Grey Owl Capital on Investing in a Low-Return Environment: Q1 Letter

Jeff Erber and Grey Owl Capital are out with their Q1 letter to investors and in it they highlight how they're approaching investing in a low-return environment.  They're employing a three-pronged attack as follows:


1. Look for undervalued securities:  They've been "high-grading" their portfolio by buying cheaper, high quality US names.  This is a concept long echoed in commentary from Oaktree's Howard Marks as well as GMO's Jeremy Grantham for the past few years as rates have remained low for a prolonged period.

Here's what individual names Grey Owl's been trading in:

New stakes: Pepsico (PEP), Blackrock (BLK), BMC Software (BMC), and Excelon (EXC)
Added to existing stakes: eBay (EBAY)
Exited: Apollo Residential Mortgage (AMTG) and Western Union (WU)
Trimmed: Apollo Group (APOL), Bridge Point Education (BPI), Market Vectors Gold Miners (GDX), Lexmark (LXK), and Transocean (RIG).


2. Invest in short dated high-yield fixed income:  Given that the Fed has in the past signaled potentially raising rates in 2013, this short-dated approach makes sense.  They've purchased the following bonds (with full write-ups on each stake in the below letter):

MGM Resorts 6.75% 9/2012 - purchased in December 2011
CSC 5.5% 3/2013 - purchased in January
Western Alliance Bancorp 10% 9/2015 - purchased in early April


3. Hold plenty of dry powder anticipating better opportunities: This might look counterintuitive at first glance given that holding cash earns you practically nothing, especially in a low yield environment.  However, consider that many hedge fund managers often hold cash as a hedge and as a utility to deploy when better investment opportunities arise. That's exactly what Grey Owl has done as they've deemed the current set of opportunities less desirable and they think better prices to buy at lie ahead.


Embedded below is Grey Owl Capital Managment's Q1 letter & you can download a .pdf here:




For more investor letters we've posted up Dan Loeb's Third Point Q1 letter as well as Passport Capital's letter.

Death of Stockpicking Claims Are a Good Sign for Value Investors

The following is a guest post from Grey Owl Capital. In the past, Market Folly has posted their second quarter letter that outlined how uncertainty can provide opportunity. Here is Grey Owl's recent commentary on the influx of claims that stockpicking is dead:

A recent Wall Street Journal article highlights the macro-driven nature of today’s stock market. In it, long-time value investors lament the current environment where stocks appear to trade in unison based on unemployment data or European bank stress test results. If stocks are driven by macro factors instead of individual company fundamentals, stock pickers can’t get an edge. Market strategist James Bianco of Bianco Research asserts “stock picking is a dead art form.” Macro hedge-funds are opening at a rate equivalent to that of traditional stock funds and the big asset management firms are even launching macro mutual funds.

We think stock-picking is very much alive. In fact, we recently wrote a 20-page investment guide that details a bottom-up approach for today’s environment. Call us contrarian, but we couldn’t think of a better sign than this article that fundamentally-driven, bottom-up stock-picking is likely to make a comeback sooner rather than later. Didn’t the commodity bubble burst right around the time that the asset management firms were rolling out a new commodity fund or ETF every week? Moreover, didn’t “the death of equities” cover stories in the early 1980s signal the start of a 20+ year bull market for stocks?

The Wall Street Journal article presents data that shows the correlation of stocks in the S&P 500 between 2000 and 2006 was 27% – quite a bit of disparity indicating undervalued stocks could appreciate and overvalued stocks could depreciate as opposed to trading up or down in unison. The article also points out that correlation spiked to 80% during the credit crisis and again more recently during the European sovereign debt scare. As these issues petered out, correlations never dipped below 40% and today hover around the mid 60s. However, the article does not point out the length of time over which the correlations were measured – days, weeks, months?

The time period over which the correlation is measured is critical. “Time arbitrage” has proven to be a very effective investment strategy. Who cares if individual stocks are correlated over days and weeks when your investment horizon is years? Glenn Tongue (one of the Ts in T2 Partners along with Whitney Tilson) highlights this fact in a recent appearance on Yahoo! Finance. Like us, the partners at T2 believe buy-and-hold stock picking is far from dead. Mr. Tongue also makes a critical point about matching the duration of the investment strategy and the investors. This is why we work very hard to ensure our investors understand our process before they become clients.

Don’t misunderstand our view. We agree the data shows a significant increase in correlation between individual stocks (and we witness this as we watch the market and our individual names on a daily basis). We also agree that the macro backdrop driving the market will remain for some time. The over-leveraged PIIGS, US federal and local governments, and the US consumer will likely take years to adjust to sustainable levels. In addition, the massive government intervention in fiscal and monetary policy does not appear to be subsiding with Bernanke and company preparing for QE2’s maiden cruise. (We have discussed these issues at length in several of our recent quarterly letters.) The market will certainly react to macro factors over short time periods, but that doesn’t mean significantly undervalued stocks or significantly overvalued stocks won’t gravitate toward fair value over a longer period of time.

In our recently published investment guide titled How to Prosper in Volatile and Range-Bound Markets we detail the strategy we are employing to deal with the current environment. We believe a concentrated portfolio will be more likely to outperform – a few deeply discounted names that are returning capital to investors (via share repurchases or dividends) and that also have a catalyst can outperform even if the majority of the market moves in unison. In addition, the flexibility of corporations to deal with macro shocks (be they slower growth, inflation, government regulation) means equities have a better chance of outperforming government bonds, currencies, or commodities (areas macro funds are more likely to play in).

Finally, we think valuation-based timing will be more important than it has been for traditional stock pickers. While Japan’s macro-driven market now trades at close to a quarter of its peak value 20 years ago the market experienced four rallies and five sell-offs of greater than 30% over that period. That type of volatility creates terrific opportunities for value investors to increase exposure as the macro shock of the day creates fear and to pare exposure as the fear fades away.

The above was a guest post from Grey Owl Capital. Be sure to check out our coverage of their second quarter letter as well where they outlined how uncertainty can provide opportunity.