Friday, March 30, 2012

Top 25 Highest Earning Hedge Fund Managers of 2011

AR Magazine has revealed a list of the top 25 highest earning hedge fund managers from 2011. This is their 11th year of doing the rankings and they found that the upper echelon earned an average of $576 million and a combined total of $14.4 billion. Here's the top five:

1. Ray Dalio (Bridgewater Associates): $3.9 billion. You can view Ray Dalio on deleveragings, his newly released research paper

2. Carl Icahn (Icahn Capital Management): $2.5 billion. One of his holdings was featured as a previous stock of the week: what Carl Icahn sees in WebMD.

3. James Simons (Renaissance Technologies): $2.1 billion. We just recently posted up Jim Simons' presentation at MIT. Simons is one of the top earners on this list despite having retired.

4. Ken Griffin (Citadel): $700 million. You can view some of Citadel's latest moves here.

5. Steven Cohen (SAC Capital): $585 million. We've posted up recent portfolio activity from SAC Capital as well.

It's interesting to compare the above individual earner list to the list of the top 10 hedge funds by net gains since inception as there is no doubt some overlap.

Other Notable Earners: Chase Coleman from Tiger Global slides in at the sixth position. Recall that his fund saw big gains from private investments that IPO'd during last year. Andreas Halvorsen of Viking Global earned $300 million and Paul Tudor Jones (Tudor Investment Corp) earned $175 million.

New Additions to the List: 2011 saw plenty of new faces on AR's list including: Philippe Laffont of Coatue Management, Boaz Weinstein of Saba Capital, Jeffrey Ubben of ValueAct Capital, Paul Singer of Elliott Management, Renaissance's Robert Mercer and Peter Brown, as well as Bridgewater's Greg Jensen and Robert Prince.

Notably Absent: AR mentions that the most notable absentee from the list is John Paulson. He fell off after a weak 2011 performance wise after he was the top hedge fund earner the year prior. George Soros misses the list after he returned outside investor money and converted his hedge fund into a family office.

You can view the rest of the top 25 earners list here.

Steve Cohen's SAC Capital Pumps Up GNC Holdings (GNC) Stake

Steve Cohen's hedge fund firm SAC Capital just filed a 13G with the SEC regarding its position in GNC Acquisition Holdings (GNC). Per the filing, SAC Capital now owns 5.4% of the company with 5,726,780 shares.

This marks an increase of 540% in the hedge fund's position size since the end of 2011. The filing was made due to trading activity on March 19th, 2012.

We recently also detailed how SAC Capital started a position in Hyatt Hotels and also made some additional portfolio moves.

Per Google Finance, GNC Holdings is "It is a specialty retailer of nutritional supplements. Nutritional supplements include vitamins, minerals and herbal supplements (VMHS), sports nutrition products, diet products and other wellness products. GNC operates in three segments: Retail, Franchising, andManufacturing/Wholesale. The Company’s operations consist of purchasing raw materials, formulating and manufacturing products and selling the finished products through its primary segments. The Company's brands include Mega Men, Ultra Mega, GNC WELLbeING, Pro Performance, Pro Performance AMP and Longevity Factors."

Soros Fund Management Initiates Digital River (DRIV) Position

George Soros' hedge-fund-turned-family-office Soros Fund Management just filed a 13G with the SEC disclosing a brand new position in Digital River (DRIV).

Due to trading activity on March 19th, Soros crossed the regulatory threshold that required the filing. They now own 7.98% of the company with 3,084,460 shares. Soros did not own shares of DRIV at the end of the fourth quarter.

In other recent portfolio activity, we also touched on how Soros added to its Acacia Research position. One of the firm's holdings was recently featured as our stock of the week. Check out why George Soros owns Comverse Technology.

Per Google Finance, Digital River is "engaged in providing end-to-end global e-commerce and marketing solutions to a range of companies in software, consumer electronics, computer games, video games, and other markets.

The Company’s services include design, development and hosting of online stores and shopping carts, store merchandising and optimization, order management, denied parties screening, export controls and management, tax compliance and management, fraud management, digital product delivery through download, physical product fulfillment, subscription management, online marketing, including e-mail marketing, management of affiliate programs, paid search programs, payment processing services, Website optimization, Web analytics and reporting, and compact disc (CD) production and delivery."

George Soros' Quantum Endowment recently ranked second in the top 10 hedge funds by net gains since inception.

Thursday, March 29, 2012

Bruce Berkowitz's Basic Checklist For Investing: CIMA Conference

Continuing the series of notes from the CIMA Conference (Columbia Investment Management Association), we shift to Fairholme Capital's founder Bruce Berkowitz and his basic checklist for investing as well as what he's learned as an investor.

Bruce Berkowitz's Basic Checklist For Investing

1. Can you kill the investment? Is there adult supervision at the company?

2. Is the company essential? Does it depend upon the kindness of strangers?

3. What can the company make? Reasonable profitability for owners?

4. How are owners paid? Distributions?

5. Management - honest in past and present?

6. Does accounting reflect reality?

7. Does the balance sheet match up with the income statement?

8. Catalysts - Buybacks? Misunderstood? Is enterprise having a big problem that is fixable? Everyone's been burned by the stock so afraid to buy it.

9. Are there irrational fears of current headwinds?

10. Does the business have pricing power or unit growth?

11. Can you hold the investment for a long time & does it improve portfolio performance?

On Financials: He's "all in" on financials now. American International Group (AIG). CIT Group (CIT): misunderstood. Bank of American (BAC): misunderstood. Fixable problems. Likes holding companies like Berkshire Hathaway (BRK.A / BRK.B) or Sears Holdings (SHLD). No interest in Europe, plenty to do in the US.

On Sears (SHLD): "I'm happy for people to push down the price." You have to understand the history of anchors in malls in the US to appreciate Sears and Kmart.

Top Ten Lessons Berkowitz Wishes He Learned Long Ago:

1. You always have to have cash, especially when no one else has it. (John Burbank of Passport Capital has said the same: "Cash is most valuable when others don't have it.")

2. No free lunch- it’s not free, or it’s not lunch.

3. You can’t change people! You can change yourself, but not others.

4. You only see reality under extreme stress- you want to get to know someone, you need to see them under extreme stress. (MF note: Completely baseless guess, but does anyone else think he's possibly referencing the situation where Fernandez left FairholmeCap here?)

5. Volatility is not risk!

6. Always assume you will have bad luck.

7. Few variables to win. Once you have to think about more than 3 variables, your odds of winning are low.

8. If you have to use more than 6th grade math, you’re in trouble.

For the rest of the notes from the CIMA Conference, head to these posts:

- Dan Loeb: Lessons He's Learned as an Investor

- David Einhorn Question & Answer Session

- Distressed Investing Panel (Dan Loeb & Daniel Krueger)

- Long/Short Equity Investing Panel: Whitney Tilson

- Bill Miller on What Stock He Likes Now

- Michael Karsch on Risk Management

- Bruce Greenwald's Market Comments

Bill Miller on What Stocks He Likes Now: CIMA Conference

Continuing the series of notes from the CIMA Conference (Columbia Investment Management Association), we move on to the presentation and Q&A from Legg Mason's Bill Miller.

Bill Miller on What Stocks He Likes Now

He started out discussing how he is different from traditional value investors. Low P/E, low cash flow not enough. Focus on long-term creation of business value, the future, not just the past. Allowed them to avoid the terrible returns of value investors. How does he invest in tech? There are a few platforms that are locked in long-term. They did do 10-year projections on Amazon. If you think through it carefully, you CAN make long-term projections on tech. (They are doing it with Facebook now).

AMZN example: high growth, high valuation companies, in aggregate, have small chance of maintaining that rate. But some can. What is the probability that this is an exception to the base rate? Once companies get a certain level of market share, it is very difficult for that share to be eroded. (Network effect). True even with low barriers to entry. You want a business with low switching costs that nobody switches from. GOOG/MSFT search example- GOOG has 66%; MSFT has 14%, even with spending. Once you have stable market shares, and large market. It’s judgment, understanding the industry, not just looking at P/E ratios. They are looking at Facebook now.

AMZN: low 20s GMs, and high cost structure. Bezos exploited technology and customer-focus, to achieve critical mass, costs all up front, market would finance it. When stock was down, Bezos said he was focusing on new markets and customer service. They had a dominating presence by then. Issue now is what is the level of OM long term? Bezos says it will still be a double-digit OM business long-term. Bezos said, “I’m not going to make the Steve Jobs mistake of pricing the iPhone to subsidize the rest of the world R&D by pricing it so high.” IPad is priced much more competitively, so they have total share.

Bruce Greenwald says cloud isn’t that profitable because they have to provide capacity when everyone needs it, so it’s not really just using their excess capacity. The device business is bad, too. Miller says the device business is defensive. All of retail is realizing that AMZN is a threat to EVERY segment. AMZN has all the data about what you buy, like, etc. Ease of use. End market is so large. GOOG: internal discipline issue on capital spending.

How he does valuation? Build probabilistic models. No predictions: what does the market believe, what is embedded in the price, what is the trajectory of the business? INTC, CSCO, AAPL, MSFT, good business with reasonable valuations today.

Macro is fading as an important thing for investors. People have adequately discounted the macro risks.

Biggest Lesson He's Learned: if building an investment business, you need to be different, and right. That will attract assets. He went from zero to 75B in assets. Those assets will also fly out when you are different and wrong. To build a business, be different and right, to retain the business, you have to be a closet indexer.

Things change. Understanding and recognizing them is the key. They were late in the game in recognizing how far valuations would be squeezed by the financial crisis. “Don’t rule anything out.” When in a crisis, wait for the global coordinated action.

Stocks Miller Likes Now

2008 was a lot of permanent loss, 2011 was temporary losses.

1. Bullish on housing already, all data-driven. KBH up 80% for the year! Still lower than it was a year ago. Housing cycle in process of bottoming, orders are up, better business models. Massive cyclical turn, with profound implications for the US economy.

2. Genworth: Mortgage business down, 50-100% gain in 12 months.

3. Financials: C, BAC below tangible book.

4. Insurance companies: below book value.

5. Airlines: Worst industry in the history of the world. Here’s the difference now. Was commodity business, unionization, high regulation, and fuel costs volatile, fragmented. Highest share was 12% in the US. United now 26%, DAL 25%, so story is consolidated business with better pricing. Positive FCF for 3 years straight now. UAL 40% ROIC. $5 FCF, will be investment grade in a year, trades at 3.5x earnings. Small, risky position.

6. Techs: AAPL, largest position. What kind of company is it? Debate is if Apple is just a really good tech company, what’s it worth? Not much, these things change rapidly. If Apple is a recurring revenue company, consumer products company, then it’s radically mispriced. Bill makes the case that it is a consumer products company; the repurchase rate on the iPhone is 95%. Very few SKUs in line-up. Only 375 stores, only in a third of the carriers worldwide. Share in iPhone doubled from a year ago. Stock is 10x eps and low earnings estimates. 90B in cash, dividend possible. In short term, very low risk. Value it at the least, like a cable company. Compare to KO, or NKE.

7. Facebook: actually, the higher it goes, the more the probability of winning. You can’t look at it like paying $85B for $1B in operating profit. That’s what they DID; they’ll do $2B this year, more than AMZN ever had in history, higher margins, less competition.

Q&A Session:

Why banks? How can you trust the B/S? Have to compare categories to overall market prices. Consolidation means top 6 banks are 63% of GDP. It’s impossible for the US GDP to grow without the assets of the banks growing. Banks as a whole are mispriced, but not compared to each other. BAC has 70B market capital; they were earning 40B a year ago pre-tax, pre-provision. Biggest beneficiary of housing recovery. Can’t get comfortable at the micro level on all their assets, but you can get comfortable about the direction of those assets.

AMZN: can it wipe out other business? Way too early to say. No threat to WMT, COST, JCP.

Market: Best thing for the stock market would be for the bond market to sell off; indicates fear about tail events is dissolving. Biggest risk to the market is Israel attacking Iran. Policy errors. Like in 2008, they wiped out capital as they told people to raise capital.

For the rest of the notes from the CIMA Conference, head to these posts:

- Dan Loeb: Lessons He's Learned as an Investor

- David Einhorn Question & Answer Session

- Bruce Berkowitz's Basic Checklist for Investing & What He's Learned

- Distressed Investing Panel (Dan Loeb & Daniel Krueger)

- Long/Short Equity Investing Panel (Whitney Tilson)

- Michael Karsch on Risk Management

- Bruce Greenwald's Market Comments

Long/Short Equity Investing Panel: Whitney Tilson (CIMA Conference)

Continuing the series of notes from the CIMA Conference (Columbia Investment Management Association), we turn to the long/short equity investing panel with Whitney Tilson of T2 Partners.

Whitney Tilson On Various Longs/Shorts & Lessons Learned

On His Netflix (NFLX) Trade: over 2 years, they’ve broken even. Shorted at 100, covered at 200, felt smart as it went to 300. Wanted to kill themselves as their short thesis played out, got back long on the day in blew up going from 120 to 77 in a day.

Lessons: what they missed on the short side: very dangerous shorting an open-ended situation with a lot of momentum. Both stock and business had momentum, and they didn’t fully appreciate the quality of the business or the momentum the stock has.

Why was he short? Because P/E was 75x, also NFLX needed to invest heavily in streaming content to grow, which would have compressed margins. It happened, should have been more patient before entering the short. Now, balance sheet has tripled in a year, CEO has given up on core business, has bet entire company on the streaming business, with 3B of deals, which is senior to the debt. Stock could be 1000 in 5 years, or zero in 5 years. Each incremental sub is almost pure profit. Good news is they learned the company VERY well and could act very quickly when the stock collapsed. “We didn’t change, the stock price changed.” Every stock in the universe is a long at one price and a short at another price.

On Berkshire Hathaway (BRK.A / BRK.B): 15% position, held continuously for 13 years. Upside, worth 170k, up from 117k. Based on investments 100k per share, then 10x multiple on operating businesses, add it together. Any method you value it, worth at least 150k. Buffett buys it back at book. 8% downside, 50% upside stock. Railroads, housing sensitive business are doing great, insurance business is getting better. What is the bear case? No catalysts. No activists, can’t break it up, no dividend. Cheapness is the only catalyst, and the valuation gap will close. Single biggest area of cheap stocks, they are cheap on risk-adjusted basis.

Tilson on His Short Positions: Says to size your shorts small. Has there ever been a $10B market cap that traded at 10x REV that didn’t collapse?

Lululemon (LULU), (CRM): good businesses at ridiculous prices

Green Mountain Coffee Roasters (GMCR): OK business, may be chance of fraud of channel stuffing. See David Einhorn's short thesis on GMCR here.

Interoil (IOC): interoil, claims to have found world’s largest natural oil field in Papua New Guinea, they think the value is zero.

Nokia (NOK), Barnes & Noble (BKS): terminal value zero, thinking of adding Research in Motion (RIMM) to the list, waiting for a bounce. Tricky with a lot of cash, doesn’t expect NOK and RIMM to survive in Android business. Bigger, better player can go under- Borders Books failed, BKS will be next. Any time you’ve seen a stock that has moved a lot, and you say, “I missed it.” Instead, stop and do your work, pretend like it never was at a price before. Only thing that matters is where the stock is today and where it’s likely to be in the future.

Two types of shorts: both very tough. Where is it on the life cycle? Broken momentum shorts. Value traps. Best Buy (BBY): value trap, or say it’s trading at 8x FCF?

Q&A Session:

On Hedge Fund Management Fees & Investor Expectations: If you’re having a ballet in an auditorium, that’s fine, as long as you say that outside. If it’s a rock concert, that’s fine too, as long as you’ve labeled it as such. The problem is when you say it’s a ballet and it’s a rock concert. Make investors aware of exactly what your style is. He’s more volatile than the average hedge fund, so they communicate with their clients frequently. Had only single digit redemptions last year, up 12% so far this year. Manages ~$150 million: if he thought cutting fees would get him to $1B, he would do it. The money chases performance regardless of fees anyway. No clever fee arrangement works anyway.

For the rest of the notes from the CIMA Conference, head to these posts:

- Dan Loeb: Lessons He's Learned as an Investor

- David Einhorn Question & Answer Session

- Bruce Berkowitz's Basic Checklist for Investing & What He's Learned

- Distressed Investing Panel (Dan Loeb & Daniel Krueger)

- Bill Miller on What Stocks He Likes Now

- Michael Karsch on Risk Management

- Bruce Greenwald's Market Comments

Michael Karsch on Risk Management: CIMA Conference

Continuing the series of notes from the CIMA Conference (Columbia Investment Management Association), we present Karsch Capital's Michael Karsch talking about risk.

Michael Karsch on Risk Management

Gross exposure is more important than net exposure. When you’re not exposed enough, cut your least conviction shorts. When you’re too long, instead of shorting more, cut your least conviction longs.

Sometimes it’s dangerous to be near other hedge funds. Manage your gross carefully, not just your net. Hedge fund stocks did a lot worse than the market in 2008, so you got hurt both long and short. Just by shorting, more gross, less net, was actually higher risk. He did 100% over last ten years vs. SPX 12% over same time.

For the rest of the notes from the CIMA Conference, head to these posts:

- Dan Loeb: Lessons He's Learned as an Investor

- David Einhorn Question & Answer Session

- Bruce Berkowitz's Basic Checklist for Investing & What He's Learned

- Distressed Investing Panel (Dan Loeb & Daniel Krueger)

- Long/Short Equity Investing Panel (Whitney Tilson)

- Bill Miller on What Stocks He Likes Now

- Bruce Greenwald's Market Comments

Wednesday, March 28, 2012

Notes From the CIMA Conference 2012

Last month, numerous hedge fund managers gathered at the Columbia Student Investment Management Association (CIMA) Conference. This event focused less on specific stock picks and more on stock process, which we thought readers would find very useful.

Continuing to compile a compendium of timeless educational material here at Market Folly, today and tomorrow we'll be presenting a series of posts from the conference:

- Dan Loeb: Lessons He's Learned as an Investor

- David Einhorn Question & Answer Session

- Distressed Investing Panel (Dan Loeb & Daniel Krueger)

- Bruce Berkowitz's Basic Checklist for Investing & What He's Learned

- Long/Short Equity Investing Panel (Whitney Tilson)

- Bill Miller on What Stocks He Likes Now

- Michael Karsch on Risk Management

- Bruce Greenwald's Market Comments

Distressed Investing Panel: Dan Loeb & Daniel Krueger (CIMA Conference)

Continuing the series of notes from the CIMA conference (Columbia Investment Management Association), we turn to the distressed investing panel with some featured comments from Third Point's Dan Loeb and Owl Creek Asset Management's Daniel Krueger as well as some answers from Bruce Berkowitz (Fairholme Capital).

Distressed Investing Panel

Dan Loeb's Comments: Distressed investing applies to a process in securities that are not performing, it starts with a valuation of the enterprise- they buy anywhere in the capital structure. When they find one they like, they “jump in with both feet.”

In Q4 last year, it seemed that the concerns about the Europe crisis were well discounted in the market, and the US data was getting better. As January progressed, tail risk appeared off the table, and valuations of stocks were cheap. Administration realized that either beating up on the banks, or allowing them to grow, it was better to let them grow.

He got much more bullish in Jan, especially financials (Third Point has increased net long exposure). Bought Unicredito rights. Tech is ridiculously cheap- owns AAPL, GOOG, CSCO. “I’ve made more money going with the along with the crowd than against it.” Still maintain shorts, exposure went from 20% to 40% net long. Still long-tail hedges in case they’re wrong. Portuguese debt looks cheap. You can see Loeb's rationale for owning UniCredit and more in Third Point's investor letter.

Daniel Krueger's Comments: Besides just valuation, they look at each situation totally differently. Most situations require different skills than just valuation.

In distressed, you don’t need to know what is going to happen, for example, no one would have predicted with certainty that MF global was going to happen. You wait for situations to emerge. WAMU is an example- anyway that was an expert on WAMU the day before it was seized by the FDIC knew nothing now, it was all changed.

Distressed in Europe? 3% default rate vs. 2% in US. US high yield market current prices implies 7% default rate in the US over the next 5 years. (This seems ridiculously high). Europe has different rules than the US Chapter 11 rules. Look at process, not just outcome. Distressed is very binary. Your investment in Fannie for example at 5 cents on the dollar could go to zero. Assuming that is a bad decision may be wrong, if your process is right. The upside to these deals could be 20x, so don’t just look at outcome to decide if it was right or not, win or lose.

Idea: Seat Pagine Gialle SpA in Italy, yellow pages company. Been crushed all year, easy to hate yellow pages business, but has 40% EBITDA margins, no CAPEX, true monopoly, cheap price. Enough FCF over 4 years to repay the entire capital structure.

Bruce Berkowitz's Comments: “Shows you what kind of year I had last year, I didn’t think I WAS a distressed investor!” We often underestimate how important the price you pay for an investment; it may be 50-75% of the investment process, what price you pay for it.

Q&A Session:

1. Chrysler situation does not affect how they invest today.

2. How has Loeb’s process evolved? Started out in a single office, by himself, trying to raise money early, picked stocks during the day, and did bookkeeping at night. Now he has a 60 person staff, he has had to create an organization. Totally transparent, totally collaborative, defined investment framework. Research process defined. Learning turns on his team. He likes “high performance activity” like skiing, surfing, ran a triathlon. Something youthful about it. Had former CIA agents teach them deception detection. Always learning. It will naturally find itself into your investment process.

3. Tail hedges? About 50-100 bp of overall fund, that would have 10-20-30x payoffs if they materialize. Out of money calls on oil, for example, used to hedge against war in Iraq. Australian dollar put options, hedge against things slowing down in China.

4. When do they cut their losses? Berkowitz says if the facts tell you you’re right but the price tells you you’re wrong, you give yourself a lot of time. He basically never uses stops, he goes for years. Ask yourself “what am I missing?” Krueger says same thing – has never cut losses. Loeb: we may realize management is not as good as we thought, in case of YHOO, we try to change their behavior, or we just move on. Earnings misses- when stock falls, is the value impaired or our analysis was wrong. He sells at a loss often.

For the rest of the notes from the CIMA Conference, head to these posts:

- Dan Loeb: Lessons He's Learned as an Investor

- David Einhorn Question & Answer Session

- Bruce Berkowitz's Basic Checklist for Investing & What He's Learned Now

- Long/Short Equity Investing Panel (Whitney Tilson)

- Bill Miller on What Stocks He Likes Now

- Michael Karsch on Risk Management

- Bruce Greenwald's Market Comments

Lessons Dan Loeb Has Learned As An Investor: CIMA Conference

Continuing the series of notes from the CIMA conference (Columbia Investment Management Association), we move on to comments from Third Point founder Dan Loeb on lessons he's learned, value investing, and risk management.

What Dan Loeb Has Learned As An Investor

1. His style of investing has evolved and adapted to the investment environment, his process has evolved significantly. Importance of process itself on running an investment management firm. Leadership is very important. Most firms fail from dysfunctional process, or leadership of the firm.

2. Areas of focus and interest: if spending all your time reading research reports and only looking at screen, you will fail. Be well-rounded, travel, study things outside of the narrow topics of finance. If investing was just about numbers, any young accountant could do this. More than industry analysis, need to understand why you make decision, when it’s right to be contrary, when its not. Santa Fe institute has good ideas.

3. Importance in today’s world of political analysis. You can be right about financials, but if you don’t understand what the next move is by our politicians, you can get it wrong.

4. Looking at portfolios, think deeply about process over outcome. If you do something the right way enough times, you’ll win. Look at risk in an intelligent way, look at Alpha generation, not just how much money you make.

On Value Investing: Let's not delude ourselves; some of us are just buying really crappy companies at low prices. Don't make excuses for making bad investments at apparently cheap valuations. He'd rather pay up for a better business that has some growth.

On Managing Risk: He was down 30% in 2008, went from 6B in assets to 1.4B in assets, so he knows that everyone says they’re long term investors, but they still don’t want to lose money in any given year. He’s back up to 9B in assets now. He doesn’t want to lose money in any given year. Tries to have things in different sectors, and asset classes. Has 1.8B mortgage portfolio now for example. Uses tail-risk hedges, and shorts to hedge risk. To have a sustainable, growing business, managing volatility is important.

On “Stinky Feet Stocks”: When your first reaction to a pitch is that’s a terrible stock or industry, those have often been some of their best investments. He considers that a positive when it’s something in an out of favor industry. Auto parts in 2009, European banks in beginning of this year.

They use private investigators on shorts, to know the situation better than the rest of the world. Be sure to also check out Dan Loeb's recommended reading list.

For the rest of the notes from the CIMA Conference, head to these posts:

- David Einhorn Question & Answer Session

- Distressed Investing Panel (Dan Loeb & Daniel Krueger)

- Bruce Berkowitz's Basic Checklist for Investing & What He's Learned

- Long/Short Equity Investing Panel (Whitney Tilson)

- Bill Miller on What Stocks He Likes Now

- Michael Karsch on Risk Management

- Bruce Greenwald's Market Comments

David Einhorn's Extensive Q&A Session from the CIMA Conference

Continuing the series of notes from the CIMA conference (Columbia Investment Management Association), we move on to the portion with Greenlight Capital's David Einhorn. He did his entire session in question and answer format.

David Einhorn's Q&A Session (CIMA Conference)

1. How do you look for ideas on a day-to-day basis? No method for doing it. We are looking for situations where we think something is mispriced. We start with a story, a thesis of why it’s misvalued. There is no systematic way to do this; it’s like going to a bookstore to browse for books. We don’t start with “is it cheap?” That’s easy to find on the computer, but we view cheap as secondary situation. Our goal is weed out as many things as fast as we can.

Example? Process is lack of a process. Sometimes an analyst generates the idea, sometimes other fund managers, a conference, or an idea dinner. Market Folly note: you can also get a good look at Einhorn in action in his book: Fooling Some of the People All of the Time. Be sure to also check out Einhorn's recommended reading list.

2. Once you have an idea, what is your edge? We want to find out what the misunderstanding is. Sometimes it’s a conspiracy to misinform people. Wall Street has this agenda. We like to identify something in which the public has been misinformed. How do you know you’re right? That’s what the work is. We find out what everyone thinks, and then what we think, and then we test it. What we need to know to convince ourselves that we understand it. Fairly informal process, not a firm checklist.

3. Where do you see the most promise today- an example? Long first: large position in AAPL. What could we possibly figure out that not every other person on the planet could figure out? Come to the view that large cap stocks have the same efficiencies as small cap stocks if you take a step back. Compare to KO a decade ago, selling bottlers to make earnings, and it was a high multiple stock. We didn’t short it because, we thought, “What could we possibly know about coke?” KO then declined like crazy- we realized we were making a big mistake by ignoring large companies with large inefficiencies.

What is the inefficiency at AAPL? It trades at a low multiple because people have seen the history of hardware companies, such as the Motorola RAZR, which has been learned. Issue with AAPL is it started with the iPod, got all your music. Now you have the music on your iPhone. TV, iPad, photos. Once you have an Apple device, you buy a second. You become an “Apple customer.” You’re not going to choose your next phone by it being 5% better than the iPhone5. Most people will just go buy the new iPhone5. It’s not a one-time hardware sale; you need a new one every 2 years. They simply wear out, it’s not just to get better phone. Market thinks it’s a hardware company that could lose its edge. Instead, it’s a growth, recurring revenue business that the market has refused to award it. The majority of market practitioners misunderstand it. Bought at 60, sold at 80. Watched, watched, and bought back at 240.

4. More on AAPL: TVs with low margins. Answer: (Note that AAPL shares have jumped 25% since he made these comments) At this valuation, you are not paying for TV at all. You’re not even paying for the current business. $390 per share for business ex cash, earn $45, getting it at 8x p/e. Grew rev at 70% last year, still penetrating the world on early stage iPads, geographically still penetrating for iPhone, especially in China. Even on a bad day, that multiple should be more than a premium of the market. Best company on the market, and trading for half the market premium. Room for value destruction at this price. Never done big acquisitions, R&D expenditure is tight, CAPEX is smart. On TVs: they’ll have to revolutionize the TV like they have the iPhone. Otherwise, they won’t do it. The cable companies might even subsidize the TV. But you don’t have to be right about the TV to make money on the stock.

5. Risk/position sizing? He doesn’t believe in any of the quantitative measures of risk- instead the common sense of risk- how much can you lose? How quickly can you get out of a position? Never bet the whole firm on one position. Large long position is small double digits. Short position smaller, because of upside risk.

6. On poker: skills are somewhat related, you have some information you can see for sure, and some you can deduce, and then you have the future which is a range of possible outcomes. You try to optimize it based on all these factors. In the past, we've highlighted the growing number of hedge fund managers that play poker.

7. Japan- still in trouble, out of the money options are mispriced because people pricing them are using VAR, which is fundamentally flawed.

8. Gold: how do you value it? He is long a lot of gold, has been for a few years, since the financial crisis. Moved all the problems from the private sector to the public sector, which will have an effect on the currency. Gold is money; you don’t value it for its use as a productive commodity. This money only grows at 1-2% per year and the other kind of money changes whenever the central banks decide they need to lend the banks a trillion euros. Policies being pursued now are fraught with risk. Makes sense to have a fraction of your assets that is not exposed to the consequences of their decisions.

Einhorn originally bought physical gold in 2009. Since then, he's also bought gold miners.

9. Emerging Markets? Don’t invest in emerging markets; not comfortable with accounting, risks.

10. Walgreens? Thought about being long WAG, due to fight with ESRX. Idea is they will make up eventually and the stock will pop higher. First, figured out they can’t get any edge on whether they work it out or not. Now they think that since WAG customers can’t use ESRX, it is already a permanent loss for WAG because they may change already. Compromise will still be a lower price per prescription, so everyone else will want the same deal as ESRX gets with WAG. Caremark could demand the same deal since ESRX did. Believe it will be a more sustained, permanent impairment of earnings.

11. Why doesn’t Android win? AAPL has high switching costs. They don’t have a lifetime guaranteed annuity, what they have is a happy, loyal customer. Most of the time these types of franchises have 20-30x multiples, but it’s being priced as a deteriorating business, which it’s not.

12. Fed Balance Sheet: He can’t figure out what the implications of the increased fed balance sheet means, and he doesn’t need to for holding his longs. We’re not going to know what could go wrong, it’s almost certain to be something we don’t think it will be. The fed chairman is a “fanatic” who is living out his academic thesis. We could have a real problem on the way out.

13. New York Mets: of all of his investments, he thought for sure this was the most certain to be negative risk-adjusted return, which made it so irritating that he couldn’t do it.

14. Research in Motion (RIMM): has problems, but could be an interesting long (Einhorn established a new long position in RIMM in Q4 2011). Critical mass for app developers, and they may have missed it. Has a good B/S, trades at a low multiple, and has some IP that a lot of tech companies would want. Trades on a run-off basis, it’s a reasonable speculation that it won’t melt. Not a fantastic investment, but the price has come down so far, that it makes no sense to short it.

15. Shorting GMCR and being public about it - do you have confidence in the SEC? He has no confidence in the SEC. There are about 20 or 30 ways he can win on the GMCR short, but SEC is not on the top of the list. Accounting practices are rather blatant and obvious that the SEC should do something about it, but they don’t look likely to do anything.

If you haven't seen it yet, you can view Einhorn's short case on Green Mountain Coffee Roasters (GMCR).

16. Time arbitrage: he thinks their time horizons of 1-3 years is longer than most market active participants. Most hedge funds under 6 months, long only 6-12 months. Don’t want to hold things that could be in half before it works. But don’t say “dead money” because it could move when you least expect it.

MF note: Blue Ridge Capital's John Griffin has often classified investments as time arbitrage or catalyst driven. Joel Greenblatt's Gotham Capital also utilizes time arbitrage as part of its investment strategy.

17. Long DELL: AAPL is much better than DELL, but DELL has been a great business innovator. They were lousy capital allocators, bought back stock at 40-50x earnings. Then once the stock collapsed, they bought businesses at high multiples instead. In the middle of 2011, they woke up and started buying back stock cheap. They haven’t made any bad acquisitions lately either. $15 stock, $7 per share, $2 EPS, getting stock at 4x P/E even if they’re not growing fast. If they use part of the $7 to buy back stock, you could win. Misunderstanding is at least half of their business is not PCs or notebooks. If you put 8x p/e on other stuff, you get the PC business for free. You can see further thoughts on DELL in Einhorn's investor letter.

18. Industries he won’t touch? He learned to never say never. Six months before he bought gold, he said never to buy gold. His mind can change at times. Betting on outcome of clinical trials is very challenging, and he has no expertise. But he still won’t rule it out. He never would have a large allocation in technology 11 years ago. Time and place for everything just recognize which areas are harder for you.

19. Economics is not a science, it’s an art. He’s very critical of it, people make some very bad conclusions that have had awful consequences for our society. Winning Nobel prizes, but enacting their views as if their science instead of art, have had huge negative consequences.

20. Online gaming? He has no idea how it will sort out. If it opens up, it will be very competitive.

21. St. Joe (JOE): concept stock runs into a math problem. You know exactly what the values are today, because you have transactions and you know what the value is. They can’t create value through actively managing. All they can do is reduce the amount of value that’s being destroyed every day. Land worth $7, stock worth $14. not levered, but it’s also good that it can’t rocket up either. Only way it works is if they discover oil, and his diligence says they’ve already looked.

If you haven't seen it, check out Einhorn's short thesis on JOE.

22. Commodities business? Very hard- need to figure out the normal price of the company, and see if the business is value added or subtractive, and then see if the business is cheap. So when the prices swing quick, you can get hurt badly. You need to have an insight on which way the commodity price will go.

For the rest of the notes from the CIMA Conference, head to these posts:

- Dan Loeb: Lessons He's Learned as an Investor

- Distressed Investing Panel (Dan Loeb & Daniel Krueger)

- Bruce Berkowitz's Basic Checklist for Investing & What He's Learned

- Long/Short Equity Investing Panel: Whitney Tilson

- Bill Miller on What Stocks He Likes Now

- Michael Karsch on Risk Management

- Bruce Greenwald's Market Comments

Bruce Greenwald on the Market: CIMA Conference

Continuing the series of notes from the CIMA conference (Columbia Investment Management Association), we present Bruce Greenwald's introductory comments. Greenwald is the Robert Heilbrunn Professor of Finance & Asset Management at Columbia Business School.

Bruce Greenwald's Introductory Comments

1. Apocalyptic viewpoint is almost never justified. At the absolute worst, it will be a decline of 1-2% in economic activity, much less than the 5-8% in 2009. (Not true of Greece & Portugal).

2. Through the crisis, corporate profits other than financial sector have been extraordinary. Even Deere & CAT had profit declines of 40-50%, but no losses.

3. Securities are not grossly mispriced if you look at growth expectations. 8-12% likely stock moves based on operating earnings. No bubble in stocks. 3% on 30-year government bonds, with no inflation protection, seems risky.

For the rest of the notes from the CIMA Conference, head to these posts:

- Dan Loeb: Lessons He's Learned as an Investor

- David Einhorn Question & Answer Session

- Distressed Investing Panel (Dan Loeb & Daniel Krueger)

- Bruce Berkowitz's Basic Checklist for Investing & What He's Learned

- Long/Short Equity Investing Panel (Whitney Tilson)

- Bill Miller on What Stocks He Likes Now

- Michael Karsch on Risk Management

PIMCO's Bill Gross: How To Generate Returns in Low Yield Environment

PIMCO's bond vigilante in chief, Bill Gross, is out with some pertinent commentary addressing how investors can generate returns in a low yield environment while still keeping risk reduced.

Given that the Federal Reserve has signaled they'll keep rates low until mid-2013, Gross lays out a playbook in his April investment outlook entitled, The Great Escape: Delivering in a Delevering World.

Bill Gross' Advice

"When interest rates cannot be dramatically lowered further or risk spreads significantly compressed, the momentum begins to shift, not necessarily suddenly, but gradually - yields moving mildly higher and spreads stabilizing or moving slightly wider..

In such a mildly reflating world, unless you want to earn an inflation-adjusted return of minus 2%-3% as offered by Treasury bills, then you must take risk in some form.

We favor high quality, shorter duration and inflation-protected bonds; dividend paying stocks with a preference for developing over developed markets; and inflation-sensitive, supply-constrained commodity products" (emphasis ours).

Gross then goes on to break down specific plays in each asset class, writing:

"For bond markets: favor higher quality, shorter duration and inflation protected assets

For stocks: favor developing vs. developed. Favor shorter durations here too, which means consistent dividend paying as opposed to growth stocks.

For commodities: favor inflation sensitive, supply constrained products.

And for all asset categories: be wary of levered hedge strategies that promise double-digit returns that are difficult in a delevering world."

Bill Gross' entire April market commentary is embedded below:

If you missed his last note, we've also posted up Bill Gross' investment outlook: defense.

For a somewhat related macro/econ post, head to Bridgewater's Ray Dalio on deleveragings.

What We're Reading ~ 3/28/12

Wisdom from Jason Zweig [Kirk Report]

35 years of Warren Buffett's greatest investing wisdom [Motley Fool]

Risk parity vs endowment model vs permanent portfolio [World Beta]

Mutual funds, track records & departing managers [Reformed Broker]

How FairholmeCap alums started GoodHaven Capital [Morningstar]

Also: The GoodHaven managers will be presenting at the Value Investing Congress

Hedge funds buying hand over fist [Business Insider]

Lowes Corp cheap on sum of the parts basis [Rational Walk]

Post-bankruptcy shares face headwinds [Gemfinder]

5 things learned about a career on Wall Street [Big Picture]

Warren Buffett's $50 billion decision [Forbes]

Charlie Munger on the perfect turnaround [Variant Perceptions]

The case for remaining long risk [Economic Musings]

On the equity risk premium [Aswath Damodaran]

On equities versus bonds [FT]

Why stocks are riskier than you think [WSJ]

On Mitt Romney's hedge fund backers [Fortune]

Psychology of Intelligence Analysis [Central Intelligence Agency]

Tuesday, March 27, 2012

2012 Hedge Fund Compensation Report

We've found a great resource if you're looking for data to help get a raise in the hedge fund industry, to switch funds, or to enter the industry as a new hire. Or if you run a hedge fund, you'll find it useful because it lets you see how much your competitors are paying their employees.

The new 2012 Hedge Fund Compensation Report is out and definitely worth a look.

Here's some key takeaways from 2012:

- Annual average cash compensation for hedge fund professionals is $311,000

- Average hedge fund employee said base pay was up 8% & bonus down 4%

- Parity: Senior associates saw 28% increase in pay, COO's saw steep drop

- Funds that focused on event-driven strategy had the best paid employees

- One in four funds say they're hiring for research positions

The full report is 44 pages long and also includes looks at base package versus bonus, year over year comparisons, average earnings by title, breakdowns of fund size, and more.

If you're wondering their sources, in the past they've pulled data from the likes of Citadel, Lansdowne, Carlson, Peak 6, Morgan Stanley, UBS, Barclays, and tons of smaller funds as well. The report is definitely a comprehensive benchmark for hedge fund compensation practices in the industry.

If you're an analyst, trader, IR professional or COO, the 2012 Hedge Fund Compensation Report is a great tool for comparison and salary negotiation. Click here to check out the report.

Monday, March 26, 2012

SAC Capital Starts Hyatt Hotels Position, Boosts Amarin Stake

Steve Cohen's hedge fund firm SAC Capital just filed two separate 13G's with the SEC:

Hyatt Hotels (H)

First, the hedge fund disclosed it has initiated a brand new position in Hyatt Hotels (H) with 2,804,400 shares, which is a 6.2% ownership stake in the company. They did not own any shares at the end of 2011. They filed the disclosure today due to portfolio activity on March 14th when they crossed the regulatory threshold.

This is the second hotel/hospitality-related transaction for the hedge fund as SAC bought more Marriott Vacations (VAC) recently as well.

Per Google Finance, Hyatt is "a global hospitality company. The Company manages, franchises, owns and develops Hyatt-branded hotels, resorts and residential and vacation ownership properties globally."

Amarin Corp (AMRN)

Second, Cohen's firm has revealed it now owns a 4% ownership stake in AMRN with 5,415,392 shares. This is an increase of 57% in their position size since the end of 2011. The disclosure was filed today due to trading activity on March 14th.

Shares of AMRN jumped days after SAC boosted its position as the company received a new patent.

Google Finance, Amarin is "a clinical-stage biopharmaceutical company focused on developing improved treatments for cardiovascular disease. The Company’s development programs capitalize in the field of lipid science and the therapeutic benefits of essential fatty acids in cardiovascular disease. It is focusing its efforts on its candidate, AMR101, a prescription grade Omega-3 fatty acid, comprising not less than 96% ultra pure ethyl ester of eicosapentaenoic acid (ethyl-EPA)."

Trian Fund Management on Kraft, Family Dollar, & Wendy's (Investor Letter)

Nelson Peltz's Trian Fund Management finished 2011 up 3.9% in their Offshore Fund and up 5.6% in their Onshore Fund. Their year-end letter to investors touched on some of their largest investments:

On Kraft (KFT)

They established a new position in KFT during 2011 and their thesis was that scale "had become a vice, not a virtue" and they also thought it "offered a compelling risk-reward (one of the lowest forward earnings multiples in the packaged food space and an almost 4% dividend yield)."

The company announced it would split itself in two via a tax-free spinoff: a growth company (their global snacks business) and a cash company (a slower growth, North American grocery business). Trian believes this will lead to "reduced complexity; better resource allocation; margin expansion; and improved organic growth."

Bill Ackman's Pershing Square Capital also bought KFT in August.

On Family Dollar (FDO)

Peltz's firm first invested in mid-2010 and the thesis was that if operating metrics caught up to their closest competitor (Dollar General), the stock would trade higher. Trian offered to buy the company, but the board rejected the offer. Many investors thought this was a maneuver to invoke other takeover offers, but nothing materialized in that regard.

Since then, Family Dollar has implemented a new President, increased store openings, and renovated more stores. Bill Ackman also owns shares and has in the past laid out his FDO thesis.

On Wendy's (WEN)

Trian notes that the company divested its stake in fellow fast food chain Arby's in 2011 and it is now a pure play on the single Wendy's brand. The firm likes that the company's new menu items led to higher sales and that store level margins have improved.

In early December, Trian filed a 13D with the SEC that it was allowed to boost its ownership position in WEN to 32.5%, up from their 26.2% stake per an agreement with the company.

On Potential New Buys

In terms of other positions, the investment firm says that they expect to make 2-3 new core investments in 2012 as they've built a solid list of potential buys. Regarding what they're looking at, Trian writes:

"We like the large-capitalization profiles as these companies tend to be higher quality companies (companies with significant market shares, investment grade balance sheets, strong dividend paying capacity and attractive trading liquidity) where we attempt to minimize risk and maximize reward by making our investment at what we believe are attractive valuations and having a plan to make them more profitable."

Trian also believes the M&A landscape will pick up in the future.

For more from them, we've posted up Trian's bullish case for Tiffany & Co (TIF). And in recent portfolio activity from Nelson Peltz' firm, we've highlighted they've sold some H.J. Heinz (HNZ). They've done so largely because the company has traded at a premium to its competitors.

Jeff Saut Says Wait For a Fatter Pitch

Market strategist Jeff Saut is advocating patience in his latest investment strategy comments. He writes,

"Indeed, many investors suffer from an 'action bias,' aka a desire to do something, when in reality there are times in the markets when there isn't much to do. When that occurs the best plan is to do nothing and wait for a 'fatter pitch.'

Obviously, that is what I have been doing since the buying stampede ended in late January. Well that's not entirely true, because I have actually raised some cash in anticipation of either a pause in the stock market or a correction."

Last week Jeff Saut said the easy money's been made in this market and he's been cautious but not bearish.

It's obvious he's simply looking for an opportunity to buy the dip. But then again, so are many other investors. So what does the market do? Grind slowly higher, of course.

Embedded below is Jeff Saut's full weekly commentary:

You can download a .pdf copy.

To see what Saut is waiting to buy, check out his portfolio positioning here and this list of stocks.

Why Phil Falcone Likes Spectrum Brands: Stock of the Week

This week's focus stock is Spectrum Brands (SPB) and the article takes a look potentially at why Phil Falcone's hedge fund Harbinger Capital Partners has established such a large position. Previous write-ups include: why Maverick Capital owns Amdocs and why George Soros owns Comverse Technology.

The following is written by Tsachy Mishal, portfolio manager at TAM Capital Management.

The subject of billionaire hedge fund manager Philip Falcone elicits strong feelings. He is best known for his big bet on Lightsquared but lesser known for his other big bet: Spectrum Brands (SPB). Phil Falcone controls over 50% of the $1.65 billion company.

Spectrum Brands is a roll-up of many consumer brands such as Rayovac batteries, Remington shavers, Hot Shot bug killer, Tetra fish food and many more. The largest chunk of the profits comes from the batteries division. Spectrum Brands has had good momentum versus its peers as their discount brands tend to gain market share during difficult economic times.

SPB has a $3.35 billion enterprise value and a $1.65 billion market cap. On an enterprise value to EBIDTA basis, Spectrum Brands trades at an 11% discount to peers based on 2013 expectations. This does not even take into consideration the $1.2 billion net operating loss carry forwards (NOLs) they hold.

What I Like:

- Spectrum's stock has 23% upside before trading at the valuation of its peers, even ignoring the NOL's.
- The businesses have positive momentum and are gaining share. Consumers are likely to continue shifting towards lower price brands.
- Spectrum Brands has a greater than 12% free cash flow yield based on 2012 expectations.
- The controlling shareholder seems to have his incentives aligned with the best interests of other shareholders.

What I Don't Like:

- The company is carrying a lot of debt.
- The business is cyclical both from an economic perspective and a market share perspective.
- The stock is illiquid as a few owner's control 70% of the company. Fewer than 200k shares trade a day on average.
- Phil Falcone does not seem to have the highest ethical standards as he borrowed money from his hedge fund while locking up other investors.

The valuation of Spectrum Brands is attractive compared to its peers and is the most tempting aspect of the stock. I suspect that it will outperform but in the end I decided not take a position due to the negative factors I listed.


Thanks to Tsachy for the write-up. We've also highlighted how Harbinger has been buying SPB shares recently. The hedge fund originally acquired shares back in August 2009 when the company emerged from reorganization (Chapter 11).

At a past investment conference, Falcone has previously stated that he likes Spectrum Brands' solid balance sheet, high 11-12% free cashflow yield, and the fact that the company had been focused on debt paydown by reducing leverage from 3.5x to 3x.

You can scroll through all of the previous stock of the week articles via this link.