In early 2008 Remy Trafelet was riding high. His New York–based hedge fund firm, Trafelet Capital Management, was managing $5.8 billion, thanks in part to his 25.1 percent annualized return from inception through 2007.
But like many other investors, the onetime Fidelity Investments portfolio manager, who founded Trafelet Capital in 1999, was hit hard by the financial crisis. His long-short equity hedge funds — Delta Onshore, Delta Institutional, and Delta Offshore — lost 28.4 percent in 2008.
His investors, starved for liquidity, suddenly fled. At least half the $2.5 billion in assets in the funds Trafelet personally ran came from the proprietary trading desks at major banks, including Merrill Lynch, Deutsche Bank and Citigroup. The banks needed their money back immediately, and Trafelet refused to erect a gate on redemptions to stanch the outflows, effectively leading to a run on the bank.
Even though he rebounded in 2009 and posted a gain of 18.7 percent, Trafelet thinks he could have done much better if he had not been returning so much cash to investors. He also closed his U.S. funds to new investors. So Trafelet was essentially managing mostly personal money, solely focusing on investing and generating strong returns.
As he finally clawed his way back to his high-water mark last year after five years — finishing with a 24.5 percent net gain — Trafelet felt it was time to reboot his business. He teamed up with George Brokaw, who joined as a managing partner, and changed the name of the firm to Trafelet Brokaw & Co. They then decided to “selectively open” to outside capital, which now stands at $425 million.
Brokaw, who will spend much of his time on risk management and human resources–related tasks, previously was a managing director at Highbridge Capital Management. Before that, he held senior positions at Perry Capital and Lazard.
“I will focus on what I do best — pick stocks,” says Trafelet, whose return has compounded at 12.7 percent since inception despite the large drawdown.
Trafelet Brokaw is a long-short equity fund that takes a very long view of potential investments and looks for companies you would wish were your own family businesses. These companies typically have high recurring revenues, “tollbooth-like businesses,” a high barrier to entry and large, free cash flow yields.
This discipline has led Trafelet to invest in energy pipelines such as Atlas Energy, the general partner for two master limited partnerships (MLPs). He estimates its annual earnings distributed to shareholders will rise from $2.80 per share this year to $3.50 next year. “All of their projects are in place,” Trafelet says. “Management could go on vacation for two years and it would still do $3.50.”
He also likes amusement parks such as Cedar Fair, which is structured as an MLP. Trafelet says it has a huge barrier to entry, which has given it monopoly pricing power. And he figures its distribution will rise from $2.50 a share this year to $3.50 next year.
Trafelet is also a big fan of cable companies, although he does not own any at the moment since Virgin Media was acquired last year. However, he does own another media company — Tribune Co. — which emerged from bankruptcy. It is spinning off its slow-growing publishing business in favor of broadcasting and cable assets, like its WGN America cable station. Tribune is currently trading for $77.50 on the so-called pink sheets, and Trafelet believes it is worth $120. He now has about 20 to 25 long positions and 10 to 15 short positions in what is a fairly concentrated portfolio.
On the short side, Trafelet looks for accounting discrepancies or cash flow mismatches. “We look for a real disconnect between what the numbers are and should be,” he says, admitting that this is very hard to find.
So what lessons has Trafelet learned from his postcrisis experience? Be certain that the fund’s and investor’s return objectives and time horizons are aligned.
He also says he plans to cap the fund at $1 billion.
