Jim Chanos On Short Selling: The Power of Negative Thinking

Short selling and Jim Chanos go hand in hand. Whenever you see his name, you instantly think of Enron and how he unveiled the fraud there. The Kynikos Associates hedge fund manager is worth following due to his success but maybe more-so for the fact that he makes so many public appearances. If hedge funds operate behind a shroud of secrecy, then short sellers typically operate behind a shroud ten times as secret. Yet Chanos deviates from the norm and can often be found on television, doing interviews, and sharing his ideas. While talking his book might help some of his positions, it also means he's more often than not cast as a villain. Chanos argues that good short sellers are born, not trained. Many would take issue with that statement as numerous hedge funds recommend their analysts read Kathryn Staley's book, The Art of Short Selling to really gain an edge.

In late May, Chanos delivered a presentation at the CFA Institute's annual conference. You'll remember that Baupost Group's Seth Klarman also spoke at this event and we previously covered his thoughts on the markets as well. This time around we present you Chanos' speech entitled, "The Power of Negative Thinking" which focused on his bread and butter: short selling.

His talk centered on all aspects of the process including idea sourcing. When scavenging for shorts, Chanos says you focus on your experience, accounting related third party research, other investment managers, partners, investors, and various stock screens (though he admits this last technique is not as helpful as it once was). Chanos makes short selling seem like a much more simplistic process than it is. But he does bring up an excellent point that there are very few original ideas in investing. And if he and other short sellers are sourcing ideas through word of mouth and industry networking, this just goes to reiterate the hedge fund herd mentality we've discussed before.

Chanos also outlined that successful short positions often come from various recurring themes including:

- Booms that go bust
- Consumer fads
- Technological obsolescence
- Structurally-flawed accounting

On the point of technological obsolescence, we've seen that David Stemerman's hedge fund Conatus Capital has built short theses around this occurrence.

Throughout his speech, Chanos also dropped hints at various companies he could be short. He mentioned that it still amazed him people still rented DVD's by mail which could be interpreted as a short position in Netflix (NFLX). On that point, we've seen in the past that Whitney Tilson's hedge fund T2 Partners has been short NFLX. In fact, many hedgies have tried to short this stock to no avail as it continues to rip higher. Regarding China, Chanos is short the land development companies but did not name specifics. For those interested, we've previously posted up Chanos' in-depth speech about China overheating.

Lastly, regarding the process of short selling, Chanos iterated that position sizing and risk management are obviously key. Short selling involves the potential for unlimited losses so you obviously have to keep a close eye on things. He handles risk with stop loss orders and limiting positions to between 0.5% and 5% (max) of capital. If positions start to get too big, they'll trim them back down to the intended allocation. Also, Chanos revealed that he does not use options or derivatives.

Embedded below are in-depth notes courtesy of Cameron Wright regarding Jim Chanos' presentation on short selling, "The Power of Negative Thinking":




To learn how to become a better short seller, we of course would point you to a book that hedge fund Blue Ridge Capital has recommended: The Art of Short Selling. For more of our coverage of Jim Chanos, head to his thoughts on China's property bubble as well as his in-depth talk on investing in China. Lastly, remember that in addition to Chanos, investment guru Seth Klarman also spoke at the CFA Conference and his thoughts from the event are definitely worth checking out as well.

What We're Reading ~ 6/25/10

Security analysis and business valuation on Wall Street [Jeffrey Hooke]

Some recent hedge fund performance numbers [Dealbreaker]

A multi-section, in-depth analysis of National Presto Industries (NPK) [Kerrisdale Capital]

The controversy over for-profit colleges by Richard Posner [University of Chicago Law Blog]

Beaconcrest Capital opens hedge fund to investors [FINalternatives]

Hugh Hendry says the euro is finished [Pragmatic Capitalism]

The new economic gangs of New York [Reformed Broker]

Great company brands of tomorrow [Pragmatic Capitalism]

Fund manager Ken Heebner: A hot touch gone cold [Business Week]

In gold we trust, an in-depth report from Erste [zero hedge]

How to invest like Jim Rogers [TheStreet]

Response to Steve Eisman's Short Thesis on For-Profit Education Companies

You'll recall that MarketFolly.com recently provided a summary of the Ira Sohn Investment Conference where numerous prominent hedge fund managers presented their latest ideas. Among those presenting was Steve Eisman of FrontPoint Partners. You might remember him of course as one of the successful subprime traders profiled in Michael Lewis' latest book, The Big Short.

At the conference, Eisman presented a short thesis on for-profit education companies, interestingly titled 'Subprime Goes to College'. You can view the entire presentation through that link, but he essentially laid out a bearish view on the following companies: Apollo Group (APOL), ITT Educational (ESI), Corinthian Colleges (COCO), Education Management (EDMC), as well as the Washington Post (WPO) for its test preparation business. His thesis states that the industry will be hurt by two factors: increased government involvement & regulation, as well as a rise in employment (generating a decrease in enrollment).

Eisman's crusade against for-profit education companies has obviously lit a fire under the collective asses of said companies' executives and representatives of the industry. Courtesy of our buddy StockJockey, we see that Harris Miller, President and CEO of Career College Association has even gone as far to pen a response to Eisman. Unfortunately, Miller's retort falls short (no pun intended) right from the get-go when he immediately casts Eisman as a villainous short-seller not even one paragraph into his remarks. This rudimentary and almost Pavlovian response from various officials and executives has become a bit tired over the years, has it not? 'Oh, he's a short seller, that means he's a bad person and must be stopped at all costs!' Nevermind the fact that Eisman, you know, has some credibility in the arena of short selling. He predicted this little thing called the subprime mortgage mess. Maybe you've heard of it?

In fairness to Miller, the CEO does bring up a solid point that comparing education companies to subprime mortgages is indeed a bit of a stretch. There are some similarities between the two situations (ratings agencies/accreditation boards, etc), but the insinuation that for-profit education is the next subprime is a bit hyperbolic. While there is government involvement in both sectors and student loan default is a legitimate concern, let's be honest: for-profit education is not going to wreak near the amount of havoc the subprime mess has. At the same time, there are obviously problems in the industry as Eisman has detailed.

We've labeled for-profit education stocks as an investment battleground for some time now. Hedge funds have taken sizable positions on both the long and short sides of the trade. However, as the year began, more and more hedgies have shifted to the 'sell' or 'short' side of the seesaw. At last year's Ira Sohn event, Stephen Mandel of Lone Pine Capital gave a bullish presentation on Strayer Education (STRA). Immediately following him, noted short seller Jim Chanos presented a bearish look at the for-profit education industry. Fast forward to more recent times and we saw that Mandel is still bullish on education plays. However, when we looked at Lone Pine's portfolio, we did note that they've scaled back their position some.

We shift next to a look at one of Mandel's progeny, David Stemerman. He previously worked at Lone Pine and then left to launch his own hedge fund, Conatus Capital. Stemerman's fund had been long education stocks but by the fourth quarter of 2009 and first quarter of 2010, they had sold out of these stocks, citing increased uncertainty and increased government scrutiny. Additionally, Andreas Halvorsen's hedge fund Viking Global was a big investor in Apollo Group (APOL) as it had previously been one of their most sizable positions. Yet, recently we saw they sold out of APOL, adding to the hedge fund exodus.

Back on the bullish side of the fence, we did however see Roberto Mignone's hedge fund Bridger Management buy shares of Princeton Review (REVU), a test preparation service. The interesting thing to pay attention to here is the difference between full-on schools and test preparation services. While Eisman mainly targets programs distributing degrees, he was also bearish on Washington Post for their test preparation business.

So while a divergence of opinion is clear, we've also highlighted how some prominent players have wavered in their conviction. The moral of the story here is that hedge fund land is very decisively divided on this topic. This sector should be watched closely as it should be filled with opportunity. While the bulk of that opportunity has historically been found on the long side, it's clear that many have grown skeptical. We've already presented the bearish case for the industry via Eisman's presentation. Embedded below is the response from Harris Miller, President & CEO of Career College Association which obviously presents the positive case for the industry:



You can download a .pdf copy here.

So, the war of words has ensued and this sector will continue to be hotly debated. In the end, it seems that government regulation and intervention will likely play a large part in the final outcome, whatever it may be. You can check out Steve Eisman's original presentation where he laid out his short thesis: Subprime Goes to College. Additionally, head to the summary of the Ira Sohn Investment Conference for the rest of ideas hedge fund managers pitched.

Dan Arbess Ira Sohn Presentation: Investing As The Foundation Shifts

Today again courtesy of Dealbreaker we wanted to highlight Dan Arbess' recent presentation from the Ira Sohn Investment Conference entitled, 'Investing As The Foundation Shifts'. We had previously summarized the Ira Sohn Conference and have detailed numerous presentations from the event. This time around, we're taking a deeper look at the slideshow from Dan Arbess, the Xerion Fund manager at Perella Weinberg Partners. Just yesterday, we looked at Dan Arbess' portfolio commentary and identified that he is seeing opportunity in stressed credit and owning what China wants to buy. And now, we'll focus on some of his additional investment ideas.

When we summarized the Ira Sohn Investment Conference, we noted that Arbess was bullish on China exposure and in particular, Yum Brands (YUM) given their prolific expansion into the country. He isn't alone in his conviction here as we've seen a slew of hedge funds add positions in Yum Brands in recent quarters. In particular, we made note of Bill Ackman's YUM stake.

If you hadn't already guessed from the title, the theme of Arbess' presentation centered around a shift in the global economy. He wants to 'shake hands' with China and overall sees less borrowing in the Western world coupled with more consumption in the Eastern world. He says you can play this theme by shorting overleveraged Western producers, shorting weak currencies, and hedging monetary debasement with precious metals and miners. Arbess is also bullish on Ivanhoe (IVN) due to its solid assets and position in the metallurgical coal space.

This echoes what many hedge funds have already practiced. Hedgies have been quite short the euro (currently a weak currency) but they have been covering as of late. Additionally, tons of prominent investment managers have boosted gold exposure in their portfolios either by adding the physical metal or gold mining companies. Arbess doubts this is a top in gold and is using exposure there to hedge against inflation.

Sticking with the Asian growth theme, the Xerion Fund manager also likes Solutia (SOA) and Celanese (CE) as they both are seeing solid growth overseas. Arbess also seemingly pokes fun at a previous presentation we've posted up from Vitaliy Katsenelson entitled, China: The Mother of All Black Swans by including a picture of the lead slide from that slideshow with a giant "NOT" stamped across it. (How about a nice little Borat impersonation here for our comedic readers: "China is the mother of all black swans..... ... .....NOT.")

Ahem, anyways. Embedded below is Daniel Arbess' presentation from the Ira Sohn Conference, "Investing As The Foundation Shifts":



You can download a .pdf copy here.

For more from Arbess, head to his Xerion Fund portfolio commentary. We also recommend viewing the other presentations from the Ira Sohn Conference including David Einhorn's speech, as well as Bill Ackman's presentation and last but not least, Steve Eisman's latest investment thesis. You can also view a summary of the conference here.

Hedge Funds Aggressively Cover Euro Short Positions

Bank of America Merrill Lynch has released their weekly hedge fund monitor that updates the latest exposure levels from hedgies. Last time around, we saw that global macro hedge funds were short equities. This time, we see that they've been aggressively covering the euro. Obviously due to the European turmoil in recent months, hedgies have been very short the euro. Thus, this interruption in trend is worth pointing out.

Hedgies have been short the euro in size and so volatility will most likely continue in the forex market. To put this euro position in perspective, hedge funds were short -$13.4 billion notional as of two weeks ago. Last week, this position decreased to -$7.7 billion notional. The euro has essentially been in a 'crowded short zone' for much of 2010 so there is always that pressure of a sudden short squeeze. Bank of America thinks such a squeeze at best would take the Euro up to 1.30 but they don't see that happening anytime soon.

Shifting to equities, one trend worth highlighting is the fact that many hedgies continue to sell the Russell 2000 futures. In energy, it appears as though hedge funds were buying crude oil. Additionally, they remain long metals.

Long/short equity is one of the best performing strategies this month, up 0.33%. This is in stark comparison to last month where May was a brutal month for many prominent long/short operators. Position wise, we see that this strategy overall has increased its market exposure. Don't put too much weight on that though, as they are only 25% long, way below the typical range of 35-40% net long. Long/short funds also reduced emerging market exposure last week.

Shifting to market neutral funds, we see that recently they've reduced market exposure. Over the past few months it seems as though m/n funds and l/s funds have moved completely converse of each other with regard to equities. When l/s funds go long, market neutral funds seem to sell and vice versa.

Global macro hedge funds have been adding to shorts in commodities as well as in 10 year treasuries. Additionally, they've been adding to longs in the US dollar. This trade has become an opposite reflection of the one many funds put on during the crisis. (Back then, they were long commodities and short the dollar). As we detailed last week, global macro players have been net short equities in recent weeks and we see that they've continued to hold these positions.

Embedded below is Bank of America Merrill Lynch's latest hedge fund monitor report:



You can download a .pdf copy here.

For more on the topic of position movements, head to our examination of the hedge fund herd mentality as well as our continuous portfolio tracking series.

Perella Weinberg Partners: Xerion Fund Portfolio Review & Commentary From Dan Arbess

Thanks to Dealbreaker who posted up this gem: Perella Weinberg Partners recent May 2010 portfolio review and commentary regarding their Xerion Fund managed by Dan Arbess. If you're unfamiliar with them, here's what you need to know: Xerion is named after a legendary alchemical tool that is supposedly capable of turning base metals into gold and is also believed to be an elixir of life or enlightenment. The hedge fund "seeks to draw on fundamental valuation skills to identify opportunities that offer the potential for asymmetric returns--downside protection with upside potential." Xerion returned 0.31% in 2008, a year in which many other hedge funds suffered greatly. In 2009, Xerion returned 35.33% versus 26.46% for the S&P 500.

Thus far this year, Perella Weinberg's Xerion has had a decent outing, sitting up 3.37% for the year. The month of May was brutal for hedge funds, and the same applied to Xerion which ended the month down 4.23%. In their portfolio, Xerion's top performers were an alpha macro short on the Euro, beta hedges on the S&P 500, as well as a -6.3% short in the Australian dollar (a hedge to their mining and materials exposure). The first position of course ties in with the fact that many hedge funds have been drastically short the euro this year. However, as you'll see in a forthcoming article this morning, many hedgies have been covering their euro shorts as of late.

Arbess' portfolio commentary took somewhat of a concerning turn when he proclaimed that, "The twilight of the debt supercycle may be less dramatic yet more chronic and possibly more difficult to position around than the '08 financial crisis." He focuses on the fact that addressing the issues at hand will require fundamental changes. As the world re-balances, he feels that outbursts of asset classes and markets trading in correlation will become more frequent.

Shifting next to investment opportunities, Arbess identifies the following as areas ripe with potential:

- Owning what China's government and consumers want to buy
- Stressed credit opportunities
- Process-driven credit opportunities
- Hedging monetary instability with metals, bonds and currencies

His last point is intriguing as throughout his commentary you'll notice he is very fixated on hedging. As we've detailed countless times before, many prominent hedge funds have exposure to gold in some form. Some argue that gold is good, but gold mining is better, while others prefer to own the physical metal. John Paulson has a hedge fund dedicated to investing in gold related entities. While he primarily takes stakes in gold miners, he also owns derivatives on the precious metal. So, it seems the Xerion Fund is interested in these tools as well, but mainly for hedging purposes.

Arbess points out that May was an 'anomaly' month because there was essentially nowhere to hide on the long-side as asset classes correlated to the downside. Xerion's top losers included an equity stake in a post-emergence chemicals company, a large cap agricultural sector position, and an energy special situation. Despite the rough month, Arbess viewed May as a buying opportunity for their highest conviction ideas. Xerion has essentially been running "lean and mean" by reducing other positions in favor of their highest conviction plays.

Arbess notes that, "quality credit is just where we want to be in an uncertain environment, because it has a built-in catalyst called maturity, which delineates our return based on our conservative assessment of company performance even against a weak economic backdrop." These comments echo that of investment guru Seth Klarman who prefers bonds and recently reiterated his preference.

In overall portfolio exposure, Xerion has been 86.5% gross long and -30.7% gross short, leaving them 55.8% net long. Given that Xerion's main focus is on distressed credit, it should come as no surprise that their largest exposure levels can be found in that arena. To see how Xerion compares to other managers, check out our recent look at hedge fund exposure levels.

Embedded below is the portfolio commentary from Dan Arbess' Xerion Fund of Perella Weinberg Partners:



You can download a .pdf copy here.

For more insightful commentary and analysis from prominent investment managers, head to the latest thoughts from Dan Loeb's hedge fund Third Point, global macro fund Prologue Capital's commentary, and the latest portfolio positioning from John Burbank's Passport Capital.

Market Strategist Jeff Saut Removes Hedges During May Turmoil

It's been a while since we covered the market commentary of Jeff Saut, Chief Investment Strategist from Raymond James. Back in April, Saut advocated caution and he turned out to be right as the markets saw a precipitous decline. During the correction in mid-to-late May, Saut said the market was in a bottoming process. Obviously, May was quite a volatile month and he felt it was a constructive pullback. In his latest commentary, Saut focuses on the debate as to whether the rally since the March 2009 bottom is just a rally in the midst of a bear market or the beginning of a new secular bull market.

Generally speaking, Saut's portfolio construction has been tilted 80% toward wherever he feels a secular bull market has developed and 20% to a dynamic approach that swings with the market. So while the majority of his portfolio seems to be more static, the dynamic portion of his portfolio comes into play as he started adding hedges in April to protect his portfolio. Into the May turmoil, we learn that Saut shed those hedges. It's often said that the hardest thing to do is to remove your hedges when they are protecting you the most. Yet, that appears to be exactly what Saut has done so kudos to him for the conviction. Also, take note that the secular bull market portion of his portfolio lies essentially in "stuff stocks." Since the fourth quarter of 2001, Saut has been bullish on energy, agriculture, and metals stocks with a yield.

All said and done, Saut still leaves a few questions unanswered. It's not clear if we're in a new bull market or merely a bear market rally. In the near-term though, he feels that his call to remove hedges into the May tumult was the correct move and he obviously feels that the recent action is constructive. He'll obviously stay nimble with a portion of his portfolio but that is the latest update direct from the market strategist.

Embedded below is the most recent market commentary from Jeff Saut, Chief Investment Strategist at Raymond James:



You can download a .pdf copy here.

Saut has been right-on as of late as he called for caution in April and then recently said the market was in a bottoming process. We now see he's shed his hedges and appears to think the market is in decent shape here. While the markets and economy don't always move stride for stride, we do make note of global macro hedge fund Prologue Capital's cause for concern which we detailed this morning. Though the various economies of the world still have structural problems to work through, the market could have very well discounted this fact as they are forward looking mechanisms. This of course ties directly into the archaic market debate of perception versus reality. As always, we'll have to wait and see.

Global Macro Hedge Fund Prologue Capital Sees Cause For Concern

Global macro hedge fund Prologue Capital is out with their most recent letter to investors. They immediately address the most volatile month in the markets this year wondering, "Was it all just a storm in a teacup? And if so, will the economic recovery continue unabated? We don't think so. Rather, recent events are symptomatic of economic and financial vulnerabilities that will remain for some time." This is an interesting stance and we'll detail how they've positioned their portfolio below.

While May was a brutal month for hedge funds, Prologue did well to avoid carnage as they were up 0.85% through May 28th. This brings their year-to-date performance to 2.80%. Prologue now manages over $1 billion and were up 18.86% in the crisis-ridden 2008 and up 12.41% in 2009.

In assessing the global macro scene, Prologue's Chief Economist Tomas Jelf evaluates the US, Europe, and UK. Economically speaking, Jelf feels that there are still two main concerns. He writes, "The fiscal accounts of most developed countries create two immediate problems. First of all, the need for fiscal consolidation is a drag on economies at a time when recovery attempts to morph into an expansion. Furthermore, governments' indebtedness limits their ability to provide the type of backstop we have seen in recent years. Second, banks have yet to clean up their balance sheets to a degree that removes solvency concerns."

Overall, Jelf notes that repairing balance sheets and fiscal consolidation takes time. As such, Prologue expects some sort of turmoil to return in future quarters/years. It's obviously hard to peg the timing of such turmoil, but they are more concerned here than they have been in recent months certainly. They are concerned that this could "create more drawn out risk asset deflation and potentially halt the recovery." This isn't the first time we've seen such concern from a global macro hedge fund. Louis Bacon's Moore Capital Management pondered a return to a bear market in their past commentary. At the same time though, Prologue fully acknowledge that this turmoil could amount to nothing more than just 'hiccups' on the road to recovery.

Focusing specifically on the US, Prologue highlights the slowdown in discretionary spending. They are also concerned by an assumed rollover in housing now that the home buyers credit has expired. Overall, Prologue expects "declining year over year inflation figures throughout 2010. That, coupled with the worsening growth momentum, may lead to a decline in inflationary expectations. Suffice to say that the Federal Reserve will keep rates on hold for a long time."

In the UK, Prologue thinks there will be ample opportunities to take advantage of given that the monetary policy outlook is quite uncertain. While inflation expectations there have risen, the Bank of England's models have led them to a continued dovish stance. In Canada, Prologue favors flatteners but also thinks that bonds are cheap relative to US Treasuries. In Australia, they've reduced their exposure to the currency until the monetary path is more lucid.

Given their macro assessment, let's see how Prologue is positioned. In their last commentary, they detailed why macro factors are positive for risk assets. This time around, they are certainly more cautious as the month of May seems to have given them cause for concern. Here are their latest positions:

- Tactically long duration in the US and Eurozone

- Continued active participation in the underwriting process of government bonds

- Cross market Fixed Income - long US vs UK

- Exploiting dislocations in futures versus cash and swaps caused by flight to quality fears

- Volatility in FX options

Unfortunately, we can't post up the actual letter due to revealing watermarks. It's always interesting to see how global macro hedge funds are positioned given the fragile nature of many economies and the constantly morphing economic landscape. Those of you interested in this macro hedge fund's views can see their past commentary. For more global macro research, we have previously detailed investment commentary from John Brynjolfsson's Armored Wolf. And to learn from some of the most knowledgeable global macro fund managers around, we highly recommend Steven Drobny's new book The Invisible Hands: Hedge Funds Off the Record.

Forbes on Warren Buffett: A Multi-Decade Look At His Career

Forbes is out with an excellent compendium of articles they've released over the years regarding the Oracle of Omaha himself, Warren Buffett. Their chronicles of Buffett start on November 1st, 1969 where they introduced the soon-to-be legend to their audience. This very first article in particular details Buffett's Partnership and is of great interest of those seeking more information of how he managed money in his early days.

If you think about it, the 'early' Warren Buffett is the one investors should look to mimic and learn from. His modern day vehicle of Berkshire Hathaway is an investing behemoth and as evidenced by its full-scale acquisition of Burlington Northern Santa Fe, it's much harder for him to put money to work these days. Buffett has repeatedly said he'd be reaping much better gains if he managed a much smaller pool of capital. So, Forbes' look at the earlier stages of Buffett's career certainly prove useful here.

Given that Buffett is one of the most successful, if not the most successful value investor out there, those looking to follow in his footsteps should head to Warren Buffett's recommended reading list. The man is full of quotable quips, almost too many to list. However, one of our favorites (and one that is partially responsible for the name of this website) is, "Profit from folly rather than participate in it." Those of you seeking more words of wisdom from the Oracle can do so via our top 25 Warren Buffett quotes.

Embedded below is 'Forbes on Buffett', an excellent collection of resources regarding the investing legend himself:



You can download a .pdf copy here.

For all the Buffett disciples out there, definitely head to Warren Buffett's recommended reading list if your pursuit is to become a better investor. We've of course covered the Oracle of Omaha extensively on the site and some other points of interest might be Warren Buffett's portfolio as well as some notes from Berkshire Hathaway's annual meeting.

What We're Reading ~ 6/21/10

An addendum to our usual weekly linkfest since there have been a lot of good reads out there as of late...

Exclusive interview with Greenstone Value Opportunity Fund [Distressed Debt Investing]

Investors: individuals versus institutions [Abnormal Returns]

A closer analytical look at BP [Peridot Capitalist]

And also an in-depth look at driller Ensco plc [Manual of Ideas]

Fears of a BP bankruptcy are overblown [Bnet]

BP's wakeup call to bond investors [Morningstar]

A very in-depth look at what went wrong with the oil spill [NY Times]

Chief economist of Paolo Pellegrini's PSQR set to launch own firm [FINalternatives]

An intriguing past look at how value investors often piggyback each other [SeekingAlpha]

And if you missed it, our recent post on the hedge fund herd mentality [Market Folly]

Major investor bets big on Vegas [Las Vegas Sun]

Lee Ainslie, Kyle Bass, David Einhorn & John Burbank To Speak At The Value Investing Congress: Exclusive Discount

The upcoming Value Investing Congress has an absolutely fantastic group of speakers lined up. We're pleased to announce that both Maverick Capital's Lee Ainslie and Hayman Capital's Kyle Bass have committed to speak at the event. This joins an already heavy-hitting list of Greenlight Capital's David Einhorn, Passport Capital's John Burbank and more. We're also pleased to announce that as usual, Market Folly readers can receive over a 40% discount to the Value Investing Congress by clicking here with code: N10MF1. This discount expires on June 30th so act quickly!

The event takes place in New York City at the Marriott Marquis in Times Square on October 12th & 13th. The list of speakers at the Value Investing Congress is just packed with prominent names:

- David Einhorn (Greenlight Capital)
- Lee Ainslie (Maverick Capital)
- Kyle Bass (Hayman Capital)
- John Burbank (Passport Capital)
- Mohnish Pabrai (Pabrai Investment Fund)
- J. Carlo Cannell (Cannell Capital)
- Whitney Tilson & Glenn Tongue (T2 Partners)
- Amitabh Singhi (Surefin Investments)
- Zeke Ashton (Centaur Capital Partners)

... with many more to come. If you want actionable investment ideas from some of the most prominent managers out there, then this is the event to attend. The potential profits from one good idea would easily cover the cost of your admission. If you work for an investment firm/fund, get your employer to cover your registration because you don't want to miss this event. Not to mention, it's a fantastic opportunity to network given all the investment managers that will be in attendance. The over 40% discount to the event expires soon so take advantage of the code: N10MF1.

If you're unfamiliar with Lee Ainslie, we've covered him numerous times on the site. He is the managing partner of Maverick Capital, a long/short equity focused hedge fund that has returned 14.2% annualized from 1995 through 2009. He founded the firm in 1993 with $38 million and today manages over $9 billion.

Additionally, Hayman Capital's Kyle Bass will be speaking at the event. Bass of course is most well known for predicting the collapse of the subprime mortgage market. He was shorting those securities as early as 2006. Not to mention, we had also detailed his past notion that sovereign defaults were impending. As dominoes start to fall there, it appears as though he has been correct yet again.

Click here to receive your discount to the Value Investing Congress. Act quickly because the discount expires June 30th. The event takes place in NYC at the Marriott Marquis on October 12th & 13th.

John Burbank's Passport Capital Likes Natural Resources (Portfolio & Investor Letter)

John Burbank's hedge fund firm Passport Capital is out with their May performance update and first quarter investor letter. Per the documents, we see that Passport now manages $3 billion and their Global Strategy Fund was up 0.6% for May in a month where the market indices tumbled 8%. Overall, they fared much better than other hedge funds who were down big. Year to date for 2010, Passport is up 5.1%. Since inception, Burbank's fund has returned an impressive 23.6% annualized. Those returns, however, do come with some wild volatility. Passport Global was up 219.7% in 2007 and down 50.9% in 2008. Still though, if you can stomach the ride, the cumulative body of work is hard to argue with. Note that John Burbank will be presenting investment ideas at the upcoming Value Investing Congress and we've secured over a 40% discount for Market Folly readers here.

Turning to Passport's most recent exposure levels, we see they're overall 93% long and -44% short. This gives them 49% net long exposure and it's certainly much higher than what we've seen from other hedge funds. The vast majority of funds have had very low net long exposure. This is even more surprising when you consider that Passport had high exposure yet still managed to generate a positive return in a month where the markets were down severely. Burbank did note that this increase in exposure is not a shift in their market outlook, but rather due to appreciation of their basic materials positions.

Here are John Burbank's top 10 public longs:

1. Riversdale Mining (AU:RIV)
2. Apple Computer (AAPL)
3. Financial Technologies (IS: FTECH)
4. McKesson (MCK)
5. Teva Pharmaceutical (TEVA)
6. Labrador Iron Mines (CN:LIM)
7. CF Industries (CF)
8. Pantaloon (IS:PF)
9. TIG Holding Ltd (BZ:TARP)
10. Jordan Phosphate Mines (JR:JOPH)

As you can see, they have a lot of international exposure and also favor natural resource plays. Of their equity holdings though, two look very familiar: Teva Pharmaceutical and Apple. These two are some of the most widely held stocks amongst hedge funds. Embedded below is the May performance attribution sheet from Passport Capital:



You can download a .pdf copy here.

Additionally, in Burbank's first quarter letter to investors, he hones in on Passport's current strategy: betting on natural resources that China is structurally short. He touches on their thesis for Riversdale, their largest position and one they have owned for three years (traded in Australia). Burbank cites rising merger activity in the sector and rising coking coal prices. Passport owns around 14% of the company.

Turning to their position in Teva Pharmaceutical, Burbank cites increased opportunity in the health care sector due to reform. Passport believes the winners due to these changes will be pharmaceutical players, and diagnostics sectors. They also like pharmaceutical benefit managers (PBMs) and pharmaceutical distributors, thus reflected in their McKesson position. We've seen many other hedge funds bullish on the PBM sector as Andreas Halvorsen's Viking Global bets on Express Scripts (ESRX) and Lee Ainslie's Maverick Capital had been bullish on CVS Caremark (CVS).

Turning back to non-equity positions, keep in mind that Burbank's Passport owns physical gold as well. Embedded below is Passport Capital's first quarter letter to investors and we recommend reading it in its entirety for Burbank's in-depth explanation of some of their natural resource related bets:



You can download a .pdf copy here.

That about wraps up this comprehensive update on one of the more successful macro funds over the last decade. Keep in mind you can receive investment ideas directly from John Burbank and many other prominent hedge fund managers at the upcoming Value Investing Congress (receive a discount here).

Gold Is Good, But Gold Mining Is Better

Prominent hedge fund manager John Paulson started a gold fund as a bet against the US dollar. While he invests in some gold derivatives, he is mainly placing his bet by taking stakes in various gold miners. Conversely, we've covered how John Burbank's hedge fund Passport Capital owns physical gold. So while many hedge funds agree that precious metals deserve some allocation of capital, the dispute comes down to whether you buy the actual metal or those who mine it.

The following is a contribution from Vedant 'VK' Mimani, founder of Atyant Capital, a macro fund focused on precious metals. The below article focuses on why tomorrow's fortunes will be made investing in companies that excavate the yellow metal. Here is Mimani's rationale which originally appeared on Absolute Return + Alpha:

With gold currently trading around $1200 per ounce - an increase of almost five fold from 2001 - it is only natural to wonder how much gas is left in this tank. The fact is, we don't know and we sort of don't care. We've said it before and we'll say it again: the real opportunity for wealth creation in the years ahead lies in the business of gold mining.

The world is in the midst of a credit contraction, of the kind that always follows credit expansions. We have found from historical study that these contractions in credit tend to run about twenty years. During every single prior credit contraction, the real price of gold, as measured against all commodities and assets, had increased. This increase in the real price of gold represents expansion in profit margin for the gold mining industry.

The last major credit contraction occurred during what we now refer to as the Great Depression. During that time, gold miners such as Homestake Mining were among the few companies to reward its shareholders. The Financial Crisis of 2008 stayed true to form. Starting September 2008, gold once again has started to outperform all commodities and assets.

It may seem counterintuitive that gold mining represents the best wealth creation opportunity over the next several years. After all, in 1971, the price of gold was $35 per ounce. An investor could have bought gold bullion in 1971, buried it in the backyard, and have a thirty-five fold return and counting as of today. Yet despite the price of gold increasing thirty-five fold over the last four decades, gold mining itself has been mostly a crummy enterprise in terms of all basic business metrics during that period. This is simply because the input costs increased faster than the price of gold, resulting in little to no profit margin for the industry as a whole.

That all changed in September 2008 when private credit growth peaked. Since then, the price of gold has increased steadily, while the costs of mining gold have decreased significantly; the real price of gold, as measured against all commodities and assets, has increased. Today large cap miners have robust 40%+ operating margins as they are benefiting from the increase in gold prices relative to the costs to mine gold. A quick glance at the last two quarters of operating results for the major miners shows that the increase in the real price of gold is resulting in strong financial performance. As far as we are concerned, we are only two years into a twenty year trend. It's not late; it's early early early.

Are gold miners cheap right now? Examination of gold miners on traditional metrics such as price to net asset value or price to book value, reveals that the miners as a whole are not underpriced on an as-is basis. This is not a "buy $1 for $0.80" type story. Gold mining today is a value creation play in which the macro variables, increased real price for gold and decreased input costs, have aligned and the sector is now experiencing a tailwind instead of a headwind. When the real price of gold increases linearly, mining profits are likely to increase exponentially. (MarketFolly sidenote: This is the main question at hand in the precious metals complex. Can mining stocks outperform the actual price of gold over time? Investing in individual miners entails taking on company specific risk. But of course some of that risk can be mitigated by taking stakes in a basket of miners.)

From March 2009 through mid-April 2010, gold and gold miners have underperformed most other asset classes. In the second half of April 2010, we witnessed a turn from relative weakness to relative strength in gold and gold mining shares. Gold miners are the new leaders and have once again started to outperform all asset classes. In May alone, gold miners outperformed the S&P 500 by 9.5% (as measured by the Gold Miners ETF, GDX, versus S&P 500 SPDRs, SPY). The real price of gold is now never looking back; but from a technical perspective, in the short term, gold's relative strength is overbought and may need some time to work this off. (MarketFolly sidenote: Their highlight of gold miners' performance in May is relevant since it shows outperformance in a period of market volatility. But then again, aren't precious metals seen as an asset class that moves independently of equities, sort of acting as a volatility dampener or hedge in the first place? To play devil's advocate, we'd point out that the gold miners ETF, GDX, underperformed the S&P 500 throughout much of 2010 up until May.)

In conclusion, whether we have deflation, inflation, or pick your favorite 'flation, we ought to remember history's record that in a credit contraction, the real price of gold increases relative to all commodities and assets. This increase in the real price of gold results in margin and profit expansion for gold miners as the spread expands between the price of gold and the cost to mine gold. Gold mining will be one of the few, if not only, sectors to enjoy this type of tailwind in the years ahead.

The last cycle's mega fortunes were made mostly in real estate, computer technology and finance. Tomorrow's mega fortunes will be made mostly in gold mining. Of course, the road from here to there will continue to be volatile and laden with pitfalls, but the trend remains our friend.

---

So, interesting thoughts from Mimani and Atyant Capital. Their thoughts continue to highlight the debate between owning gold versus gold miners. We've long detailed this debate through copious amounts of hedge fund resources. As we touched on in the introduction, we've taken an in-depth look at John Paulson's gold fund. Additionally, we've covered how prominent investor David Einhorn favors physical gold and John Burbank likes physical gold as well. Lastly, Eric Sprott launched a gold trust but has also taken stakes in various gold miners as well. So while many fund managers disagree on the particular investment vessel, they all seem to agree in principle that capital should be allocated to the precious metals complex.

The above article was a contribution from Vedant 'VK' Mimani, founder of Atyant Capital. If you or other investment managers you know would be interested in contributing an article or latest investor letter to MarketFolly.com, please send us an email.

What We're Reading ~ 6/18/10

More Money Than God: Hedge Funds and the Making of a New Elite [Sebastian Mallaby]

Learning to love hedge funds, an excerpt from the above book [WSJ]

Former Atticus Capital right-hand man started a new hedge fund [FINalternatives]

A bear market or just a correction? [Pragmatic Capitalism]

Benjamin Graham on investment versus speculation [ValueHuntr ~ remember our readers receive a 15% discount to their Value Edge newsletter as well]

What have the ultimate stockpickers been buying and selling [Morningstar]

Jim Chanos is short a major oil company and it's not BP [Clusterstock]

Video: finding relative strength for the next big move [Joe Fahmy]

Asset allocation: back to basics [Humble Student of the Markets]

Interview with Eric Sprott [TheStreet]

Doomed to repeat the same buy and hold mistakes? [Investment Advisor]

Stocks too cheap? Or earnings estimates too high? [WSJ MarketBeat]

PIMCO's Bill Gross bought $100 million of BP debt [Reuters]

Byron Wien says hedge fund returns may halve [BusinessWeek]

A buy signal for stocks is emerging [Barron's]

Some background on the eclectic Hugh Hendry [Motley Fool]

Stocks that just won't quit [Barron's]

Global Macro Hedge Funds Net Short Equities

Bank of America Merrill Lynch is out with their latest hedge fund monitor report and so we'll check in on the most recent exposure levels from hedgies. Overall, managers continued to sell equities and added to shorts in 10 year treasuries. A few weeks ago, we highlighted that hedgies had very low net long exposure and this trend continues. Also, we pointed out that long/short equity was the worst performing strategy. This trend also continues as equity funds continue to feel the sting. You can see how badly some of the top dogs fared in our May hedge fund performances update (it's not pretty).

Based on CFTC data, it is estimated that global macro hedge funds are actually net short US equities as of last week. This isn't the first time we've seen this stance as of late because back in early May, it appeared that global macro funds were net short equities then as well. Additionally, these funds are in crowded longs of the US dollar and are short commodities as well. This trade seems to be the complete opposite of what many put on during the financial crisis (short dollar, long commodities). It looks as if macro funds are pressing their bets and playing catch up. After all, we previously highlighted how these funds were struggling earlier in the year.

As of last week, long/short equity hedge funds were 22% net long. Again, this is well below historical averages of around 35-40%. These fund managers continue to favor high quality and growth stocks and we've highlighted this trend numerous times on the site before. However, last week they were slightly reducing high quality exposure.

Market neutral funds also reduced exposure to the stock market. However, they are still net long and have above average exposure. They seem to prefer value and small cap names.

Embedded below is the latest hedge fund trend monitor from Bank of America Merrill Lynch:



You can download a .pdf copy here.

For more research on what hedge funds are up to position wise, head to Goldman Sachs' VIP list and stay up to date daily with our hedge fund portfolio tracking series.

Hedge Fund Lansdowne Partners' Short Positions

Today we're examining short positions in UK financial companies taken by Steven Heinz and Paul Ruddock's hedge fund Lansdowne Partners. Currently, they have four shorts in Old Mutual (OML), Legal & General (LGEN), Prudential Plc (PRU), and Aviva (AV). Kindly note that Prudential is a company based in the UK, not to be confused with the US company of the same name.

Over the last few months, we've highlighted Lansdowne's short position in Prudential several times during the period where Prudential attempted to buy AIG's Asian business arm, AIA. This position has received a lot of attention from the financial media as many argued Prudential was overpaying for AIA. Lansdowne's short thesis seems to extend beyond the AIA bid though, because they held the position many months before the bid was even made and they have not completely covered their short even after Prudential's bid failed.

Currently, Lansdowne's short of Prudential Plc stands at -1.18% of shares outstanding. They previously were short to the tune of -1.46% of shares back on May 5th, 2010 so they have covered a partial position but still maintain quite a hefty bet. As you'll see from our examination of Heinz and Ruddock's other shorts, Lansdowne tend to hold their shorts for longer periods of time.

All of the short positions listed below are currently still open. Disclosure rules on short positions in UK financial companies state that fund managers who are net short a UK financial sector company are required to disclose the position if it is greater than 0.25% of the firm's issued share capital. In addition, the hedge fund must disclose each time it increases the short by 0.1% of issued share capital. Also, they must disclose when the position falls below the 0.25% threshold. For a full list of companies deemed 'financial sector companies,' head to the FSA website.

While these regulations are obviously tedious for the hedge funds themselves, it's a prime example of how UK governing bodies are increasing regulation and it's interesting to compare it to the SEC's requirements. The UK is more 'fun' for Market Folly because it reveals short positions of various hedge funds and we get to highlight these positions. In the United States, these positions are closely guarded and rarely revealed so it will be intriguing to see if the SEC steps up regulatory requirements regarding public disclosure of short positions. Over a year ago, we highlighted how rampant public disclosure of short positions could possibly be a bad idea. But at the same time, increased regulation is definitely needed so maybe a compromise would be revealing shorts to the governing bodies, but not releasing them publicly. That is an entirely separate debate that we'll save for another time.

Turning back to hedge fund Lansdowne Partners' short positions, we see that they have been short the insurance company Legal and General for well over a year. This is not the first time this company has appeared in our hedge fund portfolio tracking series either. Back in May, we saw that Ken Griffin's investment firm Citadel was short Legal and General as well. Since then though, Citadel have reduced the position under the 0.25% threshold. Below are tables breaking down Lansdowne's various short positions:

Legal & General (LGEN)
February 6th, 2009: Lansdowne was short -0.47% of shares
August 26th, 2009: They increased their short to -1.16%
November 12th, 2009: Increased to -1.76%
June 11th, 2010: Reported as -1.02%

Old Mutual (OML)
February 18th, 2009: Lansdowne was short -0.39% of shares
April 20th, 2009: -0.75%
May 7th, 2009: -0.51%
October 13th, 2009: -0.41%
November 27th, 2009: -0.49%

Prudential Plc (PRU)
May 22nd, 2009: -0.95%
December 10th, 2009: -0.79%
December 15th, 2009: -0.43%
April 26th, 2010: -0.97%
May 5th, 2010: -1.46%
May 28th, 2010: -1.18%

Aviva (AV)
February 13th, 2009: -0.34%
March 26th, 2010: fell below the 0.25% threshold
June 11th, 2010: -0.49%

So, after previously covering the majority of their short in Aviva back in March, Lansdowne has re-shorted the name. And, as you can tell from above, Lansdowne typically holds their core short positions for an extensive period of time, trading around partial positions in the mean time.

Last month, Lansdowne's UK Equity Fund was -3.98% for May but still up 0.67% for the year as detailed in our May hedge fund performance update. You can view our coverage of Lansdowne's new longs here as well as our posts on other hedge fund UK positions.

Hedge Fund Viking Global Adds to Numerous Positions

Andreas Halvorsen's hedge fund firm Viking Global just filed a 13G with the SEC regarding shares of Owens Corning (OC). Per the filing (which was made due to activity on June 4th), Viking now discloses a 5.4% ownership stake in Owens Corning with 6,974,715 shares. This is a massive increase in their position as they previously only owned 197,955 shares of OC when we took a look at Viking's portfolio as of March 31st. Over the past three months, they've added 6,776,760 shares of OC (a 3,423% boost in their position size).

We also wanted to highlight that due to activity back on May 14th, Viking has disclosed a 5.1% ownership stake in Mednax (MD) with 2,390,987 shares. They've also boosted their holdings here as this marks a 103% increase in their position size (1,215,065 additional shares since the end of March).

Lastly, due to activity on May 6th, Viking Global has filed a 13G with the SEC regarding Sherwin-Williams (SHW). Viking shows a 5.1% ownership stake with 5,602,340 shares. This marks an 85% increase in their position size since March as they've added 2,579,522 shares. For the rationale behind some of Halvorsen's investments, head to Viking Global's investor letter. Other large bets at Viking include Visa (V), Express Scripts (ESRX), and Invesco (IVZ).

Taken from Google Finance, Owens Corning is "a producer of glass fiber reinforcements and other materials for composites and of residential and commercial building materials. The Company operates in two business segments: composites, which include the Company’s reinforcements and downstream businesses, and building materials, which includes its insulation, roofing and other businesses."

Mednax "formerly Pediatrix Medical Group, Inc., is a provider of physician services, including newborn, maternal-fetal, pediatric subspecialty and anesthesia care."

Sherwin-Williams is "engaged in the development, manufacture, distribution and sale of paint, coatings and related products to professional, industrial, commercial and retail customers primarily in North and South America, with additional operations in the Caribbean region, Europe and Asia."

You can view the rest of Viking Global's equity investments here.

The Hedge Fund Herd Mentality, Piggybacking & Crowded Trades

Loosely defined, the hedge fund 'herd mentality' is when various investment managers seemingly all invest in the same stocks. It's a trend that has occurred for years and is exemplified via Goldman Sachs' VIP list of stocks that are most commonly owned by hedge funds. It is the epitome of groupthink and can often lead to explosive situations. After all, hedgies are often perceived as primal creatures, each grasping for every basis point of performance. So, why should you be concerned with the herd mentality? Well, probably because prominent fund manager Dan Loeb is concerned about it and is taking what little steps he can to prevent it.

Earlier this morning, we posted up hedge fund Third Point's latest investor letter. In it, we got a glimpse at their portfolio, latest allocations, and manager Dan Loeb's frustration with regulators. However, none of that was as intriguing as a footnote he made on page five of his letter.

In the section regarding equity investments in Third Point's letter, Loeb writes, "Please note that we will no longer discuss investments made prior to our public 13-F filings. We have found that discussing our ideas may result in 'piling on' by other hedge funds who may subsequently sell at inopportune times resulting in greater hedge fund concentration and volatility, which is not in the interest of our investors."

Basically, he is stating that if his firm makes a new investment, investors (and everyone else) won't find out about this position until it becomes public at least forty-five days after they've established the stake. As we've detailed countless times in our hedge fund portfolio tracking series, 13F's are filed with the SEC on a time-lagged basis. For instance, the most recent filings we've covered for the first quarter were filed around May 15th, 2010 but reflect hedge fund positions as of March 31st, 2010. In the past, we'd learned about some of Loeb's new investments via his investor letters. But alas, no longer. It's a good thing that we already track Third Point's portfolio via 13F filings to begin with.

Loeb clearly doesn't want managers splashing in and out of his investments causing unnecessary tidal wives. What's interesting here is the fact that he is so certain other hedge funds are "piling on" his trades to begin with. While he might be able to discern that by price action alone in some stocks, it's as if he's received confirmation of this from traders, other fund managers, or word of mouth. While many fund managers seemingly talk their book in hopes of convincing other investors to join in on the investment, Loeb has now taken a completely converse approach. A true contrarian, indeed. In an effort to combat herd mentality, he will now only be talking about his positions long after the fact.

We highlight this because it is now the second time we've seen the herd mentality referenced in a prominent hedge fund investor letter. Andreas Halvorsen's Viking Global previously discussed the concentration of hedge funds in particular stocks in response to investor questioning. In this case, investors were essentially worried that many of Viking's holdings were (or had become) hedge fund favorites. The cause for concern was that an increase in concentration could potentially lead to elevated volatility. Halvorsen argued that it doesn't necessarily matter if other hedgies are in the same trades, as long as Viking is proven right in their analysis. On the topic of crowded hedge fund trades, Halvorsen adds,

"There is obviously some risk associated with being in an investment alongside likeminded investors who may have been trained in the stock-picking trade in similar ways in that we may decide to sell at the same time. To limit the consequences of crowded exits, we pay attention to the liquidity of the stocks we trade and take large positions only in the most liquid stocks in the world. The problem of crowding is most acute in our shorts due to the risk of unlimited loss and the potential for canceled borrow arrangements. Here we do tread carefully. As you are aware, we are guarded in disclosing our shorts to anyone and we do on occasion limit the size of our positions, or eliminate them altogether, when we perceive a position to be tight in the borrow market or crowded by equity long-short investors. Ultimately, we live and die by our analysis, portfolio management skills and efforts to contain risk - managing risk is merely another challenge we face in delivering attractive returns at reasonable risk."

So, the approach for dealing with crowded trades and the herd mentality differs between two prominent fund managers. Third Point's Dan Loeb is now attempting to prevent it from occurring in the first place by not discussing new investments until after they've been disclosed publicly via SEC filings. While his approach seems good in theory, the public will still be able to see his investments and "pile on" his investments, albeit on a time-lagged basis. Viking Global's Halvorsen, on the other hand, acknowledges and accepts crowded trades as a component of financial markets. Instead, he seems inclined to tackle it from a portfolio risk management perspective. Given that more prominent funds have sent signals of their stance and voiced their opinion on the topic, we'd expect others to follow suit and chime in as investor concern over the issue rises.

More than anything, this fixation with herd mentality most likely stems from horror stories during the financial crisis when many crowded trades imploded due to various hedge funds that were under duress. These investors were forced to liquidate positions and the severity of declines in certain stocks was only amplified by the fact that high hedge fund concentration led to greater volatility. A perfect example of this is Freeport McMoran (FCX), a metals & mining play that was owned by a plethora of hedge funds. As global economies weakened and hedge funds started their fire-sale, shares of FCX cratered from $123 in June 2008 all the way down to $17 in only six months' time. Peak to trough, the move marked a jaw-dropping 86% decline.

While the above is an extreme example, you can't help but see why some managers would attempt to alleviate or prevent any sort of herd mentality. Indeed, aligning yourself with the hedge fund herd can potentially lead to trampling outcomes. But, there can also be positive outcomes as well. 'Piggybacking', or the notion of following another manager into an investment, can be wildly fruitful if done correctly. As hedge fund replicator Alphaclone has continually demonstrated, investors can easily outperform the market indices and generate hedgie-like returns simply by following the top picks of prominent equity focused managers.

For instance, we just took a look at Alphaclone's top 3 holdings clone of Dan Loeb's Third Point to see what kind of performance could be generated via some simple piggybacking. The portfolio clone rebalances quarterly based on 13F filings and the backtested results are pretty stunning. The 'Third Point Clone' has returned 15.2% annualized since 2000 while the S&P 500 has annualized -0.9% over the same period. This long-only portfolio has a total return of 340.5% compared to the S&P 500's cumulative return of -9.3%. You can take a free 14 day trial to Alphaclone to play around with other funds and strategies as well to see just how successful piggybacking can be.

There is a slight difference between piggybacking and the herd mentality in that there is a cause and effect relationship. In short, piggybacking causes the herd mentality; one is a direct result of the other. The only thing that matters here is the endgame in which certain investment managers all end up owning the same stocks. Yet, just like piggybacking, we see (via backtesting) that you can still garner solid performance by investing in many 'herd mentality' stocks as well.

Alphaclone has also created a Tiger Cub Clone portfolio that simply buys the 10 most popular holdings amongst various hedge funds with past ties to legendary manager Julian Robertson. The long-only version of the Tiger Cub Clone has returned 8.1% annualized since 2000 whereas the S&P 500 has returned -0.9% over the same period. Yet again, we see a perfect example of mimicking prominent investors leading to outperformance.

With piggybacking and the herd mentality comes a bounty of positives, negatives, benefits and risks. It's commendable that Dan Loeb seeks to reduce volatility for his investors by no longer discussing new positions in his investor letters. At the same time though, those investors have a right to know where he is allocating capital and why. Unfortunately for investors, it now seems as though they'll be relegated to scouring over SEC 13F filings just like MarketFolly.com does on a daily basis. Despite various hedge funds' best efforts to thwart them, piggybacking and the herd mentality are traits that will seemingly never die. After all, they've been laced into Wall Street's DNA for generations.

If you enjoyed this post and/or are interested in daily updates on hedge fund portfolio movements, consider receiving our free updates via email or our free updates via RSS reader.

Dan Loeb Sells Financials: Third Point's Investor Letter (Q1 2010)

Dan Loeb's hedge fund firm is now fifteen years old. They have a lot to celebrate too considering Third Point has grown assets under management from $3.3 million to now billions. And when we checked in on Loeb's firm back in May, we saw his Offshore Fund had annualized returns of 18.6% versus 5.2% for the S&P 500. With cumulative performance of 892%, Loeb has certainly found success. To get on track toward emulating such success we'd refer you to Dan Loeb's recommended reading list. So, what has he been up to lately? We'll dive into Third Point's first quarter investor letter below.

While Loeb notes that his firm started betting on a recovery in April 2009, he fixates on the fact that investor confidence is still not what it should be. He attributes this lack of pizazz to a continually shifting regulatory environment where the rules are rapidly and repeatedly revised. In his typically eloquent fashion, Loeb summons his famously penned CEO-bashing days of old. This time though, he has a different target. He writes, "The Administration appears unable, or unwilling, to let free-market capitalism resume. Indeed, it is neither health care nor financial reform which has stressed markets most in 2010, but rather the continued politicizing of the regulatory process and the abandonment of free market capitalist principles that have undermined investor confidence".

In fact, Loeb's confidence in the system has been shaken to the point where he has sold out of practically all of Third Point's positions in financial companies. Third Point has exited their Citigroup (C) and Bank of America (BAC) stakes. Additionally, Loeb sold mostly out of his Barclays (BCS) position and only holds a small residual position in a regional bank (to the tune of less than 1%). Loeb is now the perfect example of his own point on investor confidence. Most investors haven't been confident in the markets. Loeb, on the other hand, hasn't been confident in the administration and its actions. However, his lack of confidence in regulators has in turn caused lack of confidence in the ability to invest in financial companies.

In what will surely be labeled as a strange and potentially questionable maneuver, Loeb notes that he talked about his positions in BAC and C back on January 20th at Third Point's annual investor presentation. However, in his first quarter letter he reveals that he quickly sold out of those positions only days later. While he provides rationale for his abrupt exit, it certainly wreaks of oddity and might rub some investors the wrong way that he would essentially be 'pitching' them on the latest investments in financials, only to sell out of them in the days following the event. Loeb labels political action as part of his reason for exiting and so maybe more than anything he is using this as an example to showcase how much of an effect regulators are having on investor confidence.

It's truly intriguing to see the dynamic at play with financial stocks. While Third Point exited Citigroup in the first quarter, Bill Ackman's hedge fund Pershing Square just started a position in C. As always, this is the beauty of a market and the dichotomy of opinion. Loeb also reveals that Third Point has exited their position in Wellpoint (WLP), a health care company. He says his firm is no longer able to predict how legislation or regulation will affect the company and its industry and such unknowns present too much of a risk.

On the short side of the portfolio, Loeb reveals that they have increased shorts in the for-profit education sector. This theme is now running rampant through hedge fund land as Steve Eisman presented the short case for these companies at the recent Ira Sohn Investment Conference. This stock battleground becomes even more intriguing when you consider that some of the biggest hedge funds have also previously had long positions in these companies. We'll have to see if they have since caved in with their positions or whether they are standing strong. In the past though, we have noted certain hedge funds exiting long positions in the for-profit education space.

Loeb also mentions that Third Point has reduced gross and net exposure. We of course have already taken a recent look at Loeb's portfolio positioning with Third Point's latest exposure levels. In terms of other equity investments, Third Point still fancies post-bankrutpcy equities as they are still very cheap. In terms of new portfolio activity, we've highlighted how Third Point disclosed a stake in Xerium Technologies as well as a new position in Roomstore. And for more on Loeb's holdings from the first quarter, we've detailed Third Point's equity portfolio.

Embedded below is Third Point's first quarter letter to investors:



You can download a .pdf copy here.

For now, it certainly seems as though Loeb's confidence in regulators, financials, and the financial system is certainly shaken. We'll have to see what it means for his portfolio in the coming quarters, but it sounds as though he's still finding ample opportunities in his event-driven value niche. For more resources on Third Point, be sure to check out Dan Loeb's recommended reading list, as well as Third Point's latest exposure levels.

Battle of Bulls & Bears: Key Stock Market Levels

Adam over at MarketClub recently took a look at the S&P 500 from a technical analysis perspective and has concluded that we'll continue to see choppy market action for a while. In his latest market analysis, he points out a series of lower highs, typically a sign that favors the bears. Basically, he argues that the key level to watch in the market is S&P 1,100. If the market rallies above that level, it has a strong chance of resuming the longer term uptrend we've seen over the past year or so. However, if the market continues to stall at 1,100 (as it has previously), then the bears are in control. This level becomes even more interesting when you consider it's currently right around where the market is trading and this could be a potentially pivotal point.

Additionally, he points out 1,040 as a second key level to watch in the S&P 500. This level could potentially be a double bottom as the market tested that level in late May and then again in early June. He notes that we'll get confirmation of this double-bottom (a bullish pattern) if the market rallies above that 1,100 level. So, all said and done, 1,100 is the key level to watch on the upside as it seems to hold all the technical keys. Overall though, Adam concludes that it will continue to be rough waters throughout the summer, typically a time of lighter volume as many traders/investors are on vacation. Click below to watch the latest analysis of the S&P 500:

Third Avenue Funds: Manager Commentary & Semi-Annual Report

Below is the semi-annual report from Marty Whitman's Third Avenue Funds. In it, you'll find portfolio manager commentary from their Value Fund, Small-Cap Value Fund, Real Estate Value Fund, International Value Fund, and Focused Credit Fund. We typically like to highlight intriguing market commentary from fund managers and you can view all our posts via our posts on hedge fund investor letters.

Turning to Third Avenue's latest missive, we get commentary on numerous topics. Most notably though, is the Chairman's letter from Marty Whitman. While his commentary these days is obviously less frequent than it once was, it's still always interesting to get his take on things. Last time around, he was out defending the managed mutual fund space. This time around, his letter focuses on 'eight areas of financial misunderstanding' including the "too big to fail" concept. While he readily admits that he is prejudiced since he is from the mutual fund industry, he attributes that a lot of success in his industry stems from strict regulation. As such, he argues that strict regulation of financial institutions is absolutely imperative.

Below is the latest commentary from Whitman as well as the portfolio managers of the various Third Avenue funds:



You can download a .pdf here.

If you want to learn more about Whitman and his value investing philosophies, we point you of course to his book, The Aggressive Conservative Investor. Interestingly enough, this book has landed on legendary investor Seth Klarman's recommended reading list as well. That testimonial obviously speaks for itself.

Dan Loeb's Third Point Discloses Position in Xerium Technologies (XRM)

Due to activity on May 25th, 2010, Dan Loeb's hedge fund firm Third Point has filed a 13G with the SEC regarding shares of Xerium Technologies (XRM). Per the filing, they show an 8.6% ownership stake in the company with 1,294,507 shares. This is a newly disclosed position for Loeb's firm as they previously did not show an equity stake when we covered Third Point's portfolio. However, it is very likely that Third Point owned a position in Xerium's debt as the company just exited bankruptcy (a security that they aren't required to disclose).

Per the restructuring, Xerium exchanged $620 million of existing debt for $10 million in cash, $410 million in new term loans, and 82.6% of the new common stock of Xerium. So, this is a new equity stake for Loeb's firm but they've likely received it due to the recent debt conversion. Loeb has also been active in other companies as of late since we just disclosed his new Roomstore stake. Third Point was -5.6% for May but is still up 12.6% for the year according to our May hedge fund performances update. To get an idea as to how Third Point may have generated such performance, we previously detailed their latest exposure levels as well.

Taken from Google Finance, Xerium Technologies (XRM) is "is a global manufacturer and supplier of two types of consumable products used primarily in the production of paper: clothing and roll covers. Xerium’s clothing segment products include various types of industrial textiles used on paper-making machines and other industrial applications."

To learn how to become a successful investor like the hedge fund manager himself, head to Dan Loeb's recommended reading list.