What We're Reading: Hedge Fund Links ~ 2/1/13

Earlier this week we posted up analytical links and below are updates on the industry:


Hedge Fund News Links

Highbridge's Dubin & York's Dinan make bullish case for equities [HF Intelligence]

Thoughts from Paul Singer, Lee Ainslie & Jeff Vinik at Breakers Conference [HF Intelligence]

Transcript of Ray Dalio's comments at Davos [Santangel's Review]

Greenlight Masters Fund up 10% for 2012 [ValueWalk]

Ackman vs Icahn: who's the better investor? [II Alpha]

The appeal of hedge funds that cost more and return less [NYTimes]

Palm Beach County as the next hedge fund center [Dealbreaker]

GAIM Conference: golden age of alpha is over for hedge funds [COOConnect]

Tiger Global amassing giant internet portfolio [PEHub]

Beneath the calm, SAC works to contain fallout from inquiry [Dealbook]

The demise of 2 & 20 fee structures [Reuters]

Buffett said to have expressed interest in buying NYSE Euronext [NYTimes]

Pensions bet big with private equity [eFinancialNews]

Ackman, Herbalife and celebrity short sellers [NYTimes]

Compliance: fast-changing social media makes advisers scramble [Reuters]

Steve Romick's FPA Crescent Fund Still Conservatively Positioned: Q4 Letter

Steve Romick's FPA Crescent Fund is out with its fourth quarter and 2012 year-end letter and commentary.  In it, he highlights how they've maintained conservative positioning due to concern over risk.

FPA Still Conservatively Positioned

Romick writes that,

"Artificial and unsustainably low cost of capital perverts capital allocation decisions. Fear of not having enoughincome pushes the elderly to own more equities or riskier bonds. Companies will find that they can invest capital that wouldn’t otherwise meet their return -on-capital hurdles (ROC). In general, investors are moreable/willing to assume greater risk, and they sometimes forsake liquidity in the process, even though they might have near- term needs for that capital. It’s easier to spend capital  when it’s sitting on your balance sheet, earning essentially nothing. And companies that should die are kept alive by an endless supply of cheap money  . We feel like we’ve fallen down the rabbit hole. Traditional investment decision -making processes have been hijacked by zero-interest-rate-policy (ZIRP)."

The scenario they illustrate of lack of return on cash positions driving investors to invest more fully has certainly come to fruition.  Earlier today, we highlighted how Grey Owl Capital has moved more cash into equities due to the negative real return on cash.  FPA, on the other hand, has stood steadfast and will invest only when they see opportunity by their definition.


Investment in Groupe Bruxelles Lambert

FPA notes they've taken a stake in Groupe Bruxelles Lambert (GBL), a Belgian holding company which many liken to Berkshire Hathaway as it's run by the 'Warren Buffett of Europe,' Albert Frere.  FPA liked shares due to the 25-30% discount to NAV and they term it a 'infinite duration bond.'  They also like the 4.5% dividend yield but note that they don't see a catalyst for the NAV gap to close.

They also include a write-up on their stake in Orkla, a stock they originally purchased in November 2011 but they continue to hold.


Embedded below is FPA Crescent Fund's Q4 letter to investors:




To see what FPA's invested in, we've covered Romick's pitch on Renault as well as some of Romick's investment picks.

Grey Owl Capital on the Role of Cash in a Portfolio

Jeff Erber and Grey Owl Capital are out with their fourth quarter letter to investors.  In it, they highlight how they started to move more cash into equities in Q4 and have continued to do so in 2013.  This led to an interesting discussion about how they view cash as a component of their portfolio which we wanted to draw attention to.

Cash as a 'Hedge'

Grey Owl outlines the tradeoffs between holding cash and being invested:

"We have chosen to 'hedge' our exposure to these individual equities by holding cash.  If the broad equity market was overvalued and the economy was on artificial support, we wanted the cash available in order to take advantage of likely dislocations.  Today, our analysis says that the value of holding this cash is lower than in the past few years."

While they use the term 'hedge,' what they really mean is that they view cash as an opportunistic tool to take advantage of market sell-offs that might be unwarranted.

After all, Passport Capital's John Burbank once said, "cash is most valuable when others don't have it."  We've also posted how DoubeLine Capital's Jeff Gundlach said investors should hold cash.


Cash as a 'Call Option'

Given this discussion, it's important to also highlight how Berkshire Hathaway's Warren Buffett views cash.  Alice Schroeder (his biographer) highlighted that,

"He thinks of cash differently than conventional investors.  This is one of the most important things I learned from him: the optionality of cash.  He thinks of cash as a call option with no expiration date, an option on every asset class, with no strike price."

The Downside of Holding Cash

Turning back to Grey Owl's letter, they touch on the downside of holding cash: 

"We can hold a large-than-typical cash position (which we have), waiting for the monetary manipulation and fiscal imbalances to cause market dislocations (as they eventually will).  Alternatively, we can increase our exposure to the common stocks of great businesses ... They will certainly experience more market volatility than cash and we would typically like to make purchases with a wider 'margin of safety,' but the alternative of negative real returns in cash is worse."

The interesting decision here is that they've essentially determined that the adverse effects of negative real returns in cash is doing more harm than the benefits offered by having cash on hand as a 'hedge'  and as an opportunistic tool.  As such, they've decided to allocate more of this cash into equities.

This is a phenomenon we're seeing gain steam among investors.  Bridgewater's Ray Dalio highlighted this very concept of the negative real return on cash and said that cash will move into 'stuff' in 2013.  Appaloosa Management's David Tepper is also bullish on equities.  Contrafund's Will Danoff is also bullish for 2013.


Risk/Return

Normally, the investment environment dictates how much cash an investor will hold, i.e. if things are overvalued, they will hold cash and wait for better opportunities.  What's intriguing here is how Grey Owl's decision is less about deploying cash due to low price opportunities (after all, this isn't the financial crisis).  Instead, their decision was more-so focused on the perceived lack of risk in equities.

Investors are always focused on the risk and return of a potential investment.  Most of the time, value investors will wait for risk to abate via share price declines (providing a larger margin of safety).  In this scenario, it seems many investors are investing not because of an improved risk profile due to lower security prices, but instead because of the perceived lower risk environment as a whole, led by the Fed's backstop. 

So there are obviously a few different ways to view cash as a component of the portfolio.  Monetary policy has altered the way Grey Owl views cash.  They end their missive by saying, "At this point, too large an allocation to cash might prove to be a bet on Fed failure.  More likely, the performance of the underlying businesses will determine our results."

It will be interesting to see if even more investors follow this framework and shift their views, but as illustrated above, many already have (but for a myriad of reasons).


Grey Owl's Q4 Letter

Embedded below is Grey Owl's latest letter:

Contrafund's Will Danoff Bullish For 2013: What Stocks He Likes

Will Danoff is manager of Fidelity's Contrafund and he recently sat down with Fidelity Viewpoints to share his outlook for 2013.  He's bullish and so we wanted to highlight what stocks he's looking at.


On Why He's Bullish This Year

"I’m bullish. Stocks are relatively cheap, and U.S. companies have become much leaner. Management teams were worried about the environment, so they were conserving cash and allocating capital prudently. M&A activity was down about 20% in 2012. Boards were saying, 'We’re not going for the long ball. We’re going to focus on maintaining lean inventories, low capital spending, and tight expenses.' As a result, companies are nicely profitable and generating a lot of cash.

So looking forward, I’m hopeful that we’re going to have modest top-line growth that will lead to decent earnings-per-share growth, good free-cash-flow yields, and total returns that may be a lot better than what we will see from cash and bonds."

He also went on to say that,

"My guess is a year from now the economy’s going to improve and stocks are going to be a good place to be. I’m bullish. So, I think if you’re in cash, you have to really think hard about it and say, 'How much cash do I really need?'"

This is a concept that's been talked about by many managers, including Bridgewater's Ray Dalio who said cash will move into 'stuff' in 2013.  David Tepper of Appaloosa Management has also been quite bullish.


What Stocks He Likes

Danoff notes that the key to his strategy has been identifying the best companies in each industry.  There's a few themes/industries he likes this year, and they all seem hinged on an economic recovery: housing, manufacturing, and industrials.

In particular, the Contrafund manager says he's finding most opportunities that should benefit from more competitive US manufacturing (companies are moving plants back from overseas).

He also likes US companies with lots of international exposure, like Colgate-Palmolive (CL), Estee Lauder (EL), and Starbucks (SBUX).

In tech, he likes internet plays such as Google (GOOG), Facebook (FB), and Yahoo (YHOO).  He also is bullish on the software as a service trend, fancying the likes of Workday (WDAY), Salesforce.com (CRM), and Concur (CNQR).


On Tech Giants Google (GOOG) & Apple (AAPL)

These two tech giants are some of his fund's largest holdings.

Danoff's take on Google: "The stock has done basically nothing since 2007, but the earnings have roughly doubled, and the company is generating a huge amount of free cash flow—we estimate the stock is producing roughly a 9% free-cash-flow yield. And net of the cash, the stock has been trading around 13 times earnings while core revenues have been growing almost 20% annually. So I have believed that Google could continue to grow and had the potential for P/E (price-to-earning multiple) expansion."

We've also highlighted how Ricky Sandler's hedge fund Eminence Capital has been bullish on Google as well as it's their largest position at around a 9% position for them.

Danoff also notes that AAPL has been a good holding for his fund as the company's been generating a ton of free cash flow.  The problem is that most of it is overseas (and it's a massive amount of money too) and he also pointed out that competition has intensified in the smartphone and tablet markets.  You can read more of Danoff's outlook here.

What We're Reading: Analytical Links ~ 1/30/13

Lessons from hedge fund market wizard Colm O'Shea [Finance Trends Matter]

The student loan bubble is 'simply unsustainable' [Zero Hedge]

Good read on upside risks [Reformed Broker]

What you can learn from the most popular finance films [Amazon Money & Markets]

5 reasons to remain cautious on US equities [SoberLook]

On insurance investing [Aleph Blog]

Wells Fargo (WFC) is cheap [Brooklyn Investor]

Predicting the next recession [CalculatedRisk]

Top 10 ways to deal with behavioral biases [Above the Market]

CRFN & ECBE: A look at an arbitrage opportunity [Whopper Investments]

Are you a value investor? Take the Apple (AAPL) test [Aswath Damodaran]

A look at Banco Popular (BPOP) [Corner of Berkshire & Fairfax]

All TV viewers pay to keep sports fans happy [NYTimes]

12 business lessons from Amazon founder Jeff Bezos [KissMetrics]

More homeowners are mortgage-free than underwater [Zillow]

Jack Schwager on Hedge Fund Market Wizards

Today we're pleased to present a guest post from David Shvartsman over at Finance Trends Matter where he has a lot of great posts about investing/trading process, behavioral finance, and more.  You can subscribe to his RSS feed here.  Without further ado:


Jack Schwager on Hedge Fund Market Wizards

If you're a fan of the Market Wizards books by Jack Schwager, then you've probably read (or are looking forward to reading) the latest in the series, Hedge Fund Market Wizards.

We'll be taking an in-depth look at this book and the insights of the "Hedge Fund Wizards" in an upcoming series of posts, but for now I'd like to share some key interviews and webinars with author Jack Schwager.   

These videos will give you a great inside look at Schwager's writing process, as well as offering some key lessons found in this new collection of interviews with leading traders and hedge fund managers.    

First, an Opalesque interview with Schwager in Manhattan: "15 Hedge Fund Market Wizard trading secrets and insights":



This discussion opens by noting that while markets have changed since the first Wizards books were published, the main principles behind the various traders' successes have not. Certain strategies and opportunities may have gone by the wayside, but successful traders have continued to hone in on what works for them as they strive for superior risk adjusted returns.  

Of supreme importance, Schwager finds, is the need to find a trading method that suits your personality. He cautions young traders from trying to emulate their trading heroes, since top traders may have an approach or strengths that differ from those of the would-be apprentice. You need to develop your own approach. 

If you enjoyed this interview and would like to dig further, check out Michael Martin's interview with Jack Schwager, as well as this Schwager Q&A webinar on the behaviors of Hedge Fund Market Wizards. 

One recurring theme that runs through these discussions is the quote, "There is no single true path". The Market Wizards profiled in this book, and throughout the series, have all found success by managing risk and pursuing the methods that suit their personalities and strengths. 

Join us next week, as we examine some key "Lessons from Hedge Fund Market Wizards" in our upcoming post series of the same name. See you then.


In the mean time, be sure to check out David over at Finance Trends Matter.        

Market Strategist Jeff Saut: Best Stock Ideas For Next 3-5 Years

Given that markets have been ripping higher, we thought it a prudent time to check in with market strategist Jeff Saut.  His latest investment outlook is entitled "For All the Sad Words of Tongue and Pen" where he looks at how market rallies can last longer than one would think.

He highlights how at around the 18th day of a typical 17-25 day buying stampede, certain investors will start to question whether or not they've missed "the bottom."  This then leads to a new round of buying from people who don't want to miss the big move, and thus the rally extends.

So when might this rally cease?  Saut mentions rallies can typically last up to 30 sessions while today is session 18.  He points out some of the cautious signals he is seeing:

"The S&P 500 (SPX/1502.96) remains overbought with 92.6% of its stocks above their respective 50-day moving averages (DMAs), as  well the NYSE McClellan Oscillator is still overbought in the short-term.  However, the stock markets can remain overbought for longer than most think in a bull move.  Further, the Volatility Index (VIX/12.89) is not confirming the renewed stock strength and  some of the hitherto leading stocks are not acting well."


Raymond James' Best Stock Ideas For 3-5 Years

Saut recalls Ray Dalio's recent interview where the legendary manager said that "the shift of that massive amount of cash is what will be a game changer."  If it moves into stocks (from pension funds and other large institutions), he wants to be prepared.

As such, Saut has highlighted his analysts' best stock ideas for a 3-5 year holding period with the following criteria:

- Recurring revenue stream
- High barriers to entry
- Not as dependent on economy/financial markets
- Can grow EBITDA at 5-10% annually
- Competitive edge in its sector
- Strong management

His analysts recommended the following stocks: Altera (ALTR), Conceptus (CPTS), Denbury Resources (DNR), NIC Corp (EGOB), Equinix (EQIX), EV Energy Partners (EVEP), IDEXX Labs (IDXX), Iridium Communications (IRDM), LKQ (LKQ), National Oilwell Varco (NOV), Verisk Analytics (VRSK), and Wabtec (WAB).

Embedded below is Saut's weekly commentary:




For more from this strategist, we've highlighted how Saut has been short-term conflicted and long-term bullish and how he's focused on housing as the key driver.

Eric Sprott's Latest Commentary: Ignoring the Obvious

Eric Sprott, founder of Sprott Asset Management, is out with his latest 'markets at a glance' outlook.  Entitled "Ignoring The Obvious," the piece points out how the Fed's actions are just masking real problems such as high unemployment, exploding government liabilities, and how money printing doesn't achieve anything constructive.

Sprott writes:

"The purpose of asset purchases by the Fed might no longer be improvements in the real economy, but rather a more subtle financing of U.S. government deficits. However, in the long run, expanding the money supply inevitably leads to inflationary pressures. Luckily for the Fed and the U.S. government, there is so much slack in the labour market that inflation might be years away. And, if we are right about the long run unemployment rate being structurally higher, then the Fed has all the room it needs to continue Quantitative Easing (QE) to infinity. This might allow them to continue to hide the true financial position of the government for many years to come."

Concluding his piece, he simply asks if we're going to ignore the obvious?  Well, the market is certainly ignoring it for the time being as 2013 has begun with a ferocious rally.


Stock Market Ignores the Obvious

While Sprott points out economic realities, it's always worth noting that the market can remain irrational longer than you can remain solvent.  Sometimes you just have to ride the perception until it dissipates, a concept illustrated via George Soros' best investment advice.

As you've undoubtedly seen over the past few weeks, various hedge fund managers have paraded their bullish views like David Tepper and even Ray Dalio said that 2013 will be a year that "cash moves into stuff".

So instead of asking if we're going to ignore the economically obvious (the market already has), perhaps Sprott should re-phrase his question and ask when the Fed's mirage will disappear and when we'll stop ignoring the obvious?


Embedded below is Eric Sprott's latest commentary:




For more from this investor, be sure to check out Eric Sprott's previous commentary as well.