Perry Capital: Bargains Not As Plentiful, But Growing Amount of Event-Driven Opportunities ~ market folly

Thursday, February 3, 2011

Perry Capital: Bargains Not As Plentiful, But Growing Amount of Event-Driven Opportunities

Richard Perry's hedge fund firm Perry Capital is out with its 2010 year-end letter to investors and Perry Partners International finished last year up 16.21% (more 2010 hedge fund returns here). Perry's letter places emphasis on the fact that they don't necessarily abide by economic forecasting as much as other market participants. Instead, they focus on event-driven value investing in both equities and debt and have seen an annualized rate of return of 12.28%.

Perry's Targeted Investments

The hedge fund seeks to invest in securities that fall into various categories:

- "Capture most of the bell curve's area as a positive outcome for our investments"

- "Look for securities that do not suffer huge losses from unfavorable future economic outcomes (truncate the left tail)"

- "Buy securities that offer outsized rewards versus risk on favorable outcomes (bulging right tail)"

- "Find investments with little or no correlation to the economy that have positive expected value"

Looking Ahead in 2011

For this year Perry notes that, "Bargains are not as plentiful and dislocations are fewer today than a year ago. However, there is a growing amount of event-driven investing as we start 2011. Expectations about GDP growth and the market are almost euphoric ... This remarkable rally, as usual, has led investors to be more comfortable with the market at these higher levels than at the bottom. That is the nature of the market."

Potential Risks

As such, Perry Capital maintains numerous hedges on potential tail risk events. Baupost Group's Seth Klarman has done the same. Perry has protection against: European sovereign and banking issues, inflation in developing markets, and they are also concerned about the US Treasury and municipal bond markets.

Perry is not alone in their worry as we pointed out fellow hedge fund Kleinheinz Capital also thinks inflation is the biggest threat to emerging markets. Perry is particularly concerned about food and energy inflation and notes that increases in wage and input costs are resulting in higher finished product prices.

Fourth Quarter Portfolio

Below are excerpt's from Perry Capital's letter regarding some of their investments:

"Our position in Delphi equity continued to march higher. The company has performed quite well since exiting bankruptcy and, despite significant appreciation, we continue to hold our position. Delphi is well positioned as an automotive supplier - diesel, power train, safety and infotainment - with the best balance sheet in the industry." Market Folly readers will recall that Dan Loeb's hedge fund Third Point also owns Delphi.

"Universal American (UAM) was also one of our top performers in the fourth quarter. On December 31st, UAM stock increased approximately 40% on the news that CVS Caremark had agreed to acquire UAM's Medicare Part D plan for $1.25 billion. Subject to shareholder approval (likely in Q2 2011), UAM shareholders will receive $12.80-$13.00 for the Part D plan along with one share of the NewCo (remaining Medicare Advantage business), which will have approximately $8 per share of statutory capital upon separation."

Perry also had previously invested in Potash (POT) during the company's potential takeover by BHP Billiton (BHP). They exited their position before the Canadian government opposed the offer, anticipating (and jumping in front of) a potential heavy hedge fund sell-off. They were subsequently able to re-buy.

"We were able to re-establish a sizeable position after the arbitrage sell off at $138-139 per share, and hedged it using comparable companies that had traded up during the recent strong commodity price move. Fundamentals have continued to improve for Potash and we maintain a position in the shares." Dan Loeb's Third Point also has a sizable stake in Potash.

Lastly, Perry Capital invested in the AIA initial public offering (IPO), a wholly owned subsidiary of AIG (AIG). We've detailed how Bruce Berkowitz's Fairholme Capital also bought AIA in the IPO. Perry writes,

"AIA is a unique asset with hard-to-duplicate exposure to underpenetrated Asian markets that have had a high growth profile ... In our view, the IPO came at a meaningful discount to fair value due to i) its size, ii) poor execution during 2008-2009 due to issues associated with AIG, and iii) the AIG overhang caused by its remaining stake. Our investment paid off as AIA got rerated relatively quickly after the IPO."

That wraps up the main takeaways from the hedge fund's letter. Keep in mind of course that you can view Perry's latest portfolio in the new issue of our Hedge Fund Wisdom newsletter in a couple of weeks.

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