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East Sea Capital Sailing The Macro Waters To Find Absolute Returns

The East Sea in Europe – more commonly known as the Baltic Sea – is surrounded by nine countries, each of which has their own language, culture, and history. It’s an apt comparison for namesake East Sea Capital, because as a macro manager, their exposure is to…well, many things.

Founded by hedge fund industry veterans Daniel Šimulevič, whose CV includes stints at Pivot Capital and Seia Capital, and Per Mellstrom, a Founding Partner of Pivot Capital, London-based East Sea Capital’s approach is rooted in both the founders’ experience and general outlook.

“There is a lot of pressure on hedge funds. They did OK in 2020 but at the end of the day it’s a losing game where you’re charging 1 and 20 or 2 and 20 and you’re in a specific asset class that’s being chipped away at by an ETF or a UCITS product,” said Šimulevič. “We think that the best opportunities don’t tend to be in one particular asset class or geography. We want to focus on absolute returns and casting a wide net helps us to do that.”

Following his departure from Pivot Capital, Šimulevič launched his own investment firm, Seia Capital, a predecessor firm to East Sea Capital, in Malta after moving there in 2014. He says that the benefits of doing so – a more cost-effective way of building an investment firm (“and much nicer weather than London”) – was offset by a lack of appetite from US investors, so he closed up and moved back. There were some wins, however.

“We couldn’t raise enough money in Malta,” he said. “But we did well with the shale trade; we shorted the bonds of shale producers in 2016 and took some good profits there. And learning how to run a business is never a bad thing. It set me up for coming back to launch East Sea.”

Like most discretionary macro managers, East Sea Capital begins with a top-down approach and drills into themes where it can identify market situations exhibiting panic and euphoria, and potential and ongoing economic and industry dislocations. Like many macro investors, East Sea Capital digs deeper to try and uncover hidden gems to avoid crowded trades.

“Right now, it’s tough to bet against higher tourism volumes, but markets have already bought this completely, so we’re looking for underappreciated recovery plays. An example is that in Spain, Telefonica were abandoned by the market because when Covid came along they lost all their roaming revenue and so they dropped around 50%. But they started to trade at a 12% dividend yield. It’s still 9%, and they now have momentum and outperformance. We’re long some recovery plays like this one,” said Šimulevič.

The stimulus package announced by new US President Joe Biden promises to inject $1.9trn into the American economy, some of which is earmarked for direct payments to individuals. Commentators say that inflation is looming, but Šimulevič says that it’s been here for years and that the stimulus ultimately won’t do anything.

“That is something we’ll sell short. Our basic idea is that for 80% of the population in the US, the cost of living is simply unaffordable. The cost of education, childcare, medical care and utility bills have been appreciating much faster than the headline inflation rate. Inequality has become worse. Looking at the next two years, our thinking is that they haven’t really solved any of these issues. The stimulus is comparable to the post-second world war period and in 1948/49 there was a severe recession. It’s not silly to assume there will be a relapse,” he said.

The waters that East Sea Capital sails currently are choppy; consequently, regardless of the level of conviction in a particular theme or trade, East Sea Capital maintains a handful of uncorrelated themes in the portfolio at any one time, diversifying across time horizons, instruments and asset classes. A typical equity long accounts for just 1-2% of the book, and a typical long bond 2-5%. A proprietary portfolio management system is backstopped with infrastructure provided by Quay Partners, a spin-out of Pivot Capital headed up by Thomas Underwood, Pivot’s former CEO.

“Our risk philosophy emphasizes tail risk mitigation on top of the more conventional risk measures,” said Šimulevič. “That’s one of the reasons we strive to have three to four uncorrelated themes with portfolio exposure at any one time, and we cap our allocations to these themes for that exact reason.”

Over the past 20 years, despite the supposed “great moderation”, markets have not escaped the boom-and-bust cycle that consistently provides opportunities like buying Eurodollar calls in 2020, shorting shale in 2015 or shorting subprime in 2008. Šimulevič sees history repeating itself very soon - and is positioning for that scenario.

“We think there might be another attempt at a recession. In the US stock market, people are buying calls all the time and rolling them. Look at Dave Portnoy – he compared the market to a game of craps where you can never roll a seven. Gradually, the house creates the impression that you’re winning, and then it’s all gone, just like that. That’s how the market is shaping up to me. Pretty soon, there will be the last buyer, and then it’ll collapse from there.”

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