Investment process - Long / short portfolios

The long portfolios run by Cartesian consist of the team’s current best ideas. This is a high conviction process with individual weightings sufficient in size to have a material impact on performance. An overall portfolio size of 30-60 stocks is targeted. All positions are held on a ‘need to own’ basis, continually challenged by fresh ideas, with benchmark considerations of secondary importance.

Holding periods depend on a variety of factors. Cartesian invests with a clear view as to valuation targets and the time limits to deliver investment returns. This view can, however, be flexible through time. The team is prepared to run with particularly strong stocks, and has held some positions for more than five years. When targets are approached, however, the Cartesian fund managers are ready to take profits or liquidate holdings unless the investment case has changed. With a steady stream of replacement ideas, there is no reason to run overly large or stale positions.

Share price weakness is also not an automatic trigger for liquidation. If the fundamentals remain intact, then the immediate reaction would be to exploit a buying opportunity. If, however, the story has changed, then Cartesian may sell immediately. Stocks can also be ‘timed out’ of the portfolio, by not generating the required return within an acceptable timescale.

Shorting

The Cartesian team’s short positions are a product of the same analytical process as that used to select long positions. This is not to say that shorts are simply the mirror image of long decisions.

Share price appreciation with longs can be much more gradual than adverse price movements with shorts. Equity markets are typically long-biased in terms of the weight of analytical effort and, with the exception of bid approaches, longs tend to accrue performance steadily. In contrast a much more violent reaction can be expected from shares in companies that disappoint, or become financially distressed.

Identifying shorts, or stocks to avoid in a long-only fund, follows the same process of business model assessment and valuation described above. Nevertheless, there are a number of specific issues relevant to the management of the short books in the Ignis Cartesian Enhanced Alpha Fund and Ignis Cartesian UK Equity Long/Short Fund.

The fund managers see good stock selection in shorts as an equally important source of alpha as high conviction longs. They look to keep a focused, well-researched short portfolio, and retain short exposure throughout market cycles. Short weightings will, on average, be smaller in size than long positions.

Cartesian does not use stop loss as a method of risk control. Experience has shown that significant downward moves in share prices can often be interrupted by short-term spikes. The decision to retain a short will be primarily based on the team’s company analysis and valuation view. Cartesian’s dynamic boutique approach provides a competitive advantage in this respect.

Most investor and broker commentary still focuses on a narrow range of companies and Cartesian actively looks to avoid crowded short trades that can move against the fund despite the underlying company newsflow.

As with longs, the Cartesian fund managers are pragmatic about holding periods for shorts. As indicated, however, a successful short can see a swift and extreme price correction, fully recognising investment expectations quicker than would necessarily be the case with longs. For this reason the average holding period for shorts is typically somewhat less than for longs.

In-depth company research

The use of broker research notes is limited to providing background information and initial forecasts. The added value in the Cartesian process comes from an in-depth understanding of the financial dynamics of a company or sector. This includes the stress-testing of forecasts under various scenarios, for example adjusting for cost sensitivities, revenue slippages and a variety of cashflow changes.

Cartesian’s unconstrained approach means that when the managers identify a company characteristic that has been mispriced, related stocks or areas of the market are searched for further opportunities.

A key aspect of the value Cartesian can add remains the diligent application of fundamental analysis. The fund managers make a point of thoroughly reading company announcements and accounts, which they believe remain the best source of good quality and legally verified information, before they pay any attention to media and market views and commentaries.