Dan Arbess' Xerion Fund Prefers Commodities Over Equities ~ market folly

Thursday, December 2, 2010

Dan Arbess' Xerion Fund Prefers Commodities Over Equities

Daniel Arbess' hedge fund Xerion is out with its latest letter to investors. The fund, a part of Perella Weinberg Partners, has returned 18.68% annualized net since inception in January 2003 and currently manages around $2.3 billion. Maybe the most impressive aspect about Arbess' numbers is the fact that he's done so with a correlation to the S&P 500 of only 0.34%.

The hedge fund "seeks to draw on fundamental valuation skills to identify opportunities that offer the potential for asymmetric returns--downside protection with upside potential." Xerion is named for an alchemy tool whose legend says it can turn base metals into gold. Apparently, it is also supposed to be an elixir of enlightenment. When markets crumbled in 2008, Xerion returned 0.31%, beating out numerous hedge funds that suffered. In 2009, the hedge fund was up 35.33%. Through October in 2010, Xerion is up 7.34% net.

Arbess has been positioned around 61.6% net long with equity strategies around 43.7% net long, credit strategies 35.6% net long and macro strategies -17.7% net. At the end of the month, their top 10 longs comprised 34.8% of equity. Some of the hedge fund's top performers included positions in HRT Participações em Petróleo (HRT), Abitibi (process driven distressed credit), LCORA (credit special situation), Solutia (SOA - thematic Asian growth equity), and Ivanhoe Energy (IVAN - special situation equity).

"Quantitative Easing May be Counter-Productive"

Arbess dedicates a decent portion of his commentary to the Federal Reserve, quantitative easing, and his belief that while QE may spur equity price advances, it will do little to make a real difference in the economy.

He writes, "The unintended consequences of QE are eroding confidence in the Dollar and the entire monetary system. We generally prefer commodities over equities as a medium term play on the 'Fed Put'. Equities may not keep going up if QE doesn't work, but it seems to us that commodity-related investments will have legs whether QE works and economies improve, or QE doesn't work and more Dollars are left chasing the same commodities."

This viewpoint is generally aligned with that of John Burbank's hedge fund Passport Capital as Burbank favors hard assets. However, their shared thinking contrasts with that of David Tepper and Appaloosa Management. Tepper doesn't want to 'fight the Fed' and thinks equities will continue to rally.

"Shake Hands With China"

One of Arbess' ongoing themes has been to own what China's government and consumers desire. He argues that China is transforming itself from the world's factory into the world's consumer. As such, the Xerion fund is investing in hard assets that China and developing nations need to build infrastructure and fuel urban growth. The hedge fund has also been researching cheap producers in southeast Asia and retail distributors that will serve this rising consumer.

HRT Participações em Petróleo (HRT)

Arbess' letter also singles out their investment in newly IPO'd HRT. Xerion made an initial $20 million private investment back in November 2009 at a $360 million capitalization. HRT went public raising $1.5 billion at a pre-money valuation of $1.8 billion. It is a Brazilian exploration and development company formed by Petrobras seismic experts who provided consulting advice to large oil companies.

Of the company Arbess writes, "We think this Company is just getting started, with the IPO implying a reasonable valuation for HRT's known onshore oil assets, but discounting its substantial gas potential in the Amazon and offshore hydrocarbon blocks in Namibia. We like this investment at its current valuation and are looking forward to favorable news as the Company's drilling program ramps up over the next several months."

Xerion Portfolio Exposures

Interestingly enough, Arbess writes that, "Our net long corporate exposures are still weighted nearly 2:1 credit to equity. About three quarters of our equity exposures (and hedges) are leveraged to the global industrialization theme, mostly through what we intend to be asymmetric commodity plays like HRT. About a quarter of our equity exposures are more domestically-focused, playing for either idiosyncratic events or high operating leverage, strong free cash flow or secular strength in a weak economic environment (hotels, transportation, technology, etc.)."

Currently, the fund has 21.4% of assets under management dedicated to special situations equities (mainly hard asset-focused). Arbess makes a footnote that the Xerion fund has been looking at stressed credit situations in the arenas of food service, lodging, and technology. Lastly before everyone asks, unfortunately we can't post a copy of the actual letter due to revealing watermarks.

We'll continue to provide updates on Arbess' hedge fund, but in the mean time you can view a previous Xerion presentation: Investing as the foundation shifts.


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