of the portfolio is key. A two-tier approach is used. We determine an overall top-down view on the global and domestic markets over the short and medium term. The sector and market exposures of the portfolio are determined by this macro outlook.

    Fitting within this macro view of the world, we use a stock selection process strongly biased to momentum factors. Long stocks with good momentum factors and short stocks with poor factors has been the key to our performance over the last two years.

    We concentrate on our skill base in local large cap stocks. Liquidity constraints exist outside the top 100 - 150 stocks listed on the ASX therefore we invest within that group.

  3. The fund targets Australian equities do you have any plans to diversify where you trade?

    Our initial plan is to invest where we believe are our strengths in stock selection exist. This is the main reason why our FUM target is conservative at $100 million.

    Going forward we see an opportunity to expand into the Pan-Asia region using a similar investment process

  4. Why are you confident all this will work?

    We back tested our stock selection process from 1995 until 2002. The results demonstrated a clear outperformance of the long portfolio over the short portfolio, over all market conditions. Actual performance over the last two years has supported this. Therefore, given we can predict the most appropriate macro style for the portfolio, our stock selection process will generate real alpha in our funds over the short and medium terms.

  5. What are your risk management measures?

    We have strict controls over individual stock positions within the portfolio. Each of the top two positions can represent 10% of the Net Asset Value (NAV) of the Fund; no other single position can represent more than 5% of the NAV.

    Maximum loss for any one stock and its derivative positions cannot be greater than 5% of NAV of the Fund.

    Total derivative time decay in any rolling 30-day period is not to exceed 5% of NAV of the Fund.

    Any exercises of long or short options positions must not cause the maximum security holding limits to be exceeded.

    Gross limit 150% long or 150% short NAV.

    Net Limit 50% long or 50% short NAV

  6. Where do you see the greatest risk to your performance?

    As we have experienced recently, sector rotation periods will be difficult for long/short managers. These tend to be short term but particularly savage in nature.
    We identified this as a possible risk and made adjustments to our level of sector risk in our portfolios following the interest rate cycle reversal in July this year.

  7. Can you tell us more about your quantitative method?

    The V-EPS model is a structured process that ranks stocks from within the ASX100. It is an exclusion model focusing on three primary share price drivers

    • Valuation - PEG
    • Price Momentum - Weighted 1, 3 and 6 months
    • Earnings Momentum - Weighted 1 to 3 months

    Secondary Short Term Pricing Overlay eliminates short term price trend reversals.

  8. How do you find Australia as the base for your fund? Seeing 100% of your trading is in the ASX, do you think it would be possible to reside anywhere else?

    Australia was the appropriate place for us to establish our business. We are close to the heart of our investment universe.

    Over the last five years the costs of setting up here have fallen considerably, and there is a strong network of service providers willing to back start-up funds.

    UBS Hedge Fund Services based in Sydney is our prime broker and have been very supportive during our start-up phase.

    The major problem we have experienced so far is getting the support of local wholsale investors. The Sydney-based BT Financial Group awarded St Helens a mandate earlier this year out of their Total Return Fund. They have been one of the only local fund of funds willing to back local managers at an early stage. They have been rewarded with good performance from those managers.

  9. What themes for both the long and short books do you find interesting right now?

    Obviously after two years of clear advantage for long/short funds, the rotation into growth out of value has caused headaches. Previously long-term underperforming shorts have seen a sharp turnaround in share price in anticipation of improved earnings next year.

    Becoming comfortable with running portfolios that are almost a mirror image of last years' winners is a big challenge for a manager.

    We now have a strong bias to being long growth stocks and short banks and property trusts in our portfolios.

  10. Sars saw a drop off in business universe worldwide. Have you noticed a return to business as usual? If not, why?

    Australian stocks as a whole suffered very little from the impact of Sars, in comparison with their Asian counterparts. Everyone here seemed to be very quick to forget the concerns.

    We can see an increase in concerns of a new outbreak as we approach the northern winter. However we see this as more likely a media beat up which will be forgotten quickly, hopefully providing us with investment opportunities.

  11. How have you found money raising in the last six months?

    We have experienced terrific interest in our funds since the beginning of the year from individual investors and family offices based in Australia. This has been the focus of our marketing since we began.

    Going forward we will be establishing our SHC Long Short Fund. The Fund, based outside of Australia, will provide a vehicle for non-Australian based investors to gain access to our investment process.

  12. Your assets under management have remained comparatively small, is this intentional? How big will you allow yourselves to grow to?

    We have maintained a relatively conservative target of $100 million for funds under management.

    We believe that our clients' interests are best served if we are focused on performance on a smaller FUM rather than, like most funds growing FUM to an excessive level, chasing management fee, which will most likely hinder performance.

    To maintain a successful business we will rely on returns to receive performance fees.

  13. Where are you currently situating the fund to make profits over the next few months?

    Global growth turnaround will occur but will be slower than expected to arrive.

    From a top-down view we believe we will be in a relatively low volatility period for the next year, similar to the early 1990s.

    The market in Australia is still significantly overweight banks and property trusts; these sectors will continue to underperform as interest rates rise and the property sector suffers.

    Over the next few months quantitative managers will begin to show outperformance over traditional managers again once the rotation filters through the models.

    Surviving the difficult periods is the key to long-term success as a long/short manager.

Contact Details
St Helens Capital Pty Ltd
61 2 9299 3898