market folly

John Kleinheinz founded Kleinheinz Capital Partners in 1996 and manages the Global Undervalued Securities Fund. He has seen a compound annual growth rate (CAGR) of 26.8% since inception and a total compound return of 3,162%. Given the solid performance, we've added this hedge fund to our portfolio tracking series and today we're detailing Kleinheinz's third quarter letter/market commentary.

Kleinheinz's fund primarily focuses on equities but also invests in emerging market debt. They utilize macroeconomic analysis to identify various investment themes across the globe with solid risk/reward profiles. Prior to founding his fund, he worked in the corporate finance unit of Nomura Securities in Tokyo as well as Merrill Lynch. Kleinheinz graduated from Stanford University with a degree in Economics.

Current Market Commentary

Kleinheinz's fund is up over 18% year to date. Interestingly enough, you can replicate Kleinheinz's portfolio at Alphaclone and investing in their top 5 holdings has returned 31.6% year-to-date and their top 10 holdings 19.7% ytd (get a free membership to Alphaclone here). This past quarter, Kleinheinz has lost money on their puts and hedges as the market practically prices in another round of quantitative easing. Their short positions in the energy sector (specifically in high beta natural gas producers) also hurt the fund.

While talk of an emerging market bubble seems to have increased, Kleinheinz is quick to point out that despite the fierce rallies, these valuations are still "within historical norms and economic fundamentals appear favorable relative to developed market peers." He believes that the formation of a consumer society in these emerging markets will be a key investment theme for them going forward.

Currently, their focus is on the geographies of Russia, Africa, China, and Brazil. In China, they like healthcare, telecom and technology. They also believe Russia is the cheapest emerging market and they're honing in on energy and utilities. Kleinheinz is generally focused on markets "with stable banking systems, under-levered consumers with rising disposable incomes and attractive valuations relative to growth prospects."

Specific Investment: Yahoo (YHOO)

Kleinheinz also dedicates a portion of the letter to talk about Yahoo (YHOO). He feels the market is under-appreciating Yahoo's international assets such as Alibaba Group and Yahoo Japan. He writes, "assuming an average multiple of 8-10x EBITDA for its core U.S. internet assets on a sum of the parts basis, we believe Yahoo could be worth $32 per share, more than double the Fund's acquisition cost and about equal to the price Microsoft was willing to pay for Yahoo during its aborted takeover attempt in May 2008."

Top 10 Positions (as of September 30th):

1. Apple (AAPL)
2. China Mobile (CHL)
3. Research in Motion (RIMM)
4. Baidu (BIDU)
5. LUKoil Holdings
6. Hong Kong Exchange & Clearing (HK:0388)
7. Veeco Instruments (VECO)
8. Google (GOOG)
9. Akamai Technologies (AKAM)
10. Chubb Corp (CB)

Embedded below is Kleinheinz's third quarter letter to investors:

*Update: Letter removed per request of representatives from Klenheinz

For thoughts from more great managers we also posted up Lee Ainslie & Maverick Capital's letter as well as Jeremy Grantham's commentary and Corsair Capital's latest ideas.