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Undiscovered in Plain Sight

Michael Aronstein’s long-short equity fund has been around since 2007, but it’s only just starting to pick up assets.

Josh Charney, 04/09/2012

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.

Filtering the Data
By 1983, another figure emerged in Aronstein’s life: a man by the name of Stanley Salvigsen. He joined Merrill as chief investment strategist and worked with Aronstein in formulating the firm’s views on the market. Aronstein had started reading Salvigsen’s economic research in the late ‘70s and was more than impressed. Aronstein believes that Salvigsen was not only one of the only people to predict the end of the high interest-rate environment of the ‘80s, but also to predict exactly how and why it would unfold. Salvigsen was hired by Merrill in 1983 to become the firm’s chief investment strategist (Aronstein believes he was instrumental in the hiring decision), and the two quickly hit it off. They would constantly talk to each other about the markets and investment ideas, having offices in close proximity. At times their conversations would continue late into the evenings by phone. Salvigsen taught Aronstein that managing the market’s expectations was important but that he also needed to finesse the data in order to ascertain a better judgment.

“Markets are extremely inefficient in incorporating big picture data, because it’s so complex, that you have to approach the spectrum of all the available data with an understanding beforehand of what is and what is not important,” Aronstein says.

In the ‘80s, investment research was moving in the direction of a heavy reliance on economic models, a direction later characterized by some as “physics envy,” or the desire to make soft sciences harder. Salvigsen brought Aronstein to realize that even the best projections (including many of the government’s forecasts) were far from precise. When Salvigsen eventually left in 1987 to found Comstock Partners, an institutional money-management firm, Aronstein would soon follow to serve as the firm’s president for the next six years.

Bounded Rationality
Aronstein learned many financial lessons before starting Marketfield. He left Comstock Partners and unsuccessfully tried to run a paper mill in Maine. He also attempted to start a private bank. Though those lessons were costly (eating up a large portion of Aronstein’s savings), few fund managers can claim to have dabbled in running a series of small businesses. Aronstein concedes that his string of entrepreneurial failures proved he was destined to be a money manager. But he also believes that through his tribulations, he gained valuable insight into the bounded rationality of the human persona, which he believes far too few investors comprehend. For example, when he was investigating a mining-rights sale in rural Appalachia, an investor raised his hand during the presentation and asked if there was an a long-short fund. But like much of Aronstein’s career, it had to be different. The common vehicle at the time, for a long-short fund was a hedge fund. Hedge funds, in Aronstein’s mind, shouldn’t be exclusive to institutional and high-net-worth investors, especially for strategies such as long-short equity. If a fund is going to trade highly liquid assets, why shroud those trades behind a veil? As such, the duo launched the Marketfield Fund in July 2007, named after a tiny alleyway off of Wall Street, where their first office was located. (They ended up establishing an offshore fund for non-U.S. investors in April 2, 2008, but Aronstein insists that it is run on equal footing to the mutual fund, without performance fees.) Since Marketfield’s birth, nearly 50 long-short mutual funds have followed in its footsteps.

Like Flying a Plane
Marketfield’s COO, Myles Gillespie, joined Aronstein and Shaoul in 2007. Gillespie is an experienced pilot, and Aronstein and Gillespie frequently fly together. Aronstein trusts Gillespie’s piloting abilities, not because he’s fairly experienced, he says, but because Gillespie knows the bounds of his capabilities, often overstating his limitations. If it looks like rain, they stay grounded. Aronstein, too, understands the need to remain grounded. He knows his strengths (which is clearly on the macro side) and avoids the “heavy” bottom-up number crunching (such as scrutinizing accounting statements).

Aronstein acknowledges that he has made mistakes along the way. He was early on his bullish homebuilders call, and he tripped up on long positions in Green Mountain Coffee Roasters GMCR and OpenTable OPEN. His firm recently hired research director David Johnson to help Aronstein pick individual names to match his macro views. Aronstein and Johnson select stocks by identifying what is changing in today’s world and then hone in on the companies that will meet tomorrow’s challenges. As of Jan. 31, for example, the fund held a 1.82% stake in Priceline PCLN, as more consumers are realizing they can save money by bundling their flight and hotel bookings. Another example is Amazon.com AMZN.

Just the Beginning
The journey of Aronstein and Marketfield isn’t over. The firm is relatively young, and assets are matriculating. Marketfield Fund will likely remain a diamond in the rough for sometime though, as investors slowly discover alternative strategies. The next time someone proclaims to have the next great hidden investment idea, remember that sometimes the greatest opportunities are found in the most obvious of places.

Josh Charney is an alternative investments analyst at Morningstar.

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