Lansdowne Developed Markets has a hard time

We just finished reading Lansdowne’s Q4 investor letter. At 40 pages of in-depth analysis that is not a sinecure. But as always the letter provides good insight into the team’s thinking and helps one to form an opinion on the outlook for the fund. We believe that outlook is favorable, despite, and to some agree because of, the rough ride we as investors have recently had.

Let’s first look at the reasons they provide for their poor showing in 2016, a year in which both their longs (-2.3%) and their shorts (-11.7%) detracted from performance.

Dominant, unexpected macro changes

The (expectations of the) nature of government support early in the year shifted from monetary to more fiscal stimulus and was reinforced by the unexpected defeat of the political establishment by more populist appeals in the UK and US. Especially Brexit hurt Lansdowne’s performance.

Secondly, the structural challenges faced by China and OPEC were met with a different policy response than in prior years, by no longer allowing weakening short-term dynamics in the interest of longer-term strength, but doing the opposite. Lansdowne believes that such moves will have a temporary positive impact, with long-term consequences most likely being less benign. Nonetheless, this was painful for their short commodity-related positions. Combined, 80% of negative performance last year can, in some form, be attributed to being on the wrong side of these developments.

How do they expect to make back these losses

The main adjustment Lansdowne made to their portfolio was to align the book with the reality of a new U.S. administration. Lansdowne’s view on Trump’s election is that, allied to a Republican sweep of the house, it will transform the investment environment building on trends that begun to be evident anyhow. Lower taxes, higher spending and a less onerous regulatory burden will be equity positive but bond negative. Inflation will rise but the Fed will likely be happy to stay behind the curve. Despite recent market moves this change remains underappreciated by markets according to Lansdowne. Equities remain very cheap relative to bonds and long -term participation in equities vs. bonds is still heavily skewed to bond ownership.

In line with this view, Lansdowne has moved the fund’s net exposure from the low end of its historical range to the high end, with around 45% net equity exposure. This was achieved by increasing the net financials exposure, adding some new long positions and closing a couple of specific shorts. The main themes in the portfolio now are summarized below:

Conclusion

We are positive on the outlook for the fund given that Lansdowne has steered the portfolio into a position that is more aligned with the recent political developments, while at the same time only realizing a small part of 2016 losses as their main theses remain intact. As we have seen in the past, the team can be early with their views but over time they are much more often right than wrong. Their positions have a lot of upside and we enjoy a cheap ride with no performance fees for the first 20% of gains.