A hedge fund in the true sense of the word, Holowesko Partners uses long and short strategies to manage its risk. For example, you could take a position in a certain technology stock, but buy downside protection by shorting a basket of Nasdaq shares.
But what’s particularly impressive about the global fund’s recent performance is that its net long exposure now sits at around 65 percent. As Holowesko says, it’s further proof that active managers can find opportunities in times of dislocation.
The battle is just beginning
“I think this is one of the most fascinating moments of my career because this volatility is fantastic. We are stock pickers.”
But Holowesko has a warning for investors who expect markets to be nearing bottom. He remains concerned that the battle central banks and governments must wage against inflation is just beginning, and he predicts that interest rates will rise much more than battered stock markets expect. His firm’s models suggest a 15% to 20% drop for equity markets is still possible from here.
“We’re still going to see damage from higher rates,” Holowesko explains. “Rates have been talked about, but they haven’t moved to the extent that they should.”
But on the eve of Australia’s federal election, Holowesko also has a warning for whoever forms the next government, and even the next.
“I think governments are going to come under a lot of criticism, and there will be a lot of changes in government because they won’t be able to control inflation in the short term,” he says.
“There are a lot of choices between now and when inflation can be brought under control, or when interest rates reach an inflationary level.”
Like most global investors, Holowesko has closely watched the action on Wall Street this week for a hopeful rally: the S&The P500 rose 4 percent between May 12 and May 17; was quelled by concerns that the US could be heading into a period of stagflation, characterized by low growth and stubbornly high inflation.
For Holowesko, such bear market rallies are to be expected in this kind of choppy environment. He points out that in the technological collapse at the beginning of this century, there were no fewer than 11 dead cat bounces on the Nasdaq from the market’s peak in March 2000 to its trough in October 2002, and two of those rallies generated gains of more than 40 percent.
Although the equity and high-yield credit markets are clearly adjusting quickly to the idea that interest rates will have to rise quickly, Holowesko, who has met with US Federal Reserve Chairman Jerome Powell in several times, says that this adjustment is far from complete.
He argues that history shows that interest rates must rise to the same level as inflation to lower prices; even if consumer price growth fades in the second half of the year, as expected, US interest rates may have to rise by 4-5 percent. US 10-year Treasuries now sit at 2.9 percent.
“That’s where it goes. And I don’t think the market reflects that.”
The savings reserves accumulated by US consumers and businesses thanks to the extraordinary pandemic stimulus unleashed by central banks and governments will likely force the Fed to do more to put the inflation genie back in the bottle, Holowesko adds.
Adjusting to higher rates will be painful in many ways and may cause the blowout that has so far been absent from this market crash; even last week’s cryptocurrency crash seemed to be fading fast from the collective minds of investors.
Holowesko isn’t going to guess where that explosion is coming from, but he points out that we have yet to see the inevitable valuation write-downs that the private equity and venture capital sectors will eventually have to take on.
“That’s why I feel like things are still very shaky, because we haven’t seen any of that burst of private capital when people start selling.”
‘An embarrassment of riches’
The eventual damage to its own industry will also be substantial, particularly among funds that have pursued high-growth stocks with little downside protection. In the global financial crisis, he says, investors forgot that money managers going down 50 percent “had to get 100 percent returns back to their high water mark. And they were trying to get a 100 percent return on things that were going to be dead money for a long time.”
“We are going to see a lot of these money managers on the hedge fund side. Those guys end up having to take more risks,” she says.
Holowesko also argues that low-income households have not enjoyed the fruits of the pandemic stimulus in the same way that wealthier households have, and as such are much more vulnerable to rapidly rising rates.
Governments, he says, will have a hard time fighting the inflation they have helped create.
“The biggest source of inequality in the world has been governments and central banks distorting asset prices to benefit the people who own assets. And I think it’s disgusting, honestly… it’s an embarrassment of riches.”
Holowesko is clearly negative on the global outlook and the US in particular, where his net exposure to US equities is just 10 percent of his total portfolio. But at the same time, the war against inflation is a boon for a value investor.
“That’s going to produce a lot of volatility and asset prices are going to fluctuate like crazy. And if you’re a stock picker, you should wake up every morning excited.”
Holowesko has a unique perspective on the markets, in part because he and his team are based in Nassau, the capital of the Bahamas, a long way from the noise of Wall Street. A world champion sailor who represented the Bahamas at the 1996 Olympics, Holowesko is heavily involved in island life; A few days before our talk, he urged local government officials to explore carbon credit opportunities.
His perspective is distinctly global, and at the moment he has around 30 per cent of his fund’s assets in Europe and the UK, and 28 per cent in Asia. In particular, Holowesko reveals that none of these investments have offset shorts because these stocks are “incredibly interesting and cheap in absolute terms.”
While the US market still looks expensive when trading at a forward price-to-earnings ratio of roughly 19.5 times, Holowesko says its Asian “longs,” which include telecoms giant Singtel, Japan’s Yamaha Motors and Australian mining giant BHP trade on average 13 times. earnings, with a dividend yield of 3.7 percent and with a free cash flow yield of 11 percent.
Its European and UK holdings trade at an average P/E of 11 times earnings, with a dividend yield of 4.4 percent. Picks in this region include UK banks Natwest and Lloyds, which should do well as interest rates rise and have strong capital buffers that can boost shareholder returns.
But the market shake-up has given Holowesko a chance to pursue some big names that were previously out of reach for value investors. One of them is Meta, owner of Facebook, while another is the Spanish clothing giant Inditex. Both have sold off heavily this year, but having bought Apple right after the global financial crisis and Cisco after the dot-com crash, Holowesko’s bear market experience tells him that big companies bounce back.
“Value investing isn’t necessarily just buying things because they’re cheap on a price-earnings or price-to-book basis. It’s also growth at a reasonable price,” he says. “Growth is returning to interesting levels and the returns on invested capital that many of these companies are producing are just phenomenal, and they are fantastic companies with great growth prospects.”