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AAM Absolute Return Fund PLC is betting on declines for energy companies that will struggle to maintain dividends.Getty Images/iStockphoto

The world's top performing hedge fund is shorting companies that are juicing their valuations by promising investors big dividends.

AAM Absolute Return Fund PLC, which according to HSBC Holdings was the world's best performing hedge fund in 2015, is betting on declines for energy companies that "even [in the] short term will struggle to uphold dividends," according to Harald James Otterhaug, who oversees the fund as the chief executive officer at Oslo Asset Management AS.

"In times of low rates when investors chase yield, we've seen that companies that pay dividends have often been rewarded with generous valuations," Mr. Otterhaug said in an interview at his attic loft office overlooking Oslo's Royal Palace. "Some stocks have ended up being very overvalued."

The world's oil majors have been borrowing more to keep up with dividend payments amid slumping profits. The debt of Exxon Mobil Corp., Royal Dutch Shell PLC and other oil giants has swelled to a combined $138-billion (U.S.) and is likely to increase in the third and fourth quarters. In Norway, state-controlled Statoil ASA added $5.3-billion in debt in the year ended June 30.

Mr. Otterhaug's $230-million fund, which focuses on long and short bets in energy and natural resource stocks, returned 58.5 per cent in 2015. It reaped the benefits of shorting stocks, particularly in energy infrastructure, after sticking it out in 2014 as its net asset value shrank amid client withdrawals and a 9.8-per-cent loss.

"Patience is the most difficult," he said. "It's frustrating when you can present a case that with high probability can give high return – 50 to 100 per cent – in three to five years. We will always be early because we're value oriented."

The fund, which uses fundamental analysis to pick stocks that it views as over or undervalued, seeks to avoid correlation with any asset class. That strategy has seen it return a net 12-per-cent a year since starting at the end of 2005. It has returned 10.2 per cent so far this year through July.

While the fund has kept its short bets after two years with crude under $100, Mr. Otterhaug now sees "very good opportunities going long for the first time in a long time" in the cyclical energy sector.

"Many investors invest with a thematic or macro perspective and don't differentiate enough on individual investments," he said. "That provides us with opportunities to exploit mispricing on individual companies without taking directional risk."

Oil field services, which have seen sales pummelled by cuts in investment by producers and explorers, is one industry that currently offers opportunities for long investors despite low oil prices, he said.

"We're in a situation where the oil price maybe isn't sustainable long term," he said. While the timing of an improvement is uncertain "you can buy relatively cheap inherent optionality in stocks that have relatively limited downside and are reasonably valued even if oil stays low."

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