Alternatives Watch 2022 Outlook: Varenne Capital

In our third installment of our Alternatives Watch Outlook Series, we get the view from Europe with Giuseppe Perrone, president and investment committee chair of Paris-based Varenne Capital.

The $4.3 billion firm’s investment strategy includes four investment frameworks: long equity, short equity, merger arbitrage and tail risk hedging. Founded in 2003, Perrone, Marco Sormani and David Mellul, Varenne has experienced asset growth due to asset flows and strong performance this past year.

The firm aims to apply private equity-style due diligence to fundamental analysis of public equities. Varenne Capital takes pride in generating all research internally, utilizing expert networks, without relying on any brokers’ research.

Here, Perrone walks us through what investors can expect this year when it comes to equity investing.

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Over the next 12 months, how are you preparing your portfolio for interest rate hikes and market volatility? What is top of mind?

We believe that volatility levels will pick up in the next 12 months. As a long-biased investment manager, we embrace market volatility at Varenne as generally this environment provides a good entry point for “quality growth” companies on our screen.

Regarding our Long Equity portfolio, we remain focused on highly cash generative, profitable companies with little or no debt. We never invest in unprofitable or highly indebted businesses, which are the ones most affected by rising interest rates. Volatility can be a source of opportunities for long and short equity as well as a major one for merger arbitrage strategies as spreads normally widen when volatility increases.

For interest rate hikes, we don’t want to second guess how many times the Fed and Central Banks will increase the interest rates, but we have implemented call options on large European banks in order to capture the potential benefits of interest rate hikes. We initiated these positions in Q2 2020 when the European banks were trading at distressed levels (less than 0.4 times price to book) and we have adjusted to restrike these options a few times over the last few months.

As we approach the third year of the pandemic, what are your thoughts about the macroeconomic picture?

The economy remains strong on the heels of sustained consumer demand and investments. The fiscal stimulus started to have impacts on infrastructure. Green Energy transitions can be seen in every corner of the world.

Service sectors will still be a laggard, depending on how COVID evolves but we see upside on that front in the second half of 2022.

We will need to monitor inflation, but it is the Central Banks’ job, and as long as inflation is demand-related, it will be a positive. If inflation is driven by the supply side, we have hedges in place in our portfolio to hedge against the resulting inflationary shocks.

What role do you see hedged strategies playing in across the alternative investment arena in years to come? Is there still room for hedge funds as an asset class to grow?

We definitely believe that hedge funds will provide a valuable component of clients’ portfolios for years to come. Many hedge funds or long/short funds suffered in the recent years especially on the short side, as the loose monetary policy by central banks and the availability of credit enhances artificially the solvency of the companies that could potentially be short candidates at normal times.

Obviously, many hedge funds failed to provide added value against their expensive fees vs passive solutions or ETFs, but there are talented hedge fund managers who continue to deliver excellent performance, particularly during market turmoil when clients are seeking investment solutions to protect against the permanent loss of capital.

Furthermore, we anticipate market returns to be significantly lower in the years to come and this should help build demand for alternatives.

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