A unique blend in hedge fund form

I chatted to André Steyn about the two significant differentiators in the Steyn Capital FR QI Hedge Fund - the way it uses shorting, and its emerging markets exposure.

Since its launch 17 years ago, the Steyn Capital FR QI Hedge Fund has displayed a distinct character.

“People speak about return-enhancing versus return-diversifying hedge funds. We try to do a bit of both,” says Steyn Capital CIO André Steyn.

“The fund is trying to beat the market over long periods of time, and it has delivered alpha of 3% per year. But it’s trying to do that while at the same time taking on a lot less market exposure.”

Since inception, the fund has averaged net exposure of 70%. However, because it also engages in merger arbitrage investments, monetisation investments and credit-like investments, its beta-adjusted net exposure averages below 30%.

Steyn Capital FR QI Hedge Fund exposures

Source: Steyn Capital Management

This, Steyn points out, delivers meaningful downside protection.

“Our upside capture over time is only around 50%, but our downside capture on average has been zero,” he says. “So, our correlation to the market is very low.

“Over 17 years our R-squared to the market is in the mid-teens. That illustrates how our blending of assets – our shorts, emerging market exposure and event-driven positions gives a different return stream.”

The Steyn Capital Management hedge fund has a distinct approach to shorting in that it runs its short book almost entirely independently from its long book.

“We want our shorts to make money and provide some downside protection,” Steyn says. “That is different to a lot of competitors who use their shorts to fund their longs.

“Since inception, we have made between 30-40bps a year on the shorts. That doesn’t sound like a lot, but if we were to buy put option protection on the portfolio, that might have cost 200bps a year. That’s the advantage we get – we are getting protection and getting paid for it.”

The firm’s primary approach to identifying shorts is finding anomalies in company earnings through forensic accounting. Most often this comes through picking up where firms are manipulating their earnings. This may be flagged by changes in accounting practices or where there are discrepancies between reported earnings and cash flows.

“You might say there are other CAs doing this, but this is a core focus for us,” Steyn (pictured above) says. “And we have the experience of doing this over a number of years.

“We look for businesses that have very weak balance sheets, companies that might be rejigging their accounting to make debt appear lower than it is, and we look for companies where share prices might be inflated because of a fad. A good example of that is Pop Mart, the maker of the Labubu doll. This time last year every parent was bugged for these dolls, but they’re not anymore.”

Occasionally, Steyn and his team will identify outright fraud. An example is their shorting of Thai company Energy Absolute, which ultimately lost 90% of its market cap when its CEO and CFO were arrested.

“We saw there was a very wide divergence between reported accounting earnings and cashflows. And when we looked at why this divergence materialised, a big proportion was because the company was doing mark-to-model accounting. They were running solar and wind plants and assuming a rate of return on those investments to come up with their earnings number.”

The company was then playing with those assumptions, generating accounting earnings that weren’t real.

“One result was that the company had big accounting profits, but an effective tax rate of only 2%. It was also hiding fake earnings by making investments. One significant investment they made was into the government bonds of an unnamed country which had a conversion option. And if someone can tell me what a sovereign bond converts into, I’d like to know.”

Emerging market exposure

This example also highlights how Steyn Capital Management has been successful in introducing broader emerging market exposure into the hedge fund. Since 2022, the strategy has found both longs and shorts outside of South Africa.

“This goes back to the founding of the company,” Steyn says. “I had worked abroad, first for big hedge fund in the US and then in London for another hedge fund where I was responsible for non-US investments. And I consistently saw how investments in emerging markets performed much better than investments in developed markets.

“That really led me to want to focus on these less efficient markets where we can generate alpha and prove our value to investors. We set up Steyn Capital in 2009 and launched the hedge fund, initially only investing in South Africa. Exchange controls were still quite strict then and people didn’t want to co-mingle assets. But in 2022 we brought emerging market exposure into the fund.”

Steyn believes this has brought meaningful differentiation to the strategy.

“We’re able to provide offshore exposure that is not limited to either investing in something listed in South Africa that is really offshore, or pursuing a very competitive large cap US market where we have no edge,” Steyn says. “We want to buy in Hong Kong or Indonesia or Brazil – markets that aren’t as frequented and where we can broaden our return streams.”

The fund has steadily been increasing this emerging markets exposure over the past few years.

“We initially put in a fairly modest amount and have been raising that over time,” Steyn says. “Last year was the first time in 16 years that emerging markets outperformed developed markets, and it’s continuing this year.

“I think those types of cycles don’t move in single-year type events. We very much think we’re setting up for multi-year emerging market bull run.”