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Odey Asset Management generated sizable returns in its European fund in March, although its Special Situations Fund is having a more challenging start to the year. Crispin Odey’s European fund returned 14.7% for March, bringing its year-to-date return to an attractive 52.8%.
However, Adrian Courtenay’s Special Situations Fund is down 0.2% for the first four months of the year following an April return of -3.1%. The Special Situations Fund has enjoyed a compound annual growth rate of 29.8% since its inception, compared to the compound annual growth rate of 10% for Odey’s European fund.
The MSCI World USD Index declined 8.31% for April and 13.03% for the first four months of the year.
In his March letter to investors, Crispin Odey noted that they should expect some pullback in the second quarter due to the astonishingly positive first quarter. However, the countertrend he was expecting started about two weeks before the end of March, so part of the drawdown has already been included in the fund’s returns.
As a result, Odey hopes that the European fund won’t lose much before the increase in interest rates across the curve resumes, even in the event of a recession. He noted that part of that depends on the war in Ukraine remaining painful but without conclusion.
The environment engineered by central bankers is gone
Odey pointed out that the world’s central banks have long held interest rates close to zero to nurture an environment in which stocks and bonds returned 5% to 8% with low volatility, but that world is now gone. He added that balanced portfolios fell 4% on average in pounds, although regulators and large fund managers desire the environment’s return.
Of course, inflation will keep that environment at bay, bringing with it significant profit warnings. Meanwhile, the long end of the bond market is inverting, resulting in 30-year money yielding 20 basis points less than 10-year money and almost what two-year money is yielding. Odey expects a recession due to the hit to real incomes caused by the rising prices.
While there’s a chance that the hit to real incomes will cause an immediate recession, he sees a much greater likelihood of stagflation as wages take up the slack, resulting in a recession with rising inflation. Odey pointed out that economists are “adamant” that this can’t happen and that inflation will fall back to 2% within a year, but he recalled the last “real” recession in 1989, when wages kept rising at 9% per annum for three years.
However, Odey said that interest rates are “so far out of whack with inflation” this time around, adding that inverted yield curves usually come some six months after rates are raised, not one month after.
How Odey is dealing with these “out of whack” interest rates and inflation
Odey generated the robust return for his European fund through his short positions in U.K. Gilts. He feels they are much less dangerous now that two-year Gilts are yielding around 1.4% while his long-dated U.K. Gilts are yielding about 1.5%.
A year ago, short rates yielded nothing when the long-dated U.K. Gilts yielded about 1.2%. However, Odey finds it “fascinating” to see how few investors have followed him in protecting themselves against inflation by shorting the long end of the bond market. He added that inflation this year appears to be annualizing at 8.3% before the latest energy cost increases.
Shorts of UKTs consist of the Odey European fund’s top three positions, followed by long positions in gold futures and SLC Agricola, a short in Tesla, long positions in Pendragon, Norsk Hydro, and Valarais, and a short in Lloyds Banking.
Odey’s Special Situations Fund
Despite the negative return in Odey’s Special Situations Fund, it still significantly outperformed its benchmark, the MSCI World USD Index, which fell 8.31% for April and 13.03% year to date. In his April letter to investors, Portfolio Manager Adrian Courtenay noted that macro factors had become more dominant variables in market performance.
Although steady merger arbitrage yields are available, he has yet to see any highly profitable competitive bidding situations. Last month, Courtenay reduced the Odey fund’s non-arbitrage risk, pushing its long equity component down to 43% of its net asset value at the end of April. More than 70% of the fund’s net asset value was in long equity positions intra-month, and 59% was in long equities at the end of March.
For April, the Special Situation Fund’s arbitrage book subtracted 0.37% from its net asset value, while equities detracted 5.39%, hedges added 2.88%, and other currency, costs, and charges subtracted 0.19%. In April, the Odey fund’s three biggest contributors were Norway Royal Salmon shares, Mincor Resources shares, and Western Areas, a competitive bidding arbitrage.
On the other hand, the three biggest stock-specific detractors were ViaSat, Turtle Beach and ImmunityBio.
Courtenay highlights the fund’s growing holdings in Singapore-listed Golden Energy Resources and its Australia-listed subsidiary, Stanmore, as a particularly attractive new opportunity in light of recent macro developments. However, he realizes that they must be more sensitive to the macro issues when selecting event-driven equities outside of arbitrage.
According to Courtenay, Western central bankers have been politically ineffective for years. The result is that governments can’t prevent what he expects to be “sustained inflation. Courtenay noted that the long-running central bank philosophy of over-stimulating their economies through monetization activities has already resulted in the highest inflation in 40 years.
He adds that this over-stimulation has included growing fiscal deficits and left the West with limited options in dealing with a recession. As a result, governments may be forced to choose pro-cyclical activities that could exacerbate an economic downturn.
Meanwhile, long-running outsourcing of labor to low-wage countries has widened domestic inequality, incentivizing the emergency of policymakers who favor erecting trade barriers. Those barriers will further worsen the sustained inflationary scenario Courtenay envisions.
Further, these pressures are occurring amid increased geopolitical tension that led to the West cutting Russia off from trading with it. Russia controls 15% to 20% of global commodities, so this severing of trade ties is further exacerbating inflation.
As long as these macro concerns are understood, the Odey Special Situations Fund can continue to enjoy rewards from its capital allocation strategies and maintain a path of robust returns. Courtenay pointed to other periods when the fund reassessed multiple variables due to changing market dynamics.
The fund remained agile in those periods, and management’s reassessments drove success. As a result, Courtenay remains optimistic about this year.
Odey SSF’s top positions
The Special Situations Fund’s top merger arbitrage positions are: Stagecoach Group, Western Areas, Liberty Media, South Jersey Industries, Vivo Energy, Randall & Quilter, Shaw Communications, Atlantia, Lundin Energy, and Orca Gold.
Its top equity special situations positions are: Golden Energy, Lookers, Crystal Amber, Caledonia Investments, Hotel Chocolat, Mincor Resources, Vimy Resources, Media and Games Invest, Advanced Oncotherapy, and Panoramic Resources.
Michelle Jones contributed to this report.