A Contrarian Fund Manager Bets Against Emerging Markets
Given the volatility of stocks in recent years, very few hedged mutual funds have lived up to their promise of protecting investors on the downside while generating positive results on the up. The Icon Long/Short Fund, for example, fell 39.9 percent in 2008, more than the S&P 500's 37.0 percent. It also lagged during the recovery, rising only 15.4 percent in 2009, compared with the S&P's 26.5 percent. Portfolio manager Michael Aronstein’s Marketfield Fund, by contrast, outperformed the S&P in both of those years.
The $1.5 billion fund has delivered a 9.2 percent annualized return since its August 2007 inception, compared with a -0.9 percent annualized loss for the average long-short equity fund and a paltry 1.4 percent gain for the S&P 500. A dyed-in-the-wool contrarian, Aronstein makes his living buying what others are selling and shorting or betting against such beloved sectors as gold and emerging markets.
While his track record speaks for itself, even Aronstein sometimes runs into trouble. He says he bought energy stocks at their high last summer, and while he had a bearish view of commodities overall, he held onto those shares thinking they would be resilient during a downturn. Problem was, when the markets fell, so did the energy stocks, putting a dent in his overall performance. Lewis Braham spoke with Aronstein at his New York office.
Q: How would you characterize your investment strategy?
A: We’re looking for circumstances where we have an opinion on the macroeconomic environment that is at odds with the prevailing consensus and where the market also reflects a difference of opinion from ours. The room in between those postures affords an opportunity to make money. It’s like hitting in baseball, where they say, ‘You hit the pitcher’s mistakes.’ We profit from conceptual errors in the marketplace.
Q: What is your macroeconomic outlook right now?
A: I’m pretty positive about the U.S., very concerned about the emerging markets and the commodity complex. Emerging markets in the past decade have gone up as much as the Nasdaq index did between 1991 and 2000. You have too many investors there with too high expectations, and these markets in my experience have tremendously wide entrance doors and one little exit that is sometimes bolted.
Q: There is not a lot of liquidity on your way out?
A: No. People kind of forget that. It worries me, particularly in China, where the expectations about a developing middle class are, I think, way off the mark. The wealth China has developed has been mostly a function of either demand or capital coming from external sources.
Q: You favor U.S. retailers like TJX and Tractor Supply instead.
A: The retailers are a long-standing position about the health of the U.S. consumer. Following the 2008 collapse, there was a general misperception that the consumer was dead. We felt very strongly that the excess leverage on the consumer’s balance sheet was the result of excess leverage on shelter. People had gotten into trouble because of their affection for real estate, but it wasn’t a generalized overuse of debt. It was very specific to a particular excess in the cycle. Once people stopped committing so much of their discretionary cash flow to property, it would free up their money for other expenditures. That’s a long-standing position but recently we started shifting a little bit toward more consumer cyclical names. We added to the home building sector back in the fall of last year.
Q: Why did you do that?
We came to the conclusion that house prices bottomed last summer. We felt that price levels nationally had reached a point where the annual yield on buying a single-family home and renting it out had gone well into the mid-teens. That was a price level where investment demand would start soaking up the excess housing inventory, particularly in parts of the country where you had the worst problems -- Florida, Arizona and some other parts of the Sun Belt and the West. We saw this process beginning and we thought that most of the negative sentiment around housing was wrong. So we own housing-related stocks -- Toll Brothers, DR Horton, Ryland Group, Beacon Roofing and Sherwin Williams.
Q: On the negative side, you’re shorting an ETF invested in China, right?
A: Yeah, we’ve been shorting that for a year. The idea many investors have that China can make a seamless transition to a consumer-driven economy is ridiculous. There is no precedence for it. They don’t have a system, cultural, legal, economic or political, that would accommodate that kind of transition. The growth they have been experiencing recently, which is due to state-directed investment in physical infrastructure, would have to stop to redirect discretionary funds to consumers through higher wages or less taxation or less stringent monetary foreign exchange controls.
Q: You’re also short an emerging markets bond ETF. Is there a reason why you chose to short bonds over stocks?
A: The bonds have less of a chance of really going up. Their yields are ridiculously low right now. So there’s not much room for gains. I think of the position like a free put option, because if something really bad comes to pass, the bonds are going to come down in a real hurry, way faster than people, believe because they are intrinsically very illiquid. They trade only in dealer markets, and at the first sign of trouble I would expect that all the dealers are going to run for the hills.
Q: Despite your negative outlook on emerging markets, you’re long a Mexico ETF. Why?
A: We like Mexico’s proximity to the U.S., and the wage differential between Mexico and China has narrowed to virtually zero. So given its proximity, Mexico is a good choice now for U.S. manufacturers. The country does have its own internal problems, but it is a society with a more general respect for property law and restraint of arbitrary power than China. China has no history of fair play. Zero. None. And I don’t think people understand that foreign participants in China’s economy have no rights when things get rough.
Q: Money managers who are afraid of economic panics are usually bullish on gold, but I noticed that you’re short a gold fund.
A: Yes. We were long gold for a long time, but the argument that gold can be an effective monetary substitute in 2012 is wrong. And the idea that at $1600 an ounce it’s going to hold its purchasing power is also suspect. It’s an asset where people are involved up to their eyeballs based on what I believe are false premises. You are starting to see the capital expenditures by all the mining companies bear fruit, and sometime in the next year or two you will see an explosion of gold production right at the point when the biggest holders of physical gold, other than central banks, are in China and India. The retail ownership in those two countries is enormous. So it is an asset class very much tied to the fate of emerging markets. Under any scenario of economic pressure, I think, you are going to see it for sale.
Q: Are you bullish on the dollar then?
A: Yes, I think the dollar is fine. We’ve been through a decade where U.S. investors managed to get out of dollar-based assets. Alternatives are now the rage among consultants and institutions. In 2000 everybody had 70 percent of their portfolios in growth stocks. Now everybody has 70 percent of their portfolios in something else, whether it’s forestland, or Chinese Internet companies, or oil and gas partnerships or European sovereign debt. All these means of diversification were appropriate in 2000 but are inappropriate now.
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