Undiscovered in Plain Sight

This article originally appeared in the April/May issue of MorningstarAdvisor magazine.  To subscribe, please call 1-800-384-4000.

When an investor hears the term “undiscovered manager,” he may think about one whose headquarters is off the beaten path, or one whose strategy is so bizarre that very few investors would consider it. Michael Aronstein, portfolio manager of the Marketfield Fund MFLDX, fits neither of those descriptions. His firm is located next to Grand Central Station in the middle of Manhattan. And his top-down long-short equity strategy, though refreshingly different from most other long-only or long-short equity offerings, is reasonably straightforward. But lying in plain sight by no means disqualifies Aronstein from being an undiscovered gem (ask any aspiring actor). His fund has been around since mid-2007, longer than most other long-short equity offerings, yet its assets have only begun to grow. Alternative mutual funds are largely unknown to many investors.

An Alternative “Alternative”
Although alternative investments, such as long-short equity strategies, are just now starting to catch on with advisors, they still only represent less than 2% of mutual fund assets. Long-short equity offerings are some of the oldest and well-known in the realm of alternative mutual funds, but they are also some of the most basic and worst-performing. The average long-short equity fund lost 2.8% last year, for example, when the S&P 500 increased by 2.1%. Aronstein’s long-short strategy is better than average, however. Last year, his fund returned 3.7% by reducing the fund’s net stock exposure to less than 50% and shorting emerging-markets exchange-traded funds. Instead of selecting stocks from the bottom up, Aronstein and his small team comb macroeconomic data to find contrarian investment ideas and then determine which stocks or ETFs will best execute those ideas. His macro-mindfulness and concentrated playbook have set him apart from the long-short crowd, not just in 2011, but since the fund’s inception.

Aronstein has consistently demonstrated his ability to time the market. In late 2007 through 2008, Aronstein shorted bank stocks. The fund fell by only 9.6% in 2008, significantly outperforming the S&P 500, which dropped 35.9%, as well as the average long-short fund, which lost 16.1%. When equities came roaring back in 2009 and 2010, Aronstein dialed up the fund’s net exposure and took long positions in economically sensitive stocks and ETFs such as retailers, homebuilders, and airlines. The fund outpaced both the S&P 500 and the category average by a wide margin over this two-year period.

Aronstein attributes some of his success to two people who mentored him early in his career. These figures were instrumental in shaping his investment philosophy.

Being Right Is Not Enough
When a younger Aronstein started working at Merrill in 1979, he crossed paths with a rising legend, Bob Farrell, one of the early pioneers of technical analysis. Despite being trained by Benjamin Graham and David Dodd, Farrell was quick to learn that market psychology played a fundamental role in markets. He was an avid contrarian. Farrell instilled a set of core values that are still with Aronstein today. While far too many investors (and television pundits alike) become trapped in group think, Aronstein instead hones in on managing the market’s expectations and where his fundamental views differ from them.

“Being right when the market expects the outcome that you’re right about is meaningless,” he says. Farrell taught Aronstein that research had its limits; when market participants are analyzing the same data under the same criteria, research should be geared toward understanding the divergence of judgments among various market outcomes. Farrell was one of the first people to study a field now referred to as behavioral finance; Aronstein was fortunate enough to have a front-row seat.

Aronstein most recently applied Farrell’s thought process to Europe and, more specifically, to Greece. To Aronstein, the probability of Greece leaving the euro monetary union was less than 10%, even though the media was widely speculating on a doomsday scenario. Instead of focusing on European shorts (which in his mind was a risk-on, risk-off trade), Aronstein figured that investors would start to question the stability of emerging-markets economies. Because there was wide disagreement over how well they could skirt the European slowdown, Aronstein knew there was a tremendous opportunity in shorting emerging-markets ETFs. The market quickly sided with Aronstein’s bet. Investors starting fleeing the emerging markets in droves. In fact, when the S&P 500 lost 7% in September 2011, the fund eked out a 0.3% gain.