Watermark is a Sydney based funds manager that
specialises in “hedged” strategies through both listed and unlisted vehicles.
Watermark has approximately $A700 million under management.
The listed vehicles are the Australian Leaders Fund
(ALF.AX), Watermark Market Neutral Fund (WMK.AX) and the Watermark Global
Leaders Fund (WGF.AX).
The Watermark Global Leaders Fund listed late in 2016
at $1.10 per share and now trades at around $0.92 (a 16.4% loss for investors
in under one year).
While the above listed companies have slightly
different strategies, they are all essentially variations on the same theme,
i.e. to have a long portfolio which is more or less identical in size to the
short portfolio.
Let’s say a fund manager employing this strategy has
$100 million in capital to invest. He first deposits that capital with a prime
broker and then he sells short $100 million of equities that he thinks will
fall in value. As a result of his short sale, he receives $100 million which he
then takes and invests in equities he thinks will rise in value. He now has
$100 million short and the same amount long which means (in theory) he has no
exposure to the movement in the equities market.
If the long portfolio were to rise by 6% and the short
portfolio fell by 2%, the total portfolio would be up by 8%. The manager can
now either retain that 8% or pay some (or all) of it out as a dividend to his
investors. Of course, if the opposite were to happen, the long portfolio
declined by 6% and the short portfolio rose by 2%, he would lose 8%.
Unlike in a long only listed investment company (LIC),
there is virtually no scope for the manager in the above strategy to simply pass
on dividends received to investors because those dividends that he receives on
his long portfolio will be used to pay the dividends of the investors whose
stock he has borrowed to sell short. This
means that the manager can only generate positive results from superior stock
picking.
As we all know, over time, stock markets rise, and
because of this, it is more often than
not a sound strategy to keep the long portfolio larger than the short portfolio
(so that you capture some of the returns of rising markets over time).
If you are running a completely market neutral
strategy, (the longs and shorts are equal), if your stock picking is average,
you will not make any money. This is the exact situation that Watermark has
found itself in over the last 18 months or so.
Watermark has made no money (after fees, it has lost
money for investors) and that in turn has opened a substantial gap in the share
prices of the listed vehicles to the net asset backing of the shares. In
effect, the market is saying that it doesn’t have much faith in Watermark to
recapture their results of previous years.
One unfortunate result of Watermark’s poor performance
is that the “dividend” from the Australian Leaders Fund now comprises of a
capital return, or in other words, giving investors their own money back under the guise of a dividend. (Incidentally, the Magellan Global Trust which
listed in October 2017 will almost certainly end up doing this as well -
something that I don’t think subscribers to that float understood at all).
Some of my observations on Watermark are:
1.
I don’t think their investment team is as
good as the Chief Investment Officer Justin Braitling believes – great teams
don’t deliver the poor results that Watermark has had over the last 18 months
or so. The team is also quite young and therefore not as experienced as one
would ideally like;
2.
They seem to have had a reasonable amount
of staff turnover in recent times – not usually a good sign;
3.
They have almost certainly made some execution
mistakes in attempting to deliver their strategies (which is worrying and a
sign of inexperience);
4.
For the average stock picker, running
completely market neutral funds is a mistake as the long-term appreciation of
equities over time is just thrown away through the short portfolio – yes, you
will be a genius once every 5-10 years (and a fool the rest of the time).
Better to take that part of your money and put it in a bank for a guaranteed
2.5% or so, rather than pay someone fees to make no money at all!
5.
The fondness of Australian fund managers
for short positions over specific stocks rather than the use of put options
over an index is a strategic mistake in my view. Over the years, I’ve seen very
few Australian fund managers who can successfully short companies over time,
but there has always been a misplaced confidence in their abilities to do just
that;
6.
As with almost all of the newer listed
investment companies, the fees are too high for the performance that has been
achieved in recent times.
Fortunately for Watermark, most of their funds under
management are in the closed end listed vehicles, had they been in unlisted
vehicles, Watermark would have lost significant funds through redemptions.
Let’s keep watching and see if they can turn it around,
I hope they can.
