Polar Capital adds to banks and miners during market volatility

The managers of Polar Capital’s UK Absolute Return fund have used the turbulence of the past fortnight to increase net market exposure to its highest level this year, adding to positions in favoured banks and miners.

Philip Hardy and Nick Shenton say: “During the course of the week of 3 May we used the pull back to reinforce the positive view we have had since the beginning of the year by targeting specific core longs where we feel the risk-reward is compelling.”

On 3 May, the £125m fund’s net exposure was 26%, with gross exposure of 129%. These were 39% and 130% respectively by 10 May, when markets absorbed the enormity of the e750bn (£641bn) EU bailout packages.

Hardy says: “Net exposure at 39% is as high as it has been all year. Over the week, we probably added 10 percentage points to our net exposure.”

The fund’s weighting in natural resource companies has fluctuated from being modestly short in January to in excess of 10% currently. Aggregate banking exposure sat consistently above 8%.

However, individual position sizes have changed.

Shenton explains: “The bad news for miners was pretty obvious, but it was priced in fairly aggressively. Xstrata fell about 30% from highs in April.

“If you take a 12- to 18-month view, miners are interesting because valuations are low and fundamentals support industry returns above the cost of capital.”

Hardy says the fund will continue holding a core 4%-6% in favoured miners, while also trading around the periphery on price movements.

He says: “We believe UK stock valuations are pretty attractive, cashflow generation is likely to remain positive, meaning strong dividend growth and share buybacks. In addition, the UK is likely to be a focus for M&A activity.”

Polar’s team points out UK banks are well capitalised relative to history and to other countries.
Their share prices are at a point that suggests they will not even achieve a return above their cost of capital.

But Shenton is sceptical this is the case, saying such pricing offers an attractive risk/reward for being long banks.

The team increased its position in Lloyds to about 6% in two tranches as its shares fell during the market pullback. The bank is now the largest position in Polar’s fund.

“We think Lloyds’ share price could double or triple on a two- to three-year view,” Hardy says.