market folly

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.