Wednesday, October 15, 2008

Hedge Fund Performance as of Late

The last quarter has been, as Dinakar Singh put it in his investor letter, “abysmal”, as returns have significantly decreased prompting an increase in redemptions. We have four investment letters from alternative investment funds and will go fund by fund to include aspects of the letter we found to be the most telling. It’s interesting to note that whereas Cerberus reads like a market overview and Tontine fails to accept much responsibility for losses, TPG-Axon’s letter refers to the firm as “overconfident” and claims hedge funds are one of the factors contributing to market turmoil. While much of the blame for this turmoil is attributed to credit, an overarching theme seems to be the impact of commodity prices as a major factor, globalization and emerging markets, the government as a financial player, hedge funds and increased velocity, and the self-perpetuating nature of redemptions.

· We’ll start with David Einhorn’s Greenlight Capital, dated October 1, 2008. Greenlight Capital is an activist hedge fund started in 1996. The firm primarily invests in the publicly traded North American corporate debt and equity markets. They also manage a fund of funds and pa private equity fund through affiliates. Of note was their Motorola spinnoff of Freescale Semi, the biggest LBO ever for the tech sector. As of the end of 2007 Greenlight was able to boast annualized returns of 27% going back 10 years. Einhorn’s most recently been in the news in relation to his calling a short on Lehman much prior to their downfall.
Greenlight : Sept 08, -12.40%; YTD, -15.20%
o “Since our specialty is not macro forecasting, let alone guessing how some erratic actors in Washington will behave, we are not in a position to know when these headwinds will reverse. However, we believe they will.”
o In hindsight, our suggestion from last quarter’s letter to go to cash and go to the beach would have been the better option”
o Einhorn attributes much of the situation to investors unwinding trades due to: a) nervousness about short-term losses, b) reducing risk, 3) redemptions
o Einhorn describes current volatility in the markets as “almost schizophrenic in nature”.
o Short-selling restrictions from the government helped fuel losses this quarter
- “On several of the ‘government bail-out days’ or more aptly ‘change the rules of short-selling days’ the shorts recovered dramatically more than the longs, especially the financial shorts abundant in our portfolio… Our plan is to balance waiting out this period in our highest conviction short ideas, while also maintaining reasonable portfolio exposures”.
- “The short positions in the portfolio generated about 1% of the loss during the quarter. While we did have another contribution from the Lehman short, most of those gains were earned in prior quarters”.
o While they have recently been closed to new capital they are opening the funds for a limited amount of additional capital on November 1, 2008.
o “There’s no crying in baseball” – Jimmy Dugan played by Tom Hanks in “A League of Their Own”.

· Cerberus Capital
o Dated September 25, 2008 the letter opens with notes on returns from the quarter ending June 30
o “One of the best buying opportunities in distressed assets in our career”
o The letter reads more like a market overview of recent events coupled with opportunities Cerberus sees as profitable
o “None of our problem positions are large enough to create a real return problem for the fund.” !!! - Signed Stephen Feinberg, Managing Member, and William L. Richter, Senior Managing Director

· Tontine Associates, LLC is Jeffrey L. Gendell’s fund. Gendell started the fund in Greenwich in 1997 after leaving Odyssey Partners. As of 2007 they managed about $7BN in assets.
Tontine Partners : Sept 08, -59.30%; YTD, -66.70%
Tontine Capital Partners : Sept 08, -38.50%; YTD, -31.50%
o “The combination of falling commodity prices, massive anticipated hedge fund redemptions and the seizing up of the credit markets caused an enormous dislocation in our portfolios.
- “We clearly underestimated several things, most importantly the tsunami of redemptions that are being delivered to hedge funds as investors line up to get out of these funds as well as record outflows from equity mutual funds.”
o Tontine Partners portfolio heavily invested in steel:
- “Unfortunately, the public is not interested in future earnings or large cash positions and we saw U.S. Steel fall from $180 per share to $70 per share despite the expectation that they will earn over $18 per share this year.”
o Tontine Capital Partners portfolio:
- We hesitate to give you any names here as to encourage short sellers but the smaller cap stocks were just blasted in September, especially those that are associated with anything related to energy. We did not own any oil stocks.”
o Tontine-25 Fund:
· “We called August right but September… was a mistake.”
o “We still believe the best use of funds for our companies is to continue to buy back stock on a systematic basis.”

· Dinakar Singh’s TPG-Axon sent investors a 17-page letter.
o “This is the first major global economic inflection point we have witnessed in the ‘new’ era of interconnected global markets, and with high velocity investors (hedge funds) as significant players… so far it has not been pretty”.
o “In sharp and dramatic contrast [to the first half of 2008], the last quarter has been abysmal, and we are sorry to have let you down with the terrible performance of the portfolio.” (Writer’s bold and underline).
o “Fundamental ‘disruptions’ were created by wild swings in commodities and growth sentiment. This was followed by remarkable degrees of hedge fund disruption, as funds rushed to unwind positions and ‘de-risk’… In hindsight we grew a bit overconfident in our ability to navigate treacherous waters.”
o “The skyrocketing prices of most commodities caused investors to flee toward commodity rich countries and industries, and away from commodity users. As a result, an accelerating focus on the ‘rest of the world’ vs. the domestic US economy morphed ultimately into an even narrower focus on commodities.”
- “The mid-year data served as the spark for a wild rush from one side of the ship to the other… everything that had gone up in the past few years was dumped by investors as they fled in the other direction”
- Credit fears triggered panic in US financials, spurring broader market panic in September
o The integration of 3 major structural factors:
- An end of an era of an ‘amplified US economy
- Increased globalization and inter-dependence of markets
- Dramatic increase in market ‘velocity’ – hedge funds.

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