market folly

Lansdowne Partners have been regularly rated as one of the best hedge fund managers in London. Whilst they do have global macro and long-only funds they specialize in long-short stock picking. Their flagship, the UK Equity Fund, has returned an impressive 19.37% annualized since 2001 (see table below). Additionally, we recently saw that their UK strategy fund was up 0.32% for the month of October and is now up 22.19% for the year.

Source: Trustnet Offshore

One of the interesting things about Lansdowne is that they currently have a much more bullish outlook on the economy and equities than many other hedge funds we follow on Market Folly. Lansdowne are strongly opposed to a downbeat view and point to a number of factors that they see as positive for equities and the economy in general.

They argue that current valuations in both absolute terms and certainly relative to government and corporate bonds are compelling. They believe that it is premature to worry about growth disappointments because there are still large boosts to growth yet to come from the normalization of the inventory cycle and importantly from the lagged response to the expansive fiscal and monetary actions. In addition, they argue that interest rates are unlikely to rise for some time because the authorities are likely to want to see firm evidence of a recovery. The output gap - estimated to be approximately 4% in the developed markets - means that inflationary pressures are likely to remain muted for some time thereby extending the period that policy can remain accommodative.

In their September 2009 report, Lansdowne argue that a combination of five factors make large-cap companies in developed countries particularly attractive at the moment. Firstly, large companies have done particularly well at cutting costs during the recession, especially labor costs. Consequently, earnings (and more importantly cash flows) have been protected. Secondly, there will be a positive, lagged impact from the fall in commodity prices on input costs mostly from natural gas and oil. Thirdly, currency tailwinds will help US and UK denominated companies where their respective currencies have been weak over the last 12 months. Fourthly, stronger companies will capture market share from weaker competitors; particularly from those who have over-extended balance sheets and are financially constrained. In addition, merger and acquisition opportunities are now back on the agenda. Finally, emerging markets remain a strategically important and ever increasing focus of growth for multinational companies with strong brands.

Lansdowne say that they continue to discover a very large range of potential investment opportunities. In case you were wondering, all this bullishness is not just talk. In their October report, Lansdowne noted that their gross long exposure level was 149% of NAV, up from the previous month (it also includes a 10% short futures position). This is extremely close to the top of their stated range (150%) but even so, they were not inclined to take profits believing that further upside was achievable. Gross short positions were 72% of NAV. Compare that exposure with, for example, David Einhorn's Greenlight Capital who recently disclosed they were 99% long 59% short. Lansdowne say that they are likely to remain bullish until the authorities step back from their accommodative stance and raise interest rates, which they believe is unlikely in the short-term.

We can get an idea of the type of large-cap company that Landowne believe will prosper going forward because they detail their largest 11 holdings in their UK Strategic Equity Fund in their September letter:

Barclays, BHP Billiton, Coca Cola, Colgate, Goldman Sachs, International Business Machines, JP Morgan, Palmolive, Rio Tinto, Roche, Wells Fargo

Plenty of US large-caps there for a fund with a supposed UK focus! In terms of sector and thematic positioning from their September update, they maintained exposure to the banking and mining sectors. Lansdowne believe that the biggest exogenous threat to their world view would be 'cost push inflation' arising from the commodity markets. In order to combat that threat they own out-of-the money call options on oil and miners like BHP Billiton and Rio Tinto.

In their October letter, they note that they added to their positions in Lloyds and Barclays on weakness. To hedge this, they also added to their shorts in the insurance sector. They also boosted their position in Roche up "to a full weighting" after shares slumped around Q3 sales. They think the pharmaceutical sector is intriguing here after underperforming for many years.

Now let's turn to look at what we can learn about Lansdowne's holdings in the UK market from their regulatory filings to the London Stock Market. Our primer on understanding the UK disclosure system can be found here. Remember that there is no equivalent of the 13F form for hedge funds in the UK and generally speaking hedge funds only have to disclose long positions that are greater than 3 percent of a company's outstanding equity. It's important to recognize that the UK disclosure system provides us with a distorted view of hedge fund holdings as large-cap holdings are rarely seen because they often do not breach the 3 percent threshold but investments in mid-cap and particularly small-cap companies show up prominently. Of course this information is still useful because when a hedge fund builds a large stake in a small or medium sized company, it demonstrates a great deal of commitment to the investment thesis as such positions can be difficult to exit at speed, particularly in a down market.

It's interesting that Lansdowne holds a big 13 percent chunk of Inmarsat (ISAT). ISAT provides global mobile and transportable broadband communication services to maritime, aeronautical and land mobile users. Many believe that activist hedge fund Harbinger Capital is likely to make a formal offer for Inmarsat anytime soon. Harbinger currently hold a 29 percent stake in the company as we detailed in our article on Harbinger's activist positions in the UK.

Renewable Energy is a position that Lansdowne share with Paul Tudor Jones' hedge fund Tudor BVI Global. (See our article on Tudor's holdings in the UK here). Renewable Energy Holdings owns and operates windfarms in Germany and Wales. The Company’s subsidiaries are also involved in developing wave power technology and as a by-product, desalinated water. Oxford Catalysts Group PLC has close links with the University of Oxford and is engaged in the design and development of catalysts and microchannel systems. It develops technology for the production of clean fuels from both conventional fossil fuels and renewable sources, such as biowaste. IP Group helps owners of intellectual property like universities to develop commercial ventures through the formation of long-term partnerships and the management of venture funds. They focus on early-stage United Kingdom technology and pharmaceutical companies.

The holdings in Herderson Group and Evolution Group provide support for the idea that Lansdowne believe in further recovery in the financial sector. Henderson Group Plc is a United Kingdom-based company engaged in providing investment management services. The Evolution Group through its subsidiaries is involved in investment banking and also provides private client investment management.

Both Afren and Heritage are independent companies involved in the exploration and production of oil and gas. Afren has an African focus while Heritage is involved in Africa, the Middle East, Russia and South Asia.

Proximagen Neuroscience plc is focused on developing drugs for the treatment of age-related neurodegenerative disorders, including Parkinson's disease and Alzheimer's disease.