All up, the Auscap Long Short Australian Equities Fund returned 18.5 per cent in 2023, just behind Mercer’s one-year Australian equities long-short winner, QVG.
Rather than attributing the move to a stroke of expert timing, Carleton says the decision shows that by leaning into the fund’s strengths, concerns around market timing and its reliance on short bets had fallen by the wayside.
“We’re a little bit different from a lot of long short funds. We’re only shorting very selectively,” says Carleton, who co-founded the hedge fund with fellow Goldman Sachs alum Matthew Parker in 2012.
“Historically, we’ve generated almost all of our returns on the long side, around 99.7 per cent, so we’ve been a lot more focused on that than the other 0.3 per cent.”
According to Carleton, the arrival of Mumford, who stepped up to deputy portfolio manager in the middle of last year, accelerated the fund’s shift in style.
“Will’s biggest impact on the team has been to focus on quality,” says Carleton.
“Over the last few years, he’s talked me out of anything that looks like it’s not a best-of-breed business.”
Mumford – who joined Auscap in 2018 after two years as an investment banking analyst at Macquarie Capital – appears largely uninterested in the short-term thinking and quick wins that other funds have built their reputations around.
“He’s convinced me to forget anything other than what we feel like we’re good at, which is identifying businesses we’re very confident will grow over time, and then just not overpaying for them,” says Carleton.
The sweet spot
That remit has Mumford zeroed in on a narrow and often maligned segment of the ASX – mid-caps.
“In the ASX 20 you’ve got the big banks, which haven’t really been able to meaningfully grow earnings over the last decade, and at the small-cap end, the earnings growth has disappointed because you’ve got a lot of pre-profit businesses,” Mumford says.
“Whereas in the mid-cap sector, you get this sweet spot where stocks are probably dominant in their market and have the ability to scale and grow earnings.”
According to the pair, it’s a thinly spread combination of wins from these quality mid-cap picks – JB Hi-Fi, ARB Corp., CAR Group, NIB Holdings, and the like – that’s fuelled the fund’s strong performance over the last few years, rather than all-in bets on short-term rallies.
The arrival of Will Mumford at Auscap has heralded a new focus on quality at the long-short fund. Peter Rae
“We’re not trying to do anything particularly tricky. We just want to find businesses that we are very, very confident are going to take their earnings from point A to point B,” adds Carleton.
“Even if that takes a decade, the share price will reflect it.”
And with annualised five-year returns of 15.8 per cent, few investors would complain that the long-short fund isn’t adhering as strictly to its nominal style as others might.
“Our investors like to think of us more as a high conviction fund than long-short,” Carleton says.
The success of the strategy has prompted Auscap to double down on its mid-cap pivot, launching a long-only mid-cap fund at the back of last year.
The pair hold up healthcare stock NIB as an example of the “sweet spot” they’re looking for when hunting among the mid-caps.
“NIB is an ASX 100 business with market-leading metrics in the private health insurance industry, but it still only represents less than 10 per cent market share in its core market,” Carleton says.
“It’s the same with JB Hi-Fi, that’s 40 per cent of the electronics market. They’re dominant but still with all this organic room to grow.”
That fund’s focus on quality has Auscap confidently wading into arguably the ASX’s most beaten up sector over the last 12 months: lithium stocks.
Mineral Resources and Pilbara Minerals are among the fund’s major holdings, despite that latter holding the dubious moniker of the most-shorted stock on the ASX, with more than 20 per cent of shares held by short-sellers. Around 5 per cent of Mineral Resources’ shares are shorted.
Short sellers feasted on the lithium sector in 2023, cashing in on a collapse in the price of lithium which dragged the shares of producers and developers into the doldrums.
New iron ore project
Carleton believes, however, that when it comes to Mineral Resources, investors are looking in the wrong place.
“MinRes is an interesting one. It’s got two exposures. Everyone’s focused on the lithium at the moment, but their new iron ore project will come online hopefully during this year,” he says.
“We don’t think the market is ascribing a huge amount of value to the iron ore business at this point. If iron ore prices are anywhere near where they are today, that operation could be enormously profitable.”
As for Pilbara Minerals, it’s the fund’s strict focus on quality operations that has the portfolio managers unperturbed by the short interest.
“We’ve been very pleased with them – just look how disciplined they look. They’ve been keeping all that cash on the balance sheet, recognising the cycle was going to be volatile,” says Carleton.
“They’re in a remarkable position … and there’s a pretty strong chance that their Pilgangoora operation [in Western Australia] becomes the lowest-cost lithium mine in the world.”
Looking at the sector more broadly, Carleton says the fund reduced its exposure to lithium in the lead up to 2023 but stepped back in towards the end of last year.
“The lithium price cycle has been extraordinary. No one ever thought the price would get above $US6000 per tonne or that we’d get back down to $US1000,” he says.
“The reports say underlying demand for electric vehicles has disappointed, but to us, it still looks to be very strong, so we’re equally fascinated by the short interest.”