Posted with permission from Value Walk

Dale Wettlaufer, an associate professor at the Columbia Business School and also the founder and Chief Investment Officer of Charlotte Lane Capital Management, is reviewing the lessons he has learned as a fund manager. After a 2016 in which the short-biased hedge fund was up just 1.84% when the S&P 500 was up 11.95%. Carrying a net short exposure of 19% since early 2014 in a Long / Short strategy can be costly, and July’s loss of -1.1% against the S&P gain of 2.1% has put the New York-based Long / Short fund manager in an apparent  reflective mood. In a July letter to investors reviewed by ValueWalk, he laments some of his portfolio decisions like a professor grading a student’s paper.

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Investors have "paid my tuition" as professor gets a learning experience in hedge fund management

Charlotte Lane Capital Management manages a Long / Short equity book very differently than most fund managers. Since the first quarter of 2016, the fund has had significant net short exposure at a time when the stock market has been booming.

While a more common portfolio tilt might be between 35% and 45% net long, Wattlaufer spent most of 2016 on average -27% net short. "Fundamentals in US equities are poor and

"Fundamentals in US equities are poor and ex energy, net income has not declined," he told ValueWalk. "The expectations embedded in stocks that justify a fair return from today are too high and about 2x the long-term real EPS growth rate of the market. Using a long-established real EPS growth rate of 1.7%, the market will deliver slightly negative real return to zero over the next five years, compounded."

 

It is here, on the short side, the professor engages in his most serious introspection.

“You have paid my tuition,” he told investors in the letter, those who have forgone nearly 20% returns over the past two years had they simply invested in a long-only S&P 500 ETF. But investors in this fund get short exposure and protection of capital.

In some respects, Wettlaufer is like Crispin Odey. He is significantly hedged and points to the central bank's quantitative experiment like it is a Frankenstein monster, waiting for the asset bubble to burst.

"Who knows what central banks will do next to keep the illusion alive?" Charlotte Lane Capital Management commented to ValueWalk. "Valuation on most metrics is near historic highs and growth, returns on capital, returns on incremental capital, and asset velocity are poor to very average. The expectations embedded in stocks that justify a fair return from today are too high and about 2x the long-term real EPS growth rate of the market. Using a long-established real EPS growth rate of 1.7%, the market will deliver slightly negative real return to zero over the next five years, compounded. So I'm still short."

Unlike Odey, however, Wettlaufer is not delivering negative returns.

Charlotte Lane Capital Management

Charlotte Lane Capital Management - "Rookie mistakes" are questioned as short exposure methods have changed

There are a number of nuanced changes Wettlaufer has made to his investing style, chalking some of the issues up to potential “rookie mistakes.” Real time portfolio management comes at people fast, and the bearish portfolio manager is looking to sharpen his short exposure knife.

“Despite incubating the strategy for seven quarter and doing better the short side than the long, incubation isn’t the same as this being one’s only P&L,” he says, noting he “was too tight emotionally in the first 1+ year.”

Wettlaufer is a thoughtful and honest portfolio manager, speaking to investors in a tone that is typically reserved for trade rooms that employ a “ radical truthfulness” approach to addressing portfolio management issues.

“Beginners don’t know what they don’t know,” he said. “A veteran has a better idea of the white spaces in their knowledge and portfolio management,” pointing to risk management that “was too tight” and “was very bearish but didn’t blow up.”

While he recognizes the need to hedge and the related costs – and appears to believe this is one purpose of a “hedge fund” – it is on the short side where the professor notices room for improvement.

Saying Charlotte Lane Capital Management was “too protective of the P&L on the short side,” he has become “far more patient,” but he has also changed his approach, visible in 2017 Long / Short exposure. Whereas in 2016 his net short position was -27% -- not quite approaching Crispin Odey’s infamous bearish short exposure, but noticeably short – in 2017 there is more balance in his approach. His net short average of -8% year to date in 2017 is one sign of change, but so too are adjustments in patience – an emotional factor that is difficult to teach or learn from a textbook.

Another noticeable change that can be quantifiably taught and recognized is portfolio turnover. In this regard, his trading activity has “plunged” as he is willing to give investments more time to play out.

However, all is not lost.

While the Charlotte Lane Capital Management short book has cost the fund performance, heading into a potentially turbulent fall where a host of known unknowns could haunt investors there is one area where Wettlaufer is proud. He is positioned to “ preserve capital” in a world where low stock market volatility belies a strange and unpredictable world.

The post Net Short Hedge Fund Manager Generating Positive Returns For Back To Back Years appeared first on ValueWalk.