Hedge funds, coming off their second-worst year in two decades, are on the rebound this year, but they’re still trailing the broader market.
Hennessee Group, a hedge fund adviser, said its composite index of hedge fund performance gained 2.5 percent in January, versus a gain of 4.4 percent for the S&P 500 index of the largest U.S. companies.
That comes after a disappointing 2011 for most hedge funds, which control about $2 trillion in assets. As a group, they lost 5 percent in 2011, while the S&P 500 was flat. Equity hedge funds lost 8.3 percent, and macro funds, which have a wide array of holdings, dropped 3.8 percent, and event-driven funds declined 2.8 percent.
Nevertheless, as a group they still saw inflows of $28 billion, according to another industry analyst, Hedge Fund Research.
Hedge funds of all kinds had about $70 billion in inflows last year, with the bulk of it going to fixed-income investments, a trend that is indicative of investors’ defensive positioning last year.
Hedge funds turned risk-averse last year as they tried to minimize losses, as the ongoing European sovereign debtcrisis and a weak U.S. economy resulted in a pullback by investors worldwide. That sort of allocation may have hurt many funds’ returns in January.
Hedge funds are typically a portfolio allocation used by institutional investors and wealthy individuals to maximize returns. The can invest in stocks, currencies, commodities, strategic acquisitions, and fixed-income securities, depending on their goals.
But some funds may have been positioned for a rally late last year that didn’t come.
Charles Gradante, of the hedge fund advisory firm Hennessee Group, said “the top-performing managers were positioned for a January rally and were long stocks that underperformed in 2011.”
But that was “after several months of treading water,” he said, and managers were relieved to see that stocks “rallied on fundamentals, being driven less by macroeconomic and political news and more by underlying company-specific fundamentals.”
Hedge funds’ Securities and Exchange Commission quarterly 13F filings are due next week, and they will disclose what investments caused last year's disappointing performance for some, and what they are buying going into what is expected to be a rebound.
Some fund managers have already disclosed some of their top holdings either in letters to investors or at conferences.
Typically, for some of the bigger hedge funds, managers are trying to use their leverage as stakeholders to unseat current management or get their own representatives on company boards. According to their view, that’s to enhance shareholder value so some managers use their shareholder letters to take potshots at companies that are in their crosshairs.
Here are five hedge funds that have disclosed what their investment focus is now:
David Einhorn’s Greenlight Capital, a $5 billion fund, returned 9.7 percent in the fourth quarter of 2011, bringing the full-year return to 2.9 percent, he said in a letter to investors Jan. 17.
There was no mention of the $11 million fine he and the fund must pay in Britain as that nation’s financial regulator, the Financial Services Authority, charged him with using inside information he obtained from a broker before selling shares in a U.K. company in 2009.
But, on a conference call, he told investors that he didn’t believe the firm or he had any inside information when it traded the stock.
In the Jan. 17 investor letter, Einhorn told the fund’s investors that “throughout the year we found very few places to make money, but we likewise kept our mistakes to a minimum. For the most part, our long portfolio went sideways.”
Einhorn said a short positionon solar-energy power products maker First Solar was the hedge fund’s biggest winner, as it was the worst-performing stock in the S&P 500, dropping from $130.74 to $33.76.
The fund also took a profit on a short position it closed out on Green Mountain Coffee Roasters. Einhorn had questioned the company’s accounting methods at a public conference last year, making his lack of confidence in it clear, and said its management failed to respond adequately to him, “other than a blanket denial of wrongdoing.”
He said the fund’s current strategy is to “own cheap stocks of good businesses, largely in the United States,” and the portfolio is “more net long equities than it has been in some time.”
Recent buys include computer maker Dell, which it bought at $15.53 per share. Einhorn notes it has about $7 per share in cash and equivalents on the books and currently earns about $2 per share. He said its current valuation is “usually associated with collapsing businesses.”
The fund also re-established a position in office equipment maker Xerox at $7.61. The acquisition of the business process outsourcing firm Affiliated Computer Services early last year gives Xerox a strong position in a new business that also bodes well for its future, Einhorn wrote.
Long term, Xerox is expecting 6 percent annual revenue growth, and 10 percent to 15 percent adjusted earnings per share growth, while the company has a $1 billion-plus share repurchase plan in place, according to Einhorn’s letter.
Third Point, a $4.6 billion hedge fund run by Dan Loeb, has a 5.2 percent stake of Internet firm Yahoo, and Loeb has been in a dog fight with its board of directors, as he says it has mismanaged Yahoo and bungled chances to sell the company at a premium.
Yahoo has a five-year annualized loss of 12 percent and is down 2 percent this year.
Yahoo made up almost 30 percent of Third Point’s portfolio late last year, so Loeb has good reason to want its management to do something to boost share returns.
Loeb wrote in a letter to Yahoo directors that his firm is “not surprised by this mismanagement given the history of strategic bungling by Yahoo Board Chairman Roy Bostock and founder Jerry Yang, which has been chronicled in our previous letters and in numerous critical media and analyst reports.”
Third Point returned 3.8 percent in January and has a one-year return of 17.5 percent.
The fund's second-largest holding at the start of the fourth quarter was The Williams Co., a natural gas transmission company, at 6 percent.
Pershing Square Capital Management
Pershing Square Capital Management’s activism at two companies seems to be paying off.
The fund, run by Bill Ackman, has recently built a 26 percent stake in the century-old department store chain J.C. Penney.
While its mid-market department store competitors have struggled, J.C. Penney has prospered, and its stock is one of the top gainers this year, up 20 percent. The shares have a three-year average annual return of 41 percent.
J.C. Penney hired a new CEO, Ron Johnson, in November, and he would seem to have been hired to shake things up in the store format. Johnson pioneered Apple’s wildly successful retail concept, and the thinking is he can bring some of the innovations to J.C. Penney.
And Pershing Square disclosed early this week that it holds 24 million shares of common stock, or about 14 percent, of Canadian Pacific Railway, to allay rumors that it only held options, swaps, and derivatives.
Ackman is using that position to agitate for the current board to replace the current CEO with his preferred candidate, former Canadian National Railway head Hunter Harrison, who has rejuvenated two rail companies in his career.
Canadian Pacific’s shares are up 13 percent this year and have a three-year annualized return of 35 percent.
Ackman said CP is 70 percent the size of Canadian National yet has an enterprise value 40 percent as large because of its inferior profitability and asset utilization, hence his interest in new blood for the CEO post.
SAC Capital Advisors
SAC Capital Advisors, the $12 billion hedge fund run by billionaire Steven Cohen, has its sights set on two companies, upscale clothing retailer American Eagle Outfitters and coffee purveyor Peet’s Coffee & Tea.
In two 13G filings in January, SAC disclosed two huge investment increases in each firm since the end of the third quarter.
SAC Capital Advisors now owns 9.5 million shares of American Eagle, or 4.9 percent of its shares, the bulk of that bought in the fourth quarter.
American Eagle's shares are down 9 percent this year, but have a three-year average annual return of 16 percent. Its stores are one of the most frequently shopped brands in the teen retailing space and posted strong holiday sales.
And SAC now owns 740,074 shares, or 5.7 percent, of Peet’s, according to the January filing, a huge increase since the end of the third quarter.
Cohen must love coffee, as his fund previously was a big shareholder in Peet’s top competitor, the aforementioned Green Mountain Coffee Roasters, but has since sharply reduced its stake or eliminated it.
Peet’s shares are up 10 percent this year and have a three-year average annual return of 48 percent. The company is a specialty coffee roaster and retailer, with more than 110 coffee shops in seven states.
Peet’s shares hit a 52-week high last Friday after a Baird analyst lifted his rating to “outperform” from “neutral,” saying he expects fast earnings growth starting later in 2012.
T2 Partners Fund
Although T2 Partners Fund gained 12.6 percent in January, the $275 million hedge fund helmed by Whitney Tilson and Glenn Tongue lost 25 percent in 2011.
In a letter to investors Jan. 31, the partners mostly focused on its January performance, but noted that “our portfolio today is nearly identical to the one that did so poorly last year,” adding that “time will tell whether we were wrong or just early on many of our favorite stocks.”
Among its winners in January, the partners said, were on-demand video provider Netflix, Pep Boys, Goldman Sachs, and J.C. Penney.
The partners’ letter claims that Ron Johnson, J.C. Penney’s new CEO, is “the best retail CEO in the world, bar none,” hence their continued long position in the stock.
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