Why One Money Manager Shorts Stocks, Part 2

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Includes: BH-OLD, INT, SAM, TAP
by: Valulicious

This is the second installment of an interview with Vestopia Investment Director Dan Knight (pictured at right). In Part 1 Dan discussed the rationale for his long/short strategy. Today Dan talks about his performance in the current high volatility environment and where's he's made--and hopes to make--fat profits.

Eliot: In the first part of this interview, you explained how you short stocks in order to reduce risk and shoot for positive, uncorrelated returns. Let's talk about a recent trade of yours so we can see your strategy in action.

Dan: Well I just closed out a successful paired trade in the energy industry. I sold my long position in Marathon Oil (MRO) at a loss of about 15%, but I covered my short in World Fuel Services (INT) after it fell 40%, for a rough 25% net, hedged gain on the pair. So despite seeing many energy stocks declining, I squeezed out a profit from being long/short hedged.

Eliot: Congrats to you on a 25% winner. More generally, how has your hedged strategy been holding up with all of the volatility we've been seeing lately?

Dan: Knock on wood, it has been holding up well. Over the last 3 months my portfolio is up about 9% and is holding up well across most market sectors, that is, no one part of the market is generating disproportionate results.

Eliot: It must feel pretty good to be up over a period when so many others are losing money. Do you think it's advisable for individual investors to consider a long/short strategy such as yours, or would you suggest a more traditional long-only portfolio?

Dan: Each investor's situation is different, so that's a tricky question to answer. Personally, I take no market view and just aim to earn profits in both up and down markets. Those who are attracted to a hedged strategy are welcome to follow my personal trading through Vestopia. And I hope that the long portion of my portfolio will give long only investors not just ideas for market exposure, but for excess returns too.

Eliot: Keeping in mind your earlier comment on the importance of taking a portfolio view and managing risk from that perspective, can you still talk about a specific long-short pair in your portfolio, and why it makes sense?

Dan: Sure. My positions are based on quantifiable factors that have proven to be generally successful at discriminating between expected performance. For example, I own Yum! Brands (YUM), think Taco Bell, because it looks relatively cheap compared to peers, has a pattern of surprising to the upside on earnings, and recent estimates have been revised upwards, among other positive traits. To hedge the consumer discretionary and restaurant industry exposure, I am short Steak n Shake (SNS), which is relatively over-valued, has slowing growth, past negative earnings surprises and negative sentiment. This pair has worked out well, with YUM up about 8% since I bought it and SNS down over 40% since I shorted it. I've made some fat profits on fast food.

Eliot: I'm checking your portfolio holdings at Vestopia--and let me point out that for a limited time during the free beta period readers can follow Dan's portfolio and get live trade notification for his account (and mine too!)--and I see that you are long Molson Coors (TAP) and short Boston Beer (SAM). Is that also a hedged pair?

Dan: It is. It has nothing to do with the beer, I drink both. It's about the relative valuations. Similar to the YUM/SNS methodology, Molson Coors looks relatively cheaper than Boston Beer, has better growth, earnings surprise history and relative strength. And just a reminder not to take this thinking out of context--I have no more confidence that this pair will be profitable than any other pair in my portfolio, and to lessen my risk, I have many long/short positions to keep me diversified.

Eliot: Terrific. Thanks so much Dan. Now let's head out for a little field research in Sam Adams versus Coors.

PS - Don't miss out on Vestopia's free beta, where you can track the real money portfolios of Dan Knight and other talented money managers.