The range of UCITS alternative funds offered by Rothschild & Co is expanding with InRIS Prentice, a long/short equity fund specialising in US consumer-related themes and developed in partnership with Prentice Capital Management.
Why did you launch this new fund InRIS Prentice, on your alternative UCITS platform?
Charles Lacroix: When we plan to launch a new partnership on the InRIS platform, in addition obviously to the intrinsic quality of the manager, one of our priorities is to ensure that the strategy is complementary to existing funds. From this point of view, InRIS Prentice represents a new diversification solution, the performance and risk drivers of which (long/short on US equities with limited net exposure) are very different from those of InRIS CFM Diversified (systematic funds capturing alternative betas) or InRIS Perdurance (Strictly Market Neutral European long/short equity).
Despite their very different natures, these three strategies share a common objective: to offer a performance that is uncorrelated to that of traditional asset classes (bonds, equities, currencies) in order to provide an efficient diversification within an investor’s overall portfolio. In addition, the simplicity of the long/short strategy for US equities of InRIS Prentice, the readability of a portfolio of around fifty liquid stocks, and the fact that it is only marginally leveraged, allow us to replicate under the UCITS format a strategy that has proven its worth over the past fifteen years in an offshore format.
How is this fund different from the UCITS long/short equity fund offer?
Charles Lacroix: First of all, it is important to note that while many UCITS long /short equity funds have been launched in recent years, most of them are global or European equity funds, but the offer of US long/short equity funds is much more limited. This is not intuitive when you consider that the long/short equity strategy was invented in 1949 in the United States and that US equities are by far the most liquid and deep market in the world. This is probably explained by the fact that US fund managers have a large investor base in North America for strategies that are, by nature, of limited capacity. InRIS Prentice is therefore one of the few UCITS funds that is investing in US equities with a limited level of net exposure (historically between +30% and -10%).
Furthermore, this strategy focuses on themes related to US consumers, and Michael Zimmerman, founder and PM of Prentice Capital Management, has been a specialist in this field for over 20 years. Having studied at Harvard and pursued a career as a professional tennis player (playing the US Open and Wimbledon), Michael then joined Lazard Asset Management before joining leading hedge funds first as an analyst and then as a PM. He then founded Prentice Capital Management and is surrounded by a team of specialised industry analysts, focusing on stocks with less Wall Street research coverage and staying away from the stocks usually found in US equity portfolios, such as GAFAs.
In addition to studying financial data, Prentice’s teams consolidate their analysis with grassroots research made possible by the creation, over the years, of a network of surveyors travelling throughout the United States to make, for example, franchisee conferences, store surveys and web scraping with a view to compare their investment thesis with the market’s expectations. This empirical approach is unique and the team’s specialisation in less sought securities, combined with limited net exposure, has enabled the strategy to historically offer a very low correlation to the S&P 500 (at around 0.3) as well as to other US long/short equity funds.
Michael Zimmerman and his team are implementing an original approach to selecting turnaround stocks for which they have identified a short-term catalyst (three to six months). In other words, the “long” book is typically composed of companies with strong brands, facing a difficult environment (increased competition, pressure on margins, etc.) that led to market sanctions, but which have just changed senior management team, strategy or launched an innovative product.
Conversely, “short” securities are characterised by peak margin and high valuation levels, supported by one-off factors that charmed the market despite weaknesses that might soon become apparent. This approach, which may at first seem contrarian, is nevertheless always associated with a short-term catalyst and leads to very dynamic portfolio management. This feature has probably enabled Prentice Capital Management to generate significant alpha on the short leg of the portfolio in recent years, when many longer-term long/short funds have suffered greatly from the strong resilience of their short positions. Just a figure to illustrate the dynamic nature of portfolio management: the annual turnover rate of portfolio names is estimated between 2 and 3 times and between 4 and 5 times in US dollar terms.
What is the expected level of volatility and what is Prentice Capital Management’s risk management approach?
Charles Lacroix: As previously mentioned, the InRIS Prentice portfolio is relatively concentrated, resulting in an expected annualised volatility of around 10-12%, despite a limited net exposure, for a Sharpe ratio target of 0.8. Much like the investment process, risk management is also dynamic. As Michael Zimmerman says, “if a stock contributes negatively for more than 3 to 6 months, it means we’ve missed something” and the PM will not hesitate to reduce or even sell the position. More specifically, when a long position loses more than 25%, it is reduced by 50%. And if the stock were to lose another 5%, the position would again be cut by 50%, i.e. a quarter of its initial size. The strategy is therefore just as dynamic in terms of risk management as it is in terms of risk control and follows a very disciplined process.
Is the US consumer-related theme not too nichy and does it make sense to invest in sectors marked by many disruptions?
Charles Lacroix: The themes related to US consumers, which represent approximately 70% of US GDP growth and 20% of the S&P 500, are meant here in the broadest sense of the term. They cover both basic and discretionary consumption, as well as stocks that are impacted by the behaviour of American consumers, such as the Internet and Media sectors. It is therefore a vast universe of some 450 securities, covering eleven sub-sectors.
In addition, major disruptions are occurring within these themes. For example, Uber is challenging the taxi business model, Amazon and Wayfair are affecting traditional distributors, and Airbnb is forcing hotels to reinvent themselves. These revolutions create many opportunities, both on the long and short legs. On the one hand, provided that they know how to sort the wheat from the chaff among these “disruptors” (how many e-business “fallen angels” for one Amazon?) or that they identify the traditional players sacrificed by the market but who will be able to revamp their model. For the short side, provided you know how to identify new players who are adored but whose business model is fragile or “dinosaurs” who will not be able to adapt.
If we add the limited net exposure, one would realize that investing in InRIS Prentice is not the same as taking a bullish bet on the US consumer sectors, but rather opting for an absolute return strategy, uncorrelated to equity markets and naturally positioned to take advantage of the seismic shocks experienced by entire segments of the US economy.
