R Parus Fund has managed to capture some of the upside of the equity market through its growth names while limiting the cost of the short book this year.

The current environment seems to offer new opportunities in equity markets. What have been the main changes to the portfolio and what is the outlook? Marc-Antoine Chatin, Co-Portfolio Manager, Parus Finance, explains their current allocation.

What have been the main changes within R Parus Fund so far this year in terms of portfolio construction and stock-picking?

This year, we first continued to shrink our «shorts» and to redirect our «long» one, with our gross exposure rising from 65 percent 70 percent at the beginning of the year to about 93 percent currently.

To reposition our long book, we completed the sale of our cyclical stocks while expanding our weightings in growth stocks, increasing our exposure to Apple, Alibaba, Nvidia and Adobe. We then began to expand our «short» portfolio in structural themes such as retailers, media (advertising agencies and television channels), as well as in cyclical themes in auto loans and credit cards.

At this point in the economic cycle, do you see more opportunities in «long» or «short» positions?

We believe that the current economic recovery is being driven mainly by the delayed impact of the 2015 to 2016 Chinese tax stimulus.

Its global impact has continued to increase as Chinese GDP has grown, now accounting for 14 percent of global GDP, up from 7 percent in 2007. Stimulus measures are not as aggressive in the rest of the world, particularly in the U.S., and this has raised the relative weight of these Chinese pro-cyclical measures at the world level.

«Growth stocks continue to perform well and are relatively cheap»

After the Plenum, we see the government trying to contain pro-cyclical stocks or, at least, limit their excesses. This should show up soon in data figures. Keep in mind that between 2014 and 2017, shadow financing in China rose by more than 9 trillion dollars, whereas GDP rose by just 1.4 trillion dollars. In light of this, we prefer to remain cautiously positioned, despite historically low volatility in equity markets. Growth stocks continue to perform well and are cheap.

However, given their recent gains, we would be looking for a correction to expand our positions. We currently see more opportunities in the «short» portfolio, but as the Trump Administration’s tax reform could offer a temporary boost to faltering stocks, we are waiting for the U.S. Senate vote before raising our exposure. As a whole, our portfolio has generated significant alpha this year, both on «long» and «short» positions, and we are keeping a very low net exposure (i.e., «long» positions minus «short» positions) to equity markets.

One of the areas that Parus Finance excels at is identifying quality, high-growth companies. After the steep rally in tech stocks so far this year, do you believe they still offer upside potential?

These growth stocks continue to perform very well, not only from a stock performance perspective but also looking at their excellent earnings results this year. They are not very expensive given their top-line and bottom-line growths, which continue to defy the law of large numbers.

«In our short portfolio, we continue to increase our weighting in the retail sector»

These stocks are backed by unique business models and high barriers to entry, and we are happy to have them in the portfolio over the long-term. However, as we mentioned earlier, we currently don’t want to expand their sizing in the «long book» after their recent rally.

What are the new themes in the «short» leg?

In our «short» portfolio, we continue to increase our weighting in the retail sector, which we have expanded with positions in shopping malls. Retailers are faced with declining footfall and excessive fixed costs. Only companies which own monetizable real estate are likely to survive. Retail needs to reinvent itself.

We are currently seeing other types of stores emerge, smaller ones that are actually showrooms incorporating a web experience to give consumers wanting to shop online an opportunity to check in person whether the product is right for them. These new shopping areas, generally about one tenth as large as their predecessors, which forces a massive real estate reshuffling exercise.

«Volumes and prices are beginning to fall sharply, and default rates are rising.»

We also have «short» positions in advertising agencies. We are seeing a disruption in the relationship between their level of activity and economic growth, which historically have moved in tandem. These companies are mainly present in low-growth, mature markets. Their business model remains dependant on TV advertising, a stagnant market, as advertising shifts to digital media such as Google and Facebook.

In addition, these companies generate most of their sales in the food & fast consumer goods sector, which is cutting back on advertising in reaction to its own declining growth. TV audiences that until two years ago held up well are beginning to see high single digit declines. U.S. TV channels have managed to increase their advertising rates. This has helped them to offset their shrinking margins, but this is unlikely to last long.

«These areas have indeed stabilised»

We also have «short» positions in Australian banks, in order to benefit from the downturn in the real-estate cycle. Volumes and prices are beginning to fall sharply, and default rates are rising. Finally, our shorts in auto loans and credit cards in the U.S. are themes that are moving forth more slowly.

These areas have indeed stabilised rather than declined since last summer, so we continue to watch for indications that these delinquencies will continue to pick up again.

Marc-Antoine Chatin is Co-Portfolio Manager, Parus Finance, Rothschild Asset Management

R Parus Fund, in short: Based on a partnership between Rothschild HDF Investment Solutions, Innocap the managed account platform and Parus Finance, R Parus Fund, a subfund of the InRIS SICAV, is a Long/Short Equity UCITS-compliant fund mainly invested in global markets. With a long-term absolute return target, its management process is based on a bottom-up approach combined with an analysis of the economic cycle. This allows the team to determine the portfolio’s net exposure. The portfolio’s «long» bucket invests mainly in quality growth companies enjoying a sustainable competitive edge and healthy level of liquidity. The «short» positions are composed of companies at a very advanced stage of decline that may require recapitalisation.

R Parus Fund’s strategy is based on a dual approach: depending on the positioning in the economic cycle, the fund goes «long» in sustainable growth companies and goes «short» in declining companies. It then takes a «mean reversion» approach by incorporating companies with financial and/or operating leverage, such as financial, cyclical or commodity companies. As of 28 November 2017, R Parus Fund has returned 14.86 percent since its 31 July 2013 launch.