Manager Monday: Roystone Capital Management
Today's Manager Monday takes a look at a Roystone Capital Management, which has had a hard time generating alpha in the current environment.
Thus far, our Manager Mondays have tended to focus on popular funds that have no trouble generating alpha. Today, we’ll examine a manager that public data indicates has had a slightly more difficult go of it (albeit over a much shorter time period in a low dispersion environment).
Roystone Capital Management is a value-oriented hedge fund founded in 2013 by Rich Barrera, formerly of Redwood and Glenview. The fund invests both long and short in equities and credit. All the below analysis is purely on their long equity book they’re required to publicly file, so does not encapsulate their entire book. Given the asset class profile of Roystone’s investments, and the fact they did not reach sufficient size to file till Q4 2013, this is an important disclaimer. This analysis does not include their first year, and the multi-asset class long/short nature of their portfolio means actual performance and portfolio composition may differ greatly.
Asset Growth / Transmission
Roystone has grown explosively: AUM (as measured by market value) has roughly doubled from where it was in the first filing in Q4 2013.
As we’ve pointed out a few times in the past, an increase in assets is typically reflected in an equity fund’s portfolio through three metrics: an increase in the number of securities (as the manager tries to find new names to deploy the capital), a rise up the market cap spectrum (as the manager searches for names big enough to be able to accept the additional money), and/or a decrease in liquidity (as the manager decides to double down on the same names).
When we inspect Roystone’s portfolio, we first see that the number of securities they’ve publicly filed on has stayed roughly stable (with some ups and downs).
Meanwhile, 30d liquidity has actually increased.
Given this, one would posit that Roystone has likely pushed the third lever to accommodate asset growth – and sure enough, examination of their portfolio shows that on a weighted average basis, the fund has crept up the market cap spectrum. Later, we will explore whether this shift has been a good thing.
Absolute and Relative Analysis
On an absolute basis, Roystone seems to have done a decent job, generating nearly 1,300bps of contribution. Of the 80 names they’ve filed on since Q4 2013, they’ve made money on 61% of their names (what we here at Novus refer to as a batting average), and have deployed 66% of capital into these winnings. These impressive metrics have been hamstrung slightly by the fact their average winner makes 66.6bps, whereas their average loser detracts 64.1 bps. This unimpressive win/loss ratio of 1.04x suggests that Roystone may have some issues around sizing up their winners and cutting their losers (see this Novus paper that goes into some more depth about the importance of the win/loss ratio).
More worries come up when we look at Roystone’s performance on a relative basis. Comparing each security to the market and to its relevant sector benchmark, we can dissect how much of the fund’s contribution from that security has come from exposure to the market/sector (“beta”), and how much has come from security selection/trading (“alpha”). The results of this analysis across the portfolio can be seen below:
The data suggests that the entirety of the 1,277bps that Roystone has generated on its long equity book has come from beta. Security selection/trading detracted 530bps. While this obviously isn’t great, there is an interesting observation one can make upon examining the biggest alpha generators/detractors.
With the exception of Valeant on the long side, and Media General on the short side, none of these names are particularly popular amongst hedge funds. Indeed, when we examine the Novus Top 50 (the 50 most popular names among hedge funds our research has found), we find just 5% overlap with Roystone’s book. What this means is, for better or for worse, Roystone (unlike numerous other funds) is not collecting 2 and 20 to go to “idea lunches” and schmooze stock picks off the competition.
Since their first filing, the fund has been focused on three main sectors: Consumer Discretionary, Healthcare, and Tech. More recently, they have increased exposure slightly to Industrials and Utilities, and have exited the financials space entirely.
As we dig in further, we see that the book has generated alpha primarily in healthcare. Positive performance in other segments has largely been driven by market/sector exposure. Worryingly, significant alpha has been detracted in the core Consumer Discretionary and Tech sectors. In the chart below, the lighter bars are beta, and the darker bars are alpha.
Additionally, despite relatively small allocations, utilities and materials have been the heaviest detractors. With the lack of success in their core sectors, the manager can’t be blamed for exploring other options, but these do not seem to be working out.
Market Cap Analysis
As we previously noted, the avenue that Roystone has appeared to have gone down to incorporate asset growth is a move into larger market capitalization names. Often, this can be a sign that a manager’s style is drifting into an area in which they don’t have expertise. Let’s see if that’s the case here.
As expected, mega and large cap exposure have risen since late 2014, at the expense of mid and small cap exposure.
Fortunately, it appears that this move up the market cap spectrum has been additive to the portfolio: substantively all alpha has been generated by large and mega cap names.
Position sizing is another way for a manager to generate alpha. Getting one name in ten right is fine if 90% of your money is in that winning name. Splitting Roystone’s book into various position sizing buckets, we can examine the returns they generated across the buckets.
What the chart above is showing is had they deployed 100% of their capital into names in the 0-50bps bucket, Roystone would have annualized at 78%. This points to an underlying issue with conviction: the right securities are being picked, but are not being sized up.
In previous Manager Mondays, public data has shown managers to be rock stars. While the data does not show Roystone in equally favorable light, all this analysis needs to be taken with a grain of salt – their shorts, along with their credit positions may have performed very differently to the names we examined. Additionally, the time period in question is probably not statistically significant, especially given the low dispersion environment that has made it difficult for most managers to generate alpha. Finally, there are a few positives to be taken: their relatively unique portfolio, along with a move up the market capitalization spectrum into names where they’ve been able to generate more alpha.