Favorite Quotes from Q1 Hedge Fund Letters: Passport, Kleinheinz Capita, and Omega

One of the most fascinating aspects of the investment business is manager commentary in the form of hedge fund letters. Sometimes these letters take the form of an aggressive rant, or a "teach-in" session of some strategy the fund is employing (see: Michael Burry @ Scion), or simply a commentary on what's keeping the hedge fund manager up at night. I try to read as many of these letters as possible (hint: send me more letters). I also believe in a post-Madoff world, increased disclosure of underlying investments can generate investment ideas for your own portfolio.

Over the past few months, I've received a number of letters from readers. After the litany of 13Fs coming out today, I thought it would be productive to pull out a sentence of two from a number of prominent hedge fund managers' letter that I particularly found insightful. I have split this post into two individual posts with the second one coming later in the week.

Kleinheinz Capital Partners, a legend fund in the hedge community (26.1% annualized returns over 182 months...you can read more about them here) wrote:
"In summary, while the near-term case for uranium equities has been significantly weakened as investors take a wait-and-see approach, we believe that in the long-term nuclear power will provide as essential component of the world's energy consumption. Therefore, the Fukushima accident is unlikely to cut short the nuclear power growth story the way Chernobyl did twenty-five years ago, because even in the worst case scenario Fukushima would remain a narrowly localized problem with limited radiation beyond the immediate area surrounding the plant. Additionally, twenty-five years ago, growth in nuclear power was driven mostly by societies in Western Europe and North America, while future growth is expected to come from emerging markets such as China, which has a more centralized decision making process and a very large population with rapidly growing needs for electricity. China, Russia, India, and South Korea account for about 75% of the projected nuclear build-out and those countries have a constructive view on nuclear power."
I spoke with a number of brilliant analysts after the Fukushima accident and the smarter ones of the group started doing their work on the various uranium producers. If you look at the charts of many of these companies, they've traded down hard to the point of a significant discount to NAV (the spot market for the actual underlying commodity is actually fairly tight right now). Names include Berkeley, Denison, Cameco, ERA, Extract, Paladin Energy, Ur-Energy, Uranium Energy, and Uranium One. I think here you go for a low cost producer with an unlevered balance sheet trading at or below NAV.

Omega Advisors, founded by "The Doctor" Leon Cooperman, wrote in his quarterly letter:
"Equity-market valuation is attractive. However, valuation by itself does not bring higher share prices. We are all aware of, and have experienced, value traps. There almost always needs to be a catalyst to activate market undervaluation. We are constructive on U.S. shares because we believe that there are several important, significant, and long-lasting catalysts to activate share undervaluation. These catalysts include:
  • A self-sustaining U.S. economic expansion that should last at least as long as the average post-war expansion of 60 months.
  • An economic and inflation cycle characterized by a low level of volatility.
  • A very sweet profit cycle.
  • A significant allocation shift to equities from fixed income by individual and institutional investors."
I always have enjoyed Leon Cooperman's commentary both in his quarterly / annual letters and his appearances and conferences and on CNBC. The letters particular are stocked with charts and graphs that really back the fund's investment positioning. While I am not as bullish as Omega on the overall public equities markets (I believe that profit margins are characteristically too high and even with sales growth fueled by an economic expansions, profit growth will be less than analysts' estimates), I 100% agree with point 4 above. I saw a statistics of the amount of equities, as a % of net worth that people under 40 have, and it's staggeringly low. Further, once inflation rears its ugly heads, fixed income investors will realize that past performance, i.e. a 25 year bond bull market, does not guarantee future returns.

Passport Capital, led by John Burbank, had a fascinating disclosure on the purchase of a Chinese Renminbi (RMB) non-deliverable forward contract:
"We believe that the RMB will continue to appreciate at a mid to high single-digit rate each year for the foreseeable future. To maintain Beijing's target for growth, acceptable levels of inflation, and to prevent an excessive correction of home prices, we believe China must develop independent monetary policy. Over the long run and as evidenced by their recently released five-year plan, China intends to rebalance its economy from export to consumption. This should drastically reduce China's trade surplus, as suggested by Yi Gang of the People's Bank of China in October 2010. Gradual appreciation of the RMB helps China move judiciously in that direction."
The letter goes on to note that the fund estimates that the break-even for the position is 8% from entry over the next two years and a 11% move (5% for two years...or the pre-crisis average growth rate) would net Passport a 2x reward with further upside.

This sort of trade as well as another fascinating one disclosed in the letter (adding aggressively to their Saudi portfolio during late February), as well as other commentary from John Burbank and his team that these guys understand value in a global context and position the fund to capture the upside while minimizing the downside. I learn more about the global economy each time I read one of Passport's letters.

Later in the week we will post the second part of the series of Q1 hedge fund letters. If you have any letters you would like to share, please send them to hunter [at] distressed-debt-investing.com


Anonymous,  5/17/2011  

saying that RMB will appreciate is like saying that water is liquid. We all know that, what matters is how slow/fast..

Anonymous,  5/17/2011  

@ anonymous
"We believe that the RMB will continue to appreciate at a mid to high single-digit rate each year for the foreseeable future."

good to know your attention span stretches to exactly 9 words.

Brian 5/17/2011  

Any chance of sharing the letters themselves?

Anonymous,  5/18/2011  

@ Anon, Why? were you expecting 3 digits per year? I am sorry but it is still like saying water is liquid or GLD will be in trading 800-1700 range throughout the year

Anonymous,  5/18/2011  

I'd rather be short China fx than long. Everyone and their mom is long and their export sector has average profit margins in the low single digits. 5% increase in the exchange rate and they're all bust.

Unknown 5/18/2011  

Good bearish case for China here, particularly touching on the showdown between the export sector, the friendly state-owned creditors that are extending cheap credit to fuel housing developments and the new political regime due to come in to power next year. Prof. Michael Pettis from the Guanghua School of Management who specialized on China's financial markets says: "The gossip that I have heard in Beijing is that both Wang and Li Keqiang – expected to be named Premier next year – understand China’s debt position, worry that the current growth model is unsustainable, and want to move quickly towards an economic growth model that de-emphasizes investment and exports."

Here's the full link: http://globaleconomicanalysis.blogspot.com/2011/05/chinas-real-estate-developers-struggle.html

It seems the bear hypothesis is that the new political regime will allow for a more market-driving exchange rate policy which could stymie growth in the short term and see a big rebound in the medium term.

Personally, I would expect the slowdown to come around 2014 after China's honeymoon on the global stage ends and these guys have had a couple of years at the helm of the communist party.

Anonymous,  5/18/2011  

hunter maybe you should have mentioned that kleinheinz capital was already long uranium stocks before the japan earthquake, so they are simply talking their book. Now they can double down, yeah! Uranium is a commodity, so before you run out and buy uranium stocks you may want to look at the HEU supply and the 5 year supply/demand balance.

Anonymous,  5/20/2011  

do you know if Kleinheinz Capital talked about the risk from sustained nuclear fusion since research is going on on this topic. This might be a big threat to the uranium theme. Is there a link for their letter? thanks


hunter [at] distressed-debt-investing [dot] com

About Me

I have spent the majority of my career as a value investor. For the past 8 years, I have worked on the buy side as a distressed debt and high yield investor.