Earlier this month we reported that Balyasny Asset Management (BAM was up 0.67% in February thanks to gains in their long/short portfolio, but now that we’ve had a chance to review Balyasny’s investor report we can give more detail about which sectors contributed the most to Atlas Global Investments returns as well as the fund’s sector exposures..

FX losses overshadow AGI’s other returns

AGI’s long/short portfolio is up 1.37% through the end of February, but the fund is still in the red because macro/credit is down 1.62%, with a 1.79% loss from FX overshadowing everything else the fund has done this year. The biggest contributor among equities is consumer discretionary, up .44% through February, but that has been more than offset by a 0.49% loss in index/funds. Fortunately returns from every other sector is positive for the first two months of the year.

In the macro/credit portfolio equity is up 0.19%, credit is up 0.05%, and fixed income is up 0.03% through February, while commodities are down 0.08%, but once again the forex reserves turn what would be a moderate gain into the fund’s biggest source of losses so far this year. Those FX losses were mostly confined to January (0.05% loss in February), because they stem from the surprise decision by the Swiss National Bank to remove the franc/euro peg in the middle of January, and Balyasny Asset Management was certainly not the only hedge fund to get taken by surprise. In February BAM had much better macro results, ending down 0.09% for the month.

Balyasny is long on IT and Consumer Discretionary, short on Index funds

The heavy FX losses are also surprising since AGI only has a 5.6% exposure to FX, about a third of its total macro exposure (all exposures as of the end of February). The long/short equity portfolio is many times larger at 224% gross exposure. Most of that comes from large caps, where AGI also has the biggest long bias.

On a regional basis, AGI is mostly invested in US equities (160.8% gross exposure, 0.7% net) followed by Europe (27.9% gross, 0.9% net) and Asia Pacific (26.1% gross, 0.8% net). The fund’s biggest long bias is in North America ex-US, with 7.4% gross exposure and 1.9% net. AGI is clearly bullish on IT, making it the fund’s biggest position both in terms of gross and net exposure (though it still has a sizable short position). It also has large net-long positions in consumer discretionary, energy, and health care.

The post Balyasny Asset Management Still Trying To Overcome Earlier FX Losses appeared first on ValueWalk.

The revolving door from Washington D.C. to Wall Street is spinning so fast it will make your head spin. Among the first was former fed chair Alan Greenspan leaving retirement to join Paulson & Co. back in 2008. Now, a couple (okay an understatement) of dozen turns (okay still an understatement) of the revolving door later, former fed governor Jeremy Stein has announced he is joining hedge fund BlueMountain Capital Management as a consultant.

Jeremy Stein , a former Federal Reserve governor who noted worries that central bank policies could eventually lead to financial instability, will now be advising a hedge fund on how to make more profits in the frothy, sloshing-in-capital economy created by the fed over the last right years.

BlueMountain, which manages more than $20 billion, issued a press release that Stein was joining the firm. BlueMountain was founded 12 years ago by ex-JPM trader Andrew Feldstein and Stephen Siderow. Both men have law degrees from Harvard, where Jeremy Stein has a professor for a number of years.

More on Jeremy Stein joining hedge fund

Analysts note that Jeremy Stein developed significant influence in his two year stint as a Fed governor. Unlike most other governors, Stein was concerned about asset bubbles from the Fed’s long-term post-crisis stimulus. For the other fed governors at the time, financial stability was a secondary concern given the ailing economy. Jeremy Stein resigned from the Fed in May of last year.

The revolving door from Washington to Wall Street spinning like a top

Hedge funds, and investment firms in the alternatives sector more generally, have become the landing spot of choice for high-ranking federal officials leaving their government jobs in recent years. Of note, former Obama chief of staff William Daley took a job at Swiss hedge fund Argentiere Capital, and former Treasury Secretary Timothy Geithner and ex-CIA head David Petraeus settled into high paid jobs at PE firms Warburg Pincus and KKR, respectively.

“We’re very lucky to have the opportunity to work with Jeremy,” said Andrew Feldstein, CEO of BlueMountain. “He has been widely recognized by leaders in government, academia and the private sector for his talent and impact.  His experience, research interests, and intellect will add real value to BlueMountain’s investors.”

“I’m excited to be working with the BlueMountain team,” said Professor Stein.  “They are at the cutting edge with respect to the development of both investment strategies and risk management tools, and I look forward to learning much more about the markets from my collaboration with them.”

The post “Revolving Door” Continues As Ex-Fed Governor Jeremy Stein Joins Hedge Fund appeared first on ValueWalk.

Since Pershing Square Holdings went public last year, Bill Ackman used a portion of this year’s annual letter to investors to explain the large cap activist investment strategy followed by Pershing Square Capital Management (which manages PSH) and the transition from what Ackman calls Pershing Square 1.0 and Pershing Square 2.0.

“In Pershing Square 1.0, we took substantial stakes and pushed for corporate changes which we believed would create shareholder value. Our holding periods were shorter. We achieved high rates of return, but required constant recycling of capital into new ideas. The changes we advocated were more structural and corporate than managerial and operating,” Ackman writes. “In retrospect, the development of our investment in General Growth Properties (GGP) represents the inception of Pershing Square 2.0.”

Bill Ackman: Pershing Square is value investing writ large

The approach that Ackman describes, especially for Pershing Square 1.0, will sound familiar to value investors. He looks for ‘simple, predictable free-cash-flow generative’ businesses with some sort of competitive moat and modest leverage if not extra cash on hand. He also looks for businesses without too much exposure to commodity prices, interest rates, or other macro conditions that are completely outside the company’s control. Short positions are just the opposite: high leverage, bad business models, and the need for access to capital are sure to draw a look from Pershing Square analysts.

Ackman determines valuations by estimating the present value of future cash flows to owners (eg dividends) only buys when the current price is a deep discount to what he considers to be fair value. For short positions he looks for a ‘ceiling on valuation’ that plays the same role as the margin of safety on long positions in keeping risk under control. And again in the vein of value investing, risk is defined as the chance of losing principle, not price volatility.

Investment in GGP fundamentally changed Pershing Square

Not of that has changed, but the transformation to Pershing Square 2.0 happened when Ackman took a position in General Growth Properties in 2008 and then took a seat at the GGP board. The creation and spinoff of The Howard Hughes Corporation two years later was meant to collect unrelated, non-core assets in a new company that would better unlock their value. Pershing Square got to appoint a third of the HHC board and Ackman became chairman, building the rest of the management team from scratch. Successful deep engagements at Canadian Pacific, Air Products, Platform Specialty Products, and Zoetis followed, as well as the investment in J C Penney that ended in deep losses.

Pershing Square exited its investment in GGP last year, but it is still invested in HHC and doesn’t appear to have any plans to exit soon. In fact, Pershing Square 2.0 won’t necessarily move on just because the initial gains from restructuring have been realized.

“Once we are in a position of influence and own a high quality business run by able management who manages the business well and allocates free cash flow intelligently, absent excessive overvaluation or a substantially better use of capital, there are few good reasons to sell,” writes Ackman, in what sounds a lot like Buffett’s statement that his “favorite holding period is forever.”

This change means that Pershing Square can focus on delivering with its core positions instead of always looking for new investment ideas and avoid all of the costs that come from building up a new position and developing (or fighting for) influence in a new company. It also builds Pershing Squares reputational equity – since other institutional investors know that Pershing Square intends to stick around for the long-term it’s easier to get them on board with proposed changes.

Pershing Square’s changing capital structure

But this approach only really works if Pershing Square has stable capital that it can invest for very long periods of time, a major factor behind last year’s IPO. Replacing redeeming investors with equity (the letter mentions the possibility of issuing low-cost, long-term, unsecured, covenant lite debt as well) allows Pershing Square to fully invest instead of always needing some liquid investments to satisfy redemptions.

If you count equity and employee capital, than permanent capital is nearly half of the total that Pershing Square is working with, and if you throw in ‘loyal investors’ and long-term contractual commitments in the funds, Ackman says that Pershing Square is approaching the ‘ideal of permanency’.

See full PDF below.

The post Ackman Explains The Transition To Pershing Square 2.0 appeared first on ValueWalk.

Armajaro Commodities Fund, a pure commodities strategy that trades in base metals, precious metal, energy, soft commodities, grains and livestock reported negative performance year-to-date.

Armajaro Commodities Fund is one of the specialist hedge funds operated by Armajaro Asset Management, a UK-based investment adviser.

Armajaro Commodities Fund utilizes a discretionary approach combined with technical signals in investing. Its investment strategy includes trading long/short directional, spread and volatility trades using exchange-traded futures and options.

Portfolio Manager steps down

The fund’s portfolio manager, John Tilney will step down from his position in April this year. Tilney joined the investment adviser in 2004 to establish Armajaro Commodities Fund.

His co-manager Oliver Denny will take over.“The next phase of the commodity cycle will be very interesting, and I believe it will provide some excellent investment opportunities for ACF,” said Denny.

According to sources with direct knowledge of the matter, the decision by Tilney to step down was likely due to his desire to have more free time and not because of anything related to the fund or the job specifically.

Armajaro Commodities Fund performance

Armajaro Commodities Fund Class A and Class C (USD) declined 3.78% and 3.77% respectively on February. The fund’s Class C (EUR) dropped 3.70% last month.

Its Class C (GBP) and Class E (GBP) fell 3.74% and 3.71%, respectively while its Class E (AUD) dropped 3.60% last month.

In a note to investors, Armajaro Commodities Fund said the decline was due to losses from investments in coffee and nickel.

“Over the medium-long term, portfolio returns are expected to be uncorrelated with the main equity and bond markets,” according to Amajaro Commodities Fund.

Armajaro Commodities Fund commentary

Amajaro Commodities Fund noted that Arabica Coffee ended February down by 13.64%. The fund explained that better-than-expected weather conditions reduced concerns regarding a shortfall in Brazil’s capacity to meet strong export demands. It drove prices lower on thin volumes. The fund explained that many investors were not present due to a public holiday in the United States.

“The manager has weather data showing a strengthening third El Nino that may cause dryness in coffee areas in Vietnam and Indonesia,” according to the fund.

Armajaro Commodities Fund said palladium outperformed in the precious metals market last month driven by lower oil prices and robust petrol engine car sales in China and the United States. Palladium gained 6%.

Platinum declined 4.25% due to reports from South African mines regarding faster-than-expected post-strike production ramp up. The ongoing concern regarding the European economy also led to large ETF outflows and record-high gross shorts in platinum.

Armajaro Commodities Fund suggested that platinum’s premium over palladium appears to decline further due to the growing concerns over the impact of diesel fumes to the environment.

The fund noted that major European cities are phasing out diesel cars. South African miners also intend to continue to maximize their platinum output.

The post Armajaro Commodities Portfolio Manager Steps Down appeared first on ValueWalk.

Calling 2014 “the year of the hack,” a new report outlines major hedge fund trends for 2015 from a technical perspective.

EzeCastle: The fund manager “Chief Technology Officer” as strategic partner

An emerging role inside hedge funds is the Chief Technology Officer (CTO), a position the report from EzeCastle says will emerge from a day-to-day technical manager to more of a “strategic business partner for the firm.”  As funds move operations to the cloud, it will lessen the day-to-day IT management role if not make it “obsolete,” the report said.  “If firms are leveraging the power of a fully outsourced, private cloud solution, they no longer need to worry about software upgrades, patch management and other mundane technology tasks.”

The lessening demands on the CTO due to moving technology to the cloud allow them to take on upper-level management projects and increasingly become involved in strategy discussions, IT integration projects, and compliance requirements, the report said. “Additionally, as we see cybersecurity become a prominent issue, CTOs can manage security infrastructure and operations across the company to ensure not only are SEC/ regulatory expectations being met but also increasing investor demands.”

EzeCastle: The cloud adoption continues to roll

Underpinning many of the technical changes anticipated in the hedge funds industry is the adoption of cloud computer technology. “We’re seeing the majority of firms leveraging outsourced cloud solutions to satisfy their infrastructure needs,” the EzeCastle report observed.

In a 2013 report, the technical integration firm noted that 87 percent of funds they surveyed were using cloud technical solutions.  For new funds, the report observed that nearly all startup firms are selecting the cloud for their IT infrastructure as a means to avoid upfront capital expenditures and achieve inherent flexibility and scalability.

EzeCastle; Cybersecurity is the critical factor for hedge funds

When cloud computing is discussed, the word “cybersecurity” cannot be far behind, and here the EzeCastle report recommended hedge funds consider the Security and Exchange Commission findings on the issue, which point to hedge funds as being potential targets for cyber crime.

The report advocated specific cybersecurity best practices, which centers on a written IT security plan touching on not only prevention of cyber crime, but also detection of a security breach after it has occurred.

“Five or 10 years ago, technology was a ‘check the box’ field on a due diligence questionnaire,” the report said. “But as the sophistication and capabilities of technology have grown and competition between hedge funds and investment firms has also grown, investors have been forced to become more IT-savvy.”

To read the full report click here.

The post Role Of Hedge Funds Chief Technology Officer To Evolve appeared first on ValueWalk.

The Hong Kong based hedge fund Oasis Investments returned 9.37% net of fees last year, bringing annualized returns for flagship funds to 18.50% since inception in 2002 with annualized volatility of 12.95% and an impressive Sharpe ratio of 1.32. The fund’s YTD performance (the letter is dated March 26) is 2.70%, and Oasis Investments CIO Seth Fischer is excited about investments in Japan that take advantage of the ‘ROE revolution’ going on there.

“In these past few years, 60-70% of our P&L has been in Asia –ex Japan including greater China. We are spending our time focusing on this, and we expect that 60-70% of our P&L this year will be in Japan,” Fischer writes. “We hope it will be on the ‘P’ side.”

Oasis Investments – Changing expectations for Japanese corporate governance

The revolution that Fischer is talking about is part of the third arrow of Prime Minister’s Abe’s economic reforms focusing on structural reform (including corporate governance). Japan’s Government Pension Investment Fund, for instance, has doubled its allocation to stocks and benchmarked itself to the relatively new JPX-Nikkei 400 which index according to a weighted measure of 40%, ROE 40% operating profit, and 20% market cap, giving companies an incentive to get lean. Japanese companies are also under pressure from the ISS decision to recommend voting against any corporate management team that’s had ROE below 5% for the last five years (fairly common in Japan), and a new law requiring one outside director alongside guidance from the Tokyo Stock Exchange that companies should have two outside directors on their board.

Fischer specifically points to Dan Loeb and Fanuc, and states:

Take for example Third Point’s success in Fanuc Corp. (6954 JP), where the stock is up 27Yo since Dan Loeb pointed it out in February, and up 13o/o on March 13, the day that Fanuc announced their interest in boosting shareholder returns

Loeb had stated that  Fanuc “reminds us of Apple in product approach’’, but criticized the company’s governance.

According to the Wall Street Journal, Fanuc’s CEO does not credit Dan Loeb, the CEO says:

Loeb’s investment wasn’t the reason for Fanuc’s decision to improve communications with investors and to increase shareholder returns. Instead, he said, the shift was prompted by the government’s campaign for better corporate governance and by his own sense that change was due.

Fischer also gives a few other examples of Japanese companies paying more attention to investors, Fischer states:

• Although, DaiNippon Printing  (DNP) does not and will not publicly provide a target, Management is taking ROE so seriously that they are even using it as an internal performance metric for each of their individual divisions.

• Takasago Thermal Engineering is moving away from their current mix of 70o/o fixed salary and 30Yo fixed bonus. lnstead, their new compensation structure will consist of 60Yo hxed salary , 30yo bonus based purely on merit, and l0%o stock options. Additionally, senior management will be encouraged to buy stock with part of their fixed salary.

• Aoyama Trading (8219 JP), rallying by 35% since announcing a payout ratio of 130% (dividend + buyback).

• Nintendo (7974 JP) where after Nintendo’s March l7 announcement of its “super jump” to mobile, which we initially suggested to them nearly two years ago and discussed with them more intently last summer, the stock is up approximately 40o/o MTD.

He wrote about why he’s excited to invest in Japan in a Wall Street Journal op-ed earlier this year, but he discusses some of his specific ideas in the Oasis Investments letter to investors seen by ValueWalk.

Oasis Investments looking at Kyocera and Canon

Oasis Investments has 1% voting rights in Kyocera, a company with a product mix that includes everything from ceramic kitchen knives to solar arrays and which has a lot of cash and securities on its balance sheet. Oasis has made suggestions on how Kyocera can restructure its solar panel business and make its loss making handset business profitable, and is encouraging it to unload much of its investments in Japanese Airlines and KDDI. It can also return a lot of its cash to shareholders through dividends and buybacks, bringing its ROE from the current 4.5% to as much as 13.8%.

Another investment idea from Oasis Investments is in Canon Electronics and Canon Marketing, separately listed companies that are majority owned by Canon Inc. Japanese Exchange Group CEO Atsushi Saito has said that the group (which operates the Tokyo Stock Exchange) wants these double listings to be consolidated where possible, and since more than 85% of Canon Electronics accounts receivables and 82% of Canon Marketing’s payables went to Canon Inc, Oasis Investments thinks acquisitions are likely. Since both subsidiaries are debt free with cash and securities on their balance sheets, there’s no compelling financial argument against consolidation either.

Looking back, Canon has previously consolidated three other separately listed subsidiaries in stock exchange deals each with at least a 10% premium. This gives Fischer some confidence not only that a deal for the two remaining child companies is likely, but that it will probably carry a healthy premium as well.

The post Oasis Investments Up 2.7% In 2015; Bullish On Japanese ‘ROE Revolution’ appeared first on ValueWalk.

A corruption crackdown in China is boosting a short play in gaming stocks, the UBS Hedge Fund Monthly Update for February noted, while the CTA/Quant Macro category, the highest performer year to date, maintained its top spot despite fighting mighty headwinds in oil, along the yield curve and U.S. dollar price trend reversals.

What’s in a name? Will UBS change it’s publication moniker?

UBS apparently didn’t get the early memo on the name “Hedge Fund” changing, a trend initially noted by The Wall Street Journal’s Rob Copeland. It is unclear at this point the degree of persistence this name change trend will generate, but monitoring the moniker of the UBS monthly “hedge funds” update might be one important bellwether.

The February issue of the “hedge fund” publication noted that long exposure of alternative asset managers was evolving, as health care longs dropped by 4 percent and cyclicals continued to enjoy long backing while financials are underweight in the hedge funds portfolios UBS tracks.  An increased appetite for European exposure was evident as the ECB’s stimulus program was much anticipated to sprinkle fairy dust on high end assets, most specifically stocks, as the euro currency falls, making investment in the region more attractive.

CTA/Quant Macro hedge funds top UBS strategy despite strong headwinds

As the breathtaking trend in the drop in oil began to stabilize in February, with Brent crude up 18 percent on the month, it challenged certain medium and long term momentum players. However, relative value funds might have noticed the dislocation with West Texas Intermediate oil, which was up just 3 percent on the month, and wonder if mean reversion of related prices might occur of if a fundamental shift in U.S. oil production is driving a larger trend in price relationships.

Shift in U.S. yield curve also affecting CTA/Quant Macro hedge funds

In addition to oil causing the CTA/Quant Macro category problems, UBS noted that the U.S. yield curve shifting higher had also caught category flat footed on the long end of the curve but these losses were offset by smaller profits on the short end of the curve.  Year to date basis February, CTA/Quant Macro was the top strategy, closely followed by Event Driven and Equity Long Short funds. All hedge funds’ categories UBS tracks were up on the year, while Global Macro funds were were the only fund losers in February.

The February letter noted that UBS noticed increased stock borrowing demand for the gaming and leisure space in the hottest market for the sector: Asia. The increased short interest came amidst a corruption crackdown in Macau, which separately is said to be a haven for money laundering for Chinese nationals, as well as fears of an economic slowdown in China are driving short interest in Las Vegas Sands, Wynn Resorts, MGM Resorts and Caesar’s Entertainment among other names.

The post UBS “Hedge Funds” Update On Exposure Trends Itself Becomes A Benchmark appeared first on ValueWalk.

Investing in a hedge fund isn’t much different than selling put options on the S&P 500, notes a new study from a Harvard and Princeton academic.

Harvard University’s Erik Stafford and Princeton’s Jakub Jurek consider the mass of hedge fund performance can be compared to what is known to be a relatively mechanical managed futures strategy – a strategy that has been known to bankrupt several CTA fund managers and their investors during periods of crisis: naked put option selling.

What are the real risks in a put selling option strategy

In their academic paper to be published in the upcoming Journal of Finance titled “The Cost of Capital for Alternative Investments,” the pair of researchers “document that the risk profile of the aggregate hedge fund universe can be accurately matched by a simple index put option writing strategy that offers monthly liquidity and complete transparency over its state-contingent payoffs.”

The paper’s essential thesis was that hedge funds are not a much better investment than a put writing strategy. However, the term “unlimited loss” or description of the investor losing potentially more money than they invested was not mentioned in the white paper. The author’s appear to be oddly considering the short volatility put strategy loss being limited to the amount invested. While in certain investment structures this would be true, if naked short selling options directly this is not the case. Note the last sentence in they use to describe the strategy, leaning on the oft used “exchange professional’s” steamroller definition:

Investments made by sophisticated individual and institutional investors in private investment companies like hedge funds and private equity funds are referred to as alternative investments. These investments are frequently combined with financial leverage to bear risks that may be unappealing to the typical investor or that require flexibility that public investment funds may not provide. The economic nature of these investments is commonly described as “picking up pennies in front of a steamroller” indicating that it is understood that there is a real possibility of a complete loss of invested capital.

While the “real possibility of a complete loss of invested capital” indicates that short selling puts has a real potential to lose all an investor’s money. However, when naked short selling any put option the theoretical risk is in fact much higher: The risk in a naked option selling strategy can be much higher than the initial investment amount, a risk calculation factor the white paper did not mention.

Why is factoring hedge fund investment structure into risk analysis important?

The paper, using unnecessarily obfuscating language language at times, is comparing the risk of a naked short selling put strategy to that of investing in limited liability hedge funds. Many sophisticated hedge fund allocators are well aware that short selling puts carries in many cases theoretical unlimited liability risk, and they would naturally assign such risk into their asset models.  From a risk standpoint, this unlimited liability structure is very different than an investment in which the investor’s liability is limited to the investment made. The hedge fund limited liability investment structure, as its name suggests, limits the investor’s loss to the amount invested.

In practice, any hedge fund allocator considering using an option short selling strategy would likely consider the risk of structure, but they might also find interesting the performance calculations for put option selling used in the study as performance correlates to risk.

Was the actual risk of a put selling strategy in 2008 reflected in an average drawdown of 11.2 percent?

The options CTA strategy s known to have an attractive win percentage near 75 percent, generally lower aggregate rolling volatility but most importantly a worst drawdown near 34 percent, which is a rounded average of performance of some CTAs who did not report performance in 2008. From a performance standpoint, 2008 is an important period from which to consider the put selling strategy, as several CTAs and their investors discovered the real risk in the strategy.

During the 2008 period, the study identifies the worst drawdown for the put writing strategy to be 11.2 percent. This is an oddity as professional put writers during that period reporting to the Barclay CTA index reported much worse performance. In fact, 2008 was such a bad year for put writing that many of the larger put writers were forced out of business during the year, as they were during 2001 a generation of CTAs earlier.

Sol Waksman from BarclayHedge said that hedge fund performance reported in his database “the vast majority of hedge funds provide net of fee returns.” The authors range for average hedge fund fees from 6 percent to 10 percent appears more like an investigation of the right tail of fees, not the average.

The report acknowledged that “linear regression analysis indicates that hedge funds deliver significant alpha,” but then also observed the high fees, which does not appear consistent with direct CTA fee reporting, which is the strategy that uses a naked put selling strategy:

Over the period from January 1996 to June 2012, pre-fee alpha estimates for diversified hedge fund indices range from 6% to 10% per annum, and thus even after deducting fees, investors appear to earn large abnormal returns relative to commonly used risk models. These estimates indicate a degree of market inefficiency, which is dramatically different from other areas of investment management (Fama and French (2010)), and suggest that hedge fund returns cannot be replicated by portfolios combining traditional risk factors.

The author, in somewhat typical Harvard fashion, needlessly obfuscate and at times they defy logic as to the point they are making. For instance, watch how they measure of negative asymmetry of aggregate market shocks, or the varying magnitude of market crashes that have dramatically negatively impacted the put selling strategy in previous periods of “adverse economic states:”

These risks concentrate losses in highly adverse economic states, and are known to receive high equilibrium risk compensation. Importantly, the additional compensation demanded by investors that specialize in bearing these risks is likely to be large relative to that prevailing in the absence of segmentation, as these assets magnify the negative skewness of aggregate (market) shocks.

Said another way, there message appeared to be: market crashes are not symmetrical and pretty, investors should be compensated for the risks they take, particularly given an institutional investor’s flexibility in terms of lock up fees.

Next the authors make very interesting points, opening up an old debate when they consider that a high performing hedge fund could simply be a nontransparent, over-leveraged bet on the S&P 500 index. This is a fascinating topic, but the report fails to mention that market correlations with various funds are tactic used by sophisticated hedge fund allocators to determine if a hedge fund is simply “juicing” the S&P 500 to beat the market or if they really have noncorrelated alpha:

What are the true risks of alternatives? Properly evaluating the risks of alternative investments is challenging. At the individual fund level, this will be especially difficult. The nature of a private investment company is such that the manager typically has discretion over the composition of the underlying risks, financial leverage, and hedging rules, all of which can vary at high frequency (e.g. intraday). Periodic reporting occurs monthly or quarterly, and direct monitoring of portfolio risks by limited partners is typically not feasible. The investor must infer risks from realized returns, which are typically unrevealing about the specific nature of their downside exposure. Measuring the risks at the asset class level is easier because the idiosyncrasies of individual funds tend to diversify, but this too is a complex exercise.

The decision to allocate capital to alternative investments is typically made by sophisticated investors with a long investment horizon who are in a financial position to bear the risks of these often illiquid investments. Given the specialized investment expertise required to properly evaluate and monitor these investments, it is common for allocations to be relatively large to amortize the fixed costs associated with expanding the investment universe to include alternatives (Merton (1987)). Additionally, we would expect that the investors in alternatives are relatively risk tolerant given the tendency for these investments to fail to pay off in poor economic states where the marginal value of wealth is high. Highly risk averse investors will require very large risk premia for downside risks.

Yes, indeed. Highly risk averse investors will require very large risk premia when trading a naked short put strategy, too. The next time the Ivy League professors are considering such a strategy, they might want to factor the unlimited loss potential of options into their own risk modeling.

See full PDF below.

The post Did An Ivy League Study On Put Selling Miss A Key Risk Factor? appeared first on ValueWalk.

EDITORIAL: Marc Mezvinsky’s Eaglevale hedgefund may be Clinton conflict of interest

The post Editorial: Marc Mezvinsky’s Eaglevale Hedge Fund May Be Clinton Conflict Of Interest appeared first on ValueWalk.

The Amici Strategy Fund is up 5.53% net of fees through the end of March according to an update reviewed by ValueWalk, pulling ahead of the S&P 500 which is currently up 1.25% YTD – a welcome change for its investors after returning just 0.08% net in 2014. The fund’s cumulative returns since inception are more than double the S&P 500 or the Credit Suisse Long/Short Equity Index, a result of the occasional incredible year (a few with over 50% annual returns) and only two down years since 1994.

Amici’s top long positions

Our most recent look at Amici’s holdings come from its February when its largest positions were a $141 million stake in United Therapeutics Corp, a position in Biomarin Pharmaceutical that included $138 million in stock, $11 million in call options, and $35.7 million in commercial paper. Amici also had a $90 million stake in Assured guaranty (plus some call options), an $86 million stake in Liberty Global PLC, $75 million in Facebook, and $71 million in Asbury Automotive Group. Amici has nearly tripled its position in Era Group since then according to a recent SEC filing, but that still doesn’t put it in the fund’s top 5 long positions.

While the March note doesn’t specify Amici’s current exposure, the $1 billion fund has ranged from 96% – 233% gross exposure and 7% – 96% net exposure, averaging 164% and 53% respectively.

Stock-pickers like Amici have a chance to earn their fees

Last year was a particularly tough year for hedge funds because even the ones that didn’t get blindsided by the crash in oil prices had trouble generating alpha. Now that there is more volatility in the market and greater price dispersion, long/short equity funds like Amici have a chance to demonstrate their stock picking skills. But even if you have enough money to invest with Amici (it’s a $3 million minimum) it’s as difficult to choose active managers as it is stocks, especially when they have to beat the market net of fees. Warren Buffett has famously made this the center of a $1 million bet that he is currently winning handily.

The post Amici Strategy Fund Up 5.53 Percent YTD appeared first on ValueWalk.

Zach Schreiber’s PointState Capital has raised $486 million for two new funds, PointBridge and PointArgentum, which are specifically aimed at investments in Argentina (h/t Bloomberg Briefs). Argentina has gotten a lot of bad press for its ongoing fight with Elliot Capital Management, but PointState isn’t the first to see opportunity there. Other hedge funds including Maglan Capital and Brevan Howard have also opened Argentina-focused funds in the last year.

PointState divides Argentina strategy into two parts

According to PointState’s SEC filing, the two funds have broad mandates including long/short equities, macro, distressed debt, special situations – they can even invest outside of Argentina. But it also says that PointBridge will focus on sovereign and provincial debt and it sounds like PointArgentum will invest primarily in Argentinean companies, though there may be some overlap between the two funds.

Under the description of PointBridge’s investment strategy the filing points out that it may invest in “debt issued by the Republic of Argentina, denominated in Argentinian pesos, U.S. dollars or foreign currencies and governed by the laws of the Republic of Argentina, the United States or other foreign jurisdictions,” a pretty clear reference to Argentina’s attempts to re-issue its debt locally so that future payments don’t have to be approved by the US courts.

Schreiber known for calling the oil shock

Schreiber, who is a protégé of Stan Druckenmiller, is best known for having called last year’s fall in oil prices that caught nearly everyone else off guard. Speaking at the Ira Sohn Conference last May, Schreiber said that the increase in US production had yet to make an impact on prices, and that oil longs had grown complacent after years of strong crude oil prices and that “complacency is a killer”.

Of course you can always find someone who was betting against a particular asset before a big crash, but it’s worth noting how Schreiber’s analysis from last year matches what most analysts will now tell you with the benefit of hindsight – that supply disruptions abroad were masking the effect of growing US production. More than betting correctly, having the right insight a full six months before the rest of the market is reason to watch where Schreiber is investing next.

The post Zach Schreiber Raises $486 Million To Invest In Argentina appeared first on ValueWalk.

Groupon CTO Sri Vishwanath sold 10,923 shares in an open market transaction on Tuesday. The stock was sold at an average price of $7.19, for a total value of $78,536.37. Following the sale, the CTO owns 78,765 shares or 0.01% of Groupon’s total market capitalization.

Another recent insider transaction

Separately, Viswanath offloaded 5,461 shares in an open market transaction dated Monday, April 6^th. The CTO sold the stock at an average price of $7.11 for a total transaction value of $38,827.71, according to a recent filing with the SEC.

Various analysts have produced an opinion on Groupon in recent weeks. The Vetr analysts upgraded the stock from a Hold to a Buy rating, and assigned a price target of $8.71 in a research note on March 30^th. Wunderlich analysts revised their rating on the stock from Hold to Buy, and increased the price target from $6.00 to $10.00 in a research note to investors on March 25^th. The Street analysts have assigned a Sell rating on the stock, a downgrade from Hold, in a research note to investors on March 18^th. Groupon currently has a consensus rating of Buy and an average price target of $9.03.

Hedge fund ownership of Groupon

According to fourth-quarter 2014 13F SEC filings, 197 hedge funds own shares of Groupon. Institutional ownership in Groupon totaled to 64.99% of the stock’s outstanding shares, says a report from Octafinance.

By the end of that quarter, these professional stock owners owned 438.95 million shares. A total of 31 funds closed their positions in Groupon, and 64 reduced their holdings. A total of 54 funds initiated position in the stock, while 55 funds increased their holdings. According to SEC’s 13 F filings, six hedge funds are especially positive on Groupon as it’s in their Top 10 picks in their stock portfolios.

Nea Management Company is the most upbeat on the stock with ownership of 44.17 million shares as of the fourth-quarter 2014, accounting for 17.69% of the fund’s portfolio. Next, Stanley Shopkorn And Douglas Day’s Hilltop Park Associate hold 350,000 shares of the company or 10.25% of their stock portfolio. TCS Capital Management, a New York-based company, has 5.23% of their stock portfolio invested in Groupon, or 1 million shares, notes the report.

The post Groupon Inc Insider Selling: CTO Sells 10,923 Shares appeared first on ValueWalk.

Hong Kong-based commodity trader NOBLE GROUP LTD ADR (OTCMKTS:NOBGY) is down 6% in trading today after Carson Block’s Muddy Waters Research announced that it was shorting the company, less than two months after Iceberg Research accused Noble of fraudulent accounting practices. Noble’s stock price has been falling for months, and is currently trading at $12.69, down from a recent high of $17.82 in February.

Noble says that Noble holds a lot of difficult-to-price assets

The Muddy Waters short thesis focuses on two things, Noble Group has a lot of flexibility in how it prices the assets on its balance sheet and Muddy Waters believes there is good reason for investors not to believe that management is making those judgment calls in good faith.

The Financial Accounting Standards Board (FASB) divides assets into Levels 1, 2, and 3 to give investors a sense of how easy it is to check fair market prices. Level 1 assets have readily available market prices (eg stocks), Level 2 assets can’t be priced as directly but can still be priced in a reliable way (eg derivatives where the underlying is easily observed), and Level 3 assets don’t have clear pricing (eg structured credit). Muddy Waters says that last year 70% of Noble’s net income came from unrealized gains on Level 3 assets, which isn’t necessarily a problem but does require trust from investors.

“With a company as complex and opaque as Noble, there is no way for investors to definitively answer the above questions. It becomes a question of how much investors should trust Noble’s management to be straight with them. Noble Group’s management has adamantly insisted that its accounting is conservative, and by implication, is reflective of reality. We do not believe Noble’s management,” says the Muddy Waters report.

Muddy Waters focuses on PT ALH deals

To show why, Muddy Waters focuses on the acquisition of PT Alhasanie in 2011. In 2011 Noble bought PT ALH for $300,000 and booked $46.4 million in negative goodwill (ie it claimed to have bought a company actually worth $46.7 million for peanuts). It then resold PT ALH a year later for $4 million and took a fair value gain of $1.9 million. In 2013 Noble benefited again when PT Atlas Resource Ptk, in which Noble has a 10% stake, bought PT ALH for $4 million and claimed $6.1 million in fair value gains.

There are more reasons to be skeptical about this deal (the owner of PT ALH in between Noble and PT Atlas is a law firm that may have represented Noble), but the huge swings in value on their own are enough to worry. Based on today’s price drop, the market apparently agrees that Noble has some explaining to do.

See full Muddy Waters research below.

The post Noble Group Slides 6 Percent On Muddy Waters Short appeared first on ValueWalk.

One of the world’s most noncorrelated hedge funds, Balyasny Asset Management and its $8.3 billion Atlas Global Investments, moved the needle ever so slightly in March, up 0.39 percent, the fund’s monthly performance sheet shows. The fund is up just 0.09 on the year and illustrates the risks and rewards of a “hedge fund” that truly “hedges.”

Is it safe to occasionally use the term “hedge fund?” Just checking for a friend

Please excuse the use of the now seemingly political incorrect term “hedge fund,” which has fallen out of favor in certain powerful corners. But to a certain group of financial professionals the absolute point of a hedge fund is to provide a cushion during periods of economic storms.

The “hedge” verbiage is critical to the core mission of the fund, and this is exemplified in Balyasny and other noncorrelated fund manager’s performance. In fact, if the truly talented noncorrelated fund managers were to have their own category and index – it’s much more than managed futures or any one noncorrelated investment method – public recognition of the value would increase. The reason “hedge funds” exist would be much more apparent not just to the general public, but its corollary in the media might realize the value of not “correlating to one” during crisis.

Balyasny proof not all investments “correlate to one” during crisis

Although the Wall Street mantra after the 2008 derivatives implosion was “all assets correlate to one during crisis,” Balyasny, like many such funds, proves this dated notion to be a fallacy. At its root, the reason for this noncorrelated magic in the fund can be found at the performance driver level.  This materializes not just the high level correlation statistics of the fund, but with an understanding of the core strategy as it relates to positive and negative performance attribution.

On the surface, Balyasny’s AGI fund has a 0.01 all-time correlation to the S+P 500. In a fund such as this, the investor should anticipate this correlation level to fluctuate with market environments. A stimulus driven market environment, for example, is likely to create a higher correlation to the stock market as asset bubbles driven by QE tended to lift all equity boats to a larger extent.  During this period of time – why don’t we call it an “anti-stock picking” environment – correlations should be expected to be different than during periods when more “natural” market forces reenter the picture and return distribution fat tail models revert to the norm.

Recognize Balyasny’s primary noncorrelated performance driver

What is interesting in Balyasny AGI’s 1.34 Sharpe Ratio is that this formula typically considers upside deviation, positive returns, as to be equal in risk weighting to negative deviation, or investment loss. Same a winning investment return is equal to the risk in a losing investment in the Nobel Laureate’s mind.

While a 1.34 Sharpe is droolingly attractive – the S&P 500 and other hedge fund indexes display a poorer Sharpe numbers typically near 0.30 and 0.50 during modern times – it is important for noncorrelated investors to recognize that at times, noncorrelated performance has a cost.

Noncorrelated performance and risk management always has a cost

In its performance report, Balyasny puts that cost if you know where to look.  To figure this out, first consider the fund’s primary noncorrelated performance driver. While little information is available to conduct this analysis outside of Balyasny’s current performance sheet, recognizing their performance attribution one can surmise that the long / short equity component, on a day in and day out basis, is the primary noncorrelated performance driver.

There are likely other risk management protocols designed to provide a cushion during periods of market volatility, and their impact on risk management during crisis could only be more fully understood upon a detailed under-the-hood examination that performance tear sheets typically don’t provide.

Long / short attribution is always interesting to watch during varying market environments

On the fund’s attribution listing, consider the monthly long / short equity numbers and focus on the cost short exposure subtracts from performance. An “ambitious” absolute return focused investor might say the problem with this hedge fund is easy to diagnose: Pull that short collar off the performance and let that horse run!

That, of course, is the quick, easy and simple solution – and it is also a false idol. When you look at 2008 performance, with Balyasny’s AGI up a skinny 0.47 percent on the year, and compare it to various investments highly correlated to the stock market during crisis – stock-based investments down 30 to 50 percent on the year – and you recognize the forthcoming challenges the world could face, the cost of the short exposure, along with the discipline to stick with strong risk management during good times and bad, is one correlation that matters.

Always questioning investment thesis, poking holes in potential risk management issues, is more than an academic exercise

This is not to say Balyasny is a perfect investment or hedge fund. Markets and hedge funds can be unpredictable at times. But the key when evaluating a hedge fund is to understand the risk management processes they have in place that test the system, probes itself for weakness and investment thesis holes on a daily basis. Ray Dalio at Bridgewater is perhaps the shining example of this methodology, which Balyasny seems to have adopted but to a different degree. This is a key process point – critical self-inflection into how investments are managed – that is used by certain sophisticated asset allocators when building a noncorrelated investment portfolio.

Probing for holes in its risk management, the fund reveals modeling in one corner of the report where it conducts stress tests during the 2001 market crash (it was up 2.03 percent), the LTCM and Lehman derivatives implosions (down -1.06 percent and -1.86 percent respectively). This is a high level look at a much more complex risk modeling exercise, to be sure, and the details of how the modeling was conducted will come into play. Such attention to crisis management performance is all too unusual in the long only dominated hedge fund world.

This, of course, is but one consideration point in a noncorrelated investment evaluation method.

The post Balyasny Didn’t Have A Big March, And That’s OK [Analysis] appeared first on ValueWalk.

First of Its Kind Program Offers Participants Invaluable Insight Into the Hedge Fund Industry

For program enquiries, please contact:

Henley Business School
Dennis Chan
2529 9337
Email Contact

For media enquiries, please contact:

Artemis Associates
Kay Withers
2861 3255
Email Contact

Jonathan Yang
2861 3234
Email Contact

The post The Henley Business School Launches World-Class Executive Hedge Fund Program in Hong Kong appeared first on ValueWalk.

Financial Innovation and Governance Mechanisms: The Evolution of Decoupling and Transparency via SSRN

Henry T. C. Hu

University of Texas at Austin – School of Law

March 20, 2015

Business Lawyer, Vol. 70, No. 2, 2015

Abstract:

Financial innovation has fundamental implications for the key substantive and information-based mechanisms of corporate governance. “Decoupling” undermines classic understandings of the allocation of voting rights among shareholders (e.g., “empty voting”), the control rights of debtholders (e.g., “empty crediting” and “hidden interests”/“hidden non-interests”), and of takeover practices (e.g., “hidden (morphable) ownership” to avoid Schedule 13D blockholder disclosure and to avoid triggering certain poison pills). Stock-based compensation, the monitoring of managerial performance, the market for corporate control, and other governance mechanisms dependent on a robust informational predicate and market efficiency are undermined by the transparency challenges posed by financial innovation. The basic approach to information that the SEC has always used – the “descriptive mode,” which relies on “intermediary depictions” of objective reality — is manifestly insufficient to capture highly complex objective realities, such as the realities of major banks heavily involved with derivatives. Ironically, the primary governmental response to such transparency challenges — a new system for public disclosure that became effective in 2013, the first since the establishment of the SEC – also creates difficulties. This new parallel public disclosure system, developed by bank regulators in the shadow of Basel and the Dodd-Frank Act and applicable to major financial institutions, is not directed primarily at the familiar transparency ends of investor protection and market efficiency.

As starting points, this Article offers brief overviews of: (1) the analytical framework developed in 2006-2008 for “decoupling” and its calls for reform; and (2) the analytical framework developed in 2012-2014 reconceptualizing “information” in terms of three “modes” and addressing the two parallel disclosure universes.

As to decoupling, the Article proceeds to analyze some key post-2008 developments (including the status of efforts at reform) and the road ahead. A detailed analysis is offered as to the landmark December 2012 TELUS Corp. opinion in the Supreme Court of British Columbia, involving perhaps the most complicated public example of decoupling to date. The analytical framework’s “empty voter with negative economic exposure” concept is addressed in a dual class share context. The Article discusses recent actions on the part of the Delaware judiciary and legislature, the European Union, and bankruptcy courts — and the pressing need for more action by the SEC. In addition, at the time the debt decoupling research was introduced, available evidence as to the significance of empty creditor, related hidden interest/hidden non-interest matters, and hybrid decoupling was limited. This Article helps address that gap.

As to information, the Article begins by outlining the calls for reform associated with the 2012-2014 analytical framework. With revolutionary advances in computer- and web-related technologies, regulators need no longer rely almost exclusively on the descriptive mode rooted in intermediary depictions. Regulators must also begin to systematically deploy the “transfer mode” rooted in “pure information” and the “hybrid mode” rooted in “moderately pure information.” The Article then shows some of the key ways that the new analytical framework can contribute to the SEC’s comprehensive and long-needed new initiative to address “disclosure effectiveness,” including in “depiction-difficult” contexts completely unrelated to financial innovation (e.g., pension disclosures and high technology companies). The Article concludes with a concise version of the analytical framework’s thesis that the new morphology of public information — consisting of two parallel regulatory universes with divergent ends and means — is unsustainable in the long run and involve certain matters that need statutory resolution. In the interim, however, certain steps involving coordination among the SEC, the Federal Reserve, and others can be taken.

Financial Innovation and Governance Mechanisms: The Evolution of Decoupling and Transparency – Introduction

Financial innovation as we know it-the new financial products themselves and the process through which they are invented, introduced, and diffused-is only a generation old. Yet financial innovation is now critical to markets and economies. The first over-the-counter (OTC) derivative product, the currency swap, appeared around 1976.1 The first model to value derivatives appeared in 1973, sparking a new, model-based process for the creation, pricing, and hedging of a continuing flow of new financial products.2 With financial innovation, risk and cash flows could be reconfigured, sliced, and transferred in ways precisely calibrated to the hedging, investing, and speculative needs of market participants. The promise has proven irresistible. Today, the market for OTC derivatives products stands at roughly $700 trillion notional,3 and model-based processes inform not only the analysis of new financial products but also the risk assessments used by both financial and non-financial entities.

Financial innovation also has a dark side, including the challenges it can pose to financial stability. These challenges, however, were not widely appreciated for many years, much less responded to.4 The near-collapse of the world financial system in 2008 concentrated minds wonderfully. Among other things, the Dodd-Frank Act of 2010,5 the most important piece of financial legislation since the 1930s, brought OTC derivatives into the regulatory fold and took a few steps to address asset-backed securities (ABS). Implementation of Dodd- Frank continues, even as the statute itself is modified.

The potential for transforming risk and cash flows and the challenges posed to financial stability largely frame the conventional analysis for how governments and markets should respond to financial innovation. This is understandable, given the enduring importance of this potential and these challenges. Certain other transformations and challenges are at least as important for banking, bankruptcy, and corporate lawyers and academics; the Delaware judiciary and legislature; and the U.S. Securities and Exchange Commission (SEC).

This Article focuses on one such transformation-the “decoupling” of rights and obligations of equity and debt—and one such challenge—the inability of the long-standing public disclosure system to capture highly complex realities, most notably those that can be created by financial innovation. This decoupling transformation and this informational challenge implicate some core mechanisms of corporate governance.

See full PDF below.

The post Financial Innovation And Governance Mechanisms: Decoupling & Transparency Evolution appeared first on ValueWalk.

Hedge funds are increasingly converting to family office structures, avoiding costly regulatory oversight, notes a recent study, but the trend is not applying to all funds.

Hedge funds move to the family office structure

According to a recent study from Citi Private Bank and an accompanying study from eVestment, an increasing number of hedge funds are converting to family office structures for various regulatory and compliance reasons.

The trend, however was spotted in January of 2012 in ValueWalk. Where the trend has led is some of the largest hedge funds, well established in the institutional market, have migrated to family offices.

The most high profile of hedge fund / family office conversions was when SAC Capital Advisors, under pressure from regulators in the wake of an insider trading scandal. The firm’s founder, Steven A Cohen, changed the name and the regulatory structure to a more lightly registered family office nearly one year ago. Since that point, the flood gates opened for some, but not all, hedge funds.

Grossman: Hedge fund trend primarily limited to upper end of the market

“The conversion from hedge fund management to family offices is really only happening at the upper levels of this industry as very few start up managers have the wealth to forgo a business and instead manage their own family office,” said Meir Grossman, Investment Management Partner at Seward & Kissel LLP.

In the case of Cohen, he returned outside capital he was managing and focused only on managing his own wealth. But a well-established manager such as Cohen can make the transition, but smaller funds, particularly those in start-up mode, don’t have similar options.

“It is absolutely the case that start-up managers have a much higher barrier to entry these days due to a combination of factors including the increasing need to develop an institutionalized platform with robust operational procedures in order to attract capital from sophisticated investors,” Grossman said. “And it is certainly the case that the time it is taking a manager to launch a fund has practically doubled from approx. 2-3 months to 4-6 months, especially given the trend of managers requiring a significant seed investment to properly launch.”

To read the Citi report, click here.

To read the Evestment report, click here.

The post Trend Continues Of Hedge Funds Converting Into Family Offices appeared first on ValueWalk.

Hong Kong financial tech firm Aidiya is getting ready to launch an AI-managed long/short equity hedge fund this summer, the first of many such funds if everything goes according to plan (h/t Adrian Wan at SCMP). While it’s not the first fund to use AI, co-founder and chief scientist Ben Goertzel is an expert in artificial general intelligence (AGI) and the system he’s developing is supposed to take a broader view of the market than the competition.

“Our algorithms go far beyond just looking at technical patterns in price data –- they look at news in multiple languages, fundamental and economic data, and price and volume data from various markets[…] forming multiple predictive models giving information about a stock’s price movement in the next week or month,” says Goertzel.

Artificial General Intelligence

Using Artificial General Intelligence in finance

At this point the use of AI in finance exists is more of a spectrum than something firms either engage in or stay away from. On the one end you have traditional hedge funds like Bridgewater that have started using AI but still insist that it is a tool being used by human minds and algorithmic trading firms like Cliff Asness’s AQR Capital that are dedicated quants, but don’t necessarily use AI (a line that can be hard to draw). You also have so-called narrow AI used by firms like Renaissance Technologies.

Aidiya says that it is at the far end of that spectrum, trusting its AGI to devise novel trading strategies one its own and to use what it learns about one market to interpret data about new situations, just like a human investor would. That means Aidiya isn’t just trying to compete on a second by second (or even faster) basis. Goertzel thinks that his AGI can disrupt strategies operating on an investment horizon of days to weeks.

Distinction between good algos and low level Artificial General Intelligence is blurry

As AI and Artificial General Intelligence become more commonplace, it will be difficult to distinguish who exactly is doing what since the difference between an AI and an algorithm isn’t visible to people who can’t look under the hood. For people trying to understand what hedge funds are up to, this creates a new challenge. The SCMP story, for example, speculates that most financial transactions will be done by computes in 20 years, but that’s really already true. Even without getting pedantic (does any trading happen without a computer these days) high frequency trading is estimated to account for about half of market transactions, with non-HFT algo-trading pushing the share even higher. That’s not what Aidiya is up to, but the differences are getting fuzzy.

The post Artificial General Intelligence Hedge Fund Launching In June appeared first on ValueWalk.

At the Ira Sohn Conference Monday Greenlight Capital’s David Einhorn, known for memorable snarky one liners to communicate a sometimes complex investment thesis, didn’t disappoint. But this morning Stifel is disputing Einhorn ripping into “the Mother Fracker” yesterday, Pioneer Natural Resources, a $27 billion oil fracking concern based in the land of big hats, Irving, Texas.

David Einhorn: Pioneer and other frackers producing oil at a loss

In yesterday’s presentation, David Einhorn said Pioneer Natural Resources (PXD), the second largest pure play in oil fracking, amounted to a company that had “all hat but no cattle.” His primary short thesis is the oil frackers have been spending more money to extract oil than they receive, even during the best of times. “It’s like using $50 bills to counterfeit $20 bills,” he said to what was perhaps the most audience laughter of any presenter. When he wasn’t engaged in a stand-up act, David Einhorn made the point that oil fracking is a general industry that didn’t make money even when oil was trading near $100 per barrel. (Gas frackers, it should be noted, are profitable, and Einhorn pointed out that important distinguishing characteristic.)

The large frackers have spent $80 billion more than they have received selling oil, David Einhorn noted, as the industry has gone on a spending spree, sinking money into new wells that generate oil and lose money with every gallon they drill. Thus, this might seem the perfect environment from which Wall Street could come in and offer securities with fuzzy disclosures to investors on the product.

Wall Street sold securities lending oil patch producers money, but David Einhorn charges they lack proper earnings disclosure

Like any red-blooded businessperson, with interest rates near zero and Wall Street saying it was ready to pile on cash, the Texas drillers, true to form, grabbed the money and proceeded to drill holes regardless of the profitability of those holes, is the charge.

“Wall Street greased the skids by underwriting debt and equity securities that allowed (the banks) to garner billions in fees,” David Einhorn said. “The banks are clearly incentivized to enable the frack addicts.”

Einhorn key point: “EBITDAX” depletion isn’t properly accounted

From here, David Einhorn launches into his primary investment thesis: “What is less obvious is whether the investor is furnished a clear analysis of the returns these companies actually generate.”

When analyzing the investment case David Einhorn is making, and comparing it to Stifel’s rebuttal, this is where to focus. Any information not related to the actual profitability of the company’s oil drilling activities is secondary noise.

David Einhorn says pioneer “Trades at a fancy multiple” on last year’s oil prices before oil fell and the method upon which profits are calculated to sell the company’s value to investors is not an SEC reported measure.  Because frackers say they are “investing for growth,” investors are asked to ignore traditional metrics, Einhorn said.

‘EBITDAX stands for “earnings before a lot of stuff,” David Einhorn said, a play on traditional revenue analysis which considers earnings before tax and depreciation. The traditional EBITDA formula is designed to provide an investors a picture into the “real” profitability of a company because sometimes tax and depreciation on capital expenses is taken off the tax burden and can be adjusted in such a way to intentionally mask profits.

Bulk of fracking drilling expenses occur up front

The bulk of expenses in an oil well occurs up front. Once the oil comes out, it’s a revenue generation stream for the most part over many years.  When the oil is sold, the producers expense the up-front capital costs of production, which David Einhorn called “depletion,” which represents the “d” in EBITDAX shorthand.

“Investing for growth is a fiction” with the oil frackers as the value in the wells has a diminishing value which is not captured in the earnings formula. At some point the oil in the well runs out, “poof, its gone,” and the value of the well, which might have a value on the books, is now worthless, no longer producing oil.

“The mantra from the frackers and the bankers who profiteer from funding them is ‘energy investors do not look at gap earnings’ and depletion gets ignored because it is not a cash item and CAPEX gets ignored because it is funding future growth,” David Einhorn said, which he then related to a “Wizard of Oz” like fairy tale where it was important not to look behind the curtain and see how the loose disclosure and accounting slight of hand operated, particularly as it relates to the diminishing value of an oil well no longer producing oil as it runs dry.

“When someone doesn’t want you to look at traditional metrics,” David Einhorn said, using some old school analytics methods, “it’s a good time to look at traditional metrics.”

Stifel strikes back, says PXD generating solid returns and disagrees “on all accounts”

This morning Stifel analysts rebuffed David Einhorn, challenging his investment thesis by saying “Einhorn claimed most sell-side analyst valuations are done using inaccurate short-hand math focusing solely on EBITDA multiples. We disagree on all accounts.”

David Einhorn didn’t exactly say those selling Pioneer investments focused “solely on EBITA multiples.” What Einhorn said somewhat humorously used to make the point was that “EBITDAX” was the formula, and it did not properly consider the depreciation of oil reserves over time.

Another somewhat troubling point is that Stifel disagrees “on all accounts.” Typically when an investment thesis is made by a hedge fund there is some primary truth they uncovered. Rarely are the issues they raise “all wrong.” To ignore the shades of grey in arguments can over simplify a response.

Stifel doesn’t address primary charge regarding depletion, but instead points to lowered production costs on new wells and a $71 oil price hedge

In regards to the primary charge David Einhorn made regarding “depletion,” Stifel doesn’t directly address this key charge in their analysis. The word “depletion” was not mentioned in the entire document but the concept was lightly addressed in its NAV analysis, but a specific formula for how depletion plays into the loss of value was not provided in the analysis.  “Because we are heavily risking PXD’s acreage, we believe near-term high-grading will not lead to diminishing returns over time…”

What Stifel did say is that the cost of production is declining, the company has hedges in place at $71 to manage drops in oil prices, something Einhorn didn’t address, although it might not matter if David Einhorn is correct that Pioneer can’t make money near the $100 per barrel level.

Stifel reiterates buy on Pioneer, $195 price target, while banks express concern over oil patch loans

Stifel, for its part, reiterates a buy recommendation and points to a $195 price target. The stock is currently trading at $165, after taking a nose dive from $172 yesterday afternoon after David Einhorn’s short was announced. Meanwhile, banks are worried about their oil patch investments, a Federal Reserve survey released Monday and reported in MarketWatch shows. Einhorn has these same worries.

Who won this fight? Its early, but many of David Einhorn’s key points appear unaddressed. That said, if Stifel is correct that costs of production are dropping and they can deliver profits near their $71 oil price hedge, which appears a difficult call, this could turn the tide. What Stifel didn’t address in its lowered cost of production assessment is the cost of production is sunk upfront and thus wells drilled to date are still pulling out expensive oil. Further, derivatives hedges fade over time as well, as it is impossible to drill new wells and currently hedge oil at $71 per barrell.

When asked to point out where in their analysis Stifel specifically addressed Einhorn’s depletion point, the report authors did not respond by publication time. Greenlight Capital did not respond to a request to comment.

If I were grading this on a fight card, David Einhorn would receive 7 out of 10 points while Stifel might receive just 2 or 3 points, based on initial discretionary analysis.

The post David Einhorn Attacks “Mother Fracker,” Stifel Fires Back appeared first on ValueWalk.

Armajaro Asset Management’s flagship Commodities Fund was able to net a 1.74% return in the month of April, reducing its year-to-date loss to -4.83%. This marked the fund’s first month of positive return in this year so far. The largest gain was recorded in its base metals portfolio whereas energy bets caused most loss to the fund. The flagship fund currently has 173% long exposure and -82% short exposure.

Armajaro shuts down STS fund

Armajaro has been in the news lately, as it had decided to shut down one of its smaller commodity funds. The fund moved to close the STS Commodities Fund after its assets under management had shrunk to a very small size. The STS fund which used computer algorithms to trade commodities was down 7.8% till the end of February this year.

In the monthly report the fund said that the Federal Reserve will likely raise rates later than was previously expected. While U.S data came in weaker than expected for the first quarter, Europe reported its strongest growth run since 2007, except for Germany and France. As April turned out to be a surprise for the markets, some large reversals in the commodity markets unfolded during that time.

Best plays for Armajaro

The manager’s report said that the fund is focusing its main plays in coffee, nickel and precious metals. The fund said that USD strength was shaken in the past month which is likely to boost the downtrodden prices of gold and silver.

Armajaro said that copper reported the largest weekly gain towards the end of April, as consumption of the metal increased. The fund believes that Chinese state grid consumption of copper is an upside risk to copper prices. Armajaro sees recovery in nickel imports in China as the discount to London’s market has narrowed. The manager said that exports of nickel are unlikelyto increase going forward.

Armajaro Asset Management was founded by Anthony Ward, who is famous for amassing a large portion of the world’s cocoa produce, hence earning the nickname ‘chocfinger’. Armajaro runs a dedicated CC Fund which trades only cocoa and coffee.

The post Armajaro Records Its First Up Month Of The Year appeared first on ValueWalk.