The Horatius Fund Newsletter February 2020
NEWSLETTER / FEBRUARY 2020 MONTHLY REVIEW
The Horatius fund was -1.47% in February and -0.57% YTD, the benchmark average is -1.49% for the month of February and -1% YTD.Under normal circumstances, as we sit down to write this commentary, we generally do so feeling well- equipped to describe how the market is behaving, what the most likely developing factors are that could determine tomorrow’s winners and losers and how we are positioning accordingly. It would be misleading of us to try and paint such a picture today. Until last week, we might have been able to say that it is now all about the response to the Corona virus – but, as of the weekend, even that it is no longer the case. The emergent price war in oil, ostensibly between the Saudis and Russia, has been like pouring petrol on a fire and now with Transatlantic trade closed between the US and continental Europe– for the first time since the 1940s - Western economies are effectively on a war footing.Let us at least start with the relatively easier period of February. For the first three weeks of last month, the world took the view that the COVID-19 virus in Wuhan province was unpleasant, certainly needed watching but, ultimately, was probably a relatively short-term phenomenon which would likely crimp growth, mainly in Asia and certain sectors which have particular exposure to travel and entertainment, but that a V-shaped recovery in the not too distant future was the most probable outcome. We now, of course, know differently.
Until this week the market was still doing its best to cling on to rationality: how exposed was each sector to the virus, how long might it last and, thus, what proportion of companies’ annual earnings might be impacted by the virus. Such logic, it was supposed, would enable one to determine new, adjusted fair values. This week, though, has seen a departure from such thinking. Inevitably, comparisons have been drawn with 2008 and even, in the face of stock market falls in the last couple of days, with 1987. There are undoubtedly similarities with 2008 in that we have now witnessed several days of the market gapping lower in a vacuum and liquidity drying up as investors flee to cash, even selling gold. But 2008 was a financial market crash – thus concentrated in key Western financial centres; this time the health crisis is global, and is certainly paralysing almost every aspect of the Western market economy.For the fund there is good news and bad news.▪ The good news is that we came into this period with our risk close to its lowest levels of the last 18 months and during February we reduced leverage to almost zero. In addition, we had been buying fairly deep out-of-the-money puts on both equity and credit indices. These have helped considerably over the last fortnight. We continue to have significant downside protection in place.▪ The bad news is that, in spite of this protection, mark-to-market losses have nevertheless been substantial. Another similarity to 2008 is that risk management has become increasingly difficult: relationships (i.e. the beta) of each position can alter dramatically under these conditions; correlations have already begun to converge to 1, just as they did in the financial crisis. This means, in practice, that one’s risk becomes best-denominated in simple, notional terms.Horatius Capital Limited Registered Company No. 10436077 Registered Address 22 Chancery Lane, London, WC2A 1LS, United Kingdom Horatius Capital Limited is an Appointed Representative of Privium Fund Management (UK) Limited, Authorised & Regulated by the Financial Conduct Authority
For this reason it is very helpful that we have an unlevered balance sheet. Similarly, the last couple of days have seen investors beginning to panic sell: selling not what they want to sell but what they can sell. On the plus side, if one is looking to tick off Things That Need to Happen Before We Can Rally, this would certainly be one of them.Whilst we have now seen very meaningful responses across the world, both on the monetary and, increasingly now, on the fiscal side, we believe that we are still some way from ‘peak negativity’ in terms of the spread, and the impact, of the European and especially the US, response to the virus itself. Such measures are clearly helpful but it is still too early to say that markets have yet found a bottom. While this remains the case, just as in 2008, there will likely be large gyrations, both intra-day and over coming weeks. As such, whilst under such circumstances, having hedges in place can, on days when the market rallies, be doubly painful, as they rally while slower-moving bond longs do not, we believe that for the time being it is prudent to remain cautious.There will, of course, be opportunities thrown up by this extreme turbulence. As mentioned above, redemptions and forced selling have already begun to cause investors simply to sell what they can: this inevitably means that many high-quality bonds are becoming very attractive. The yield on the portfolio is now over 9%, with an average duration of 3.6 years. Not only have we tried to avoiding unnecessarily selling ultimately robust bonds, but we are very much focused on identifying others which we are looking to buy.When – not if, but when – the smoke clears, we will find ourselves in a world where underlying Treasury yields have become even lower, where most governments are committed to large-scale spending plans and thus a scenario where excess return is as important as ever. Today, we are looking at bonds which are at worst defensive (even those working from home will need to use telephones and download data –many solidly structured, blue-chip EM telecom bonds are offering yields today of c.8%-9% in dollars) and at best could easily see price appreciation of up to 20% in short order when markets turn in the months ahead. That won’t be tomorrow but already Horatius is beginning to see some extraordinary value, and is clear eyed, ungeared and ready with dry powder to begin selective buying when the time is right of uniquely high quality, high yielding bonds as the market turbulence throws up opportunities.
DISCLAIMER This communication is for information purposes only and not intended to be viewed as independent investment research. It is not an invitation to buy or sell any of the securities or fund(s) referred to in the document and is not a personal recommendation or advice on investments, taxation or on any other matter. The prospectuses and supplements of the funds are the only authorised documents for offering of shares of the funds and these may only be distributed in accordance with the laws and regulations of each appropriate jurisdiction in which any potential investor resides.This communication has been prepared by Horatius Capital Limited which is an Appointed Representative of Privium Fund Management (UK) Limited (“Privium”). Privium is authorised and regulated by the Financial Conduct Authority (“FCA”) in the United Kingdom. It is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation. Within the EEA, the fund is only available to Professional Investors as defined by local Member State law and regulation. Outside the EEA, the fund is only available to Professional Clients or Eligible Counterparties as defined by the FCA, and in compliance with local law. This communication is not intended for distribution in the United States (“US”) or for the account of US persons, as defined in the Securities Act of 1933, as amended, except to persons who are “Accredited Investors”, as defined in that Act and “Qualified Purchasers” as defined in the Investment Company Act of 1940, as amended. It is not intended for distribution to retail clients.The representative in Switzerland is ARM Swiss Representatives SA, Route de Cité-Ouest 2, 1196 Gland, Switzerland. The paying agent in Switzerland is Banque Heritage. The Prospectus, the Articles of Association and annual financial statements can be obtained free of charge from the representative in Switzerland. The place of performance and jurisdiction is the registered office of the representative in Switzerland with regards to the Shares distributed in and from Switzerland.We believe the information in the document is based on reliable sources, but its accuracy cannot be guaranteed. The views expressed are the views of Horatius Capital Limited at time of publication and may change. Where this document contains “forward-looking” information, including estimates, projections and subjective judgment and analysis, no representation is made as to their accuracy or that these projections will be realised. Neither Horatius Capital Limited nor Privium are liable for any losses relating to the accuracy, completeness or use of information in this communication, including any consequential loss. Where comparisons are made to an index, this is for information only and should not be interpreted to mean that there is a correlation between the portfolio and the index. Past performance does not predict future results and the capital value of the fund’s investments and the income generated can fluctuate. Where investments are exposed to currencies other than the base currency of the fund, they may be subject to foreign exchange rate fluctuations.The registered office of Privium is The Shard, 24th Floor, 32 London Bridge Street, London, SE1 9SG. Copyright©2020, Horatius Capital Limited. All rights reserved.Horatius Capital Limited Registered Company No. 10436077 Registered Address 22 Chancery Lane, London, WC2A 1LS, United Kingdom Horatius Capital Limited is an Appointed Representative of Privium Fund Management (UK) Limited, Authorised & Regulated by the Financial Conduct Authority