Broyhill's Affinity Hedge Fund: Betting on Deflation (Q2 Letter)

Broyhill started as a family office to manage Paul H. Broyhill's assets and has since evolved into a multifaceted investment firm. Their Affinity hedge fund was up 4.6% for June and was up 6.6% for the year at that time. We've touched on how the majority of hedge funds had a very rough second quarter performance wise. That said, not every hedgie out there as been battered down and Broyhill is evidence of that. So, how did they sidestep the volatility, you ask? They called in an old fashioned contrarian prescription to combat the market's sickness.

Their hedge fund has put on a contrarian bet on long-term treasuries (outlined via their ten reasons to buy bonds). Yet with a lack of inflationary signals as of late, maybe their bet isn't so contrarian after all. While hedge funds in general have had below average net long exposure, it was still evident that many funds were taking on more risk than they realized when May and June came around. The fact that most asset classes seemed to move in lockstep didn't help things either as everything seemed correlated to the downside. Everything but treasuries, that is.

Believe it or not, Broyhill had actually been short treasuries up until about March of this year. They then went long essentially as a hedge against deflation. Broyhill isn't the only one worried about deflation either. We just detailed how David Gerstenhaber's global macro hedge fund Argonaut Capital thinks deflation is the greater risk.

In recent commentary, Broyhill has reminded us that legendary hedge fund manager Michael Steinhardt coined the term 'variant perception' in which he focused on contrarian analysis and wagers by taking positions opposite those of consensus opinion. East Coast Asset Management recently highlighted the consensus versus variant perceptions in today's market as well. Broyhill has done the same as their bet on treasuries represents their highest conviction variant perception.

Christopher Pavese, the fund's Chief Investment Officer writes,

"Quite simply, we believe investors are worrying about the wrong type of 'flation' here and now. In the near term, the ongoing contraction in private sector credit - estimated by the OECD to reach 7% of the developed world's GDP or $3 trillion - combined with the threat of fresh credit strains ahead, should more than offset the long-term inflationary impact of increased government spending. The major point here is that most strategists today remain adamant bond bears, and after missing the call at four percent, it is near impossible for them to recommend buying treasuries yielding three percent!! We welcome Wall Street's hatred of government bonds and expect to hold our position at least until the consensus capitulates .... which looks to be a ways off given today's sentiment."

Here are the Affinity hedge fund's top ten longs:

1. iShares Barclays 20+ Year Treasury (TLT): 11.1% of assets
2. Vodafone (VOD): 3.2%
3. Wal-Mart (WMT): 3.2%
4. Kraft Foods (KFT): 3.1%
5. Humana (HUM): 3.0%
6. Nintendo (NTDOY): 2.9%
7. Market Vector Gold Miners (GDX): 2.8%
8. iShares Silver Trust (SLV): 2.8%
9. PowerShares US Dollar Index (UUP): 2.7%
10. Republic Airways (RJET): 2.7%

Keep in mind that we've previously detailed Broyhill's write-up of the bullish case for St. Joe Company (JOE) as well. So in addition to their hefty treasury position, it's clear that Broyhill has two other portfolio themes in play: high quality large caps, as well as precious metals exposure. For the latter, they've chosen to play silver and a bundle of gold miners. For the former, they've picked Vodafone (VOD), one of David Einhorn and hedge fund Greenlight Capital's largest holdings. Additionally, we've seen many hedgies favor Kraft (KFT), including Bill Ackman's Pershing Square.

Although they do not disclose specific positions, Broyhill's Affinity hedge fund has revealed its top sector short positions, including:

Education (5.2%) of assets
Global Financials (2.9%)
Business Equipment (2.9%)
Euro (2.7%)
Automotive (2.5%)
Appliances (1.9%)
Employment Services (1.8%)
Credit Rating Agencies (1.7%)
Global Resources (1.7%)
Recreational Vehicles (1.2%)

We'll continue to keep an eye on this hedge fund's successful wager on treasuries and embedded below is Broyhill's second quarter letter:



You can download a .pdf copy here.

For more on this deflationary wager, head to Broyhill's ten reasons to buy bonds as well as the thesis behind their bet on long-term treasuries. Additionally, more research from the hedge fund can be found in their bullish case for St. Joe (JOE).

Buy When There's Oil In The Water: Bullish Case for The St. Joe Company (JOE)

Below you'll find an in-depth presentation from Broyhill Asset Management on an intriguing way to play the Gulf oil spill from an investment standpoint. Hedge funds like Whitney Tilson's T2 Partners are buying oil giant BP (you can see their in-depth analysis of BP here). Others are buying drilling companies such as Transocean (RIG), Noble (NE), and Ensco (ESV). Broyhill, however, takes a slightly different approach. Their presentation "Buy When There's Oil In The Water" presents the bullish investment case for The St. Joe Company (JOE).

As you'll see in the presentation, the case for St. Joe starts with the fact that they own numerous real estate assets along the Gulf coast of Florida (assets that unfortunately could possibly be in danger from the oil spill). Christopher Pavese, Chief Investment Officer of Broyhill outlines St. Joe's competitive advantage in their near-zero cost of land. He writes, "Its massive scale and low-cost basis is impossible for other developers to replicate, making JOE the partner of choice for all development activity in Northwest Florida."

Broyhill is a Family Office that was started to manage the assets of Paul H. Broyhill and has since evolved into a multi-pronged investment firm. We've previously detailed commentary from Broyhill's Affinity hedge fund with their contrarian bet on long-term treasuries. Additionally, we've covered their ten reasons to buy bonds. And now below, we'll detail their hedge fund's latest investment idea.

Aside from its real estate assets, JOE has a pristine balance sheet with tons of cash and practically no interest-bearing debt, a much 'leaner' cost structure compared to prior years. A true investor often models and examines the worst case scenario for a given company. Broyhill has done just that, outlining a scenario where no one is really ever interested in JOE's land. In such a case, they estimate the stock is worth $15 (JOE currently trades above $25), assuming the land is sold for a paltry $2,000 an acre. To put this in context, consider that Leucadia recently paid $80,000 per acre in the same region.

The key for this company is monetizing their assets and the assumption that they will be able to do so. This play obviously requires patience on the investing end and Pavese highlights that St. Joe already has some near-term catalysts already lined up. However, as the oil spill nears St. Joe's properties, the stock has become more volatile. Broyhill argues that JOE's volatility leads to opportunity. Embedded below is the full in-depth presentation on The St. Joe Company (JOE) from Broyhill Asset Management:



You can download a .pdf copy here.

So while many other hedge funds and investment managers target oil companies as a proxy for oil spill plays, Broyhill has taken a roundabout approach. And, they aren't alone in this investment either. Bruce Berkowitz's Fairholme Fund has St. Joe as one of their largest positions and has for some time. So while Pavese fully acknowledges that JOE is a slow and boring story, he is confident this unfortunate oil spill has presented a fantastic opportunity for the long-term. For more from Broyhill's Affinity hedge fund, head to their contrarian bet on long-term treasuries as well as their ten reasons to buy bonds. Stay tuned tomorrow as we'll be covering their latest market commentary as well.

Broyhill's Affinity Hedge Fund: Contrarian Bet on Long-Term Treasuries (Investor Letter)

In a continued effort to expand our hedge fund coverage, we're always on the lookout for intriguing insight from 'under the radar' investment managers. As such, today we present you with market commentary and investment ideas from Broyhill Asset Management's Affinity hedge fund. Broyhill started as a family office managed by Paul H. Broyhill and has developed a long-term investment philosophy focused on capital preservation first and foremost. In their first quarter investor letter, we see they were right on the money recommending a cautious stance. As we all know, last week marked a precipitous drop in the market via the flash crash. To arrive at such a viewpoint, Broyhill used contrarian indicators such as the CBOE equity put/call ratio as well as extreme magazine covers & headlines. These are some of the same signals we pointed out in Jeff Saut's sell in May and go away missive.

To get a better idea as to Broyhill's investment exposure, let's take a look at their latest portfolio. Do you like going against the crowd? Well then you've certainly come to the right place. While numerous hedge funds (a.k.a. the crowd) have been shorting long-term treasuries, Broyhill is bullish on long-term treasuries and it marks their largest exposure today. Chief Investment Officer of their Affinity hedge fund, Christopher Pavese, wrote in a past commentary that, "It is important to note that in the near term, the contraction in private section credit combined with the threat of fresh credit concerns ahead, will likely keep a lid on inflation pressures. This view is perhaps where we differ most from today's consensus thinking, where many expect an immediate and permanent increase in inflation levels. We aim to capitalize on this departure from consensus later in the year, but importantly, the difference is simply one of timing."

Well for them, 'later in the year' quickly became 'now'. Investors flocked to safety in US treasuries during the flash crash last week and Broyhill expects the move out of risk assets and into government bonds to accelerate. Again this marks a contrarian stance as we recently saw global macro hedge fund Prologue Capital outline why macro factors are positive for risk assets. Broyhill has clearly taken a converse view. We like to present both sides to a compelling argument and Broyhill has certainly helped us in that regard. Interestingly enough, Chief Investment Officer Chris Pavese notes that they were previously short treasuries but covered in late march and then became buyers. Keep an eye out later today as we'll be posting up a separate piece from Broyhill outlining ten reasons to buy bonds.

Turning to equities, we also got a recent look at their top ten holdings, listed below:

1. St. Joe Company (JOE): 4.3% of assets
2. Wal-Mart Stores (WMT): 4.2%
3. Vodafone (VOD): 4.1%
4. Microsoft (MSFT): 4.0%
5. Kraft Foods (KFT): 3.9%
6. Nintendo (NTDOY): 3.8%
7. Humana (HUM): 3.6%
8. iShares Silver Trust (SLV): 3.3%
9. Market Vectors Gold Miners (GDX): 3.3%
10. ConocoPhillips (COP): 3.1%

As you can see, Broyhill favors high quality names which is in line with numerous other hedge funds. As we've detailed before, David Einhorn of hedge fund Greenlight Capital is bullish on Vodafone, Bill Ackman of Pershing Square had assembled a large Kraft position, and numerous hedge funds have added Microsoft shares, citing undervaluation. So while Broyhill has gone against the crowd with their treasuries play, they are certainly with the crowd in the equity arena.

We also got a recent look at some of Broyhill's short exposure. Like the majority of hedge fund land, they are keeping individual names close to the vest, but they have listed their top sector shorts:

Education (9.6)% of assets
Automotive (4.1)%
Recreational Vehicles (3.9)%
Business Equipment (3.9)%
Global Financials (3.9)%

This information is intriguing because they clearly have a large bet against education related stocks, a sector many Tiger Cub hedge funds have been quite bullish on. David Stemerman's hedge fund Conatus Capital had been long education plays but then sold out of them. We'll have to keep an eye on that as it has become a sector ripe with difference of opinion. Overall, Broyhill is 75.3% long and 44.7% short, leaving them 30.6% net long. This falls directly in line with what we've seen recently as hedge funds have reduced equity exposure.

In currencies, Broyhill has been long the Renminbi and short the Euro and the Yen. This again coincides with what we've seen in terms of hedge fund currency exposure. In commodities, Broyhill is long gold 9.6%, long oil 4.6%, and short copper -4.4%. Embedded below you will find their latest market commentary via Broyhill's first quarter 2010 letter:



You can download a .pdf here.

Intriguing stuff from Pavese and Broyhill and we'll certainly keep an eye on their contrarian wager. We've been covering a lot of excellent hedge fund commentary as of late and we posted up the following investor letters which we highly recommend reading:

- Louis Bacon's global macro fund Moore Capital Management
- Ricky Sandler's Eminence Capital
- David Einhorn's latest Greenlight Capital commentary
- Jay Petschek's Corsair Capital investor letter

Check back each day as we continue to chronicle what some of the most prominent hedge funds are up to.