Animal Spirits Podcast: Detailed Summary of "Talk Your Book: Matching Longs with Shorts"

Podcast Information:

• Title: Animal Spirits Podcast
• Host/Author: The Compound
• Episode: Talk Your Book: Matching Longs with Shorts
• Release Date: December 9, 2024
• Guests: Mick Rasmussen from Wasatch Global
• Description: Animal Spirits explores markets, life, and investing with insights on reading, writing, listening, and watching. Hosted by Michael Batnik and Ben Carlson, the show dives deep into investment strategies and market psychology.

1. Introduction to Long Short Strategies

The episode opens with Michael Batnik expressing interest in the psychology behind managing long short books and funds. He highlights the necessity of balancing optimism and caution, akin to "separating the two parts of your brain" to navigate the cognitive dissonance inherent in long short strategies.

Notable Quote:

Michael Batnik [00:47]: "Long short, you have to have both of those abilities. You have to be able to fight through the cognitive dissonance."

2. Evolution and Challenges of Long Short Funds

Mick Rasmussen provides historical context, explaining that long short was once the most sought-after hedge fund strategy. However, the strategy faced significant challenges in the early 2000s and 2010s due to disconnected valuations and unsustainable performance dynamics.

Notable Quote:

Mick Rasmussen [02:18]: "Long short was a huge category of hedge funds back in the day... but it went through a really tough environment."

3. Wasatch Global's Long Short Alpha Fund

Wasatch Global, traditionally known for managing approximately $30 billion in small cap investments, has ventured into long short strategies with their Long Short Alpha Fund (Ticker: WALSX). Mick discusses the fund's structure, typically going long 90% to 140% and short between 0% and 60%, aiming to match exposures within the small cap universe.

Notable Quote:

Mick Rasmussen [06:37]: "Our strategy is all about taking that source of risk we want in the long side and hedging away the piece we don't want."

4. Risk Management in Long Short Funds

A significant portion of the discussion centers on risk management. Mick emphasizes that Wasatch's long short strategy is directional, maintaining exposures between market neutral and fully long. The primary objective is to enhance the Sharpe ratio by optimizing risk-adjusted returns.

Notable Quote:

Mick Rasmussen [05:59]: "Really what we're solving for is a Sharpe ratio. The best thing we want is that risk adjusted return."

5. Stock Selection and Market Efficiency

The guests delve into the efficiency of small cap markets. Mick contends that, despite debates on market efficiency, there remains ample opportunity for stock selection based on fundamental analysis. He acknowledges that mispricings can persist for extended periods but asserts confidence in long-term mean reversion driven by solid business fundamentals.

Notable Quote:

Mick Rasmussen [07:09]: "It just can take many, many years for that to play out sometimes."

6. Short Position Strategies and Challenges

Mick explains Wasatch's approach to short selling, highlighting the challenges posed by stock squeezes and high short interest. The firm avoids high short interest stocks to mitigate risks associated with coordinated attacks, ensuring that their short positions do not become liabilities.

Notable Quote:

Mick Rasmussen [08:04]: "100% we're out in that environment... we have some pretty tight restrictions on our short book."

7. High Short Interest and Market Dynamics

The conversation touches on the prevalence of unprofitable stocks in the Russell 2000 index, making the small cap space ripe for short selling. Mick notes that Wasatch leverages the vast differentiation in small caps to identify both strong long candidates and weak short candidates.

Notable Quote:

Mick Rasmussen [09:07]: "There's tons of differentiation between if you can find these really awesome businesses, there's still hundreds of these every year that are growing 20 plus percent."

8. Impact of Interest Rates on Strategy

Mick discusses how rising interest rates affect small cap growth investing, particularly for companies reliant on external financing. While higher rates make equity prices less attractive, they also influence the short side by impacting company valuations.

Notable Quote:

Mick Rasmussen [13:00]: "It's the fact that the market's not willing to pay nearly as much for a company when you can get 5% on your cash balance as they were when you could get 0%."

9. Quantitative Analysis and Management Quality

A key differentiator for Wasatch is their quantitative analysis combined with qualitative assessments of management teams. Mick explains that top-ranked management teams receive more significant allocations, a strategy that has historically driven outperformance.

Notable Quote:

Mick Rasmussen [21:31]: "We rank our management teams... it's been by far our best source of outperformance."

10. Portfolio Management and Turnover

The fund maintains a higher turnover on the short side (around 100% annualized) compared to the long side (20-30%). This approach ensures agility in responding to market dynamics and minimizing exposure to volatile short positions.

Notable Quote:

Mick Rasmussen [22:59]: "On the short side, it's going to be maybe three times that. So about 100% annualized turnover on our shorts is what we're going for."

11. Operational Considerations and Future Outlook

Mick highlights operational controls necessary for managing liquidity and position sizing in small cap stocks. He also touches on the potential for expanding the long short strategy but notes the current preference for mutual funds and separate accounts over ETFs due to transparency and liquidity concerns.

Notable Quote:

Mick Rasmussen [27:07]: "The ETFs and small caps, active small caps just really isn't a great fit yet."

12. Conclusion and Takeaways

The episode concludes with Mick Rasmussen directing listeners to WasatchGlobal.com for more information and resources. The discussion underscores the complexity and disciplined approach required in managing long short funds, especially within the small cap universe. Key takeaways include the importance of robust risk management, the value of qualitative assessments in stock selection, and the strategic alignment of long and short positions to optimize risk-adjusted returns.

Final Notable Quote:

Mick Rasmussen [28:37]: "We have lots of resources on that website, recent white papers about how we use quantitative and fundamental research together that we think are very relevant for this audience."

Key Insights:

• Psychological Balance: Effective management of long short funds requires a balance between optimism and caution.
• Risk Management: Prioritizing the Sharpe ratio through intentional risk exposures enhances performance.
• Stock Selection: A deep understanding of management quality and business fundamentals drives successful long and short positions.
• Operational Discipline: Rigorous controls and agility in portfolio adjustments are vital, especially in the volatile small cap space.
• Strategic Alignment: Matching longs with shorts based on sector and risk factors ensures a cohesive investment strategy.

Listeners who seek to understand the intricacies of long short investing, particularly within the small cap realm, will find this episode invaluable. Mick Rasmussen’s insights provide a comprehensive look into the sophisticated strategies employed by Wasatch Global to navigate and capitalize on market inefficiencies.