Dan Arbess' Xerion Fund: 2011 Investment Strategy & Outlook ~ market folly

Wednesday, January 12, 2011

Dan Arbess' Xerion Fund: 2011 Investment Strategy & Outlook

Daniel Arbess' Xerion Fund is out with its investment strategy and outlook for 2011. The hedge fund, part of Perella Weinberg Partners, manages $2.3 billion and has annualized returns of 18.97% net since inception in 2003. For 2010, Xerion finished up 12.66% net. Our previous coverage focused on how Xerion likes commodities.

2011 Market Outlook

Taken directly from Xerion's year-end letter to investors, here is a breakdown of their outlook for the new year,

" - Global economy and markets remain unbalanced, dependent on government support and highly vulnerable to policy changes and conflicting national agendas. Government-stimulated market momentum will recede in 2011, in favor of either gradual normalization or renewed crisis.

- Expect continued moderate economic recovery, however frequently punctuated by episodes of macro instability. Key risks include potential over-heating and reversal in China, persistently high domestic unemployment and acceleration of sovereign debt crises in Europe and other developed economies.

- Receding tailwinds from government intervention imply security selection and idiosyncratic opportunity will be most important in 2011. Select U.S. credit opportunities as rising yields signal higher re-financing costs. “Shake Hands With China” with exposure to commodities and equities, industrials and Asian consumer- facing industries. Selective sector opportunities in U.S. Equities. Commodity bias captures both fundamental demand in EM and fiscal crisis hedge in DM."

Portfolio Positioning

Given the above themes, Xerion is positioned cautiously long and they expect U.S. credit opportunities to be limited given the large wave of restructurings over the past two years. In developed markets, they see a few equity opportunities but they still favor emerging market equity plays and continue to play their 'shake hands with China' theme.

Of Xerion's positioning, Arbess writes, "Our portfolio structure and positioning going into 2011 is quite consistent with where it was one year ago - slightly longer and more skewed toward equity strategies versus credit, but also more hedged (which is to be expected given the higher beta and volatility of equities)."

Credit: In this asset class, they're focused on event-driven corporate plays and an opportunistic tilt toward distressed credit. Arbess writes, "we also see M&A as an evolving high yield catalyst for 2011, given that sponsors have cash to use and limited organic growth opportunities, while high yield companies are in the mode of bolstering liquidity and shedding assets to fund creditor friendly actions."

Equities: Xerion is generally cautious on domestic equities and favors high growth plays in emerging markets. Specifically, they are focusing on the rise of China's consumer and how to play that. The hedge fund is concerned with the liquidity of Asian equities in general but is intrigued by the state-owned segment of China's economy. Overall, they continue to favor their 'shake hands with China' portfolio theme.

Commodities: Arbess and his team believe that industrial commodity demand has been in a 'supercycle' since 2004. They like commodities for a couple of reasons, citing that they "benefit from robust and growing fundamental demand from industrializing emerging markets, and also attract financial investors looking for monetary debasement hedge."

In particular, Xerion prefers industrial commodities to even gold, claiming that the latter is less supported by demand and more-so driven by a financial crisis hedge. The hedge fund also likes various equity plays for this theme, specifically the junior resource companies (such as Fortescue Metals Group, Ivanhoe Mines, OGX and HRT).

Concerns In The Coming Year

Xerion rounds out its commentary and outlook by commenting on reasons to be cautious this year:

"For the past two years, markets have rallied in response to government stimulus and the anticipation of an economic recovery. We are cautiously optimistic that strong growth in the developing economies will continue to anchor the global economy in 2011, while improving sentiment in the developed world could potentially unlock cash-laden corporate balance sheets, supporting an investment-led recovery. However, bullish sentiment is already largely priced in. We expect the tailwinds of QE-inspirited rising markets to subside in 2011, further highlighting the importance of security selection, idiosyncratic opportunity and events, and, above all, hedging ever-present macro risks."

In the end, Arbess' hedge fund identifies the following as the key to continued economic recovery:

"The sustainability of global growth in 2011 will be highly dependent on G-20 policy makers’ successfully reining in short-term national interests in favor of longer-term globally coordinated efforts to shore up consumption growth in the EM."

For more on Dan Arbess' hedge fund, head to our past post on Xerion's 'shake hands with China' play.

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