Moab Capital Partners Portfolio Manager Michael Rothenberg watches this market activity while scratching his head. Markets have priced in a significant degree of Trump perfection, which seems odd given the known unknowns. Looking over 2016 the $572 million hedge fund manager noted its performance was tempered by market hedges – which smoothed out volatility during the many points of stress throughout the year. Nonetheless, given its 2016 performance closely matched that of the S&P 500 over the period of time, the hedges served their purpose. The issue is how will the strategy perform in 2017?

2016 Hedge Fund Letters

Moab Capital Partners

Moab Capital Partners close to matches the S&P 500 with considerable drag from hedges

In a year where the returns distribution of unpredictable events had rather fat tails, Rothenberg is nonetheless pleased. The 10.16% annual performance Moab Partners L.P. netted investors was close to the S&P 500 year end return of 11.94%. Not bad considering Moab mostly missed the “Trump bump,” delivering 1.43% and 0.10% in November and December respectively. Given the S&P 500 had its second biggest month of the year in November, up 3.70%, and December was no slouch at up 1.97%, Rothenberg is nonetheless generally pleased.

“We continued our tradition of mitigating volatility,” he wrote, pointing to a noncorrelated strategy that “allowed us to largely avoid a first quarter 2016 market collapse.” When the S&P 500 was down -4.95% in January 2016, for instance, Moab was down only 1.42% and up in February. By contrast, the Credit Suisse Event Driven hedge fund index was down -3.05% in January. During the drawdown Moab added exposure in credit and arbitrage positions.

Hedging and volatility reduction systems often costs a portfolio during times of strong market advances, which can be seen in March. With the S&P 500 up 6.78%, Moab followed along with more modest 2.47% performance.

“We ran a portfolio that was consistently well hedged throughout the year,” Rothenberg wrote. Beta to the S&P 500 during the year was never more than 0.25 and net exposure on the Long / Short ratio dial was never more than 59%.

“We lost too much money on hedges in 2016,” the fund manager bemoaned as he noted planned adjustments. “This can be improved upon in 2017 thanks to a dramatic narrowing of credit spreads. More of our hedge opportunity will be in credit in 2017 and if markets deliver similar returns to 2016, we’ll lose less on the hedges.”

Illustrating the fact that hedging costs money, the two top yearly losers in the portfolio were: #1) equity hedges, costing 1.9% of performance, and #2) Credit hedges, costing 1% of returns. Short exposure on the S&P 500 Industrials ETF (XLI) and a short on individual equity Neustar (NSR) each cost -0.7%.

Big winners were Air Transport Services (ATSG), up 2.7%, while two new positions, Armstrong Flooring (AFI) and Tower Semiconductor (TSEM), each contributed just over 1%.

Moab Capital Partners – The Trump rally isn’t considering reality

Looking backwards is not Rothenberg’s primary or most material focus. He looks at the current Trump rally with a scratch of the head that comes from questioning consensus activity.

“We naturally react to investor euphoria with skepticism, particularly as Trump’s policies remain unclear,” he wrote, wondering out loud how is it markets can be so positive with so little hard information.

He attributes the price rise to a number of issues, all of which are technically unclear.

Broadly markets are on a bullish sugar high due to expectations under the Trump administration for: less regulation, easier access to offshore cash and lower taxes.

This is curious positioning, particularly as policy development, negotiation and approval is a messy and uncertain process. Rothenberg, in particular, sees risk in certain sectors and individual names based on what is known:

Trump may go the populist route and beat up pharmaceutical companies who he says are “getting away with murder” for excessive drug price hikes. Trump intends to repeal and replace the Affordable Care Act which has been a boon for the managed care sector. Trump says he wants to slash payments to Boeing for Air Force One and Lockheed Martin for the F35 fighter. He says Amazon has a “huge antitrust problem” and he has vowed to block the AT&T Time Warner proposed merger. As for the sector which Trump knows best, real estate, political insiders seem to have more questions than answers.

But it is not just idiosyncratic issues that is troubling Rothenberg. Equity market price/earnings multiples are near historic highs, interest rates are reversing a historic downtrend and moving higher – a particular threat to highly levered companies – and the US Dollar has significantly strengthened, which places pressure on un-hedged US multinationals who make up a high percentage of the S&P 500.

There are risks all around, and Moab is ready for them, the letter indicates.