Stephen Mandel Jr.’s Lone Pine Capital, which lost between 1 percent and 3 percent in its funds in the first half, does not apologize or second-guess its decisions. Why should it?
The Greenwich, Connecticut–based hedge fund, possibly the most successful Tiger Cub of them all, tells clients its mistakes this year “have largely been ones of omission, not commission.”
In the second-quarter letter obtained by Alpha and signed by Mandel and three others, the hedge fund firm provides some insight into why it is struggling so far this year and reminds investors of its criteria for picking stocks.
For example, Lone Pine reports that its largest longs have mostly performed as expected, but stresses that the market is rewarding five other types of investments. “Each has its roots at least partially in the easy-money policies of global central banks and each remains largely, although not entirely, absent from our portfolios,” the firm notes.
Lone Pine calls one of those five groups “blue-sky” stories. These are companies that have meager earnings but are able to “dream big” and are therefore easily forgiven by investors. They include Tesla Motors and Zillow.
Another group leading the market these days are companies the firm says benefit from yield compression — the higher-paying dividend stocks, such as master limited partnerships (MLPs) and real estate investment trusts (REITs).
Lone Pine also points out that many previously low-return, capital-intensive industries are attracting investors playing industry consolidation “due to a reduction in the number of industry players and a corresponding increase in industry profitability.” The hedge fund firm cites airlines and semiconductors as examples.
The hedge fund firm also says that thanks to easily available cheap credit, virtually any acquisition is “accretive to earnings.” As a result, investors are bidding up acquirers, incentivizing them to do more deals. “Deal activity has been significant across many industries, most notably pharmaceuticals and technology,” Lone Pine states in the letter.
Finally, the current combination of low interest rates and merger mania has emboldened activists “to push agendas of cost-cutting, divestment and increased leverage to drive shareholder value.”
These are not the themes that Lone Pine generally plays, the hedge fund firm reminds its investors. “Our investments tend to favor either companies that compound value through organic earnings growth or companies undergoing favorable management and strategic changes not yet realized in their valuations,” Lone Pine stresses. “While not in favor currently, this approach has characterized our investing since our founding and we believe strongly in its long-term validity.”
Lone Pine singles out current examples of those “compounders” among its holdings, including Baidu, Cognizant Technology Solutions Corp., MasterCard, Michael Kors, Priceline Group, SBA Communications Corp. and Tencent Holdings.
Investments undergoing changes that are not yet fully reflected in their valuations include Adobe Systems, Comcast Corp., Gap, Global Logistic Properties, McGraw Hill Financial and Microsoft Corp.
The hedge fund also addresses “artificially low global interest rates,” which it calls the investing “elephant in the room.” Lone Pine explains such rates are encouraging investors to take more risk, “arguably creating mispricing of risk and at the same time making short-selling difficult.”
Mandel and his team say no one knows how quantitative easing will end but suspect it won’t end well. They add, “We are poised to take advantage of those companies treading water without swimsuits when this tide eventually goes out.”
