Bronte Capital has racked up one of the most impressive performances of its hedge fund peer group over the past six years. From inception during the first-half of 2009, to the beginning of July 2014, when Bronte Capital pooled its funds, the group’s separately managed accounts produced an annualized return of 31.5% and cumulative return of 293.2% after fees.

Bronte Capital returns

Below is a copy of Bronte Capital's client letter for the month ending 31 March 2010. During the month, the value of Bronte's managed US accounts increased by 10.9%, easily beating benchmarks. After a brief discussion of the fund's monthly performance figures, Bronte Capital moves on to present its short thesis of First Solar, a short which paid off handsomely for the fund.

Bronte Capital - Client Letter for Month Ending 31 March 2010

In March our performance was very much better than our benchmarks. Our USA reference account increased by 10.9% and our Australian reference account by 8.2%.

After 10 months and allowing for all paid and accrued fees US $10,000 invested with Bronte is now worth US$14,487 and for our Australian accounts A$10,000 has increased to A$13,368. Although the Australian account has not achieved the same percentage gain as the US account we are nonetheless pleased with its performance which has been against the headwind of a very strong Australian currency.

Our returns however have come in spurts. We had unsustainably good performance when we started our fund. In the middle four months we lagged indices by one or two percent per month – and we had slightly negative returns. We have now recovered all that underperformance. [This is a relief, in part, because we had a large client who invested on the exact day our fund peaked.]

New positions

After spending much of the first quarter trawling through the wreckage of American small regional banks we changed tack in March to increase our short positions. Most notably we are now short First Solar and discuss it later in this letter. We have also shorted a number of very hot speculative stocks in the resource sector some of which have been heavily promoted by brokers or promoters we believe are dodgy. We think that honest large-caps on average offer reasonable value (especially in the United States). However we are finding rampant frauds and stock promotes in the small and mid-cap area. As per usual we will discuss some of our shorts based on fundamental analysis or straight overvaluation but we will not discuss shorts where our reason for being short involves issuer or promoter fraud.

See the full PDF from Bronte Capital below.

[munger]

The post Bronte Capital Shareholder Letters: First Solar Case Study appeared first on ValueWalk.

Bronte Capital has racked up one of the most impressive performances of its hedge fund peer group over the past six years. From inception during the first-half of 2009, to the beginning of July 2014, when Bronte pooled its funds, the group’s separately managed accounts produced an annualized return of 31.5% and cumulative return of 293.2% after fees.

[schloss]

Bronte Capital returns

Below is a copy of Bronte Capital’s first letter to investors of its separately managed accounts. The letter was sent to investors only a few months after the fund had started trading. A full list of positions are included.

Bronte Capital Client Letter for Quarter Ending 30 June 2009

Dear fellow investors in Bronte Capital funds,

Welcome to our first client quarterly letter. We have been operating less than a month and will be brief. There is currently no individual fund. Instead we are running separate client accounts based off two model portfolios. [These portfolios are for clients denominated in US Dollars and Australian Dollars.]

We plan to open a central fund at some stage in the future – depending on investor demand. We will open separate accounts for any client with substantial funds to invest in us – though until we have finalised our US License we are not allowed to seek clients in the US.

Bronte Capital The Portfolio

We would love to say that there is a theme to our portfolio – some unifying world view that explains why our positions are sensible. Alas there is not – and besides we think that such themes are inherently dangerous. Nobody knows how the world will end up – and a single unified theme can leave your portfolio in pieces on some intermediate point – even if you are ultimately right. At my old firm we started shorting housing cycle stocks two years too early. The theme was right – the execution left a lot to be desired. Our portfolio should have enough diverse ideas that we are not – in aggregate – likely to be victims of that sort of execution error. In that light we give you our portfolio with a brief explanation of most of the major positions. For this quarter only we give a full list of all Bronte positions. In future we intend to list only substantial and new positions....

See the full PDF from Bronte Capital below.

[klarman]

The post Bronte Capital Shareholder Letters: The Beginning appeared first on ValueWalk.

Bronte Capital has racked up one of the most impressive performances of its hedge fund peer group over the past six years. From inception during the first-half of 2009, to the beginning of July 2014, when Bronte Capital pooled its funds, the group’s separately managed accounts produced an annualized return of 31.5% and cumulative return of 293.2% after fees.

[munger]

Bronte Capital returns

Bronte Capital: The year of the short

2013 was the year of the short. At the beginning of the year, the market held large short positions in high-profile short targets such as Herbalife, Tesla, and Netflix.

At the end of 2013, Bronte Capital declared in its year-end letter to investors:

"...we are now seeing people pile into worthless stocks on worthless analysis and being fooled by momentum into believing they are geniuses. This will end sometime and short-sellers will again have their day. We look forward to making real alpha on the short-book again.

We are now getting long a few high-short interest names though as a hedge against a further generalized squeeze. We are rigorous about investigating the short thesis. Only one name springs to mind – Blue Nile. Blue Nile is an online jeweler and a very fine company sporting a very high valuation. The short-thesis is essentially a valuation thesis. We think the short-thesis is only marginally wrong – but the high short-interest skews the trade in our favor. Still this sort of “trade” warrants only a single digit percentage of our portfolio. It’s just a little “spivvy” for us. Still it’s not a bad place to be. We are buying high-quality companies at the wrong price but as a necessary hedge against crappy companies shorted at even more egregious prices. We stress however that typically the long portfolio stands on its own merits." -- Bronte Capital year-end 2013 letter to investors of its separately managed accounts.

Bronte was able to avoid heavy losses from these favorite short positions, by conducting its own original research and avoiding crowded trades.

"Still by intellect, temperament and energy expended we are short sellers and bull markets have been known to leave short-sellers so ground up they look like some hapless Chinese protester after the tanks have run them over thirty times. Blood, and mush. Not recognizably human.

Genius in this case is dodging the bullets and not being around for the tanks when they want to grind away the evidence. And mostly we have succeeded at that. We have, despite this bull market, a large number of shorts on which we are showing profits. Almost none of those positions are USA listed shorts with a high short interest. There is plenty of plagiarism in the short-selling community and in this case plagiarism is almost never profitable. High short-interest stocks have gone up, up further, doubled and then continued to roll over the still-warm bodies of anyone foolish enough to follow the short-selling crowds.

Because we do a lot of original research we have ducked most of the bullets. We have shorts in many jurisdictions and many with no identifiable interest from short-sellers." -- Bronte Capital separately managed account client letter for April 2013.

Bronte managed to avoid these crowded trades but was still caught out on one of its own shorts, Uni-Pixel – a highly promotional touch-screen manufacturing company. The fund shorted its typical sub 1% position at $12, and the stock went into the mid $40s. Bronte Capital was forced out of the short by lack-of-borrow in the low $30s. Unfortunately, by the end of the year, Uni-Pixel's share price had returned to $10. At the time of writing, Uni-Pixel currently trades at $0.951, so as it turns out, Bronte's short thesis (embedded below) was correct.

Separately Managed Account Client Letter for April 2013

Our results this month are good for a long /short fund, and good results are continuing. [They are also much better than for our managed funds due to their much higher loading of “legacy” Fannie Mae and Freddie Mac preferred shares]. However at least for the long side of our book not much credit is due. It's a rising market. Any fool can make money in this market and many fools have.

We don't have a single disaster on the long side of our book and we have not had one for some time. We think we are good - even very good - but we are not that good. We should have the odd failure-stuff-up or just plain piece of idiocy showing us sharply negative returns. At least somewhere in our portfolio. We are sure there are some plain dumb longs in our portfolio, you just haven't been punished for them yet.

Possibly our best long (way too small in retrospect) is Virtus Investment Partners (NASDAQ:VRTS). As we write this it is trading at just shy of $225. We purchased it just over $50. Credit where credit is due though. We borrowed/stole the idea from Gator Capital Management - a Florida based firm run by a smart kid who is sometimes right. [We call him a kid only because he is so much younger than us. His returns seem to indicate that he is right better than sometimes.]

Generally we are not shy about stealing long ideas from whatever good source we can find. But as per usual we did some work to verify the value in the position. Plagiarism, like a rising market, sometimes appears to be genius: whatever, it was plenty profitable.

Short selling in this bull market

Still by intellect, temperament and energy expended we are short sellers and bull markets have been known to leave short-sellers so ground up they look like some hapless Chinese protester after the tanks have run them over thirty times. Blood, and mush. Not recognizably human.

See the full PDF from Bronte Capital below.

[klarman]

The post Bronte Capital Shareholder Letters: The Generalized Short-Selling Debacle Of 2013 appeared first on ValueWalk.

Carl Icahn is not having a good year. As we reported earlier this month, almost all of Carl Icahn's personal holdings, and those of Icahn Enterprises LP have underperformed the market. Excluding dividends, year-to-date Icahn Enterprises LP (NASDAQ: IEP) LP is down 29.5%.

However, Icahn received some good news today. Cheniere Energy Inc., the liquefied natural gas company, in which Icahn reported an 8.2% stake in earlier this month, has named two Icahn Capital LP managing directors to its board.

The two directors in question are Jonathan Christodoro and Samuel Merksamer.

Carl Icahn has not had much luck this year. Credit: Yahoo! Finance

Carl Icahn: Activist ideas

Icahn announced his 8.18% stake in Cheniere earlier this month. At the time, Icahn's representatives said that they intend to have talks with the company’s management and board about operations, capital expenditures, financing and executive compensation.

Cheniere, which is also a favorite of renowned value investor Seth Klarman (Baupost's biggest largest public position worth a total of $1.7 billion) is preparing to export the first major amounts of US natural gas by sea later this year from its plant on Louisiana's Gulf Coast.

Cheniere has already obtained federal permits to export U.S. natural gas abroad and has signed deals with buyers to purchase the gas over 20 years. The company has committed to building a second $16 billion natural gas export facility near Corpus Christi, Texas and teamed up with another Houston LNG company on two mid-scale projects in Louisiana. Cheniere has not secured contracts for the full capacity of projects already announced.

The company's contracts to sell gas, promise to generate billions of dollars annually in steady cash flow once gas shipments begin. However, the group has reported a loss every year since it was founded two decades ago.

But despite the fact that the company has never reported a profit, Cheniere granted its chief executive, Charif Souki, a pay package valued at $142 million for 2013. This move prompted plenty of criticism from shareholders and proxy advisory firms. Still, last year Cheniere valued Charif Souki's pay at $7.7 million, and as of this year he no longer receives a salary.

The post Cheniere Energy Reaches Agreement with Carl Icahn: Announces Appointment of New Board Members appeared first on ValueWalk.

Hedge fund investor Dan Loeb openly mocked Hillary Clinton for being married to "a liar and a cheat," but had an Ashley Madison account himself.

Loeb's name features among the data released by the Impact Team hackers, who published information that they stole from the infidelity network Ashley Madison. Loeb founded hedge fund Third Point LLC and is an important contributor to the Romney campaign, and has since confirmed that the account was genuine, writes Sam Biddle for Gawker.

Loeb now a vocal opponent of Hillary Clinton

Although Loeb used to support Obama, he has recently diverted his generosity to Republican candidates and conservative Super PACs. He recently donated a million dollars to American Unity PAC, and $250,000 to the Ending Spending Action Fund, in addition to tens of thousands to the Republican Party itself.

This June he posted a derogatory joke about Democratic candidate Hillary Clinton on his Facebook page, decrying her relationship with husband Bill Clinton. Loeb removed the post shortly after, telling Politico that it was an "old meme [that] ended up on my Facebook page inadvertently."

A year before he made that post, Loeb created an account on Ashley Madison. He signed up using his private email account, and the zip code and birthday match Loeb's own.

Investor says Ashley Madison account was for research purposes

When Gawker asked Loeb about the account, it received the following statement: “As my family, friends and business colleagues know, I am a prolific web surfer. Did I visit this site to see what it was all about? Absolutely – years ago, at the time I was invested in Yahoo and IAC and was endlessly curious about apps and websites. Did I ever engage or meet with anyone through this site? Never. That was never my intention — as evidenced by the fact that I never provided a credit card to set up an account.”

It all sounds plausible, but suspicions are raised by the fact that Loeb described himself as looking for “discreet fun with 9 or 10” on his profile. Loeb later said that the "field was part of going on the site and I gave a brief line that sounded plausible.”

He also does not explain why he would check his inbox on an account that he never intended to "engage" with anybody on. Ashley Madison data shows that Loeb checked his private messages in December 2013, 8 months after he joined the site.

The post Billionaire Dan Loeb Used Ashley Madison Account For “Research” Purposes appeared first on ValueWalk.

At one point in time, Renaissance Technologies charged the highest charged the highest hedge fund fees in the world. And for investors, it was probably worth it.

Whereas most hedge funds have a 2-20 fee scheme (2% for management and 20% for performance), Renaissance was doing 5-44, meaning a 5% flat fee and 44% of the upside. It was also averaging a staggering 71.8% annual return, before fees, from 1994 to 2014, according to Bloomberg.

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Get the entire 10-part series on Ray Dalio in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues.

“We made good returns, yes,” said Renaissance founder Jim Simons in a recent TED talk. People got very mad: ‘How can you charge such high fees?’ I said, ‘OK, you can withdraw.’ But ‘How can I get more?’ was what people were [asking].”

Renaissance has since bought out its investors because, as Simons put it, “there’s a capacity to the fund.”

The former NSA codebreaker talked about his earlier life and noted he got fired for political reasons. In a fascinating interview, Jim Simons told TED:

Well the NSA -- that's the National Security Agency -- they didn't exactly come calling. They had an operation at Princeton, where they hired mathematicians to attack secret codes and stuff like that.And I knew that existed. And they had a very good policy, because you could do half your time at your own mathematics, and at least half your time working on their stuff. And they paid a lot. So that was an irresistible pull. So, I went there.

..............

I got fired from the NSA..... the Vietnam War was on, and the boss of bosses in my organization was a big fan of the war and wrote a New York Times article, a magazine section cover story, about how we would win in Vietnam. And I didn't like that war, I thought it was stupid. And I wrote a letter to the Times, which they published, saying not everyone who works for Maxwell Taylor, if anyone remembers that name, agrees with his views. And I gave my own views ...

 ... which were different from General Taylor's. But in the end, nobody said anything. But then, I was 29 years old at this time, and some kid came around and said he was a stringer from Newsweek magazine and he wanted to interview me and ask what I was doing about my views. And I told him, "I'm doing mostly mathematics now, and when the war is over, then I'll do mostly their stuff." Then I did the only intelligent thing I'd done that day -- I told my local boss that I gave that interview. And he said, "What'd you say?" And I told him what I said. And then he said, "I've got to call Taylor." He called Taylor; that took 10 minutes. I was fired five minutes after that.

Jim Simons' secret behind Renaissance

So what is the method to Simons’ – and Renaissance’s – magic? Math, for one thing – Simons is a PhD-holding mathematician who is sometimes referred to as the “quant king.” But also, people:

I did it by assembling a wonderful group of people. When I started doing trading, I had gotten a little tired of mathematics. I was in my late 30s, I had a little money. I started trading and it went very well. I made quite a lot of money with pure luck. I mean, I think it was pure luck. It certainly wasn't mathematical modeling. But in looking at the data, after a while I realized: it looks like there's some structure here. And I hired a few mathematicians, and we started making some models -- just the kind of thing we did back at IDA [Institute for Defense Analyses]. You design an algorithm, you test it out on a computer. Does it work? Doesn't it work? And so on.

Of course, there’s no denying Jim Simons and his team see things in the markets that most people don’t. When shown a typical commodity graph, he was asked to explain how he couldn’t see something that wasn’t just random:

In the old days – this is kind of a graph from the old days, commodities or currencies had a tendency to trend. Not necessarily the very light trend you see here, but trending in periods. And if you decided, OK, I'm going to predict today, by the average move in the past 20 days --maybe that would be a good prediction, and I'd make some money. And in fact, years ago, such a system would work – not beautifully, but it would work. You'd make money, you'd lose money, you'd make money. But this is a year's worth of days, and you'd make a little money during that period. It's a very vestigial system.

But trend-following, while useful in the 60s and 70s, wasn’t working so well in the 1980s (Simons launched Renaissance Technologies in 1982). So the fund had to use other, short-term approaches and gather data. And in the days before the current technology-driven era, that meant doing things like going to the Federal Reserve to copy interest rate histories in order to make models.

Jim Simons said some of what they did at Renaissance was machine learning, predicting different predictive schemes and improving over time.

“Weather, annual reports, quarterly reports, historic data itself, volumes, you name it. Whatever there is,” he said. “We take in terabytes of data a day. And store it away and massage it and get it ready for analysis. You're looking for anomalies. You're looking for – like you said, the efficient market hypothesis is not correct.”

And while Jim Simons admits that any one anomaly can be a random thing, with enough data, the picture becomes a lot clearer. “You can see an anomaly that’s persistent for a sufficiently long time – the probability of it being random is no thigh,” he said. “But these things fade after a while; anomalies can get washed out. So you have to keep on top of the business.”

And the process, albeit complex, has worked out well. Jim Simons said that while hedge funds haven’t done especially well on the whole in recent

The post Jim Simons: From NSA Codebreaker To Top Performing Hedge Fund Manager appeared first on ValueWalk.

The Wolf At The Door: The Impact Of Hedge Fund Activism On Corporate Governance

John C. Coffee Jr.

Columbia Law School; European Corporate Governance Institute (ECGI); American Academy of Arts & Sciences

Darius Palia

Rutgers Business School; Center for Contract & Economic Organization

September 4, 2015

Columbia Law and Economics Working Paper No. 521

Abstract:

Hedge fund activism has increased almost hyperbolically. Although some view this trend optimistically as a means for bridging the separation of ownership and control, we review the evidence and find it far more mixed. In particular, engagements by activist hedge funds appear to be producing a significant externality: severe cut-backs in long-term investment (and particularly a reduction in investment in research and development) by both the targeted firms and other firms not targeted but still deterred from making such investments.

We begin by surveying the regulatory and institutional developments that have reduced the costs and increased the expected payoff from activism for activist investors. We give particular attention to new tactics (including the formation of “wolf packs” — loose associations of activist funds that do not constitute a “group” under the Williams Act) and new institutional structures (such as the alliance between an activist hedge fund and a strategic bidder struck in the recent Allergan takeover battle).

Then, we survey the empirical evidence on how the investment horizons of firms are changing. Next, we review prior studies on the impact of activism, looking successively at (1) who are the targets of activism?; (2) does hedge fund activism create real value?; (3) what are the sources of gains from activism?; and (4) do the targets of activism experience post-intervention changes in real variables? We find the evidence decidedly mixed on most questions.

Finally, we examine the policy levers that could encourage or curb hedge fund activism and consider the feasibility of reforms (including with respect to the law on insider trading). In particular, we consider possible private ordering responses, including new defensive tactics. Our policy preference is to find the least restrictive alternative.

The Wolf At The Door: The Impact Of Hedge Fund Activism On Corporate Governance - Introduction

Hedge fund activism has recently spiked, almost hyperbolically. No one disputes this, and most view it as a significant change. But their reasons differ. Some see activist hedge funds as the natural champions of dispersed and diversified shareholders, who are less capable of collective action in their own interest. A key fact about activist hedge funds is that they are undiversified and typically hold significant stakes in the companies in their portfolios. Given their larger stakes and focused holdings, they are less subject to the “rational apathy” that characterizes more diversified and even indexed investors, such as pension and mutual funds, who hold smaller stakes in many more companies. So viewed, hedge fund activism can bridge the separation of ownership and control to hold managements accountable.

Others, however, believe that activist hedge funds have interests that differ materially from those of other shareholders. Presidential contender Hillary Clinton has criticized them as “hit-and-run activists whose goal is to force an immediate payout,” and this theme of an excessively short-term orientation has its own history of academic support. From this perspective, the rise of activist funds to power implies that creditors, employees and other corporate constituencies will be compelled to make wealth transfers to shareholders.

This article explores this debate in which one side views hedge funds as the natural leaders of shareholders and the other side as “short-term” predators, intent on a quick raid to boost the stock price and then exit before the long-term costs are felt. We are not comfortable with either polar characterization and thus begin with a different question: Why now? What has caused activism to peak over the last decade at a time when the level of institutional ownership has slightly subsided? Here, we answer with a two-part explanation for increased activism: First, the costs of activism have declined, in part because of changes in SEC rules, in part because of changes in corporate governance norms (for example, the sharp decline in staggered boards), and in part because of the new power of proxy advisors (which is in turn a product both of legal rules and the fact that some institutional investors have effectively outsourced their proxy voting decisions to these advisors). Second, activist hedge funds have recently developed a new tactic—“the wolf pack”—that effectively enables them to escape old corporate defenses (most notably the poison pill) and to reap high profits at seemingly low risk. Unsurprisingly, the number of such funds, and the assets under their management, has correspondingly skyrocketed. If the costs go down and the profits go up, it is predictable that activism will surge (and it has). But that does not answer the broader question (to which we then turn) of whether externalities are associated with this new activism.

Others have criticized hedge fund activism, but their predominant criticism has been that such activism amounts in substance to a “pump and dump” scheme under which hedge funds create a short-term spike in the target stock’s price, then exit, leaving the other shareholders to experience diminished profitability over the long-run. This claim of market manipulation is not our claim (nor do we endorse it). Rather, we are concerned that hedge fund activism is associated with a pattern involving three key changes at the target firm: (1) increased leverage; (2) increased shareholder payout (through either dividends or stock buybacks), and (3) reduced long-term investment in research and development (“R&D”). The leading proponent of hedge fund activism, Harvard Law Professor Lucian Bebchuk, has given this pattern a name: “investment-limiting” interventions. He agrees that this pattern is prevalent but criticizes us for our failure to recognize that “investment-limiting” interventions by hedge funds “move targets toward…optimal investment levels” because “managements have a tendency to invest excessively.” We think this assumption that managements typically engage in inefficient empire-building is today out of date and ignores the impact of major changes in executive compensation. The accuracy of this assertion that managements are systematically biased towards inefficient expansion and investment becomes the critical question, as the scale and magnitude of “investment-limiting” interventions by activists have begun to call into question the ability of the American public corporation to engage in long-term investments or R&D. Is the new activism a needed reform to curb managerial self-interest or a hasty overreaction? Or somewhere in between?

See full PDF below.

The post The Impact Of Hedge Fund Activism On Corporate Governance appeared first on ValueWalk.

Family offices have become all the rage today. A "family office" is not a physician's or dentist's office, it is a special type of lightly regulated financial firm used by the ultra-rich to manage their uber wealth. Until recently, family offices were mainly used by corporate billionaires such as Bill Gates as the most tax- and cost-effective way to manage their wealth over the long run.

Today, however, a growing number of prominent hedge fund titans are also quietly creating family offices for themselves, in many cases actually as a part of their  firms. Billionaire hedge fund managers Bill Ackman, Ray Dalio, Eric Mindich and Dan Och among others have established single family offices, and the trend is raising some hackles in the industry. The critics argue that its obvious that hedge fund managers should remain focused on their hedge funds and live by the results of their efforts.

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“I expect hedge fund managers to be 100 percent invested in their hedge funds,” argues Karl Scheer, chief investment officer of the $1.2 billion endowment at the University of Cincinnati. “I prefer that they’re singularly focused in order to achieve the best results.” A statement which seems a bit extreme in our humble opinion.

Are hedge fund family offices just diversification or do they cross the line?

As some analysts point out, the super-rich hedge fund managers are just diversifying their assets. However, both clients and government regulators are concerned that these hedge fund family offices could lead to potential conflicts, including who covers costs for what and in particular the potential for investments to overlap or be on opposite sides.

Critics point out that the lines can and do get blurry. Ackman's Table family office, for example, took a position in Sprout Pharmaceuticals, maker of the first female "Viagra". A soon as the new drug was approved by the FDA in August, Sprout was snapped up by Valeant, a firm that Ackman and Pershing had inside knowledge of related to a recent a hostile-takeover situation.

The business of loosely regulated family offices has mushroomed in today's world of Wall Street plutocrats. It's not just the corporate titans and hedge fund princes who are joining the trend, private equity billionaires including Leon Black and David Bonderman have set up family offices as well.

The post Taking A Closer Look At Hedge Fund Family Offices appeared first on ValueWalk.

Fund Structure And The Long-Run Performance Of Activism

Namho Kang

University of Connecticut

Gideon Ozik

EDHEC Business School

Ronnie Sadka

Boston College - Carroll School of Management

September 1, 2015

Abstract:

This paper demonstrates the importance of fund structure for understanding hedge fund activism. Firms targeted by activists with transparent fund structures outperform those targeted by activists with opaque fund structures by roughly 22% per year (risk adjusted). Outperformance is also measured in return-on-assets and valuation ratios. The effect is neither explained by superior target selection ability nor by takeover activity, but rather by increased operational efficiency and transparency of the target firms. However, the fund structure effect is not priced around the activism announcement date.

Fund Structure And The Long-Run Performance Of Activism - Introduction

Investor activism has been the center of debate among finance researchers and legal academics. Earlier studies (e.g., Black (1998), and Gillan and Starks (2007)) show that activist institutional investors, usually mutual funds and pension funds, do not significantly influence management on their activist agenda However, the pioneering work of Brav, Jiang, Partnoy, and Thomas (2008) shed light on the importance of the type of institutional investor for successful activism. In particular, these researchers show that hedge funds, contrary to other types of institutional investors, are able to influence corporate management due to their different organizational structure and incentives. They show that activist-targeted firms exhibit increases in performance measures and CEO turnover. Indeed, the equity market responds with an average of 7% return for targeted stocks around the announcement dates of 13D filings.

However, critics of activism argue that the positive response of the stock market to an activism announcement is only a short-term gain, while the cost of activism, such as the distraction of management from long-term goals, outweighs the short-term benefit to shareholders. This area of research has engendered growing debate in law and economics literature and in the general press; critics of activist investors indicate conflict of interest, wealth transfers, and overall poor long-run performance of target firms. Bebchuk, Brav, and Jiang (2013), however, debunk this myopic view of activism by providing supporting evidence for the positive impact of activism on long-term performance as measured by operational efficiency and valuation ratios. Also, Greenwood and Schor (2009) study takeovers as one possible avenue of value creation by activist funds. They demonstrate that the positive stock market reaction to 13D announcements reflects the market's perception of the chances that the target firm will eventually be acquired by another firm. Also, Boyson, Ma, and Mooradian (2015) show that hedge fund activists exhibit performance persistence in successive target firms and this persistence is due to long-term improvements in target firms, rather than activist reputation effects.

In addition to the cited literature on activism, several recent papers study issues pertaining to the structure of hedge funds. Relying on SEC filings, Brown, Goetzmann, Liang, and Schwartz (2008, 2009, 2012) study fund operational risk and conclude that investors do not consider fund operational risk despite its capacity to predict fund failure. Ozik and Sadka (2013) highlight the conflicting incentives of fund managers and investors pertaining to the information asymmetry in the presence of share restrictions (see also Aragon (2007) who studies the effect of share restrictions on hedge fund returns). They show that this issue is intensified in funds with low-transparency standards, where the latter is gauged by fund domiciliation, quality of service providers, SEC registration, financial auditing, and the implementation of high-water marks.

See full PDF below.

The post Fund Structure And The Long-Run Performance Of Activism appeared first on ValueWalk.

Billionaire Tepper bought the property in Sagaponack, New York in 2010 and work has just been completed.

Tepper used to work at Goldman Sachs before setting up hedge fund Appaloosa, which now manages approximately $20 billion in assets. During his time at Goldman, Tepper worked with Jon Corzine, and later bought the property in the Hamptons from Corzine's ex-wife, writes Julia La Roche for Business Insider.

Hedge fund billionaire can now enjoy his revenge mansion

The oceanfront mansion cost Tepper $43.5 million, but it apparently wasn't to his taste. He saw fit to tear down Corzine's former summer home in order to construct an entirely new mansion in its place.

Tepper's new mansion is twice the size of Corzine's old house, and the two have history. Corzine, the former CEO of Goldman, decided against promoting Tepper to partner, and it seems the latter never forgot that fact.

“You could say there was a little justice in the world,” Tepper told New York Magazine in 2010, addressing renovation plans for his newly bought property. Five years on, the mansion is complete and Tepper can stare out to sea content in the knowledge that he has outdone the man who spurned him.

Extravagant Hamptons property rises from the dust of rival's house

The property is certainly impressive, and aerial photographer Jeff Cully took a helicopter ride to take some snaps from the air. The property was rebuilt by Cooper Robertson Architects in a Georgian Colonial style.

Among the distinctive features of the property are huge windows which run the length of the dining room on the second floor, designed to allow Tepper to watch the sunset. The swimming pool is massive, and comes with an ample pool house, while there is also a tennis court and a huge second-floor deck with jacuzzi.

Despite Tepper's obvious displeasure at being passed over for promotion at Goldman, it looks as though it may have been for the best. Appaloosa has made him a multi-billionaire, affording Tepper the opportunity to prove a point to his former boss in a very extravagant way.

As the saying goes, revenge is a dish best served cold, and Tepper certainly took his time sending a message to Corzine.

The post David Tepper Completes Huge Mansion In The Hamptons appeared first on ValueWalk.

Reinsurance: the perfect hedge fund strategy to enhance a portfolio’s Sharpe ratio? By Donald A. Steinbrugge, CFA

Reinsurance is one of the few hedge fund strategies that has almost no correlation to the stock or bond markets and has the potential to generate high single digit to low double digit returns on average over the next 5 to 10 years, regardless of the direction of the capital markets. It is important for investors to stress test their overall portfolio for major market selloffs, because most hedge fund strategies’ correlations to the capital markets are dynamic and rise dramatically during market selloffs as we saw in the 4^th quarter of 2008. Reinsurance funds provided valuable diversifications benefits during that period. This brings us to the question: what is reinsurance and how should an investor evaluate managers in this strategy?

What is reinsurance? It is important to differentiate between the asset class and the legal structure of reinsurance. This paper will be focusing on the asset class of reinsurance and not the legal structure. A number of hedge funds have created a reinsurance structure for their hedge fund strategy, creating a more tax efficient fund for their investment strategy.  The current tax benefits are that taxes are deferred as long as they stay in the fund and gains are primarily long term capital gains. The objective is to generate returns from their core strategy, and have as little risk exposure to insurance as possible, but still keep the tax benefits. These are not the type of investments we are referring to in this paper.

The best way to understand the asset class of reinsurance is to compare it to structured credit. Lending institutions can either hold various loans they have made on their books, such as residential and commercial mortgages, credit card receivables or bank loans, or they can sell the loans to other institutions and keep a small transaction fee for sourcing the deal. Insurance companies can do the same thing with insurance policies they underwrite. The insurance market is made up of 2 major risks which include life with approximately $2.5 billion annual premium per year and non-life $1.8 billion premium based on a Swiss Re/Sigma Global 2012 report. Non-life can further be divided into casualty and property.  This paper will focus on the property reinsurance market.

When a bank sells their loans to a third party, often the interest and principal payments are broken out into various structured credit tranches, where a purchaser can elect to only purchase the specific cash flows that meet their needs. This carving up of a security concept is similar to how insurance companies carve up a basket of insurance policies. Reinsurers can elect which liabilities on which they would like to bid. For example, they might bid on a bundle of earth quake policies heavily weighted to Southern CA, where they would only be responsible for the liability after a certain dollar amount was paid out first. They could also size the risk to less than 3% of their portfolio.

How do reinsurance firms build out a portfolio? A reinsurance fund is heavily regulated and is limited to how much insurance risk they can assume based on the assets of the fund. Most of these property risk policies have relatively short lives of 1 year or less, but can range up to 2 years. The objective of any good reinsurance fund is to maximize the risk adjusted returns for their investors by building a diversified portfolio of policies based on geography and peril. In building out the portfolio, the reinsurance company should be using sophisticated analytics to identify cheap policies and construct a portfolio by assessing the downside risk of the policies in the portfolio based on a one in a hundred years scenario. This reliance on analytics for security selection and portfolio construction also has similarities to structured credit managers.

How does the math work? Let’s assume the reinsurance fund is targeting a maximum drawdown of 22% percent based on a once in a 100 years occurrence. For this level of downside volatility, the fund would potentially accumulate insurance policies that would generate an 18% return from premiums assuming no claims and a 10% return based on the historical average claims for similar historical risks. The nice thing about property insurance is that perils tend to be very geographically isolated, which means that earthquakes tend to affect very small areas. As long as the portfolio is geographically diversified, and the liability is limited in each specific geographic area, one large earth quake should not have a large impact on the portfolio. To generate negative returns typically requires multiple devastating earth quakes in different locations during the same year. The same is true for hurricanes where most of the damage tends to be concentrated in small areas. For example, hurricanes that hit Florida do not wipe out the whole state, although they might do heavy damage to parts of the state where the center of the storm passes. Reinsurance funds can diversify their exposure with the state by owning separate bundles of insurance policies that are concentrated in different locations within the state.

What is the downside of investing in reinsurance? All reinsurance funds should clearly be able to articulate what their drawdown will be given a one in a 100 scenario of events. There is a very wide range across the industry and it is important to understand what this statistic is to properly compare multiple reinsurance funds. The above “how does the math work example” might have targeted a 30 percent decline for this statistic.   This might sound like a lot, but actually is less than the drawdown that many other strategies experienced in 2008. In addition, the tail risk of potential negative performance tends to be much narrower than many other hedge fund strategies with a more consistent return pattern. For example, the one in 20 scenarios of events drops to around seven percent. Doing this same analysis on the S&P 500 would show a decline of 39% based on a one in a 100 scenario and this statistic would only decline to approximately to negative 23% in a one in 20 year scenario.

What is the current market environment? Prices for reinsurance fluctuate over time based on supply and demand. Recent prices have trended lower due to minimal major insured loss occurrences and increased competition from hedge funds entering the space for the tax benefits. This second component may reverse itself because the IRS has begun to aggressively focus on non-traditional reinsurance structures.

What evaluation factors should be used in selecting a reinsurance fund? Like any other hedge fund strategy, multiple evaluation

The post Reinsurance: the perfect hedge fund strategy to enhance a portfolio’s Sharpe ratio? appeared first on ValueWalk.

Harvard University once again showed the world that it has the largest endowment in academia, but its returns are left a little wanting.

Harvard's fiscal year

With an endowment of $37.6 billion, the Harvard Management Company expects that it will have the largest endowment of universities in the United States. Neither Princeton or Yale have reported their years but barring something miraculous it's expected that Harvard will still rule the roost both in the Ivy League and beyond.

The annual returns were reported by the president and chief executive officer of Harvard Management Company Stephen Blyth in his first letter to alumni having taking the helm of the company in the beginning of the year. All told, HMC managed a 5.8% for the fiscal year that ended on June 30, 2015. Unfortunately, this lagged well behind the 13.2% that the Massachusetts Institute of Technology saw for its endowment; Stanford (the "West Coast Harvard") managed a return of 7%.

Despite these "disappointing" numbers, Harvard's return surpassed the Standard and Poor’s 500 index of 4.5% over the same period.

Going forward and short?

In the long letter to Harvard alumni, Blyth signaled that he wanted to continue with the Harvard tradition of having some of the university's assets managed internally, but suggested that he wanted said money managers working in closer conjunction. It's believed that he would like to see manager compensation tied not just to the assets they manage but the endowment's performance as a whole.

He's also not afraid of going short due to "potentially frothy markets."

"We have renewed focus on identifying public equity managers with demonstrable investment expertise on both the long and short sides of the market," he said.

Harvard continues to use endowment returns to finance roughly 35% of its annual budget and expects great things from Blyth. However, he is a bit hamstrung by his inability to meet Wall Street salaries for those that manage the endowment.

Harvard does it different

Harvard is one of the only, if not THE only university, that employs external money managers including those that work for hedge funds. This practice has been responsible for a rift with faculty over what are viewed as outrageous fees when compared to the salaries of those with tenure or those whom work for the university.

The post Harvard’s Huge Endowment, And “Poor” Return Announced appeared first on ValueWalk.

Hao Capital, a small hedge fund managed by electronics engineer Zhang Hao, delivered a strong performance—doubling investors’ money amid the market volatility this year.

According to Reuters, Hao Capital achieved 97.8% returns year-to-date from its long positions in appliance companies and short bets in the solar industry. The hedge fund did not join the pack of investors, who made investments in China A shares that crashed in August.

Hao Capital delivered 132.5% returns since its establishment in August 2014. The hedge fund left its peers in the dust with its nearly triple-digit performance. Data from eVestment, an industry tracker showed that the average China-oriented fund recorded 1.09% return during the first eight months of this year.

Hao Capital shorts solar industry

Hao Capital has long positions in Haier Electronics Group and Gree Electric Appliances and short bets in the solar industry, according to individuals who invested in the hedge fund.

One of the investors said, "This fund has made money in both the long and the short side, and the manager has been very excited about short positions in the solar industry, which he did not name.”

In August, Mr. Hao informed investors that his firm lost 9.5% amid the broader market decline, but its portfolio achieved a 7.63% gain driven by its short bets.

The hedge fund managers said he stayed on the sidelines in May when most investors rushed into Chinese A shares. According to him, he was concerned about the emotional nature of individual investors, who account more than three-quarters of the trading volume.

"From a cultural perspective, these investors are less prone to logical thinking, and prefer stories of a company to its market value calculation," according to the hedge fund manager.

Based on Hao Capital’s investment document, its long positions and short positions generated returns of 9.4% and 6.02%, respectively in May. His instinct for avoiding the pack probably helped the hedge fund to outperform its peers in the industry.

Hao Capital looks for “significantly mispriced targets”

Hao Capital is looking for “significantly mispriced targets.” The hedge fund aims to deliver an annual return of 30% to clients.

Mr. Hao said he made some big bets on large and mega-cap companies. He also makes the significant amount of investments in Chinese equities trading in Hong Kong and the United States.

Last month, he said, "We should be buying as the market falls. Cheap valuations represent the greatest opportunity for the Fund."

The post Hao Capital Doubles Investors Money Amid Market Volatility appeared first on ValueWalk.

Shorting is a tricky business. No fund manager is more aware of this than Whitney Tilson.

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Nine times out of ten, Whitney Tilson is on the money when it comes to picking shorts (see below), but timing the shorts is a different game altogether.

A year ago (October 2014), as markets pushed to new highs Tilson made the decision to cover the majority of his short book. He covered 41 shorts and left eight open. Then, two months ago, Tilson sent out an analysis of the 41 shorts covered during 2014, which is shown below.

These results underscored the dangers of shorting amidst a bubble. Among the losers, the two largest, three of the top five, and five of the top 10 were in the pharma/biotech industry. Tilson commented at the time:

"...it’s hard to predict when the bubble will pop – and, in the meantime, you can get destroyed being short these stocks. Thank goodness I got out of them – but, having avoided the pain as they ran up, I am going to think carefully about shorting a biotech index like IBB as well as the five stocks that have run up so much: Retrophin, Northwest Biotherapeutics, Opko Health, MiMedx and Raptor Pharmaceuticals. I think all five are destined to decline by at least 50%, if not 80%."

How things have changed.

Whitney Tilson sent out another update on his covered short positions this week, nearly a year on from covering the positions and the picture is completely different, according to an email to investors reviewed by ValueWalk. The average return of the 41 stocks covered since last October has gone from +12% (vs. +10% for the S&P) to -17% (vs. flat for the S&P), a 26% decline over the past two months vs. -9% for the S&P 500. The table below shows the updated figures:

As it turns out, Tilson's idea to short the likes of Retrophin, Northwest Biotherapeutics, Opko Health, MiMedx and Raptor Pharmaceuticals at the end of June this year would have been an extremely profitable trade to make. Tilson wrote on July 31:

"As I review all 21 stocks that have risen since last October – my “mistakes” – there isn’t a single one in which I say to myself today, “You know, Whitney, that was a really dumb one to be short.” They were good shorts then and are better shorts now I believe."

Since, 21 of the 41 stocks covered are down an average of 26% as the biotech bubble has well and truly burst. Tilson's top short picks for betting against the biotech bubble, Retrophin, Northwest Biotherapeutics, Opko Health, MiMedx, Raptor Pharmaceuticals and the biotech index, IBB have slumped 40%, 47%, 49%, 22%, 61% and 22% respectively. Unfortunately, Tilson didn't follow his advice to bet against these companies but he did short UBIO, a 3x levered biotech ETF, which is down more than 50% since mid-August.

Tilson also notes:

The 8 shorts I kept (I’ve since covered JOE) have continued to collapse over the past two months, led by Unilife, WRLD, LL and EXAS. F**king HLF is the only one that continues to hang in there – but it will collapse soon, mark my words!

Whitney Tilson: World Acceptance

Whitney Tilson hasn't had much luck timing his shorts in the past, but other investors can learn from his mistakes. Take, for example, Tilson's World Acceptance short.

Tilson first recommended shorting World Acceptance Corp. around two years ago in an issue of the acclaimed Value Investor Insight magazine. At the time, the stock was trading at $86.21. Whitney Tilson recently revisited the position in the September issue of Value Investor Insight, discussing the company and lessons learned from the short.

Tilson describes how he first learned about the company during May 2013, after reading an expose by ProPublica, a nonprofit investigative journalism organization.

The article described how World Acceptance traped desperate, financially unsophisticated people with broken credit in a cycle of revolving, ever-deepening debt by charging excessive interest rates on unsecured loans. Predatory lending practices actually kept World Acceptance from operating in all but 13 US states (now 15) and Mexico.

"All of these factors, however, didn’t make World’s stock a good short. On paper the company was one of the best growth stories in the financial industry...Thus I needed a catalyst, and the one I was counting on was what I called then 'the revenge of the regulators.'" -- Whitney Tilson, Value Investor Insight, September 2015.

Tilson goes on to describe how frustrating the World short became after the Consumer Financial Protection Bureau [CFPB] failed to take any action against the company during 2014.

"It would have been easy at that point to close out the position in frustration, but I didn’t do so for two reasons. One, I was convinced that my thesis remained fully intact. Two, knowing it could take time for regulators to act, I’d kept the short position small as I waited for some more clarity." -- Whitney Tilson, Value Investor Insight, September 2015.

Tilson's patience eventually. In April this year the CFPB announced sweeping regulations for payday and installment lenders. Limits on rollovers and refinancings as well as affordability assessments were introduced. Then in late June, World Acceptance revealed that its banks had placed onerous new terms on its revolving credit facility, including a reduction in available credit, an increase in the interest rates charged and limitations on cash returns to investors.

Yet another nail was hammered into World Acceptance's coffin last month when that CFPB issued a Notice and Opportunity to Respond and Advise letter, essentially advising the company it was about to be indicted for violating the Consumer Financial Protection Act of 2010.

Tilson believes that there's now a 50/50 chance World Acceptance will head to zero.

World Acceptance: Lessons learned

What lessons did Tilson learn from this experience? Well, he notes that one takeaway from the experience is the fact that sleazy companies can keep doing sleazy things far longer than they should be able to, in part because it can take regulators many years to rein in even the most obvious "bad actors".

"The implication of such lessons are clear: if you think you’ve found a great short in the mold of World, be patient. Size the initial position small, just to keep an eye on it, and then be prepared to pile in if regulators finally act." -- Whitney Tilson, Value Investor Insight, September 2015.

The post Whitney Tilson Nails Big Short In UBIO, 3x levered Biotech ETF appeared first on ValueWalk.

Two Sigma, a technology-driven hedge fund hired Dr. Alfred Spector, a former senior executive at Google to serve as its Chief Technology Officer and Head of the Engineering Organization.

According to the hedge fund manager, Dr. Spector will lead its technology strategy. He will focus on driving innovation to optimize its investment platform and overall capabilities.

Dr. Spector’s experience fits Two Sigma

In a statement, Two Sigma Co-Chairman David Siegel said, "Alfred's unique skills and experience in the areas of engineering, research, and strategy are ideally suited to our company at this stage in our development. We are confident that he will help us continue to innovate for the benefit of our investors."

Dr. Spector retired from Google early this year. He served the technology giant as Vice President of Research and Special Initiatives. During his tenure at Google, he was also responsible for the company’s open source initiatives, university relations, internationalization, and many education programs.

He also served as executive engineering lead for Google.org, which applies the company’s strengths in information and technology to develop products and advocates for policies that address global challenges.

Prior to his career at Google, Dr. Spector held various senior level positions at International Business Machines including Vice President of Strategy and Technology for IBM Software and Vice President of Services and Software.

Dr. Spector received his Ph.D. in Computer Science from Stanford University and Bachelor’s Degree in Applied Mathematics from Harvard University. He is an active member of the National Academy of Engineering and the American Academy of Arts and Sciences.

Two Sigma has unmatched ability to apply technology

According to Dr. Spector, “Technology has an exceptional and growing impact in nearly every sector over the last twenty years. When it comes to investment management, Two Sigma has an unmatched ability to apply technology for beneficial innovation.”

He is excited to work with the hedge fund’s team of talented professionals to help advance the use of technology to discover value in data.

Two Sigma was established in 2011. The hedge fund currently has $28 billion of assets under management (AUM). It has offices in New York, Hong Kong, Houston, and London.

The post Two Sigma Poaches Google’s Alfred Spector appeared first on ValueWalk.

Deutsche Bank, the largest bank in Germany, mistakenly paid $6 billion to a hedge fund client in a “fat finger” trade through its foreign exchange trade in June, according to a report from the Financial Times.

The report said Deutsche Bank recovered the money from the US- based hedge fund the following day. However, the incident raised questions regarding the operational controls and risk management of the German bank. It was an additional embarrassment to the German bank’s forex team in London, which is currently under regulatory investigations.

A junior member of the Deutsche Bank’s forex sales team processed the $6 billion trade while his superior was on holiday, according to people familiar with the situation. The junior trader processed a gross figure instead of processing a net value, explained one of the sources. He said the trade had “too many zeroes.”

Market observers were wondering why Deutsche Bank failed to spot the $6 billion error given the fact that the German bank implements a “four eyes principle,” which requires another person to review every trade before processing it.

Two persons familiar with the issue emphasized a trading mistake is common, but the $6 billion mistake was rare. Deutsche Bank reported the incident to the European Central Bank (ECB), the UK Financial Conduct Authority, and the US Federal Reserve.

Deutsche Bank CEO said tightening internal process is necessary

In July, Deutsche Bank co-CEO John Cryan emphasized the importance of tightening and sharpening its internal process and improving its culture as well as relations with regulators.

“Our cost base is swollen by poor and ineffective processes, antiquated and inadequate technology, too many tasks being completed using manual labor and, too frequently, unsuccessful investments in our infrastructure,” said Mr. Cryan in a recent memo.

Deutsche Bank is currently facing regulatory investigations worldwide due to alleged wrongdoings including violating US sanctions against Iran, rigging Libor interest rates and foreign exchange markets as well as money laundering in Russia.

A recent report suggested that the close allies of Russian President Vladimir Putin were among those who benefited from Deutsche Bank’s trades, which are currently under scrutiny by US regulators.

Deutsche Bank reorganization

Today, Deutsche Bank announced its decision to restructure its business division and leadership as part of its Strategy 2020. The Supervisory Board decided to split the bank’s Corporate Banking & Securities (CB&S) into two business divisions starting on January 1, 2016.

Deutsche Bank will combine its Corporate Finance business in CB&S with Global Transaction Banking Banking (GTB) to create a business unit called Corporate & Investment Banking.

The German bank will combine the sales and trading activities of CB&S to create a new business unit called Global markets. Deutsche Bank said it will no longer use the name CB&S.

Furthermore, Deutsche Bank announced several leadership changes. CB&S current co-head Jeff Urwin and Colin Fan will joint the Management Board. Stefan Krause, a long-term member of the Management Board, will step down on October 31.

Its current COO Henry Ritchotte will resign by the end of the year. Kim Hammonds, the current Global CIO and co-head of Group Technology Operations at Deutsche Bank will become COO.

Quintin Price will also join the Management Board while Michele Faissola, head of Deutsche Asset & Wealth Management will leave after a transition period. Karl von Rohr, current COO for Global, regional Management will become Chief Administrative Office, and Sylvie Matherat, the head of Government and Regulatory Affairs will become Chief Regulatory Officer.

Daniele Brupbacher, an analyst at UBS, commented, “This has the clear fingerprints of John Cryan. He is ready to take tough decisions and really wants to change things.”

Earlier this month, Deutsche Bank announced disclosed that it was expecting to report a net loss of €6.2 billion (approximately $7 billion) after charges for the third quarter of this year.

The post Deutsche Bank Mistakenly Paid $6 Billion In A “Fat Finger” Trade appeared first on ValueWalk.

A return dispersion in October is making it among the most difficult months for hedge funds, notes a Credit Suisse analyst, with long / short hedge funds being particularly hard hit based on their sector strategy.

Sector rotation in part responsible for long / short strategy negative returns

It was sector rotation that was responsible for equity long / short hedge fund underperformance in October, as the hot strategy turned in cold performance, as previously noted in ValueWalk.

The rotation started with losses from underweight exposure in energy and industrials combined with overweight healthcare and internet which lagged indices. “From this performance hole, earnings and company-specific news has added an idiosyncratic twist, increasing dispersion from single stock out/underperformance,” analyst Mark Connors noted.

Connors cites three primary factors responsible for returns dispersion in October.

To an extent a hedge fund manager’s strategy was responsible. Separate analysis indicates in a long / short strategy the primary performance driver is often stock selection driving long and short exposure. Some long short strategies operate on a mathematical basis to determine relative value opportunities, others base discretionary decisions on fundamental research. Still another method among several that differentiates a long / short strategy is the percentage long relative to short. This can be seen, in part, in the second causation for poor October performance.

Looking at the overweight healthcare sector, Connors noted differentials within this exposure: -7.4 percent underperformance for longs (-4.9 percent vs. +2.5 percent for the sector) while shorts outperformed by +11.5 percent (9.0 percent vs. +2.5 percent for the sector).

The third factor is that many of the long / short strategies trade activity doubled.

Long / short tail risk exposure has shifted from broad exposure to single stocks

Of interesting note is the report cited the increase in tail risk protection as the largest they have witnessed since August 2014’s Scottish independence referendum-inspired volatility, and “it also dovetails with what our equity derivatives strategy team has stated about the uptick in skew,” the report noted. “Increased option purchasing is just one variant we have noticed about the composition of shorts.” A further exposure adjustment to the short exposure executed over the past two weeks is the reduction in broad market shorts and a relative increase in single name shorts. “This phenomenon is likely related to the decrease in all manner of correlations, increase in single stock dispersion and quest for return differentiation as we close out 2015,” Connors wrote.

Specifically, Connors states:

1. We think October could see elevated, if not an all-time high dispersion of monthly returns for Equity Long/short HFs…Here’s why;

1) Healthcare single stock performance provided particular differentiation within this overweight sector.

7. -7.4% underperformance for longs (-4.9% vs. +2.5% for the sector)
8. +11.5% outperformance for shorts (-9.0% vs. +2.5% for the sector)

2) Trade activity doubled, exacerbating the dispersion…More specific to underperformance, the 2x trading activity over the past 5 weeks relative to YTD averages, likely augmented October’s dispersion of performance…The selling of defensive longs increased in October relative to September as the rotation intensified, limiting benefit from any rebound…The 3.0%+ short covering from the 4th to the 10th of October is commensurate with the large overweights in each of Energy (9.1%), Consumer Discretionary (7.7%) and Industrials (3.7%) which possibly fed the rotation

3) Equity L/S fund underperformance in October started with a sector rotation that yielded losses as underweight Energy and Industrials were favored while overweight Healthcare and internet related names lagged.

2. Two bullish indicators make us think risk-on into year end –

1) Gross exposure near bottom quartile for many strategies – bullish as managers play catch up

-Multi-strat fund gross is in the bottom quartile based on a 1yr lookback after Q3’s 15% reduction.  Macro Funds have covered only a portion of their record net equity short (4yr low, shown below), as they reduced gross 20% over the past 6 weeks. Equity Long Short gross exposure is below average after experiencing a 6% reduction in Q3

2) Declining  market contagion and Correlation indicators;

-Our Cross Market Contagion Indicator and all correlation measures we monitor, declined this week.  Our Principal Component Analysis (PCA) measure at below left rolled off a recent peak, which has historically been a constructive signal for risk assets as it was in Feb 2015, November 2014 and July 2012. Our bellwether S&P 500 v UST10Y 21D correlation declined to -44% from September’s -68%

The post Credit Suisse: Long / Short Hedge Fund Dispersion Nears Record appeared first on ValueWalk.

Steve Mandel is using the market volatility to add to key positions at his hedge fund, Lone Pine Capital according to the fund’s third quarter letter to investors, as reviewed by ValueWalk.

According to Lone Pine, recent price declines in several market sectors have created the potential for outsized returns over the long-term. As a result, Lone Pine has decided to increase some of its key positions in the sectors affected.

Unfortunately, recent price declines have also neutralized most of Lone Pine’s gains for the year.

Lone Pine: YTD returns

Lone Cypress fell 3.6% net in Q3 and has gained 3.8% net year-to-date. At the end of the second quarter, Lone Cypress had racked up year-to-date gains of 6.9%. The Lone Kauri, Lone Cascade, and Lone Tamarack funds fell 3.7%, 9.5% and 3.8% net respectively during the third quarter. Year-to-date Kauri, Lone Cascade, and Lone Tamarack have returned 4.3%, (-2.5%) and 4.5% net respectively.

As noted above, Lone Pine added to a number of its key positions during the quarter including merging natural gas pipeline companies Energy Transfer Equity and Williams. Also, Lone Pine remains optimistic (their San Francisco office is opening in the coming days) about the prospects of specialty pharmaceutical companies, Allergan, Endo International, Horizon Pharma and Valeant in particular. Lone Pine notes that many of these companies now trade at only 10x to 15x next year’s earnings and should grow at double-digit rates for the next few years. A return to average P/E multiples, combined with earnings growth should drive growth.

Priceline remains the fund’s top long equity position, followed by Amazon, which has taken second place in Lone Pine’s equity portfolio from Chinese tech giant JD.com.

Lone Pine: Long Mobileye

Lone Pine is long Israeli software company Mobileye, which has a leading position in the market for car safety software. Mobileye develops software that controls the active safety features and more advanced semi-autonomous functions in a car.

As ValueWalk reported at the end of September, Mobileye, which is currently one of Tesla’s main suppliers, could become the biggest beneficiary from the development of smart cars. Analysts at Morgan Stanley see the company “in pole position” as technology grows in importance in cars.

Lone Pine’s thesis for its Mobileye long is the auto industry’s transformation towards semi-autonomous, and self-driving vehicles. But while Lone Pine believes Mobileye is an appropriate way to play this trend, the wider market isn’t convinced that Mobileye has what it takes to succeed.  

Over the past twelve months, the percentage of Mobileye’s shares out on loan to short sellers has jumped from basically 0% to 20% of the company’s free float. Furthermore, Citron Research published a damning research note on the company at the beginning of September, stating that:

“There is NOTHING in the past or present financials, business performance or realistic future technology prospects of Mobileye that would get it within miles of justifying its current $12 billion market cap.

Mobileye’s management is riding the hype cycle of the “self-driving car” story, a decades-long high-stakes technology bet which the operators of this small fabless chip manufacturer know they can never be a serious player in.

Investing in this company is a losing bet on a blue-sky future that just does not exist.  This is not merely the opinion of Citron– it is the actions of management who have spoken with their dollars – loud and clear — selling stock more aggressively than Citron has ever witnessed — as documented in this report.”

Citron went on to say that while Mobileye is a “pioneer” in automotive safety, the company doesn’t have any patents to protect itself from the competition. Big players such as Continental and Delphi Automotive are already building businesses to rival that of Mobileye and Mobileye only spent $56 million in R&D over the past 18 months, far short of its competitors.

Citron set an initial short-term price target of $25 with a long-term target of below $10. 

Not surprisingly, the sell-side are big fans of the company.

Barclays opines in a September 19th note:

Over the last month MBLY shares have fallen 24% (vs S&P -5%) as the bear thesis was reignited. The latest iteration of the thesis is focused on increased competition, yielding risk to MBLY’s market share and margins. Yet, we see these concerns as overdone – we expect MBLY will remain a share leader, increased competition doesn’t equate to pricing pressure, and the ADAS/semi-autonomous pie is growing faster than most anticipated. We maintain MBLY as our Top Pick and reiterate our $76 PT.

Morgan Stanley:

MBLY remains our top supplier pick and we see significant upside to our $80 PT. MBLY is already moving from the first (Penetration) phase of its life cycle to the second (Execution) phase and we expect it to close out with the third phase (Domination) in a few years. MBLY’s tech, developed over the last 15 years, has helped them with penetration (phase 1) and we believe continued support for ADAS from regulatory bodies like NHTSA and IIHS will help MBLY capitalize on its platform in the second and third phase of execution and domination.

RBC Capital:

There have been recent concerns on MBLY causing significant underperformance. We believe many of the concerns and “bear points” are overdone. We view current levels as a very attractive entry point for an investment in the stock and that fundamentals will eventually trump sentiment. Below we present our views on a number of hot-button topics.

The post Lone Pine Clashes With Shorts On Mobileye NV (MBLY) Long appeared first on ValueWalk.

Vinay Pande, a partner at Brevan Howard Asset Management, is leaving the hedge fund, according to the report from Bloomberg based on information from two people familiar with the situation.

Pande managed the Brevan Howard Strategic Macro Fund. He was a former chief investment adviser at Deutsche Bank before joined the London-based hedge fund in 2012.

According to the sources, Pande’s team in New York is also leaving Brevan Howard including Morgan French, a volatility trader and Owen Job, a strategist and assistant to Ben Melkman, a partner at the hedge fund.

Bloomberg said Mr. French and Mr. Job declined to comment regarding the report of their departure from Brevan Howard. A spokesman for the hedge fund also declined to comment on the matter.

Previous departures at Brevan Howard

Some of the partners of Brevan Howard left this year after the hedge fund recorded its first annual loss last year. The hedge fund incurred a total loss of 0.8% in 2014—the first losing year since its inception in 2003. The losses prompted the firm to close funds in emerging markets and commodities last year.

Based on the hedge fund’s regulatory filing with the Companies House in the United Kingdom, Mathew James and Mark Hillery were among those who left the partnership. Filippo Cipriani and Stephanie Nicolas also left the firm.

Johan Tellvik, an equity-focused manager responsible for the Hong Kong unit of Brevan Howard resigned. He managed a portion of the capital allocated to the equity team of the firm, which was focused on capital markets events. His responsibilities at the hedge fund ceased on August 26 based on his license record at the Hong Kong Securities and Futures Commission (SFC).

Brevan Howard senior trader moved back to London

In July, it was reported that the senior traders of Brevan Howard in Geneva were moving back to London. A reversal of its decision to leave the United Kingdom amid concerns that London’s status as the leading hub for the investment industry in Europe was at risk. Brevan Howard’s decision made the decision after several other hedge funds plan to launch or expand their business operations in the British capital.

The firm’s co-founder Alan Howard decided to remain in Geneva. He left London in 2010 after the European Union introduced tighter regulations for hedge funds.

The post Brevan Howard Partner Vinay Pande to Leave the Firm appeared first on ValueWalk.

Lakewood Capital Management, the hedge fund managed by Anthony T. Bozza, recorded a net loss of 2.4% for the third quarter, according to the fund’s third quarter letter to partners reviewed by ValueWalk.

In Lakewood’s words the performance, “underscored the fund’s conservative orientation and careful approach to risk management”. Long equity positions generated a -9% return on capital, hedged long equity positions generated a -4% return on capital, short equity positions generated a +22% return on capital and fixed income positions generated a -1% return on capital. At the end of third quarter the fund’s equity exposure was 90.3% long and 37.8% short for a net equity exposure of 52.5%. The top five positions constituted 22.9% of equity capital and the top ten positions constituted 39.4% of equity capital.

On the long side Lakewood’s most profitable positions were CDW (+49bps), Tesoro (46bps) and Ingram Micro (46bps). The largest losers on the long side were Baidu (94bps), Softbank (63bps) and FedEx (59bps).

Opko Health was the largest winner on the short side adding 46bps to overall performance.

Lakewood on the market environment

“In certain respects, the current environment is reminiscent of the fall of 2011, when a long stretch of solid market performance was suddenly interrupted by a late summer swoon emanating from macroeconomic fears abroad. At that time, I detailed why we were constructive on equity securities owing to low stock valuations coupled with considerable upside potential in the economy. Today, we are a bit more cautious as the possible consequences of a China slowdown pose real threats to global growth and overall stock valuations are considerably higher than they were four years ago.” — Lakewood on the market environment

As the excerpt above from Lakewood’s third quarter letter to partners shows, the fund is cautious about the effect a slowdown in Chinese economic growth will have on the global economy. Lakewood has initiated several short positions in companies that the fund believes are particularly vulnerable.

That said, Lakewood isn’t ready to short the whole market just yet — far from it. The fund is finding plenty of attractive opportunities in the market, more than its been able to find in a long time.

Lakewood: Some new ideas

Lakewood opened a number of new long and short positions during the quarter. Two new longs were WestRock and Baidu.

Baidu is China’s leading search engine and Lakewood initiated a position shortly after the company’s elevated expense guidance drove the stock down 15%. Excluding losses associated with some new investment initiatives, Baidu’s core search business trades at just 10x next year’s earnings (net of the company’s cash position), a remarkably low level for a quality, high-margin business with more than 20% annual growth in the coming years.

WestRock is the product of a recent merger between packaging companies Rock-Tenn and MeadWestvaco. The company has outlined a $1 billion cost improvement and synergy program goal by the company’s fiscal year ending September 2018 and the company’s capital allocation strategy is highly impressive. Management has authorized a $2.5 billion share repurchase plan which equates to roughly 15% of its market capitalization. Lakewood estimates the shares can hit $100 in approximately two years.

On the short side Lakewood initiated short positions in Seagate Technology and Diplomat Pharmacy.

On Seagate Technology:

“…we foresee persistent volume and revenue declines for Seagate and significant margin compression from negative operating leverage as the business deteriorates. We believe investors have been banking on current earnings power of $4 per share with solid growth from that level next year as PC demand rebounds. We estimate current earnings power of about $3 per share with steady declines highly likely in the years ahead, driving a discounted cash flow value of around $20 per share today, or 50% below recent levels.” — Lakewood on Seagate Technology

On Diplomat Pharmacy:

“…investors and analysts who blindly assume that Diplomat can organically grow its top and bottom line annually by 20% to 30% are bound to be disappointed. In fact, we wouldn’t be surprised if the company struggles to show any meaningful organic growth in the coming year. At 10x our estimate of next year’s EBITDA, which generously ascribes a premium multiple as compared to the trading multiples of retail pharmacies, drug distributors and pharmacy benefit managers, shares would be worth $14 per share, nearly 50% below recent levels.” — Lakewood on Diplomat Pharmacy

Another new short position opened during the quarter was Ziopharm Oncology, a biotech that’s seen its enterprise value jump from $200 million to $1.4 billion despite the fact that the company only has $3 million in non-cash assets and has reported only $4 million of cumulative revenue over its 12-year history.

“After years of struggling to develop any successful drugs, the company decided to jump into one of the hottest areas of biotech by spending $50 million to license a cancer technology from the University of Texas MD Anderson Cancer Center called “Sleeping Beauty,” which promptly added $1.2 billion to the company’s market capitalization. Ziopharm also committed to spend $15 million to $20 million annually to fund research at MD Anderson, and, in one of the more desperate promotion attempts we can recall, the company paid MD Anderson an additional $15 million just to accelerate the deal signing to January 14th so it could announce the deal at a key sell-side conference that day.” — Lakewood on Ziopharm Oncology

And according to Lakewood, Ziopharm stands little chance of catching up with a myriad of well-funded competitors that all seemed to pass on the opportunity to license “Sleeping Beauty.” Then, after signing this license deal, Ziopharm and its largest shareholder Intrexon announced a partnership with Merck. However, Lakewood estimates that based on the royalty split under this deal, Ziopharm would have to generate $30 billion of cumulative sales to cover its current stock valuation.

Lakewood isn’t the only fund that is skeptical of Ziopharm’s success. At time of writing around 27% of the company’s outstanding shares are out on loan to short sellers. Although, Dan Loeb’s Third Point revealed a long position of 1.95 million shares in its third quarter letter to investors.

Still, Lakewood has a history of being on the money when it comes to short selling.

The fund announced at the beginning of the year that it had initiated short positions in Neustar, Taser International, HMS Holdings and Hanergy Thin Film Power. Trading in Hanergy’s shares was suspended earlier this year while Neustar, Taser and HMS have all declined 2.5%, 12.9% and 49.3% respectively. Back in 2014 Lakewood successfully shorted Plug Power, which has now fallen more than 70% from the highs printed during Q1 2014.

Excerpts from Lakewood’s letter on their short positions

Seagate Technology (Short)

It is not often that we short a stock that we had previously owned. In our second quarter 2012 letter, I described how we believed industry consolidation would drive increased profits at disk drive maker Seagate despite rising investor skepticism (as reflected by the stock’s multiple of just 5x earnings). Our thesis unfolded as we expected, and we exited a successful long position in Seagate (and peer Western Digital) in 2013 as the stock approached our estimate of fair value. Since then, we have

The post Lakewood Capital Opens Shorts In Seagate, Diplomat Pharmacy, Ziopharm Oncology appeared first on ValueWalk.

Like this article? Sign up for our free newsletter to get articles delivered to your inbox Rupert may hold positions in one or more of the companies mentioned in this article. You can find a full list of Rupert's positions on his blog. This should not be interpreted as investment advice, or a recommendation to buy or sell securities. You should make your own decisions and seek independent professional advice before doing so. Past performance is not a guide to future performance.