James Montier on Emerging Markets: London Value Investor Conference

We're posting notes from the London Value Investor Conference 2016.  Next up is James Montier of GMO who talked about emerging markets.


James Montier's London Value Investor Conference Presentation

It is hard to be a contrarian investor. Human nature makes us feel safer and warmer in the middle of the herd. The Institutional imperative means it is better to fail conventionally than to succeed unconventionally. Asset managers tend to play it safe. As Jeremy Grantham has noted career risk produces conformity and anchoring among investment managers . Montier pointed out that value metrics can provide investors with a powerful alternative anchor that can be used as strong form of behavioural self-defence.


Investment idea: Emerging Markets  

Earlier in the year GMO were considering whether or not to put money to work in emerging markets. EM had been hated by investors in recent years and Graham and Dodd P/E ratios showed them as undervalued. It looked as though value stocks in emerging countries were particularly cheap which got them more excited. The value proposition in EM looked the best it had been for many years.

They stripped out financials and resources stocks from their analysis because both sectors are hard to value.  It is difficult to value resource companies as future returns are tied to the price of the underlying assets such oil or gold. Financials are opaque because of the difficulty of knowing what assets they hold. After they had stripped out financials and resource stocks they concluded that EM still looked cheap.

Montier’s team asked themselves how could they be wrong? A question Montier said investors do not ask enough. They thought perhaps that EM equities have not been equity like? Perhaps they were not like developed equities? Their results showed that EM equities were indeed like developed equities at least in terms of earnings yield – with a 6.5% average annual return. 

They asked whether the average future conditions for EM going forward were likely to be similar to the average past conditions? They had been looking at the last 15 years in particular and they wondered if that period was normal? They asked what sort of growth would be required over the next 10 years in EM to make them feel comfortable that today’s prices offered a good value?

They concluded earlier in the year that about 1.5% real growth would do it. That did not seem like a huge hurdle, however, when they went back and looked at the last 15 years they was surprised to find that the EM value subgroup had only grown at 1.5% per annum in real terms. That tempered their enthusiasm a bit. It made them conclude that EM valuations were fair but not cheap. Compared to the opportunity set faced by investors today, though, EM appeared to be preferable to other assets.

They also started to worry that looking back 15 years was not long enough especially as the Asian currency crisis of 1997 was excluded from the data. This gave them further pause for thought as earnings yields in that period were crushed. He pointed out that it is also important to balance this with the recognition that EM economies are in better health than they were back in the late 1990s. For example, today most EM countries run a current account surplus rather than deficit and there are less fixed exchange rates. They also worried about the high level of private sector debt at a macro level but were relieved to find that it did not show up in the balance sheets of individual companies that make up the MSCI emerging index.

Even if they were right about valuations in local terms could they still lose on the currencies? They found that the EM currencies had already fallen a lot from expensive to fair value. This meant that if they fell further they would have the reassurance of knowing that the currencies were cheap and should mean revert at some point - a temporary but not a permanent impairment of capital.

In the end they decided they would buy some emerging equities but they tempered their buying because of the negatives they had found around earnings.



Be sure to check out the rest of the presentations from the London Value Investor Conference.

Maverick Capital Focusing on China & Emerging Markets (Investor Letter)

Lee Ainslie's hedge fund firm Maverick Capital finished the first quarter up 3.6% and has seen 14% annualized returns since 1995. Many of their recent gains are attributable to their short positions in emerging markets. As we've detailed before, some hedge funds believe inflation is the biggest threat to the emerging world.

The hedge fund is now paying more attention to global macro issues as they affect markets more than ever. Maverick is not the first equity-centric hedge fund to include macro observations in their research as David Einhorn's Greenlight Capital has done this for a few years as well.

China's Importance

In Maverick's first quarter letter, Steve Galbraith talks about the importance of emerging markets. He writes, "From a top down perspective, what we see in China is a wonderful investment cocktail characterized first and foremost by tremendous growth potential, likely laced with enormous winners and losers but with still meaningful reliance on the state for capital allocation."

Interestingly, Maverick had $2 billion in gross capital (both long and short) exposed to China. They are long consumer and technology companies, financial firms with double digit return on equity, Chinese social media companies, as well as industrial companies with wide moats. On the short side, they are focusing on bad balance sheets and bad governance. In the past we've highlighted some of the Chinese reverse merger frauds as well.

Maverick believes the biggest risk in China is the misallocation of capital. Galbraith writes that, "Ironically, I suspect the true test of the Chinese economic model will come not with hardship, but with prosperity." Many investors are watching cautiously to see how the Eastern nation handles such growth.

Embedded below is Maverick Capital's first quarter letter (email readers need to come to the site to read it):



In recent portfolio activity from this hedge fund, we detailed how they reduced their position in Rightmove recently (LON: RMV). For more commentary from Ainslie, be sure to read his 2010 year-end letter focusing on the impact of fund size on returns.

Gold is NOT Eric Mindich's Biggest Holding: A Memo to Bloomberg Regarding 13F Filings

Yesterday afternoon, Bloomberg ran a piece entitled, "Eric Mindich, Like John Paulson, Makes Gold ETF His Fund's Biggest Holding." There's just one problem with that headline: it's not really correct. Here at Market Folly, we pride ourselves on in-depth analysis of SEC Filings, and in particular, the 13F's that disclose the latest hedge fund investments. And today, we get the perfect chance to prove it.

The SPDR Gold Trust (GLD) is not the largest holding at Eric Mindich's hedge fund Eton Park Capital Management. As per the most recent 13F detailing positions as of June 30th, 2010, Eton Park's largest position is puts on the iShares MSCI Emerging Market Index (EEM). At quarter close, Mindich's position in GLD was valued at $800,289,000. His put position on EEM was valued at $895,680,000. In the second quarter, Eton Park actually increased their bet against EEM by 61%, buying puts representing 9,100,000 additional shares. Their put exposure on this name now represents 24,000,000 shares of EEM.

Maybe Bloomberg's data-set didn't take into consideration the put/call column on the actual filing. (Numerous automated data sorting programs skip over this and omit options positions entirely). Maybe it was an honest mistake. Maybe Bloomberg doesn't classify puts as an 'investment' and so it merely comes down to technicalities of the language used in their article. But even if that was the case, you still can't really call the SPDR Gold Trust their single 'biggest reported investment'.

Why? Well, because Eton Park also owns both puts and calls on GLD as well. In the second quarter, Mindich's hedge fund bought the following:

$800,289,000 worth of SPDR Gold Trust (GLD) shares
$608,400,000 worth of GLD calls
$486,720,000 worth of GLD puts

We don't know their true exposure to gold because a 13F filing does not disclose the strike price or expiration date of underlying options positions. However, you could net out their ownership of common shares, calls and puts to find that they have around $921,969,000 worth of long exposure to GLD. But you also have to keep in mind that Eton Park is an arbitrage focused fund. As such, all of these discrepancies are relevant to determine the type of wager they are making with various positions.

The only way that GLD is Eton Park's top holding is if Bloomberg is treating all of the above as gross exposure to GLD or if they are netting out the exposure as we have above. But even then, there was no mention of this in their article at all. They merely cited the $800 million position in the underlying shares. The fact that Bloomberg completely omitted the information that Eton Park owns both calls and puts on the same exchange traded fund is somewhat appalling. It's one thing to own just the shares of GLD as a directional bet (as they've mistakenly construed). It's entirely different when you add in ownership of both puts and calls on the underlying shares as those affect the net position and exposure. Nevermind that Bloomberg missed the fact that their standalone position of GLD shares are not Eton Park's 'biggest reported investment' in the first place.

The comical part of all of this is that Bloomberg completely skipped over Eton Park's options positions in both EEM and GLD, and yet they end their article with this note (emphasis added by MarketFolly):

"The SEC requires money managers who oversee more than $100 million in U.S. equities to report their holdings on a Form 13F within 45 days of the end of each quarter. The filing must include all holdings in stocks that trade on U.S. exchanges, as well as options and convertible debt."

Factually, Eton Park's largest single reported holding is in puts of the iShares MSCI Emerging Market Index (EEM). Their position in shares of the SPDR Gold Trust (GLD) is the second largest reported holding. But even then, there's some ambiguity surrounding their entire GLD exposure and the type of wager they're making when you consider the puts and calls they also own. This just goes to show that attention to detail is a must when examining SEC 13F filings.

Apologies for this little diatribe, but it's irritating when potential misinformation is floated around, especially by a mainstream media source. In the end, Bloomberg will probably update the article from 'biggest' holding to 'big' holding or something of the sort (with zero mention of Market Folly of course). That's perfectly fine, as long as they remedy the misinformation that's currently out there. Our readers know where to come for hedge fund portfolio updates.

Stay tuned this week as we are set to release an in-depth summary of the new batch of 13F filings and latest positions of the top hedge funds in the game. For more on Eric Mindich's hedge fund, we also detailed Eton Park's new Doral Financial (DRL) position.

Best Investments During Inflation

So, what is the best investment during inflation? The good news is that there are a multitude of securities and assets that can protect against inflationary pressure. The bad news is if such a scenario comes to fruition, your purchasing power is reduced. The main thing to keep an eye on is the money supply. Throughout the crisis, the monetary base has expanded, but has yet to materialize in the money supply. If/when this comes to fruition, you'll be prepared after learning how to invest for inflation below.

Interestingly enough, deflation has been the top concern amongst investors as of late and yesterday we detailed the best investments during deflation. But investors have quickly forgotten that inflation was the primary concern just a mere few months ago. This revisits a post we originally published in August 2008 examining investment scenarios for inflation versus deflation. Regardless of outcome, investors need to be prepared for either.

Why should you be worried about inflation? Well, how about because one of the greatest investors of this generation is concerned. Yup, Baupost Group's Seth Klarman is worried about inflation. Not to mention, Kyle Bass, the hedge fund manager who predicted the subprime crisis as well as sovereign defaults has voiced concern about inflation and significant currency devaluation around the globe. For every prominent investor worried about deflation, there is another concerned with the converse scenario.

Here are the best investments during inflation:

Avoid Cash/US Dollars: Inflation typically results in domestic currency devaluing. You can fight this by simply not holding it and allocating the capital into other assets and investments. Nowadays, cash is most certainly part of the asset allocation picture. During inflation, you want to have as little of it on hand if possible. Since it devalues during inflation, those of you wishing to press your bets against the US dollar can buy the PowerShares Bearish US dollar index fund (UDN).


Buy Gold & Precious Metals: If you'll think back toward the end of the crisis, gold was all the rage. As the Federal Reserve's printing presses worked overtime to churn out US dollars to resuscitate the economy, many became very worried about inflation. Their number one investment to protect against this? Gold. While precious metals in general are a solid bet, gold in particular is seen as a hedge against uncertainty and a store of value. For an in-depth thesis as to why you should buy gold during inflation, we turn you to out post on successful hedge fund manager John Paulson's gold fund. He launched this vehicle last year as a means of betting against the US dollar. Another option is the stocks of companies that mine the metal. One hedge fund recently opined that gold is good, but gold mining stocks are better.

We've detailed how countless other prominent investment managers favor yellow bricks. John Burbank's Passport Capital outlined the rationale for owning physical gold. David Einhorn's hedge fund Greenlight Capital also owns physical gold. Those of you who don't have access to physical bars can invest via the SPDR Gold Fund (GLD). Practically all of the hedge funds that are not investing in physical gold use this investment vehicle for their gold exposure. If gold doesn't tickle your fancy, legendary investor Jim Rogers sees opportunity in silver and palladium which can provide you with precious metals exposure. PALL is the ticker for playing palladium while SLV is a way to play silver.


Buy Crude Oil: Going long oil ties into the whole 'buy commodities' theme as protection. In a truly inflationary environment, oil is supply inelastic; any increase or decrease in price would not result in a corresponding increase or decrease in supply. In the past we've outlined how to invest in crude oil, as there are many investment vehicles out there, each with pros and cons. These funds include USO, DBO, & USL and are examined in-depth via the link above.


Short Fixed Income: Bonds should be avoided due to a weak domestic monetary system. In particular, avoid US Treasuries as they will underperform. As yields start to rise, bond prices will fall. A plethora of prominent investors have gone this route in order to gain inflationary protection. Seth Klarman has purchased out of the money puts on bonds. He's acquired tail risk insurance against a sharp rise in interest rates that protects him should rates skyrocket to 10%. Legendary hedge fund manager Julian Robertson had previously put on a curve steepener trade and then shifted to a constant maturity swap (CMS) trade. These are more advanced trades and typically are reserved for institutional investors. Retail investors can buy puts on or short the iShares 20+ Year Treasury (TLT).


Buy Emerging Markets: A weak domestic currency (US dollar) implies higher returns can be found abroad in other countries. A monetary system in trouble in the home land means your dollars should be invested abroad (especially consider commodity producing nations such as Australia and Brazil). You can invest in either emerging market currencies, equities abroad, or investment funds denominated in those foreign currencies. For broad emerging market equities exposure, one can purchase iShares Emerging Markets Index (EEM). For the Australian Dollar, consider FXA and for Brazilian exposure, consider EWZ.


Buy Technology: While this was also a suggestion for investing during deflationary times, it applies to inflation under the same rationale. Regardless of environment, technology is in demand and will continue to evolve.


Buy Treasury Inflation Protected Securities: These types of treasuries (known as TIPS for short) provide the safety of a government bond with the bonus of protection against inflation. You can buy these outright, or via the iShares Barclays TIPS fund (TIP).


While inflation was all the talk only a few months ago, it has since taken a back seat to deflationary chatter. Given the back and forth, it only makes sense to examine both scenarios. In the depths of the 2008 crisis we broadly examined investment scenarios for inflation versus deflation. At the time, it was unclear what type of environment we'd be entering. While still not entirely evident to this day, many have postulated that deflation in the near-term will then give way to inflation in the longer-term. A compromise of views, if you will. We've mapped out inflationary defenses above and for a look at the converse scenario, be sure to check out the best investments for deflation. Now you have a loose framework for either environment.

John Burbank's Passport Capital Hedges With ETFs, Options: 13F Filing

(This post is part of our series on tracking hedge fund portfolios. If you're unfamiliar with tracking investments they disclose via SEC filings, check out our series preface on hedge fund 13F filings.)

Next up is John Burbank's hedge fund firm Passport Capital. Burbank founded the San Francisco hedge fund in 2000 and they use sector specific and macroeconomic analysis to select their investments. Once they have identified potential themes, they'll drill down to find specific companies that can benefit.

Burbank has over a decade of experience in markets having previously worked as a consultant and as a director of research at ValueVest Management. His educational background includes an undergraduate degree from Duke University and an MBA from Stanford University. Passport previously had a track record of gaining 27% annually, but like many other funds had a rough 2008.

Previously, we've detailed a lot of investment resources out of Passport including:

- Passport's rationale for owning physical gold
- Passport's recent Agriculture Fund investor letter
- The hedge fund's case for agriculture

The positions listed below were Passport's long equity, note, and options holdings as of December 31st, 2009 as filed with the SEC. All holdings are common stock unless otherwise denoted.


Brand New Positions
iShares S&P 500 (SPY) Puts
iShares Emerging Markets (EEM) Puts
CF Industries (CF) Calls
US Steel (X) Calls
Dr Pepper Snapple (DPS) Calls
Barrick Gold (ABX)
CVS Caremark (CVS)
Materials (XLB) Puts
Terex (TEX) Calls
Barrick Gold (ABX) Calls
UnitedHealth (UNH)
Illumina (ILMN)
Ultrashort Crude Oil (SCO)
News Corp (NWSA)
Boston Scientific (BSX)
Small Cap Bear 3x (TZA)

All the rest of their new positions were each less than 0.5% of reported assets: Ensco (ESV), Tesoro (TSO) Puts, Knight Capital (NITE), Rowan (RDC), Nuvasive (NUVA), CF Industries (CF), Medtronic (MDT), Dollar Tree (DLTR), Knight Capital Group (NITE) Calls, Mosaic (MOS) Calls, National Oilwell Varco (NOV), & Omnivision (OVTI)


Increased Positions
Proshares Ultrashort Real Estate (SRS): Increased by 23,451% (was previously a tiny position)
Perfect World (PWRD): Increased by 971%
iShares S&P 100 (OEF) Puts: Increased by 356%
Onyx Pharma (ONXX) Calls: Increased by 100%
Janus Capital (JNS) Puts: Increased by 100%
US Steel (X): Increased by 78.9%
Discover Financial (DFS) Puts: Increased by 20%
Dr Pepper Snapple (DPS): Increased by 17%


Reduced Positions
Wendys Arbys (WEN): Reduced by 47.4%
Mckesson (MCK): Reduced by 5.23%
Teva Pharma (TEVA): Reduced by 2.3%


Removed Positions (Sold out completely):
Materials (XLB) Puts
PNC Financial (PNC) Puts
Wells Fargo (WFC) Puts
Covidien (COV)
Cephalon (CEPH)
Pfizer (PFE)
Las Vegas Sands (LVS) Calls
Golar LNG (GLNG)
Onyx Pharma (ONXX)
Myriad Genetics (MYGN)
Gilead Sciences (GILD)
Wright Medical (WMGI)
Amag Pharma (AMAG)

The rest of their sold positions were each less than 0.5% of their reported assets: Stryker (SYK), Starent Networks (STAR), Activision Blizzard (ATVI), Momenta (MNTA), Petrohawk (HK), Beazer Homes (BZH), Aeropostale (ARO), Hovnanian (HOV), Sanderson Farms (SAFM), BRF Brasil Foods (PDA), Pride (PDE), Impax Lab (IPXL), Weatherford International (WFT), EHouse (EJ), CKE Restaurants (CKR), & Ship Finc (SFL)


Top 15 Holdings by percentage of assets reported on 13F filing

1. SPDR S&P 500 (SPY) Puts: 15.79%
   
2. iShares S&P 100 (OEF) Puts: 14.4%
3. iShares Emerging Markets (EEM) Puts: 12.23%
   
4. CF Industries (CF) Calls: 8.21%
   
5. US Steel (X) Calls: 5.77%
   
6. Dr Pepper Snapple (DPS): 4.58%
   
7. Onyx Pharma (ONXX) Calls: 2.64%
   
8. US Steel (X): 2.64%
   
9. Dr Pepper Snapple (DPS) Calls: 2.55%
   
10. Barrick Gold (ABX): 1.85%
    
11. Perfect World (PWRD): 1.62%
    
12. Mckesson (MCK): 1.46%
    
13. AK Steel (AKS): 1.29%
    
14. Wendys Arbys (WEN): 1.16%
    
15. CVS Caremark (CVS): 1.15%
    

It appears that John Burbank's hedge fund Passport Capital utilizes exchange traded funds (ETFs) and options for hedging purposes as their top three holdings are all put positions on indexes. This falls directly in line with Goldman Sachs' recent research where they found hedge funds mainly use ETFs as a hedging tool. Additionally, you'll note that they use options to express a lot of their position views as well. Their largest actual equity position is in Dr. Pepper Snapple (DPS) and they additionally own calls on the name as well.

Assets reported on the 13F filing were $2.2 billion this quarter compared to $1.2 billion last quarter, over a 70% increase in exposure which is nothing to sneeze at. (Remember that these filings are not representative of the hedge fund's entire base of AUM). So, the vast majority of their portfolio activity was via completely selling out of some names and starting brand new positions in equities and options.

Passport is definitely focused on the global growth and natural resources themes with positions in steel companies, agriculture plays, and gold plays. Keep in mind that Passport also has many commodities positions that won't show up on the 13F filing, including a large physical gold position. (They've previously outlined their rationale for owning physical gold). Overall, we track Passport to see which sectors they are flocking to and what kind of exposure they have.

We'll be tracking 40+ prominent funds in our fourth quarter 2009 hedge fund portfolio tracking series. We've already covered Seth Klarman's Baupost Group, Mohnish Pabrai's Investment Fund, Carl Icahn's hedge fund Icahn Partners, David Einhorn's Greenlight Capital, Stephen Mandel's Lone Pine Capital, John Griffin's Blue Ridge Capital, David Tepper's Appaloosa Management, Warren Buffett's portfolio, John Paulson's hedge fund Paulson & Co, Lee Ainslie's Maverick Capital, Dan Loeb's Third Point, Eddie Lampert's RBS Partners, David Ott's Viking Global, and Chris Shumway's hedge fund Shumway Capital Partners, Chase Coleman's Tiger Global, Philip Falcone's Harbinger Capital Partners, Roberto Mignone's Bridger Management, and Thomas Steyer's Farallon Capital. Check back daily for our new updates.