| John Burbank, Passport Capital (Bloomberg) |
Passport Capital Passport Capital chief investment officer John Burbank III and the hedge fund firm’s director of marketing and investor relations, William Nolan, argued that this is the best macro investing environment the firm has seen “in quite some time,” in a year-end letter for the firm’s Passport Global Fund, dated January 30. “We are more excited about our prospects than we have been in several years,” said the letter.
Burbank and Nolan told clients that at the same time Europe and Japan are engaging in quantitative easing, the U.S. is facing real prospects of tightening, “leading investors to different prices and conclusions.” So, they said, “the opportunity to profit from longs and shorts in equities, currencies, rates and commodities is quite compelling.”
As a result, the San Francisco–based firm planned to run the Passport Global portfolio “at the high end” of the risk budget for the rest of 2015. And sure enough, in January the firm reaped huge gains from this conviction.
Passport Global, the hedge fund firm’s $1.9 billion multistrategy fund, jumped 9.2 percent for the month, while the $462 million Special Opportunities Fund surged a whopping 17.2 percent. In 2014 the two funds rose 1.2 percent and 10 percent, respectively, while in 2013 they were up 23.1 percent and 45.4 percent, respectively, according to Passport documents obtained by Alpha.
Sure, this is just one month of performance. However, the firm, which manages a total of $4.1 billion, insisted that the investment environment in January was more reflective of positioning Burbank took in the latter months of last year.
What exactly did the CIO do? To get some perspective, you have to return to spring 2013 when the Federal Reserve announced that it would begin to taper, that is, slow down, its stimulus program. Until then, the Fed’s quantitative easing program had rewarded investors with low-risk, yield-oriented assets. But the taper saw a shift in investor preference for riskier, growth-oriented assets in anticipation of higher interest rates.
In this new environment, Passport Global made a big bet on Chinese and U.S. Internet stocks, the firm’s “largest sector allocation” during this period, noted the letter.
However, the letter pointed out that by February 2014 it became apparent that growth in China was slower than anticipated, and Europe’s economy was lagging amid fears of possible deflation. As a result, Passport said it was taken by surprise when low-risk U.S. stocks outperformed riskier ones and long interest rates plummeted. Last year Chinese Internet stocks lagged the market after roughly doubling in 2013. Passport Global also experienced more losers than winners among its technology stocks even though its largest position — Vipshop Holdings, a Chinese online discount retailer — performed well.
Burbank and Nolan pointed out that last year the firm benefited from longs in consumer discretionary and shorts in metals and mining. Performance in the second half of the year was hurt by energy and Saudi Arabian longs.
However, Passport Global started to take action in the final three months or so of 2014. “In mid-October, we observed falling rates, declining oil and low beta outperforming,” the pair wrote. “It was a significant macro inflection with wide-ranging implications.”
The letter noted that “while it took time to assemble the pieces,” by late November the fund was short crude oil and had added to long positions in both short- and long-duration interest rates and “went much longer the dollar” versus short positions in the Japanese yen and euro.
Sure enough, the dollar surged more than 10 percent in the second half of 2014. “As a result, we were able to weather declines in many core longs — including the Saudi market correction of over 30 percent from September to the middle of December,” said the letter. Passport Global’s macro positions offset losses in its equity book during the fourth quarter.
“After five years of aggressive stimulus by the U.S. central bank, 2015 appears to be the year where monetary easing yields to monetary tightening,” Burbank and Nolan said. “We don’t believe that equity investors fully appreciate the implications this may have on equity prices.”
Passport Global is looking for high-quality stocks to outperform and low-quality companies to underperform. And, the pair added, this is a good time to be “aggressive on idiosyncratic shorts over indices.” Burbank and Nolan are also looking for a sharp increase in asset price volatility.
At the same time, the firm told clients that it believes the strategy in the latter half of 2014 will continue to perform and maybe accelerate. “As a result, we currently have a continued preference for large, liquid, safe, low-beta assets, high dividend yields and expect underperformance in higher beta, riskier assets,” Burbank and Nolan added.
They also think long rates are a great play on the risk of deflation. “We believe this year will offer the opportunity to generate outsized returns,” they said. “To that end, we intend to run a more elevated amount of risk relative to the prior few years — toward the higher end of our target range — given our present level of conviction.”
What produced the results in January? According to a one-page statistical summary obtained by Alpha, the Global Strategies Fund did especially well in large-cap equities — those with market capitalizations exceeding $5 billion — and nonequity investments. It reaped nearly two thirds of its gains from bets on basic materials — both longs and shorts.
Its largest public long, CF Industries Holdings, which makes and sells agricultural fertilizers, kicked in 1.3 percentage points to gross return.
In addition, three of its five most profitable shorts were various exchange-traded funds tied to different segments of the energy industry.
At the end of January, Passport Global was 35 percent net long.
Special Opportunities derived nearly half its gross gains last month from bets on basic materials, both longs and shorts. It also did very well from long bets on interest rates, consumer discretionary bets and shorts in energy. The fund was 68 percent net long entering February.
