Listed hedge funds have a deservedly mixed reputation, but those that deliver positive uncorrelated returns can be a valuable addition to a portfolio.
|Master Investor Magazine
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Third Point Offshore Investors (LON:TPOU) is an £840m London-listed feeder fund that provides exposure to manager Dan Loeb’s opportunistic investment strategy by investing in his Third Point Offshore hedge fund.
TPOU aims to deliver attractive risk-adjusted returns through event-driven, catalyst focused investments in the equity and credit markets. Although the feeder fund only listed in 2007, the underlying master fund has been around since 1996, with Loeb generating impressive annualised returns of 14.7% compared to the 8.2% achieved by the S&P 500.
There are four main areas where the manager seeks to add value with most of the recent gains being driven by his core long-term activist holdings. His biggest success was Sotheby’s, which received a bid at a 60% premium to its share price, with the other main contributors in this category including: Baxter, Nestle, United Technologies and Sony.
The second area he aims to exploit is opportunistic credit, which delivered positive returns in the six months to the end of June led by a position in PG&E unsecured debt. There were additional gains from US residential mortgage-backed securities, although these were offset by an exposure to Argentinian government bonds that has been badly sold down.
Idiosyncratic portfolio with a low correlation to the S&P 500
Loeb’s other two main areas of focus are single name short selling and identifying intrinsically mispriced value securities. The resultant portfolio is highly idiosyncratic and over the period since inception it has a low correlation of just 0.5 with the S&P 500 index, although the performance has not always been to the upside.
Last year was a notably bad one for the fund with the portfolio having too much long exposure going into the sell-off in the final quarter. It has since been re-positioned with a significantly lower net market exposure via a higher allocation to single name shorts and some sector and market hedges.
This cautious allocation reflects the fact that we are late in the economic cycle and that there are threats of a slowdown in the next few years, although Loeb doesn’t think that it poses an immediate risk. He says the low net exposure gives the fund the flexibility to take advantage of market corrections and switch into credit as opportunities emerge.
Impressive recent performance
In the six months to the end of June the fund’s NAV increased by 15.1% in US dollar terms, which was marginally behind the 18.2% gain in the S&P 500 due to the low net equity exposure. The NAV was up a further 4.4% in July.
Third Point is a complex vehicle and has a relatively low profile, which could explain why it consistently trades on a discount to NAV of more than 20%. In order to address this the company has moved to a premium listing on the London Stock Exchange, merged the sterling and US dollar share classes, dropped the dividend policy in favour of opportunistic share buybacks and reduced the fees from 2% to 1.25%. If these don’t work the board has said that it “will consider further initiatives.”
The low net market exposure of around 40% means that the portfolio is more focused on idiosyncratic stock specific risks, so the performance will be mainly driven by the manager’s stock picking skills rather than the general direction of the market. This should make it a decent diversifier and the wider than normal discount of 26% offers an attractive entry point, especially if the board is able to narrow it down to a more acceptable level.