As we sit down to talk with Odey Asset Management’s Adrian Courtenay, his Special Situations Fund is fast approaching its one-year anniversary. Though the fund is still what Courtenay describes as “green and growing”, with assets around $20m (£15m), it is off to a decent start.
Data from FE Fundinfo shows the fund has returned 39.61% in sterling terms since launch, nearly five times higher than its benchmark the MSCI World Index, which is up just 8.23%.
Courtenay (pictured) traded one famous hedge funder for another when he left DE Shaw for Crispin Odey’s eponymous boutique in March 2016.
Founder Odey has been a larger than life figure in the City for decades. The short seller and ardent Brexiteer raked in millions of pounds betting against sterling during the EU referendum, and more recently has made headlines for cleaning up during the coronavirus sell-off by shorting British businesses like Metro Bank, Fevertree and Intu Properties.
Despite working at a firm with such a high-profile frontman, Courtenay describes the atmosphere at Odey Asset Management as collegiate yet independent, “like a barristers’ chambers”.
“Crispin’s wisdom is to give freedom to managers to express how they believe optimal strategy should be deployed. That’s one of the features of Odey that makes it relatively unique among hedge funds.”
During his first few years at the Mayfair boutique he oversaw the special situations strategies across James Hanbury’s absolute return group, which has over $1bn in assets under management. But Odey Special Situations, launched last October, sees him taking the reins as the sole manager.
‘Years of plenty and years of very little’
The fund’s dual approach, pairing merger arbitrage and long/short bets, is unique, says Courtenay, not only among Odey’s stable of strategies but also within the hedge fund Ucits universe. Being able to dynamically adjust allocations between either of these two universes depending on the market environment gives the fund a clear “competitive advantage”, Courtenay insists.
He points to 2003 and 2006 as stellar years for merger arbitrage but says returns have been in the single digits in recent years. Similarly, “long/short has years of plenty and years of very little, in terms of the overall opportunity set”.
There’s also an “information advantage”, he says. “If you think about an M&A transaction, what it really represents is an expression by the insider expert of an appraisal they are making relative to the company trajectory, and they are making it with a much higher information resolution than we can expect as an outside minority market participant.
“So, we not only have a competitive advantage, but we are operating in an area that is unfamiliar to others. This anomaly encapsulates the strategy.”
Merger arbitrage funds becoming closet trackers
A common misconception about the merger arbitrage universe is that it is too vast to stay on top of. “What’s happening with a lot a merger arbitrage funds is that they’re really becoming index trackers, and they are allocating to virtually every deal. What we’re doing is saying we could allocate to 20% or 30% of the universe and really try and allocate to the stuff that has our appraisal of high impact.”
Similarly, “we’re not trying to cover all long/short opportunities”, he says. “We’re trying to cover long/short opportunities that have been informed by transactional developments, and again, that’s a much smaller universe. Also, within that, we typically have a focus on industries where the rate of change is higher.”
The portfolio’s net merger arbitrage exposure was 13.7% at the end of June, compared with the net long/short exposure at 71.7%.
Keeping tabs on the pipeline of proposed deals has helped Courtenay and Odey’s 11-strong research team uncover opportunities for the long/short book that otherwise could easily have slipped through the cracks.
This was how he happened upon hydrogen fuel cell company Plug Power, now the largest holding in the fund at 9.3%. While researching potential arbitrage situations in 2017, Courtenay spied that Amazon had snapped up a 23% stake in the business. Because the transaction was structured with warrants instead of common stock, Amazon did not appear on the shareholder register, which is why it was probably missed by a lot of market participants.
For long holdings, Courtenay is seeking high forecast accuracy, asymmetrical positions and monopolies. Plug Power currently owns 95% of the market share for hydrogen fuel cells. Though the company has struggled to turn a profit, its shares have risen 475% over the last year and its technology is being used by other major American companies such as Walmart, Coca- Cola, FedEx, Home Depot and P&G.
Long/short analysis drives merger arbitrage wins
The fund’s top eight positions have all been thoroughly vetted by Odey’s team of analysts. This fundamental deep dive is crucial to the fund’s process, says Courtenay, because the value in getting calls correct comes from the fact positions are large.
“It’s not just about coming up with the idea and saying, ‘Great, here’s the trade’. How do we know it’s right, and how do we know it’s asymmetrical? And how do we know the likely trajectory? That comes from the maintenance research.”
And vice versa, fundamental analysis on the long/short side has provided some of the fund’s biggest wins on the merger arbitrage side.
Courtenay’s research into the gold mining sector identified that with exploration activities on the decline, M&A had become the cheapest way for gold miners to acquire new reserves. This gave Courtenay confidence to act quickly and initiate chunky positions of 5% and 9% in west African gold miners Guyana Goldfields and Cardinal Resources, respectively, after each received only a single bid to buy their businesses. Both firms subsequently found themselves at the centre of bidding wars and were eventually snapped up by separate Chinese mining companies, valuing them at three times their initial worth.
“It was not clear then that there would be other bids,” Courtenay says, “but we’re achieving accuracy in those appraisals because of our fundamental work on the long/ short side.”
Finding good shorts not about predicting the next Wirecard
Odey himself confessed to Swiss publication Finanz und Wirtschaft in July that it had become “exceptionally painful” to run a short book amid the current virus crisis as central banks and governments pump an unprecedented amount of money into the system, driving up asset prices and keeping businesses that might have otherwise capsized afloat.
Courtenay declines to weigh in on Odey’s bearish take but says his shorts have delivered strong results since the fund’s inception, accounting for half the profits of the long/short book.
He was not among the Odey managers shorting German payments firm Wirecard, which collapsed into administration after being rocked by an accounting scandal. When sizing up shorts, Courtenay says it’s not about predicting which company could be exposed as a fraud or encounter problems down the line.
“What we look for is a business that is declining in value on an annual basis due to a forecast accurate variable, and is subject to economic displacement by a company that it can’t compete with. It’s that simple.”
While long book positions are scaled upward, short positions are kept deliberately small, with the average holding around 1% of Nav. That’s because you can’t achieve the same asymmetry with shorts as you do with longs, Courtenay explains.
“If the short’s share price goes the wrong way, it can falsify your short case if the company uses its equity as an M&A currency. By contrast, if a long share price goes the wrong way, the company will act to buy back shares and actually reinforce your long case.”
Courtenay loses faith in Cineworld rival
During a volatile time such as the Covid crisis, once solid investment cases can change on a dime.
Courtenay points to former holding Cineplex as a good example. UK rival Cineworld had agreed to purchase the Canadian movie chain for $2.3bn in December, but backed out of the deal six months later after the coronavirus had wiped C$1bn ($736m) from Cineplex’s market cap. Both businesses then launched legal challenges against one another for breaching the agreement.
At that point Courtenay decided to cut it out of the portfolio because it “ceased to be something within a more orthodox arbitrage dynamic”.
“What we’re looking for in large positions is both forecast accuracy and asymmetry to the upside. And, to the extent something like a Cineplex scenario happens, and you lose the level of forecast accuracy, then the asymmetry clearly goes to the downside.”
As lockdown restrictions ease, Courtenay finds himself back in the office most days. Remote working hasn’t posed too many challenges at Odey, though as a manager on a relatively new fund he admits Covid may mean it takes longer to grow.
“I think in growing a fund, it potentially could be a slightly slower process because of the client-side. Maybe a number of them would prefer to meet you in person, but not all of them. So, that may be an impact.”
This article first appeared in the September 2020 issue of Portfolio Adviser.
