Friday, September 25, 2009

Julian Robertson Shifts From Curve Steepeners To Curve Caps

Yesterday on CNBC, the wizard of Wall Street and hedge fund legend Julian Robertson was on what seems to be his once-a-year CNBC appearance. The Tiger Management founder talked about inflation expectations and a theoretical scenario if China and Japan stopped purchasing US bonds. He also talked about some of his investment plays which we were interested to hear about. It's tough to track him since he generally likes to keep out of public's eye, but we have a prime opportunity to hear his investment ideas through our discount to the Value Investing Congress (discount code: N09MF3). Julian will join prominent hedge fund managers David Einhorn of Greenlight Capital, Bill Ackman of Pershing Square, Joel Greenblatt of Gotham Capital and many more to present actionable investment ideas at the 2-day event. If you want to learn from some of the best in hedge fund land like Julian Robertson, this event is a must-attend.

Julian's Updated Position

As we covered a long while ago, Julian Robertson's favorite play at the time was essentially an inflationary bet as he liked curve steepeners. Since then, he says he has refined his play and has turned to the curve cap. He says, "The curve steepener was a measurement of the differential between short and long term rates and we figured short term rates would go down and long term rates would go up. We didn't do well on the long term part, but the short term part worked out so well that actually we made a little money on the trade. Short term rates are nothing, so they can't really go below nothing. We've shifted the curve steepeners, which are basically long-term puts on long-term bonds... highly leveraged and they're like puts in that you know what your risk is, it's measured by what you paid for the put. I think (long term rates) can go to 15, 20 percent." He then also went on to focus on the economy and the situation we are presently in by saying, "I really do think the recession is at least temporarily over. But we haven't addressed so many of our problems and we are borrowing so much money that we can't possibly pay it back, unless the Chinese and Japanese buy our bonds."

Curve Steepeners Versus Curve Caps

Robertson had been in various forms of a curve steepener for a few years now and it appears that he keeps adjusting and tweaking the play as the market and economy shifts. We've heard about curve steepeners, steepener swaps, and now curve caps as well. We thought it would be prudent to quickly touch on these instruments for those less familiar with them as they are in fact highly leveraged institutional play. The closest thing we can compare them to is put options on long-term interest rates.

Let's start with the main focus of the curve steepener. Taken from eFinancialNews, "Steepeners are a type of interest rate swap, where one party agrees to pay the other a fixed rate in exchange for a floating rate, which is derived from the difference between long and short term rates. Many of these products also use high leverage, where the difference between the two rates is multiplied by up to 50 times to produce a higher return." This seemed to have previously been the most commonly used play amongst hedge funds. However, as Robertson noted in his interview, this vehicle is less desirable now that short-term rates are at zero and can't really go below zero. As the market shifts, so does Robertson.

Seeing how he doesn't want to play the differential between the rates anymore, he has moved on to CMS rate caps, or curve caps. In an interview with Value Investing Insight back in their May/June 2009 edition, Julian Robertson says, "The insurance policy I would buy is called a CMS [Constant Maturity Swap] Rate Cap, which is the equivalent of buying puts on long-term Treasuries. If inflation happens the way it could, long-term Treasuries are just going to explode. Less than 30 years ago, long-term interest rates got to 20%. I can envision that seeming like a very low interest rate compared to what might occur in the future." As he says himself, the closest thing you can equate this play to is long-dated puts on long-term treasuries. However, the curve caps he is in are obviously more of an institutional play and are highly leveraged. The curve cap tries to capture the move in long-term rates whereas the steepener tries to capture a differential between short-term and long-term rates. For a more in-depth look at constant maturity swaps (CMS) we recommend reading the embedded document below from Eric Benhamou, a former Senior Quantitative Analyst for Goldman Sachs.

Swaps Cms Cmt

You can also download the .pdf here.

Placing the Bet

For the sake of 'looking out for the little guy,' we also wanted to briefly show how a retail investor can play it. This is by no means an identical way, but it's really as close as you can get as a retail player. We of course must preface this by saying to do so at your own risk because this is a slightly riskier and more speculative play that involves leverage (stock options) and falls outside the normal realm of just stocks and bonds. To replicate his play, one can buy puts on long-term treasury exchange traded funds (ETFs). The main vehicles in this realm are the iShares Barclays 20+ Yr Treasury (TLT) for the 20 year bonds, the iShares Barclays 10-20 Yr Treasury Bond (TLH) for the 10-20 year spectrum, or the iShares Barclays 7-10 year Treasury (IEF) for the 10 year bonds. So, which bond you play is up to your discretion. For the purpose of our example, we'll use the 20+ year treasury, TLT.

To execute the play, you then have to buy puts on the exchange traded fund. The key here is to buy long-dated puts, or options that won't hit expiration for quite some time, in order to most accurately replicate Julian's play. By using options, there are both risks and benefits involved. Firstly, there is the risk of leverage as each put is representative of 100 underlying shares of TLT. Secondly, since you would be using options, you have to be wary of time decay, as this works against you with each day that passes. However, the good thing about using puts is you can limit your downside risk. The absolute most you can lose on the trade is the value of the put you purchase. This is in contrast to a short common stock position where you can technically lose an infinite amount.

Having identified the risks, we'll look at the options table courtesy of Yahoo Finance. The option you select is up to you, but the absolute minimum we'd consider using would be options 6 months out. To best replicate the play, you'd want to use puts that are 1 year or even 2 years away. Just for fun, we've pulled up a list of the put options that expire in January 2011:

(click to enlarge)

We also want to mention that when looking at the puts you have to be wary of premium as some investors have already piled into various strike prices and expirations over the course of the past year. Not to mention, many investors are not fond of using LEAPs (long-dated puts) for various reasons, but if you want to make this play you don't have much of a choice. That's a whole 'nother debate but we just wanted everyone to be aware. You could always just sell short the ETF outright instead of using options, but there are pros and cons to doing that too. For the purpose of this article, we're focused on how best to replicate Julian's play in the retail arena, where options are a better representation than the shares themselves.

We also wanted to toss out another idea by playing the exchange traded fund: ProShares Short 20+ Year Treasury (TBF). Instead of buying puts on this ETF, you would be buying calls on it since the ETF itself is already short the long-term bonds. This is not a leveraged ETF so you don't have to worry about extreme compounding skews from the underlying index. However, do note that it still seeks to replicate the daily performance of its index so there is still potential for slight tracking error. So you can really play it two different ways in the options markets, dependent on which ETF you select. Last but not least, we want to make sure you know that this is not investment advice and make note of the disclaimer at the bottom of our site.


Embedded below is the interesting 30 minute interview with Julian Robertson:

Other Hedge Fund Legends Bearish On Long-Term Bonds

So he clearly is still fixated on the long-term bond portion of the play where he thinks rates are headed much higher due to quantitative easing and the printing of money by Helicopter Ben & the Federal Reserve, amongst other factors. There have been many hedge funds in some form of this trade as we also detailed John Burbank & Passport Capital's curve steepener play. Robertson sees rates potentially skyrocketing in an 'armageddon' scenario where China and Japan cease buying US bonds. Other hedge fund legends bearish on these bonds include Michael Steinhardt, who has labeled treasuries a foolish play. Steinhardt ran one of the first successful hedge funds (Steinhardt Management) and earned 23% a year for almost 30 years. We've also seen ex-Quantum fund manager Jim Rogers speak out against long-term treasuries as he has been short them in the past. There is definitely a confluence of smart minds here as they share similar sentiment.

We track Julian because he is a hedge fund legend in his own right for his work with Tiger Management. Not to mention, he has spawned a huge network of 'Tiger Cub' hedge fund managers that have gone on to start their own funds, many of whom we also track. (You can see a 'Tiger Cub' family tree here). Last, but not least, Robertson also called the downturn back in 2007 as he proclaimed we would be in for a doozy of a recession. He has built up quite the track record and so is at the very least worth paying attention to. It has been reported that his investors received a compound rate of return of 32% during the 1980s and 90s.

Outside of his curve caps play, he did mention a few other plays he was considering. While he hasn't put it on yet, he is considering shorting copper. This play is interesting because 'Tiger Cub' Paul Touradji of hedge fund Touradji Capital had previously advocated shorting copper. During a previous hedge fund manager panel, Touradji advocated shorting copper as the world deleveraged and the velocity of money dropped. Robertson had already shorted copper last year unsuccessfully, but got out of the trade. As we've noted on the blog before, many of the Tiger Cubs end up putting on the same positions and undoubtedly still keep in contact with each other. In terms of currencies, Robertson says the only currency worth being in is the Norwegian krone. And lastly, in terms of equities, he said he is still in Mastercard (MA), Visa (V), and Apple (AAPL) but is not as enthusiastic about being long stocks as he is about being short bonds. Those stocks are the ones he suggested buying in his last media appearance on CNBC almost a year ago and he is up substantially in those investments. He had also recommended Baidu (BIDU) back then, but has since sold out of it.

As always, we'll continue to keep track of Robertson's scarce media appearances. In the mean time though, we highly recommend hearing Julian speak through our discount to the Value Investing Congress where he and numerous other prominent hedge fund managers will present actionable investment ideas. Make sure to use code: N09MF3 to receive the discount. If you're unfamiliar with Robertson, you can always check out our profile/biography on him here.

For more on 'smart money' investment plays, check out Goldman Sachs' list of possible long & short strategies in the current market, as well as their hedge fund trend monitor that lays out hedge fund portfolio holdings. We'll of course continue to track all the latest positions and strategies that prominent hedge funds are pursuing.

Hedge Fund Compliance & Regulation Podcast

Hedge fund compliance is a growing topic these days and we've stumbled upon an interesting informational podcast for those interested. Kelly Moll, a partner at Schulte, Roth and Zabel, specializes in advising on registration and compliance issues. She has teamed up with IntraLinks to create a podcast series on the subject. Their first installment just became available and we've embedded the transcript below. The first episode is entitled, "What you need to know about U.S. and EU proposed legislation: New regulation requirements and assessing systemic risk."

Given all the recent scandals and ponzi schemes, further hedge fund regulation seems inevitable. Various proposals in both the United States and European Union address various requirements for fund manager communication to regulators, counterparties, and investors. Establishing transparency between hedge funds and their investors is key given that trust is essential in this relationship now more than ever due to all the fraudulent schemes that have surfaced. The podcast below helps to breakdown the proposed regulations and how a hedge fund firm can prepare for these possible new requirements.

You can listen to the podcast here or download the .pdf transcript here.

What We're Reading 9/25/09

10 Free trading lessons [MarketClub]

Why I am short the ratings agencies [Aiki14 - Stocktwits]

Medal of Honor For Excellent Service to top analyst Josh Rosner for nailing the crisis [Wall St Cheat Sheet]

Interview with hedge fund manager Peter Lupoff [Distressed Debt Investing]

Check out Todd Sullivan's new, now part of Stocktwits [ValuePlays]

Warren Buffett's desert island indicator - rail car data [The Manual of Ideas]

Speaking of which - The decline in US railroad carloading accelerates [My Investing Notebook]

Brief look at putting on a synthetic short position [Daily Options Report]

Role of Eton Park's Eric Mindich as chair of The Asset Managers' Committee Of The President's Working Group? [zero hedge]

Deja vu all over again; stocks already overvalued? [Business Insider]

A look at starting a hedge fund in these interesting times [The Globe and Mail]

Thursday, September 24, 2009

Hedge Fund Harbinger Capital Portfolio Update: Selling Large Chunk of Calpine (CPN) & Other Moves

If you're getting tired of reading about Philip Falcone's hedge fund Harbinger Capital Partners, we don't blame you. It's just that they've adjusted their portfolio so much recently that we've got a never ending flow of SEC filings. Earlier this morning we noted that one of their holdings, SkyTerra, was going private in a transaction that involved Harbinger in a new entity. Then earlier this week we also noted that they were selling shares of The New York Times (NYT) and Leap Wireless (LEAP). This time around, we're covering their activity in Calpine (CPN) and Complete Production Services (CPX).

Firstly, we see some big news that Harbinger is putting a chunk of their Calpine (CPN) stock up for sale. While Harbinger has been a believer in Calpine's business model, there apparently have been some clashes ever since Philip Falcone picked up shares of CPN when it emerged from Chapter 11 bankruptcy. Apparently Falcone was upset firstly that they shunned an $11 billion takeover from NRG Energy (NRG) and secondly that Calpine was searching for a CEO, something he felt would hinder a deal. According to an amended 13D filing with the SEC, Philip Falcone's hedge fund now shows a 19.7% ownership stake in CPN with 86,980,047 shares. The filing was made due to activity on September 22nd, 2009.

Their transactions in CPN are a bit more complex so let's break it down really quick. On July 29th, 2009 Harbinger received 2,784,430 shares due to various claims within the reorganization of the Issuer and related debtors. Of those shares, 2,120,959 went to their Master Fund and 663,471 went to their Special Situations Fund. In addition to this transaction, Harbinger bought 328,046 shares in their Master Fund spread out on August 14th and August 20th at prices of $12.52, $11.98, and $12.26. However, their Special Situations Fund has been selling shares as they dumped 2,672,426 shares between July 9th and 13th at prices ranging from $10.31 to $10.58. Also, they have just recently sold another 965,800 shares in the Special Situations Fund at a price of $12.66. If you net out all of these transactions from July until present, Harbinger as a whole has sold 625,750 shares.

Most importantly and in addition to the above transactions, here are the details regarding the portion of its stake that Harbinger has put up for sale, as taken directly from the SEC filing, "On September 22, 2009, the Issuer, the Master Fund and the Special Fund entered into an underwriting agreement with Morgan Stanley & Co. Incorporated, as underwriter. Pursuant to the underwriting agreement, the Master Fund agreed to sell, and the underwriter agreed to purchase, 13,333,334 shares, and the Special Fund agreed to sell, and the underwriter agreed to purchase, 6,666,666 shares in each case at a price of $11.40 per share. In addition, the Master Fund granted the underwriter a 30-day option to purchase up to 2,000,000 additional shares and the special fund granted the underwriter a 30-day option to purchase up to 1,000,000 additional shares. The public offering contemplated by the underwriting agreement has been registered under the Securities Act of 1933 and will be completed on or about September 28, 2009." Harbinger has been selling shares of CPN in the past and obviously that trend continues as they now sell a large chunk of shares. We'll post up and further updates as we receive them in this regard.

Secondly, Philip Falcone's hedge fund has also filed a 13G on Complete Production Services (CPX). In the filing, we see that Harbinger holds a 5.6% ownership stake with 4,301,200 shares due to activity on September 21st, 2009. This is a new position for them as they did not own it in their last 13F filing that disclosed positions as of June 30th, 2009. They have since acquired their stake over the past 3 months.

We also wanted to note that they filed another amended 13D on Leap Wireless (LEAP) just days after their previous filing. In the new 13D, they disclose they have sold another 1 million shares. Their ownership stake now sits at 4.5% with 3,451,000 shares remaining due to activity on September 18th, 2009.

Lastly, Philip Falcone's hedge fund also filed another amended 13D on SkyTerra where they disclosed a a 70.7% ownership stake with 61,346,518 shares due to activity on September 22nd, 2009. But as we reported earlier this morning, SkyTerra is going private with a new entity that involves Harbinger.

That sums up the changes in this particular update but be aware they've been very active as of late and we have been covering their moves. We've noted their sales of NYT & LEAP, as well as their 13D on Spectrum Brands (SPEB). Additionally, we've covered Harbinger's long US equity portfolio in the past for those interested. If you're unfamiliar with Harbinger, they're a $6 billion hedge fund ran by Philip Falcone. While Harbinger deals in equity markets, Falcone's roots are in distressed investing and his investment style focuses on bankruptcies, proxy fights, and intensive research on credit.

Taken from Google Finance,

Calpine is "an independent wholesale power generation company engaged in the ownership and operation of natural gas-fired and geothermal power plants in North America. The Company sells wholesale power, steam, capacity, renewable energy credits and ancillary services to its customers, including industrial companies, retail power providers, utilities, municipalities, independent electric system operators, marketers and others."

Complete Production Services is "provides specialized services and products focused on helping oil and gas companies develop hydrocarbon reserves, reduce costs and enhance production. The Company focuses on basins within North America, and delivers services and products required by its customers within each specific basin. Complete operates in three business segments: completion and production services, drilling services and product sales."

Leap Wireless is "a wireless communications carrier that offers digital wireless service in the United States under the Cricket brand."

SkyTerra is "operates its business through its subsidiary, SkyTerra LP, which focuses to develop, build, and operate a next generation mobile satellite system. The Company has five subsidiaries: SkyTerra GP Inc., SkyTerra LP, SkyTerra (Canada) Inc., SkyTerra Holdings (Canada) Inc., and SkyTerra Finance Co. SkyTerra LP offers mobile satellite services using two nearly identical geostationary satellites that support the delivery of data, voice, fax, and dispatch radio services."

Harbinger's Holding SkyTerra Going Private

Taken from SkyTerra's website, we see the announcement regarding Philip Falcone's hedge fund Harbinger Capital Partners and their underlying position in the name. The statement reads, "SkyTerra (OTCBB: SKYT) today announced that it has entered into a definitive merger agreement for SkyTerra to be acquired by a new corporation formed and indirectly wholly-owned by Harbinger Capital Partners Master Fund I, Ltd and Harbinger Capital Partners Special Situations Fund, L.P. Under the terms of the agreement, the new corporation will pay $5.00 in cash per share for each of SkyTerra's outstanding shares of common stock not held by Harbinger or its affiliates. The purchase price represents a premium of approximately 56% over the average closing price of SkyTerra’s common stock for the thirty days ended September 22, 2009, the last day before the announcement of the proposed transaction. Harbinger and its affiliates together hold approximately 48% of SkyTerra's outstanding voting common stock and approximately 49% of SkyTerra's voting and non-voting common stock combined.

The transaction is the culmination of a thorough evaluation of SkyTerra's strategic alternatives by a special committee of SkyTerra's Board of Directors composed solely of independent directors. The merger agreement has been approved by the special committee as well as the full Board of Directors of SkyTerra. The transaction is subject to approval by the holders of a majority of SkyTerra's outstanding voting common stock, and to regulatory approvals, including approval of the Federal Communications Commission, and other closing conditions. It is anticipated that the transaction will be consummated in late 2009 or early 2010.

Harbinger has agreed to vote its shares in favor of the merger. Since Harbinger has approximately 48% of the voting power of SkyTerra's voting common stock, approval of the merger by stockholders is virtually assured if Harbinger so votes in favor of the merger."

Bill Ackman's Pershing Square Q2 Investor Letter

Courtesy of Dealbreaker, here's the latest from Bill Ackman's hedge fund, Pershing Square Capital Management. His second quarter correspondence is a bit tardy and he acknowledges that in the letter. Referring to their positions, Ackman discusses their stakes in Target (TGT), EMC (EMC), General Growth Properties (GGWPQ), Automatic Data Processing (ADP), and his return to shares of McDonald's (MCD). He also touches on their short exposure through credit default swaps (CDS) as well as mistakes and missed opportunities regarding their due diligence. In addition to the letter below, we want to make special note of an opportunity for you to hear Bill Ackman speak courtesy of the Value Investing Congress discount we've secured for readers. The VIC features presentations of actionable investment ideas from some of the most prominent hedge fund managers out there including Bill Ackman (Pershing Square), David Einhorn (Greenlight Capital), Julian Robertson (Tiger Management), Joel Greenblatt (Gotham Capital) and many more. In the mean time, his latest investor letter will have to suffice.

In his correspondence, we learn that Pershing's largest short position is a valuation hedge for their investment in General Growth Properties (GGWPQ) because their valuation is a large component of the equation that determines recoveries for the equity holders. Additionally, he mentions they are also short a REIT that trades at a high valuation, has weak underlying assets, and poor business prospects. Since he does not name names, you can obviously speculate as to what this short position is in.

We also see that his corresponding long position in General Growth is up substantially as the equity they owned has risen more than 12-fold since their buy at $0.34 per share and the unsecured debt they own has tripled in value over the same timeframe. They consider Simon Property Group (SPG) to be the most comparable REIT. Ackman argues that since SPG trades at a cap rate of 7% using trailing 12 month net operating income, a very similar General Growth under the same cap rate would have an enterprise value of $40 billion. This would then value shares of GGWPQ at around $40 per share.

Ackman goes on to provide updates on numerous other portfolio holdings but we'll let you read about those in the letter. One last paragraph we want to focus on is Ackman's brief mention of the risk to one's purchasing power. Due to quantitative easing and money printing by the Fed, he acknowledges that there are concerns about future buying power of the dollar. Ackman highlights that many investors have turned to gold to hedge these risks, but not Pershing Square. Instead, they have decided to fight this risk by owning "high quality businesses that have pricing power due to market position and/or business model, and/or that earn their profits globally."

This is interesting to see his stance on the matter as we can't really recall him addressing it before. You'll remember that David Einhorn and Greenlight Capital made a large gold investment and now are storing physical gold. Additionally, John Paulson's hedge fund Paulson & Co bought gold via GLD (the exchange traded fund) to hedge their share class denominated in gold. It's interesting to see each fund manager's individualistic approach and hedging vehicle of choice. However, the main thing to take away from all of this is the fact that they see inflation as a potential threat in the future and are trying to mitigate this risk accordingly.

Embedded below is Pershing Square Capital Management's Q2 investor letter. Additionally, make sure you check out our coverage of Pershing Square's portfolio here:

You can download the investor letter in .pdf form here. And of course make sure you check out the discount to the Value Investing Congress where you can hear Bill Ackman and numerous other prominent hedge fund managers present actionable investment ideas this coming October in New York City.

We'll leave you with a good quote from Ackman himself in the letter, "Trading is largely an art and not a science, a discipline in which you can always look back and conclude that you could have done it better. That is one of the reasons why portfolio managers hire traders (it enables the portfolio manager to shift the blame to others) and why being a trader is such a treacherous job."

Investment Trusts Trading At Discounts In The UK: Hedge Funds Ready To Pounce?

The Financial Times ran an interesting story on Monday entitled “Activist Minnows Eye Investment Trusts”. The article suggested that many UK investment trusts (closed-end investment funds that trade like equities) offer great value because they are on sale at substantial discounts of up to 50% of their net asset value. The FT article also suggested that hedge funds are excited by the value that they see in the sector with one fund, Charlemagne Capital, set to raise $100m specifically to take advantage of the discounts. We initially found this intriguing, but still wanted to know more. Firstly, are there really investment trusts selling at a 50% in the UK? Secondly - given our main preoccupation at Market Folly - which hedge funds already have holdings in the investment trusts that are trading at large discounts?

We focused on investment trusts (ITs) that primarily hold publicly traded equities and disregarded those that primarily invest in property, venture capital or private equity. Some of the funds in the table contain a mix of assets but we have tried to limit inclusion to those ITs that hold predominantly publicly traded equities. We also focused on ITs that have some institutional ownership to some extent as we thought this might provide some insight into where the so-called “smart money” was already allocated (e.g., investment banks, hedge funds, investment advisors, mutual funds). A list of ITs meeting these criteria is provided in the table.

Investment Trust Discount to NAV Large shareholders % equity
Majedie Investments -20.1 Barclays Global Investors 1.42

Smith & Williamson Investment 3.6

Rathbone Investment Management 2.04

Strategic Equity Capital -22.3 Midas Capital Partners Ltd. 7.19

Schroder Investment Management 5.37

Advance UK Trust unknown

Herald Investment Trust -23.1 Insight Investment Management 8.94

Asset Value Investors Ltd. 7.43

Rathbone Investment Management 5.25

Advance UK Trust unknown

Value and Income Trust -26.7 Brewin Dolphin Ltd. 6.45

Smith & Williamson Investment 4.98

Barclays Global Investors Ltd. 3.94

North Atlantic Sml Comps -28.5 Insight Investment Management 9.59

Findlay Park Partners LLP 4.01

CG Asset Management 3.55

Principle Capital IT -34.3 CG Asset Management 3.64

QVT Financial LP 2.99

Invesco Asset Management 21.12

Equity Partnership Cap -49.5 Midas Capital Partners 1.5

Brewin Dolphin 1.28

Cayenne Asset Management 0.47

Discount to net asset value data:

Large shareholders data:

The table shows that there are several predominantly equity based ITs trading at a greater than 20% discount to NAV. Readers that are interested in other sectors such as venture capital, property or private equity will find that trusts in these sectors on average trade at even bigger discounts.

In terms of institutional involvement, we are a bit disappointed in that very few large hedge funds are involved. Only two of the large shareholders are hedge funds: Barclays Global Investors (BGI) and QVT Financial. BGI is London based and is one of the world’s largest hedge funds. It has medium-sized stakes in Majedie Investments and Income and Value Trust. QVT Financial is a New York-based multi-strategy hedge fund with a reputation for confrontational activism. Last year QVT were involved in a bloody spat with Principle Capital IT (see table) which for the time being it appears to have lost. It was an interesting contest not least because Principle Capital which is led by Brian Myerson, is also an activist. In recent months QVT have reduced their stake in Principle substantially.

This territory is not limited to hedge funds, as there are other activists that specialize in exploiting the pricing inefficiencies of the closed-end funds. Cayenne Asset Management, for example, is an independent investment manager. Cayenne argue that their approach tends to be constructive, rather than aggressive. They have a small stake (0.47%) in Equity Partnership. Additionally, Advance UK Trust is another small activist in the sector. It is a fund of funds that focuses on out of favor ITs trading at wide discounts. Like Cayenne, they are proactive and often work with boards, managers and advisers in an attempt to recognize shareholder value. A commonly used strategy by activists is to try to get ITs to buy their own shares in order to narrow the discount. Advance UK have holdings in Herald IT and Strategic Equity Capital (see table). For those interested their top 10 holdings can be viewed here.

Two factors are likely to be very important in determining whether the large discounts will be closed. Firstly, IT discounts tend to narrow in bull markets and widen in bear markets. Those who don’t believe that we are going to stay in a bull market for some time should steer clear of this sector. At best, the discounts will take time to narrow. In addition, some IT shares are fairly illiquid which can make them difficult to exit if you're in a hurry. The spreads are, at the best of times, eye-wateringly wide and potentially shocking to US investors. Secondly, will the activists show up to speed things up? At face value there certainly do appear to be opportunities for proactive funds. Market Folly looks forward to keeping you posted on any exciting developments regarding hedge fund activism in this sector during the coming months.

Hedge Fund D.E. Shaw & Co's Market Insight: The Basis Monster That Ate Wall Street

In continuing with our coverage of hedge fund D.E. Shaw's Market Insights, we want to bring you another installment, this time focusing on 'The Basis Monster That Ate Wall Street.' Over the past few days, we've also covered D.E. Shaw's look at tracking asset class returns through the crisis, as well as their piece that focused on common trading mistakes and the consequences that follow.

This time they focus on the 'basis' between cash financial instruments and their derivative based equivalents. They note that this "cash-synthetic" basis has shifted drastically which has created both opportunity and risk. In the piece, they examine the various risks as well as how this basis can lead to distorted perceptions of the market.

Download this edition of D.E. Shaw's Market Insights here (.pdf).

Wednesday, September 23, 2009

Market Folly Interviewed By

We recently did an interview with Hiro, the author behind both and My $10000 Dollars and just wanted to let everyone know who might be interested in reading it. In it, we talk about our background, investment style, as well as the journey we've been on in creating Market Folly.

Check out our interview here, thanks!

Joel Greenblatt At The Value Investing Congress

Just wanted to let everyone know in addition to all the fantastic speakers at the Value Investing Congress, Joel Greenblatt of Gotham Capital will now be speaking as well. So in the span of 2 days, you can hear investment ideas from literally some of the most prominent players in the hedge fund industry. In addition to Greenblatt, you'll hear from Julian Robertson (Tiger Management), David Einhorn (Greenlight Capital), Bill Ackman (Pershing Square), Eric Sprott (Sprott Asset Management), Whitney Tilson (T2 Partners) and many more excellent fund managers. We can't exclaim enough how unique and insightful this event is. You can literally hear investment ideas and learn from some of the exact managers we track on a daily basis here on Market Folly. As we get nearer to the event each week, the discount we've secured drops. Currently, Market Folly readers can save $500 off regular registration and use discount code: N09MF3. Next week that discount will drop to $300 so the faster you register, the more you save.

It doesn't matter if you are a finance professional or an individual investor, the event is for all walks of investors. Get your firm to pay the bill and the insight you'll receive and networking you do will be well worth the price of admission. If you're an investor, some of the actionable investment ideas you receive will most likely cover the cost of your ticket and more. Register now before our discount expires. The Congress was created by and for those interested in the investment methods similar to Benjamin Graham and Warren Buffett. At the event, you'll learn how to perform thorough due diligence in the current markets. Simply put, you'll learn strategies from some of the best hedge fund managers out there and receive actionable investment ideas. How often can you say that you got some picks from the best in hedge fund land? Not to mention, it's a fabulous networking opportunity as there will be a ton of people there from the industry.

We cannot stress enough how this is event is a must attend. We've managed to secure a discount for Market Folly readers so click here to save $500 off the Value Investing Congress regular price while it lasts by using discount code: N09MF3.

Interview With Lawrence McDonald, Author Of Book On Lehman Brothers' Demise

A few weeks ago we posted up a great interview with Lawrence McDonald, the author of New York Times Bestseller book, A Colossal Failure of Common Snese: The Insider Story of the Collapse of Lehman Brothers. Our buddy Misstrade interviewed Larry regarding his background and his experience during Lehman's demise. Today we have the follow-up interview where Larry gives us insight as to how things operated at Lehman on a day to day basis with a focus on the trading floors. (You can check out the first interview here). And now embedded below is the second interview courtesy of Misstrade.

(RSS & Email readers come to the blog to view the video interview):

A quote from Lawrence McDonald from the interview stuck with us. He says, "The story of Lehman Brothers comes down to this one sentence: There's 24,992 people making money and 8 guys losing it." This just goes to highlight how eight people can run amuck and go crazy with credit and ultimately lead to the demise of the firm. Lehman Brothers survived the Civil War, numerous World Wars, 9/11 and then was brought down by a combination of a poor board of directors, leverage, and a lack of risk understanding by CEO Dick Fuld, claims Larry in his book.

Very interesting stuff as we get to see how Lehman operated in its day to day operations. The shocking thing here is that at one point they had almost 40% of their net tangible assets in essentially 3 commercial real estate transactions. They had essentially become a hedge fund and private equity firm that was running 40:1 leverage at one point. For more in-depth insight, of course make sure you check out Lawrence's excellent book, A Colossal Failure of Common Sense: The Insider Story of the Collapse of Lehman Brothers. This is definitely a great inside look at what went down as Lehman went down.

Why Hasn't Gold Skyrocketed After Clearing Resistance?

This is indeed a prudent question that needs addressing. We've been covering the move in gold on the blog with our technical analysis updates and paid special attention to when gold crossed the important psychological and technical resistance level of $1000. But since this big achievement, it hasn't done a whole lot. Why hasn't it skyrocketed yet?

The guys at MarketClub have identified an interesting pattern in the gold market that could possibly highlight why gold hasn't taken off yet given the fact that it broke out above longstanding resistance levels. Check out their technical analysis video here to see a possible explanation. They've noticed a pattern that gold trades in cycles where it will make a higher low every 84-90 days or so. Looking back to October of 2008, this cycle plays out for another potential higher low soon. This could potentially be a reason as to why gold isn't skyrocketing higher as near-term pressure could be weighing on the precious metal. It hit a tradable low in November 2008, January 2009, April 2009, and July 2009. That cyclical pattern points to this coming October next.

The long-term uptrend seems to still be intact, but there could be a trading range or pullback on a shorter timeframe. They also go on to highlight a similar cyclical pattern where gold could potentially be topping out every few months too, so make sure to check out the video for the full graphical representation and explanation.

Hedge Fund D.E. Shaw's Market Insight: Tracking Asset Class Returns Through the Crisis

In keeping with our theme of interesting hedge fund reports, here's an excellent 15 page report from hedge fund D.E. Shaw & Co entitled "Is It Better Yet? Charting the Course of Various Asset Classes Through a Global Financial Crisis." Just yesterday, we also posted up a theoretical and applicational piece from D.E. Shaw that focused on common trading mistakes and the consequences associated with them.

This time around, we're posting up a piece specific to this financial crisis as the 15 page document examines how various asset classes have performed in these hectic times. While the report was released back in July, it is obviously still timely given that we're not out of the woods yet. You can download D.E. Shaw's Market Insights here (.pdf).

Tuesday, September 22, 2009

Philip Falcone's Harbinger Sells Shares of New York Times (NYT), Leap Wireless (LEAP); Adds Mercer (MERC)

We've got a flurry of SEC filings from Philip Falcone's hedge fund Harbinger Capital Partners. While the update below covers their US equity positions, we just this morning updated their UK holdings for those interested. That aside, let's dive right into the US equity filings:

Firstly, Harbinger has filed an amended 13D on Leap Wireless (LEAP) and is now showing a 5.7% ownership stake with 4,451,100 shares. The filing was made due to activity on September 16th, 2009. It shows them selling shares on the 29th and 30th of July, as well as the 16th and 17th of September. The transactions occurred in their Master Fund and Special Situations Fund and here is a screenshot of their sales:

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Harbinger continues to sell shares of LEAP as we detailed their previous sales back in August. They had previously owned over a 9% ownership stake, so they have nearly cut their ownership stake in half since then.

Secondly, Philip Falcone's hedge fund also sold shares of The New York Times (NYT). Due to activity on September 17th, Harbinger filed an amended 13D on NYT and now show a 16.38% ownership stake with 23,538,434 shares. They sold 5,000,000 shares at a price of $8.25 on the 17th of September according to an SEC Form 4 filing, having previously owned a 20% stake. A spokesman for Harbinger addressed the sale by saying, "The New York Times is still a core holding, and the sale was done to take advantage of the strength in the market, to adjust the portfolio accordingly." They have sold these shares at a loss as they initially acquired their shares between $15-20 per share almost two years ago when they invested over $500 million.

In the past, we've covered the fact that Harbinger were open to hearing suitors for their NYT stake. As always, we'll continue to track developments in this regard. In addition to Harbinger, Mexican billionaire Carlos Slim has a hefty position in NYT. Taking a step back and looking at the macro picture, we've questioned whether newspapers are a dying industry. It's definitely a prudent question to ponder and the debate has been cataloged through various mediums. Shares of The New York Times traded way down to as low as $3.51 earlier this year.

Thirdly, in a 13G filed with the SEC, Harbinger is also showing a 5.5% ownership stake in Mercer (MERC). They hold 1,995,100 shares and the filing was made due to activity on September 9th, 2009. This is a new position for them as they did not hold it as of their latest 13F filing which discloses positions as of June 30th, 2009. So they have added these shares over the course of the past 3 months. And with that, we wrap up this portfolio update on Philip Falcone's fund. They've been quite busy recently as we also detailed their position in Spectrum Brands (SPEB) late last week. We also covered their 13D on SkyTerra for those interested as well.

Philip Falcone runs $6 billion Harbinger Capital Partners and while he has numerous equity positions, his background is in the distressed arena. When we saw Harbinger's portfolio, we noted that they had been out adding to natural resource plays amongst a slew of other activity. For more background on them and their portfolio holdings, check out our post on Harbinger here.

Taken from Google Finance,

Leap Wireless is "a wireless communications carrier that offers digital wireless service in the United States under the Cricket brand. Cricket service is offered by Cricket, a wholly owned subsidiary of Leap, and is also offered in Oregon by LCW Wireless Operations, LLC (LCW Operations), and in the upper Midwest by Denali Spectrum Operations, LLC (Denali Operations). Cricket owns an indirect 73.3% non-controlling interest in LCW Operations through a 73.3% non-controlling interest in LCW Wireless, LLC (LCW Wireless), and owns an indirect 82.5% non-controlling interest in Denali Operations through an 82.5% non-controlling interest in Denali Spectrum, LLC (Denali). At December 31, 2008, Cricket service was offered in 30 states and had approximately 3.8 million customers."

New York Times is "a diversified media company, including newspapers, Internet businesses, a radio station, investments in paper mills and other investments. The Company is organized in two segments: News Media Group and the About Group. Additionally, the Company owns equity interests in a Canadian newsprint company, a supercalendered paper manufacturing partnership in Maine, and Metro Boston LLC, which publishes a free daily newspaper in the greater Boston area. In February 2008, it acquired a 25% ownership interest in quadrantONE LLC, an online advertising network that sells bundled premium, targeted display advertising onto local newspaper and other Websites."

Mercer "operates in the pulp business and is a producer of market northern bleached softwood kraft (NBSK) pulp. The Company’s operations are located in Eastern Germany and Western Canada. It operates three NBSK pulp mills with a consolidated annual production capacity of approximately 1.5 million million air-dried metric tons (ADMTs): Rosenthal mill, Stendal mill and Celgar mill."

Hedge Fund Harbinger Capital's Activist Positions In UK Markets

Philip Falcone: Slow Moving Activism in the UK

This is yet another edition of our extended hedge fund portfolio tracking series where we are now tracking UK positions. Coinciding with another update later this morning, we're today focused on the holdings of Harbinger Capital Partners. Philip Falcone’s hedge fund has had two activist positions in UK companies for quite some time, owning Tate and Lyle as well as Inmarsat. In both cases, Harbinger’s efforts to unlock value are ongoing and are probably progressing more slowly than they would like. Both cases demonstrate that contrary to popular opinion, hedge fund activism often does not produce a quick buck. Instead, it often takes time and patience before paying off, as hedge fund activists either enter the position with a long-term focus or acquire one once assessing the situation.

Harbinger Capital Partners is an activist hedge fund that was founded in 2001 by Philip Falcone. Harbinger’s website says their strategy is to seek alpha-generating ideas that are uncorrelated to investment cycles. Harbinger looks for investments that fall into four categories:

1. Event – investments in companies where the Harbinger team identifies a significant opportunity to actively engage with a company to unlock value (activism).

2. Distressed/Bankruptcy – investments in companies that are already in default, in bankruptcy, or in some other stage of financial failure or distress.

3. Value – passive investments in securities where Harbinger believes a positive catalyst for value realization is already present.

4. Corporate Shorts – passive investments where Harbinger views the security to be overvalued or believes weakening fundamental trends or identifiable negative catalysts are apparent.

While Harbinger deals in equity markets, Falcone's roots are in distressed investing and he is opening a new fund to return to these roots. His investment style focuses on bankruptcies, proxy fights, and intensive credit research. We've been tracking their US equity positions for quite some time now and you can see their latest movements in this regard here. Additionally, we've just today updated some of their portfolio holdings too.

Now, let’s take a look at their UK holdings. Tate & Lyle is a manufacturer of food ingredients that are mainly made from corn and sugar cane.

The table below shows that Harbinger started accumulating shares of Tate and Lyle as long ago as January 2008. It is believed that Harbinger are seeking to push for a link with Bunge, a US food group in which Harbinger also has an interest. In June 2008, Bunge agreed a $4.8bn takeover of Corn Products International, the US corn sweeteners group. That fueled speculation that Bunge might be interested in buying Tate as well as it has a large corn-based food ingredients business in the US.

During 2008, Tate and Lyle’s then CEO, Iain Feguson, met with Philip Falcone several times and also talked with him on the phone fairly regularly. Ferguson has said that Falcone’s investment in Tate lies behind his habit of focusing on scarce assets that are hard to replicate. Ferguson noted that in the case of Tate & Lyle, the scarce assets are the US plants - including the new Fort Dodge plant in Iowa which is the first corn wet mill built for 12 years - and the company's access to valuable slots on the US rail system.

Tate and Lyle Plc Symbol Date No. shares % issued stock Estimated price paid

TATE 09/01/2008 25945000 5.6 na

31/01/2008 46055909 10 482p

06/02/2008 51505909 11.23 491p

08/02/2008 55389320 12.01 489p

13/02/2008 59489320 13 513p

19/02/2008 65239320 14.3 502p

21/02/2008 69811234 15.3 507p

06/06/2008 74160669 16.2 440p

19/06/2008 78138514 17.1 374p

26/06/2008 83435025 18.2 395p

01/07/2009 88297800 19.3 394p

18/11/2008 85761931 18.7 367p

26/11/2008 81649497 17.8 367p

05/12/2008 77667106 16.9 395p

12/12/2008 73384822 16 403p

15/12/2008 72713213 15.86 412p

19/12/2008 64602775 14.09 412p

22/12/2008 63877775 13.9 400p

04/03/2009 60037554 13.09 236p

As we have reported before, after an extremely successful 2007 in which they shorted subprime mortgage debt, Harbinger had a bad 2008 and were, like many hedge funds, inundated with redemption requests. Harbinger appear to have been forced to reduce some holdings, including the Tate and Lyle stake. The table shows that from a high of a 19% ownership stake in July 2008, Harbinger reduced their holding down to a 13% stake in March 2009, where it still stands today. Despite some press speculation that Harbinger would sell out of Tate and Lyle altogether, they appear for the time being to be continuing their efforts to bring Bunge and Tate & Lyle together. From the outside at least, not a lot appears to have changed since March of this year. The CEO, Iain Freguson, is in the process of being replaced by Javed Ahmed. It's difficult to attribute this management shift to Harbinger as one of Tate & Lyle’s other large shareholders, Invesco, has been campaigning for a change at the top for sometime.

Secondly, let's turn our focus to Harbinger's position in Immarsat:

Immarsat Plc Symbol 03/01/2008 125142961 27.4 na

ISAT 31/01/2008 129068751 28.2 464p

04/03/2009 132041000 28.8 431p

Inmarsat was founded in1979 to ensure that ships could stay in contact by telephone. In 1999, they became the first intergovernmental organization to be transformed into a private company and in 2005 they were floated on the London Stock Exchange. Inmarsat offer a Broadband Global Area Network (BGAN) service that enables, among other things, TV broadcasters to beam breaking news live via videophone. In future they hope to offer a new service allowing mobile phone calls or text messages from aircraft transmitted via Inmarsat satellites to the ground.

Harbinger, in partnership with SkyTerra Communications (a US satellite company that they have a 48.5% stake in) has been interested in Inmarsat for some time. It is thought that Harbinger are looking to merge the spectrum holdings - the radio bands used for mobile communications - of Inmarsat and SkyTerra. SkyTerra has said that the spectrum owned by Inmarsat could be used by SkyTerra to provide "ubiquitous wireless coverage" in the US and Canada. Inmarsat’s view is that it is confident of its stand-alone prospects, but it intends to maintain a constructive relationship with Harbinger and SkyTerra.

Harbinger has not made a formal offer for Inmarsat because it needs to gain regulatory clearance for a deal first. Their intentions became clearer in July 2008 when the board of SkyTerra and Harbinger announced that they were seeking to make an offer to acquire the entire issued share capital of Inmarsat. Harbinger has given a so-called "reference price" for the possible bid of 535p, although it has stressed that this does not constitute a conditional bid price.

The approval process for the Inmarsat Change of Control Application is ongoing. Harbinger's expectations remain as stated in the July 2008 announcement and they think that approval is likely to take approximately 12-18 months from the date of that announcement. The regulatory process requires:

  • approval from the U.S. Federal Communications Commission (FCC) for the transfer of control of the FCC licences held by subsidiaries of Inmarsat
  • FCC approval for the transfer of control of the FCC licences held by SkyTerra Subsidiary LLC, an indirect subsidiary of SkyTerra
  • approval under the FCC's foreign ownership limits for Harbinger to own up to 100% of SkyTerra.

So it looks to definitely be an ongoing situation that we'll keep track of as it unfolds. In addition to the two activist holdings, Harbinger also has what appears to be a passive, value orientated stake in Northern Petroleum.

Northern Petroleum NOP 31/01/2008 7056014 10

14/05/2008 3338006 4.71

Taken from Google Finance - Northern Petroleum Plc is an oil and gas production, development, exploration and asset trading company focused on areas in Europe. The Company is recognized as an Operator of both onshore and offshore projects. Its activity is mainly carried out in The Netherlands, Italy, United Kingdom and Guyane.

This is a part of our continued expansion of our hedge fund portfolio tracking series. For a brief primer on tracking positions that various funds hold in UK markets, head to our article here. For further coverage of UK positions that prominent hedge funds hold, make sure to check out our following coverage: Coatue Management's UK holdings, as well as Moore Capital Management's positions, Stephen Mandel's Lone Pine Capital UK holdings (and their recent movements as well), Sprott Asset Management's defensive UK portfolio, as well as Citadel's positions. Check back daily as we continue to cover some of the most prominent hedge funds in the game.

Market Insights From Hedge Fund D.E. Shaw & Co: Common Trading Mistakes

This is a first for Market Folly in that we've been able to track down some market insight from none other than hedge fund firm D.E. Shaw & Co. While the commentary is from July of this year, it is theoretical and applicational in nature so it's still very relevant. Not to mention, it's probably worth your time regardless, considering it is coming from a firm who has their hand in all different types of markets. After all, they are a hedge fund, a private equity firm, and technology development shop all rolled up into one.

This particular research report focuses on intuition versus reason. Additionally, it deals with analyzing trades and what they call the "time-portal" fallacy. It makes for interesting reading so definitely check it out as they delve into the topic of common trading mistakes and the consequences that follow. You can download the .pdf here. For more on DE Shaw, check out our recent portfolio coverage on them.

Monday, September 21, 2009

Where's the S&P 500 Headed? Here's What Two Technical Indicators Say

Here's a current S&P 500 technical analysis video that takes a look at two technical indicators colliding in the chart of the S&P 500. While the market was clearly downtrending throughout 2008, it is undeniably in an uptrend from March of this year until present. However, if you draw a trendline connecting the sequential lower highs from late 2007 until now, you'll find that the market is approaching a resistance level as determined by this downtrending resistance line. You can watch the video here to see this illustrated.

Additionally, if you setup a fibonacci retracement tool from the last highs of October 2007 to the lows in March of this year, you'll see something very interesting. The 50% retracement ends up at S&P 1,122 and could very well also serve as resistance. So, you essentially have areas overhead to worry about. And, we're dangerously close to those areas already. Again, here's the S&P 500 video. And if you're unfamiliar with fibonacci retracements, watch this educational video.

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Possible Current Long & Short Hedge Fund Strategies

There has been some interesting work coming out of Goldman Sachs as of late and we wanted to take a moment to highlight the latest piece we've stumbled across. If you missed it, make sure you check out their hedge fund trend monitor where they identify portfolio holdings across the hedge fund universe as well. Turning now to another recent report, we examine their piece entitled 'State of the Markets.' Members of Goldman Sachs' sales/trading desk have compiled possible current long & short strategies they are seeing in the markets. They touch on tradable themes and various other market opportunities. In particular, they focus on the topics of commercial real estate, balance sheets of public companies, Japan, the consumer and retail, as well as commodity and event-driven opportunities. Keep in mind that these thoughts do not reflect an official view of Goldman Sachs and are solely those of the sales/trading authors.

Drilling down those talking points, the main trading and hedging opportunities they see are derived from a notion that the combination of the housing bubble and equity market decline have essentially destroyed wealth (we touched on this theme way back in December). This leads to consumer debt repayment and a higher savings rate. Due to the economic malaise, elevated and prolonged unemployment becomes a real source of problems. In turn, you then see lower consumer spending. They've also identified a second theme to take advantage of: risk shifting to public balance sheets. Based on all of these notions, various members of Goldman Sachs' sales/trading desks have highlighted the following strategies as opportunistic within the context of the current market landscape:

- Short REIT Equities
- Buy FX Options on commodity linked currencies
- Buy Equities of non-US commodity producers
- Sell Caps on the US Tax Index
- Short JPY
- Buy Yen CMS Caps
- Short US consumer and retail companies (via equities or CDS)
- Sell Aluminum Caps
- Long crude oil vs short heating oil (short the crack spread)
- Engage in market neutral strategies (event-driven, etc)

As you can see, some of these strategies are obviously not executable by your average retail investor and that is why the piece is deemed possible hedge fund strategies. As such, we insert the necessary note of caution here: Don't trade anything you aren't familiar with. Nothing herein is a recommendation and we won't be responsible for your acts of stupidity when you decide to go leverage-happy trading FX options when you've barely even traded equities. Use your head with this stuff. More so than anything, we found their report to be intriguing and figured it was good food for thought. Acting like a lemming and just following whatever you read on the internet is not a smart investment strategy (in fact, it's not one at all). Just keep all this in mind when reading and do note our disclaimer at the bottom of the site.

Overall, this is definitely an interesting mix of possible hedge fund strategies being pursued in the current markets. (These strategies were compiled in August 2009). Since we typically focus on equity holdings of various hedge funds, we'll leave all the macro trades for another day and will instead focus on the equity strategies presented.

Firstly, we'll turn our attention to the proposed strategy of shorting REIT equities. This has already been widely discussed before as the collapse in commercial real estate intensifies by the day. Yet through equity dilutions-a-plenty, REIT equities have managed to stay afloat. The fundamental problems and macro picture duly noted, members of Goldman's team have identified an opportunity to capitalize on the divergence in commercial real estate price estimates between REIT equity and CMBS markets. They identify possible trade ideas as follows: short REIT equity, long CMBS through buying AAA CMBS or selling protection on AAA CMBX.

According to S&P's rating stress for CMBS, CRE values have apparently dropped 26% from their peak and could potentially drop another 20-30%. A few recent transactions have sold around 60-65% below the peak in 2007 prices. Not to mention, you have the awesome problem of store closings that could shut down numerous regional malls over an extended timeframe. It is all a domino effect as the consumer has been wounded from the economy. As the consumer goes, so does the retail sector. As retail slowly ceases to bask in their former profitable glory, commercial real estate property owners start to suffer from lost tenants, amongst other problems.

While US REITs have raised almost $13 billion in capital year to date (mainly courtesy of the equity dilutions we referenced earlier), they still might need $40-60 billion more to stay afloat and meet impending debt maturities. Despite property values falling and equity dilution, REIT share prices have continued to ramp up. REIT indices are up well over 50% since the lows in March, yet the problems in commercial real estate seem to be accelerating to the downside.

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If there is indeed a 25% mis-pricing in loss expectations for CRE, there could be further trouble ahead.

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An example of putting on the short portion of the trade would be to buy puts or put spreads on a REIT equity index or a basket of various REITs (they highlight retail and office REITs). You can either buy the put outright or sell a further out of the money put to create a put spread (and cheapen your cost). With put options, you define the amount you are willing to lose as opposed to shorting common where a stock can rally > 100%, compounding your losses. While this could potentially be an effective short strategy, you also have to keep in mind that they have also presented a long strategy that retail investors can't pursue. But, for those of you interested, the idea as referenced earlier is a long of AAA CMBS. Obviously the risk there is that if the loans cease to pay their mortgage payments, the value of the bond price could be impaired. In the past, we've covered how various hedge funds have been short REITs as this theme definitely looks to be in play. That about sums up the CRE play for now, and you can bet we aren't done hearing about the problems in this industry.

Secondly, we'll shift the focus to public balance sheet conditions. Goldman's team has identified strength in emerging market balance sheets as developed countries increase their public debt. As such, they have proposed shorting developed countries overloaded with debt and going long select emerging market economies. They also highlight the possibility to buy equities of non-US commodity producers or inflation proxy commodity indices.

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And another idea:

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While we don't typically cover currencies here, you could implement a makeshift version of this trade using currency baskets created with ETFs such as the Australian Dollar (FXA) and the Canadian Dollar (FXC). We've seen this theme (longing commodity producers) mentioned numerous times and we would venture a guess that hedge funds like John Burbank's Passport Capital have executed some form of this trade (we've also covered their curve steepener play in the past too). Commodities definitely have piqued the interest of many this year (especially Jim Rogers) so we'll continue to keep track of that trend.

Lastly, we want to cover the theme of lower consumer spending as it pertains to the retail sector. This theme is relatively straightforward as a weaker economic outlook will impact the consumer. This obviously hurts participants in the retail sector and Goldman's team highlights a possibility of buying 6 month or 1 year put spreads on the S&P Retail Select Index (you could also sell a Call to cheapen the option). Buying protection on an individual retailer or basket of names would make sense should consumer spending drop off due to continued weakness in the economy.

They postulate that we could be seeing a structural ( rather than cyclical) change as it relates to consumer spending. While many will argue that the American consumer is the engine that somehow miraculously keeps on chugging, it's tough to argue with the fact that the US household has lost 23% in net wealth over the past 18 months (totaling over $14 trillion).

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Yet, similar to REIT equities, retail equities are up massively from their lows.

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Unemployment continues to rise and the economy is by no means 'in the clear' yet. Many macro hedge funds (Clarium Capital, Tudor Investment Corp) will be quick to highlight unemployment as a main contributor to continued pain. Can consumer spending go back to normal at the drop of a hat? We'll have to wait and see if the giant American consumption machine will be fettered by the continued effects of the recession.

Overall, very relevant propositions as it pertains to possible hedge fund strategies in the current markets. Keep in mind that these are not recommendations and do not represent the views of Goldman Sachs (or Market Folly either for that matter). If you missed the previous hedge fund report out of Goldman, it is definitely worth reading. Their hedge fund trend monitor surveys the hedge fund portfolio landscape much as we do here at Market Folly. For more on hedge fund holdings, make sure to check out our hedge fund portfolio tracking series as well.