VARENNE CAPITAL PARTNERS Investment Management Commentary (January – December 2018) March 15th, 2019 INTRODUCTION Varenne Capital’s investment objective is to deliver superior long-term returns with the minimum necessary risk-taking. We strive to achieve this goal by combining complementary investment frameworks – Long Equity, Short Equity, Merger Arbitrage and Tail Risk Hedging – in a single strategy and by relying exclusively on proprietary research. Each framework is the result of years of research and development and comprises original methodologies, formalized processes, a dedicated team of specialized analysts and bespoke information systems. By reading this document we hope you will be convinced that, throughout the cycle, our approach translates into a superior value proposition when compared to traditional long/short or long only investing. GENERAL PRINCIPLES We believe in two basic principles: solving equations differently and adding value. Everything we build stems from there and, as far as investment management goes, translates into the following: Solving equations differently - We combine investment strategies into a ‘structure’ because it: o is synergistic: Long Equity drives returns throughout the cycle, Short Equity adds idiosyncratic performance, Merger Arbitrage reduces correlation to equity market indexes and contributes to funding Tail Risk Hedging; o copes with changing market and economic conditions in an adaptive portfolio; o allows each team to focus on the most favorable opportunities available and relieves them from the pressure to be ‘in play’ all the time; 1 o efficiently employs investment vehicles’ balance sheets. While we typically do not resort to significant leverage on Long Equity and Short Equity combined, we benefit from it to fund short term Merger Arbitrage trades and Tail Risk Hedging; o optimizes risk profiles. - We separate risks from opportunities and deal with them independently. o On opportunities: ▪ Long Equity: most of the long-term returns come from the quality of the businesses that we select in this pocket of the portfolio and the price that we pay for them. We will always try to maximize our Long Equity allocation. ▪ Short Equity: short equity should be idiosyncratic and is meant to generate performance - hedging longs with shorts is at best a very costly proposition leading to sub-par long term returns. ▪ Merger Arbitrage: much like an insurance business, we underwrite risk only if we are adequately compensated and are perfectly happy to stay on the sidelines when our conditions are not met - typically at times of low volatility and strong equity market performance. o On risk and hedging: ▪ Market risk: equity market corrections and bear markets are natural events and should be seen as opportunities for both longs and shorts. In our opinion, an investor is better off accepting market risk within those boundaries and only hedging the residual risk. ▪ Hedging: residual market risk and its root causes can be hedged efficiently through asymmetric risk/reward instruments or trades. Hedging more than that subtracts performance disproportionately and deprives investors of long-term returns. Adding value - Research: we believe in 100% proprietary research. We follow a strict ‘brokers are not welcome’ policy and never employ sell-side research. - Process: for each of the frameworks, our teams add value through proprietary research and a five- step process encompassing universe reduction, idea generation, first-hand analysis, systematic portfolio construction and direct market execution. o Universe reduction: it pays dividends to define safer investment sub-universes where the odds are in the investor’s favor and focus can be put on the best available opportunities. For instance, we limit our Merger Arbitrage activity to announced and friendly deals in order to maximize our team’s hit rate. o Idea generation: we do not believe that receiving the 23rd call of the day from a sales person pitching the same idea adds any value. We generate original investment ideas internally through our databases, scoring systems and screenings that cover more than 60 countries. 2 o Analysis: first-hand analysis adds value when formalized within a sound investment methodology. The latter ensures recurrence. For each of the frameworks, we have developed specific investment principles and proprietary analytical tools to best implement them. o Portfolio construction: systematic, rule-based, portfolio construction adds value as it forces the teams to formalize decision metrics and to focus on the best available opportunities. It also keeps emotions out of the equation. o Execution: direct market execution reduces costs and enables best execution. No research costs or any other commissions are borne by the investment vehicles. - Information systems: bespoke information systems are essential at each step of the process as they allow us to manage huge volumes of information and orientate each team’s priorities. We have invested heavily in this area and continue to do so. None of the above would mean much, though, without a great and talented team. At Varenne, we are fortunate to rely on an highly competent, energetic and committed group of people. We made the choice early on to specialize our teams by investment framework with Long Equity and Short Equity being two different teams probably the best example of this approach. CAPABILITIES We operate several investment frameworks within the Long Equity, Short Equity, Merger Arbitrage and Tail Risk Hedging space. We refer internally to those as ‘capabilities’: 3 Long Equity and Short Equity teams can express their views through individual stock selection or purpose-built baskets based on fundamental and behavioral factors with the aim of optimizing the risk- return profile of the portfolio. Each book is independent with exposures determined by a rule-based portfolio construction model comparing key investment merit metrics. The aim of the model is to maximize long-term returns, reduce correlation to equity market indexes and to adapt portfolio composition to changing market and macroeconomic conditions. Unlike ‘pure player’ single strategy funds, our approach allows investment teams to focus exclusively on the most favorable opportunities and relieves them of the obligation to deploy capital when they do not find ideas that meet or exceed our risk-reward criteria – we are happy to stay on the side-lines on one or more of the frameworks when we believe that to be the most sensible decision. In the following commentary, we will touch on the philosophy of each of the frameworks and review their contribution for the year. CONTRIBUTION PER INVESTMENT FRAMEWORK In what turned out to be a challenging year, we are pleased with the overall contribution of the different frameworks: Long Equity proved resilient throughout the year, Short Equity was marginally negative - but contributed significantly in Q4 - while Merger Arbitrage and Tail Risk Hedging produced consistently positive returns. Tail Risk Hedging’s contribution was all the more satisfactory as it recovered its entire carrying cost before turning positive. Focusing on the Value Active Fund, it is interesting to note how the sub-strategies behaved on a monthly and quarterly basis in adapting to changing market conditions: 4 Finally, the uncorrelation strategies’ contribution over Q4 reveals how they played a significant role in the period: 5 LONG EQUITY Philosophy The Long Equity team applies private equity techniques to build a core concentrated portfolio of high-quality businesses whose stocks, at the time of buying, trade at a significant discount to our estimate of economic value. After applying granular universe reduction, based on GICS sub-industry classifications, to exclude highly cyclical or financial businesses, the origination team performs weekly fundamental and behavioral screenings on proprietary databases and scoring systems in over 60 markets. The goal is to search global developed and ‘emerged’ geographies for highly cash generative businesses boasting sustainable competitive advantage, superior management teams, autonomous value creation dynamics, high cash generation and, whenever possible, positive net financial positions. The analysis team takes the lead from origination and deploys a filter step aiming at quickly discarding most of the ideas to focus only on a promising few. Only when a lead appears to be interesting does a full-fledged due diligence process begin. The team combines conceptual, high-level analysis with field investigation. This risk, business, financial and industrial analysis includes several company interactions. While no use of sell-side research is made, the team is typically reinforced by the interaction with at least two industry experts providing valuable advice. Upon finalization of all of the due diligence modules, the team determines an Intrinsic Value Estimate (‘IVE’) and assigns an Economic Quality Rating (‘EQR’) to the business under review, based on our proprietary scale illustrated below. 6 The portfolio construction model draws on both sets of metrics to determine the optimal portfolio composition from all possible combinations of the available watch-list components. Most of the core concentrated Long Equity book is in what we refer to as the industrial portfolio - stakes in highly cash- generative businesses with good to excellent economic quality. Some noteworthy exceptions are turnaround situations or sum-of-the-parts investments which typically have