Contrarian & Aligned

Many hedge fund managers have spent much or all of their working lives on a figurative “Wall Street,” whereas Senvest’s founding partner started out on “Main Street” – running operating companies. The summer of 1969 saw the US put a man on the moon but today’s Chairman and President of Toronto Stock Exchange listed Senvest Capital [SEC: TSE], Victor Mashaal, had just started to see Canadian retailers attaching his high tech tags to apparel. He had acquired the exclusive Canadian distribution rights to new anti-shoplifting technology developed by Sensormatics Electronics Corp. Later he moved into one of the first pay-TV channels in Canada.

Meanwhile, his son, Senvest Management founder, CEO and co-CIO, Richard Mashaal, graduated from Wharton and after a stint of investment banking he earned joint MBA/International Relations graduate degrees from The University of Chicago. The younger Mashaal then joined the family business in 1989. In the generational transition from father to son, Richard spearheaded the effort to sell the operating units and morphed the vehicle into a merchant bank and investor with three verticals: real estate, private equity and public equity. He soon found the last was his favourite and in 1994 resolved to focus almost exclusively on investing in public securities. Senvest Managing Director and Portfolio Manager, Robert Katz, was the first hire in 1993. After investing the public company’s capital for a few years, Senvest Management was ready to open to external capital in 1997 and started its flagship fund, Senvest Partners, with $5 million. Fast forward 20-years and now Senvest Management runs $1.3 billion. A significant chunk of the growth has come from the magic of compounding. What has never changed is the huge degree of alignment of interests: almost 60% of the assets belong to the partners, staff, managers and their family vehicles, with the largest being Senvest Capital. This aligns the managers’ interests with those of investors. The firm’s capital has grown more through investment performance than from funds raised or the fees earned on external capital. Mashaal is ready for a dual runway of growth from performance and inflows. He aspires to join the ranks of legendary investors such as Warren Buffett, George Soros, Julian Robertson and Stanley Druckenmiller.

Institutional infrastructure
Just over a decade after opening to outside money, Senvest was determined to institutionalise what hitherto looked like predominantly a “friends and family” vehicle that devoted very little effort to marketing in the early years. Brian Gonick, co-CIO, has been with Senvest since 1994 as a Director and in 2008 joined full-time to help with the institutionalisation drive. “He scaled up the investment team and the back office, ensuring plenty of redundancy in regulatory and compliance, accounting and operations, as part of an ongoing process that is also continually evaluating vendors and service providers,” recalls Mashaal. The shifting profile of Senvest’s investor base mirrors that of the hedge fund industry, having started with high net worth individuals before gaining traction with family offices, endowments and foundations. These types of allocators, with their theoretically perpetual time horizons, can easily see eye to eye with Senvest’s multi-year view.

Getting paid for volatility
A stable capital base is a luxury that has always afforded Senvest the freedom to take a longer term view and look through near term volatility. “We seek out of favour, unloved, misunderstood, and underappreciated companies where expectations, sentiment and valuations are all low. Over one or two or three years they can change and improve, for a better outlook, so they are no longer unloved, and get multiple expansion,” Mashaal explains. Senvest needs investors to hang in there because these recovery trajectories rarely travel in a straight line. “Situations of rehabilitation and transformation are bumpy, with ups and downs, and we may want to average down on the position. We are often buying in a U shaped pattern so we may incur some mark to market losses on the road to outstanding gains,” he adds. The three biggest thematic sector bets made have been technology in 2002-2003, financials and real estate in 2008-2009, and energy today.

Mashaal makes no bones about that fact that (unlike some hedge funds) this is “not first and foremost a wealth preservation strategy.” Investors should be prepared to stomach double digit drawdowns from time to time, though the strategy has only had six losing calendar years: 1998, 2000, 2002, 2008, 2011, and 2015. Investing around these pullbacks would have been great entry points, but Senvest is not particularly confident about fine tuning market timing. Mashaal expects “our entry and exit levels could easily be six months or a year too early, or too late, because picking tops and bottoms is a fool’s errand.”

Mashaal is of the opinion that there is no return without risk. As Senvest is maximising returns rather than Sharpe ratios, the manager typically runs a concentrated book of up to 30 core names, generally sized between 3% and 10%. He is particularly critical of those who apply large leverage to a low volatility return stream in an attempt to reach their return and volatility targets. For Mashaal, “five or ten times leverage is extreme risk and can result in very high volatility along with low returns.” Senvest may well invest in companies that have substantial operational leverage, but prefers to avoid excessive financial leverage at both the corporate and the fund level.

Short profits
Most shorts are viewed as a profit centre, and are not designed to pair or hedge long positions, nor to reduce net exposure or dampen volatility. “Shorts over time have made absolute returns,” says Mashaal. For instance, the short thesis for a speciality pharmaceutical company was based on “illegal marketing practices and investigations by the SEC, FDA and state Attorneys General. A drug approved for cancer pain was being sold for other uses,” Mashaal points out. Further, the firm has had shorts ranging widely, from financial services to consumer names within sectors such as branded apparel, sports apparel, footwear, and restaurants. These short successes distinguish Senvest from many contrarian value investors that are long-only. Still, Senvest’s returns have come mainly from long positions, and the manager has maintained consistently net long exposure- typically between 80% and 125%. The size of the book varies with gross exposure typically between 150% and 200% based on the bottom up opportunities identified on the long and short side.

Quantitative screens and searches
Senvest’s investment process starts with science before moving to art. Its architect is co-CIO Brian Gonick, who Mashaal credits with “creating structure around a historically unstructured process and formalising the process to make it easier to instil into the growing team.” There are now ten research and investment staff. Robert Katz, assisted by one analyst, runs technology and the Israel strategy, which is also mainly technology. Four analysts report to Gonick. Mashaal’s sister, Joy Mashaal, is based in the Los Angeles office and covers healthcare and pharmaceuticals with the help of one analyst.
The scientific part involves various quantitative screens. A share price pattern-recognition tool identifies stocks that were in favour, but fell out of favour. “The shape we are looking for is like a mountain followed by a long tail,” says Gonick. Other tools search for key words, such as “turnaround,” in SEC filings, transcripts, sell side research and investor presentations (in fact over the years Senvest has identified many more less obvious words and phrases as being informative but Mashaal and Gonick do not want to give away the secret sauce!). Senvest also monitors “busted IPOs” – firms that have lost value since they floated. Insider buying and selling activity can also channel stocks into the funnel. Senvest then crunches the financial numbers and insist on “strong balance sheets, often net cash, and we generally avoid companies with leverage as they may not be able to survive transition. We want to see good gross margins, free cash-flow, high incremental margins and return on capital,” Gonick details. When it comes to sell side coverage and recommendations, Senvest is somewhat contrarian, but is not necessarily seeking out companies that are utterly hated or neglected by the analyst community. “The preference is for a “hold” recommendation, or possibly a “buy,” but with scarce analyst coverage,” Mashaal reveals. Senvest also keep abreast of holdings changes by key shareholders. After these quantitative hurdles are surmounted “the funnel gets narrower and narrower and then the fun begins,” enthuses Mashaal.

Judgement calls
The art in the process arises when Senvest meets management and “we make a series of judgment calls, asking: Can they rehabilitate the company? Can they take what is misunderstood and make it understood? Do they care about shareholder value or are they empire builders? Do they have the necessary business acumen?” says Mashaal. After leaving the meeting, Senvest carries out independent fact-checking to verify and monitor what management have told them. This process can entail gathering data on metrics such as drug prescriptions, credit card data or wholesale shipments. The objective is to see whether the story from management can be triangulated and corroborated or if it is contradicted. Establishing an entry price target is the final stage of the process, though targets allow flexibility to adjust in response to new information. “We try to be clinical about it if the facts and stories change,” says Mashaal.

Tower Semiconductor (TSEM) illustrates how patient Senvest can be in waiting for the right moment to pounce and how the firm identifies hidden value. “We had watched the company from the side-lines for 10-15 years. It had been a basket case since the 1990s and it was only when the company rotated its focus, from digital to analogue semiconductors that it hit on a strategy winner. But a weak balance sheet kept us at bay until it was cleaned up in 2015 and we began to buy the stock as management was executing well. But the stock faced an overhang from the largest shareholder selling its position. We bought at depressed prices and once the selling had subsided the stock doubled within a year,” Mashaal recalls. Many technology investors are attracted to the latest leading edge technology but a company that is essentially selling decades-old legacy technology into niche markets can be a great investment.

Israel Strategy
It was their intensive immersion in the technology sector, combined with some relatively simple value screens that led Richard Mashaal and Robert Katz to Israel. “We learned the industry from the bottom up, researching technology, companies, industries and end markets,” Katz reflects. In 2002, after the TMT bubble burst and the spectre of a second Iraq war was stalking markets, sentiment towards Israeli technology had reached rock-bottom levels and Senvest was able to find no less than 20 companies trading at a negative enterprise value. Compelling though this was, the main strategy mandate was not designed to concentrate on Israeli investments so a second strategy was launched, with Katz and Mashaal as co-managers. It started with just $2.5 million and invested in Israeli-based US listed micro and small caps. Fourteen years later, the strategy is often invested in companies with market caps of 750 million dollars or more. While Israeli equities may no longer be in bargain basement territory, “these companies benefit from a dynamic economy and a high level of innovation which makes Israel a great place to invest,” Katz finds. Though Israel is renowned for its venture capital industry, Katz still finds that “its public listed equities are overlooked and underfollowed.” In fact the mandate includes US and foreign-listed companies with connections to Israel through their management, R&D, or domicile. “The start-up nation has matured as firms have grown beyond their borders and made acquisitions, becoming larger, more global, companies,” Katz observes.

Bank of Cyprus
Senvest’s third strategy (co-managed by Mashaal and Gonick) is a single stock investment vehicle that homes in on a market that the flagship strategy has for years been investing in; Cyprus. Senvest was able to secure an allotment to Bank of Cyprus (BOCH: LSE) equity as part of the recapitalisation led by Wilbur Ross (who is now US Commerce Secretary). Senvest has a full-time consultant in Cyprus and sees great opportunities there.

“The economy is among the top performers in Europe and we expect this to continue. Cyprus could become the Singapore of Europe,” foresees Mashaal. After the infamous bail-in of depositors, capital flight did not occur, and Cyprus is now growing its bank deposits. The main strategy has added to its holding in Bank of Cyprus, at lower levels. There are several positive drivers. Mashaal expects the bank’s profits to increase dramatically next year after its need for rebuilding of reserves for NPLs diminishes. A new chief has brought UK style management to the firm. “The stock is now listed on the London Stock Exchange and could be eligible for a premium listing in 2018,” says Mashaal.

Constructive on growth, equity markets and energy prices
Though Senvest is first and foremost a bottom up stock-picker, the manager in mid-2017 has a high level of conviction around their macro and equity market outlooks. “For the first time since 2008-2009 we see a globally synchronised economic expansion including China, Japan, the US, Europe, Canada and Latin America. We think the growth has some legs,” says Mashaal. “Though Europe’s banks need some more work, we are not worried about Europe falling apart,” he adds.

What underscores Senvest’s confidence in the equity market is that the rally has continued amid actual and expected Fed rate hikes. “The big bear thesis that only low interest rates were underpinning equity markets has been discredited. Coming off zero rates, with inflation under control, we are not worried about higher rates in the near term,” he says. That said, Mashaal remains mindful of the bull market getting long-in-the-tooth and the firm’s flagship fund has a net long equity exposure at the lower end of its historical range.

Senvest also expects to see higher oil prices – but as befits a manager who eschews market timing, this is a multi-year view, not a multi-month view. “We are closer to the bottom than the top for oil prices and the world has not changed. Energy companies are drastically slashing capital spending budgets with results to be seen over several years, and US shale supply is not enough to cause a permanent glut. Russia is determined to clear out inventory as well,” foresees Mashaal. Senvest is characteristically playing oil cautiously, by picking companies that have breakeven costs of $30 to $35, and strong enough balance sheets to withstand any further lurch down in oil prices. One example is Paramount Resources (POU: TSE), which trades on the Toronto Stock Exchange. Senvest expects the increased use of technology will continue to reduce production costs for selected oil companies with Mashaal honing in on “longer laterals, more frac stages per well, and higher proppant intensity all working together to lower costs per barrel while maximizing and accelerating recoveries.” Such firms also offer great optionality: if oil prices recover, Senvest reckons some companies in the space could see their share prices multiply by a factor five or ten, partly due to operational leverage. Even without a meaningful oil price recovery the prospects for a company like Paramount Resources are quite positive.  

While some hedge fund managers have revised down their return targets, Mashaal is adamant that his strategy aims to maintain its historical average annual returns of nearly 20%. “The last 20 years have not been a walk in the park with the tech bust and the financial crisis. Our strategy and philosophy should be timeless as there will always be companies and industries that are out of favour,” he explains.