Is an allocation to the Long Short Equity Funds the answer to profitably navigate sharply turbulent markets?

Indian investors are lucky as they are in a $3-3.5bn economy that is growing at an impeccable pace. The favorable macros along with the positioning at the cusp of a credit cycle has all the ingredients for a mouth-watering dish. The equity market in the country is like fine wine, as it gets better with age. However, the long-short space in the alternates is less spoken about.

 

It is this segment that we have in our mind and no better time to have a conversation with Mr. Rajesh Bhatia, MD & CIO, ITI Long Short Equity Fund. He has over three decades of investing experience where 15 years were devoted to the long-short equity space. It is the impeccable track record of a L-S equity fund manager that makes him stand apart from his competitors.

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Risk management is one of the key aspects of a long-short equity fund manager. Quantitative easing following the pandemic has led to value being unlocked in the equity markets, domestic as well as global. We have reached a point where further easing will lead to a significant rise in inflation and hence it is important to gauge the reversal trajectory. The Ukraine-Russia war has added further uncertainties in the market leading to increased volatility and blurred market outlook.

Once the genie of quantitative easing is out of the bottle, it may not be easy to put it back says Mr. Rajesh Bhatia of ITI Long Short Equity Fund

Analysts believe that macro-driven equity markets are here to stay and volatility is going to remain the part & parcel of the game. It leaves us with a question that whether long-short funds have room for alpha generation. It was beautifully put to context by Mr. Kamal Manocha of PMS AIF WORLD who exclaimed that the returns of a similar long-only fund with higher risk have not been very different from the ITI long-short equity fund.

It takes only a year to demolish over 30 years of compounding as it was seen during the GFC’08. It took more than 6 years for fund managers to return to the pre-2008 NAV. Long-short funds have the privilege of protecting downside movement which is crucial during turbulent times.

Capital protection and consistency are the binding principles at Berkshire Hathaway as Warren Buffet believes in two rules where the first one says that never lose money and the second one urges every investor to never forget the first rule. ITI Long Short Equity Fund follows these religiously.

The first principle to accumulate wealth at a steady rate is to not lose money

ITI’s Mr. Rajesh Bhatia believes that we are in an artificially engineered equity market. A risk-adjusted strategy is important to help preserve capital for a longer duration. He even read in a book that the secret to long-term compounding of wealth is to not lose too much money. It is the focus and purpose of a long-short equity fund to preserve investor’s capital.

In the last 15 years of experience, Mr. Rajesh Bhatia of ITI Long Short Equity Fund has handled a couple of long-short funds and has never lost 2.5% of the invested capital in any year. The portfolio of ITI Long Short Equity fund is split into parts namely, the strategic portfolio and the tactical portfolio.

The strategic portfolio has the core holdings with 50% of the cash attracted towards it. It replicates the performance of a long-only fund and a long-only investor’s desire. They are less cyclical and are leaders in their particular industry.

On the other hand, ITI’s portfolio has tactical longs and tactical shorts. In addition to the companies held in the strategic part of the portfolio, individual investments are further taken with the help of derivative products. They allow you to go long or short depending on the outlook in the industry.

On the other hand, ITI’s portfolio has tactical longs and tactical shorts. In addition to the companies held in the strategic part of the portfolio, individual investments are further taken with the help of derivative products. They allow you to go long or short depending on the outlook in the industry.

Given the system that ITI Long Short portfolio follows, it should also be noted that the later stages of the cash flows calculated has a larger bearing in the NPV of a business. Furthermore, the technological disruption is leaving markets and investors with lesser confidence in the future. Hence, an ideal L-S equity fund is crucial where the future is bleak and blur. Lastly, the beta or the market risk is eliminated and the alpha or the stock picking skills are enhanced with a combined portfolio.

Mr. Kamal Manocha, Founder & CEO, PMS AIF WORLD, laid out the fact that there are 3 types of investors wherein the 1st type has complete faith in the fund manager. They hand over their wealth to be managed by a professional firm. The 2nd type relies on their own knowledge and database and carry out investments based solely on their ideologies.

Lastly, the third category involves the informed HNIs who hand over the funds and resources to firms who have a long-short investment strategy. The intensity and skills required to manage a long-short fund are far higher than that of a long-only equity fund.  Investors should also note that L-S fund managers are not judging macros.

Howards Marks says in Mastering the Market Cycles that it is important to know where you are in the cycle

ITI L-S Equity Fund does not use leverage whereas the net position of a long + short position remains at 120%. The first priority of the fund is to protect downside and preserve investor’s capital. There are opportunities in the market to unlock alpha with the geopolitical situation and oil prices rising. It was even before the war that aluminum and steel prices were on the rise.

However, given the current situations, the exposures of the ITI L-S Equity fund would be limited as volatility and uncertainty remains in the market. The digitization of businesses has left a lot of value to be unlocked by investors especially in the IT sector. A 50 lakh+ workforce with annual additions of 5 lakh is mammoth and game changing for any sector.

Conservative companies are bound to proclaim that the next 3 years will be robust for the economy with minor hindrances like cost of employees that might rise. Moreover, Infosys used to spend 2.7% on traveling which is now reduced to 0.30%.The are firms with increased savings coming from operating leverage making it a multi-year trend.

India holds a small pie of the global $4 trillion market for Long-Short equity funds. ITI L-S Equity Fund falls under the relative returns category in the country (absolute returns being the second category). The portfolio manager’s risk profile, track record and drawdowns witnessed over a period of time makes the fund unique and stand out in the market.

A risk-adjusted profile helps to gauge the market and ascertain areas to unlock value. The maximum drawdown that the fund has witnessed over a 2-month period is 5%. The fund continues to deliver equity type of returns combined with downside protection. The fund level taxation is an added benefit for investors. Adequate long-term holdings have helped the relative returns category of L-S funds especially the one provided by Rajesh Bhatia’s ITI L-S Equity fund.

The average taxation for funds under the relative returns category is 17% which is an important comparison metric for investors. L-S funds should not be looked at as an equity minus or debt plus fund. They are a different asset class altogether with asymmetric returns during turbulent times as well. The full virtue of long-short funds is realized during a downturn and it is imperative that investors look at a complete economic cycle to gauge its performance.

Downside protection alongside equity type returns is the best platform to compound wealth says Mr. Rajesh Bhatia

An investment horizon of 3-5 years would be ideal for any investor to get home with substantial returns. Asset allocation with ₹10cr as corpus should be relative to where you are on the risk-return profile with a particular asset class. Once the asset class is decided with considerable thought given to market opportunities, one should find an ideal fund manager who is able to maneuver market cycles with ease.

It takes quite some time for a long-only fund manager to break even after suffering a loss of 75% like in the case of 2008. Consequently, a 10-year horizon for an equity fund turns out to be mediocre. Long-short funds take on sufficiently lower risk, have a suitable taxation regime, a process-oriented approach where the manager’s skills are put to test and lastly downside protection combined with equity-type returns should be the go-to asset class for investors.

RISK DISCLAIMER: Investments are subject to market-related risks. This write up is meant for general information purposes and not to be construed as any recommendation or advice. The investor must make their own analysis and decision depending upon risk appetite. Only those investors who have an aptitude and attitude to risk should consider the space of Alternates (PMS & AIFs). Past Performance may or may not be sustained in the future and should not be used as a basis for comparison with other investments. Please read the disclosure documents carefully before investing. PMS & AIF products are market-linked and do not offer any guaranteed/assured returns. These are riskier investments, with a risk to principal amount as well. Thus, investors must make informed decisions. It is necessary to deep dive not only into the performance, but also into people, philosophy, portfolio, and price, before investing. We, at PMS AIF WORLD do such a detailed 5 P analysis.