Understanding The Strategy
While there are variations, long-short managers construct portfolios in two basic ways. First, they find stocks that will likely appreciate and, to partially hedge risk, short a related, weaker individual stock or basket of stocks with negative outlooks. With the short typically being smaller in size than the long position, the hedge can only partially offset the impact of unforeseen negative events. The result of this construction will be returns that are more modest than the market when it rises, but reduced losses if the market falls.

The other long-short approach, more frequently employed by leading managers, is to invest in shorts with the same conviction a manager has with his longs—identifying where the market has misperceived corporate fundamentals, which has led to overvaluation and susceptibilty to correction. The manager isn’t setting up the short to inherently hedge a long.  

Accordingly, he is taking on more risk because his positions are constructed to move independent of one another. If his call is right, he may outperform other long-short managers. But without correlated hedging, he runs the risk of underperforming his peers if his thinking is wrong.

What makes this approach more risky for single-manager funds is that these two kinds of opposing trades involve different skill sets. Not many managers can simultaneously excel in both.

Jeff Osher, however, is one who has been able to consistently pull off this balancing act.  His $418 million Harvest Small-Cap Partners fund, which started in December 2005, has been generating 16.37% annualized gains through July 2014. His five-year annualized standard deviation is half this rate of return, his worst drawdown (peak to trough and back to peak) was just 7.37%. When stocks lost 37% in 2008, Harvest rallied more than 19%.

Osher’s commitment to his shorts is comparable to his longs, with his book generally running only 10% to 15% net long. This helps to explain why the fund has been able to outperform the Russell 2000 during the 10 worst-performing months the small-cap index has experienced.

Patience is a key to his strategy. “Because information flow about small caps tends to be less efficient than larger caps,” Osher explains, “we’re happy to get into a position well before other investors recognize the triggers we’ve identified that will send a stock higher or lower.”

A recent  long example was Sun Edison, formerly MEMC Electronic Materials, which comprised two unrelated businesses. Osher saw the potential of its solar solutions operations despite a break in its financing that threw a monkey wrench in its $8 billion pipeline of projects. When he realized the firm was divesting its polysilicon division, restructuring solar production, and creating a new yield company tasked with buying Sun Edison’s finished solar projects to help recycle capital back into operations, Osher saw a more rational business model. His investment tripled in less than three years.

Incubation
When asked what he thought it meant to be a Tiger Cub—one of Julian Robertson’s hedge fund offspring—Alok Agrawal, who had worked for the venerable manager for four years before setting up Bloom Tree Partners, succinctly replied: “It means never buying a bad business; never shorting a good business.”

Tiger philosophy relies on extensive research and due diligence, understanding operations and finances, and investing only when one has crafted a strong conviction about a position.

This process has served the $304 million fund well since Agrawal started it in May 2008.  He has churned out annualized returns of more than 10% with five-year annualized volatility that’s running a full percentage point below that, and a worst drawdown of less than 10%.

This year, he has gained 26% in seeing the financial and operational benefits of the emerging business of privatized emergency room services provided by TeamHealth.

On the short side, Agrawal saw how market misunderstanding of corn production fueled the rise in the share price of pesticide maker American Vanguard (AVD).  The ethanol mandate, drought and rising corn prices led to the overfarming of corn and corresponding boost in demand for AVD’s pest-control products. This resulted in a quintupling of the company’s share to $35 between 2011 and 2013.

Thinking that corn would continue to be heavily farmed, analysts forecasted further demand for these specialized pesticides and a subsequent rise in AVD’s earnings. Agrawal, however, thought otherwise.  

“Crop rotation is essential for keeping farmland healthy from infestations,” he says, “and we saw that the rising price of soybeans was making this crop more attractive to plant.”  Accordingly, he thought demand for ADV products would falter. Analysts’ 2014 projected EPS of $1.80 was more than twice his estimate.

The manager says he was the only institutional investor to short the stock in November 2013 at $28. As the price declined, he added to his position, creating an average short price of $24. By May 2014, he was out of the investment at around $14.50.