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Why the ASX is a rich target for short-selling

Tom RichardsonMarkets reporter and commentator

Hedge fund industry pioneer, billionaire, and Tiger Management founder Julian Robertson is credited by Adam Leitzes as the greatest influence on his investing career.

Leitzes was hired by Robertson in 2008 after passing an infamous psychological evaluation as part of the interview process to work for the godfather of hedge funds at Tiger.

Adam Leitzes of Karst Peak Capital Limited poses for a portrait in the Central district of Hong Kong.  Isaac Lawrence

“It’s a two to three hour test examining things like personality, intelligence, and integrity,” says Leitzes. “Over time the data from this exam has helped Tiger to predict what types of individual will be successful investors and fund managers.”

After getting hired and spending four years working for Tiger as an analyst and director in New York and China, Leitzes soon got an offer he couldn’t refuse from the man known in hedge fund circles as the real Tiger King.

Robertson suggested Leitzes take a seed investment from him to launch his own ‘tiger cub’ fund out of Hong Kong. Taking the seed funding, experience at Tiger, and a career in Wall Street hedge funds since the age of 21 the now 40-year-old Leitzes launched the Karst Peak Asian Master Fund out of Hong Kong in 2012.

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“There’s a kind of a tiger style to investing,” says Leitzes. “The funds are all hedge funds. So the shorting aspect is very important. It’s all very fundamental, we’re not really pair trading, it’s not quantitative, it’s really just tying to find bad companies and fill positions to benefit from that over time.”

By 2020 Leitzes had made up his mind to launch a separate ASX-focused fund thanks to Karst Peak’s market-thumping success in buying and shorting Australian listed equities.

On January 1 Leitzes and his team which now includes former Macquarie and CLSA analyst Hashan De Silva launched the Karst Peak Shearwater Fund to invest predominantly in ANZ equities on behalf of wholesale investors in a Cayman Islands domiciled fund.

Leitzes has calculated the Australia and New Zealand long positions held in the Karst Peak Asia Fund between 2016-2020 delivered annualised returns of 54.8 per cent, when carved out from the fund’s other assets.

On the short side annualised returns for ANZ positions ran at 16 per cent. Total annualised returns equalled 70.7 per cent when assuming a hypothetical long exposure of 100 per cent and short exposure of 50 per cent of gross assets.

“One major reason for the disproportionate share of home-run stocks in Australia and New Zealand is that companies go public at a fairly early stage,” says Leitzes. “There’s a relatively small pool of venture capital in Australia and the ASX makes it easy and affordable for companies to list.

“This dynamic is very different from what’s happening in the rest of the world, where there’s a flood of venture capital and private equity and companies are staying private for far longer. Amazon went public in 1997 with a US$400 million market cap.

“Today, by the time most major tech companies float their shares in the US their valuation is already in the tens of billions.

“So the ASX is fairly unique in offering public market investors a chance to invest in growing companies at an early stage and reap the rewards if they back the right businesses and teams.”

Karst Peak’s biggest successes have come on the long side, where its held winners often growing outside Australia; these include Afterpay, Avita, City Chic, Cyclopharm, Genetic Signatures, Telix Pharmaceuticals, and Viralytics.

At any one time it will typically hold 15 long and 15 short positions, according to Leitzes.

“On the long side we think of ourselves as almost like a private equity firm in the sense that we’re very long term investors, we try to find positions we can own for 3,4,5 years and as a result of that we do a lot of homework before we make a decision.”

Shorting lessons

Leitzes says he’s found Australia’s equity market to be especially rich with short targets, with the sell side typically championing stocks and many companies relying on dubious EBITDA metrics to justify valuations.

On a higher level he says a typical short will be held for 9 to 18 months and to screen for ideas you can focus on the five F’s: frauds, fads, financial shenanigans, fading businesses, and the financially distressed.

The fundie says Karst Peak also try to avoid being a hero on the short side. “It’s very dangerous to try to call the top on a stock and try to short at the highs and we have the scars to prove it.

“One interesting thing about Australia is there’s a relatively low bar for reporting. I guess I’d say there are fairly loose reporting standards is one way of putting it,” he says.

“Companies are pretty promotional and often give very, very long term guidance, which is something we don’t see in other markets around the world. They try and push investors to a very rosy outlook.

“There’s a huge focus on EBITDA in Australia. Companies in the tech sector capitalise a huge amount of their R&D expense and then point to EBITDA which doesn’t really include the amortisation of the R&D expense.”

Getting going

Leitzes says he first worked on Wall Street as a high-school teenager, after his uncle who worked as a trader helped him gain work experience. While his father and grandfather were always reading the stock pages of the Wall Street Journal.

“Back about 20 years I did some journalism myself,” he says. “Writing for Forbes, and wrote a book. So I think that digging and investigative work, I enjoy that about investing and that’s really what our approach is - both on the longs and the shorts.”

The fundie became an author as a prodigious college student at the University of Pennsylvania’s Wharton Business School, after Forbes accepted a joint-application with his roommate to write about tech and investing.

“To our surprise they agreed and we started writing a bi-weekly column on Forbes.com about the intersection of investing and technology and how investors could use tools on the internet, which was very new at the time,” he says.

“A publisher noticed our columns and asked if we’d be interested to write a book around the same ideas. So I was lucky enough to publish a book about investing back in college, which helped pay the bills for some nice dates with my girlfriend, who is now my wife!”

Since its January 1 launch the Shearwater Karst Peak Fund has returned 16 per cent gross as at February 23.

Leitzes says Australia is a natural environment for a ‘tiger cub’ due to the relative lack of competition and abundance of opportunity due to a lack of hedge funds and short sellers.

“So you’re kind of in this interesting cycle where the hedge fund industry has never really taken off in Australia,” says Leitzes. ”

“Based on the data I’ve seen I think there’s less than 100 hedge funds that have over $100 million in assets and that’s pretty incredible.

“So that’s the opportunity we see, we think there’s a number of interesting inefficiencies in the Australian market. To the point I think where we thought it really made sense to launch a fund focused on the market.”

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2021/02/28 21:16