While some big-name hedge funds have posted sizable losses this year, a number of other managers have done pretty well. One of the major differences between these two groups? Savvy short-selling.
A good case in point: Brahman Capital Corp. The New York-based hedge fund firm is little known even though it has been around more than 25 years and managed $5.4 billion at the end of 2014.
Its hedge fund, Brahman Partners II, is up 12.6 percent for the year after eking out a 0.1 percent gain in the third quarter, which proved to be a treacherous period for many. Brahman has its short book to thank, according to its third-quarter letter, dated October 15 and obtained by Alpha.
In the most recent three-month period, for example, the fund’s long portfolio lost 9.2 percent. However, this was more than offset by the short book, which returned 9.7 percent, resulting in a total gross return of 0.5 percent.
For the year to date, longs have gained 6.6 percent while shorts have returned 9.3 percent, which works out to a gross total return of 15.9 percent. The firm declined to comment on the results.
Brahman was founded in 1989 by Robert Sobel, Mitchell Kuflik and Peter Hochfelder and launched its fund in 1991. Hochfelder is giving up day-to-day involvement, according to the firm’s quarterly letter. He has decided to “transition to a non-operating role over the course of 2016 to focus on family, philanthropy, and personal investing.”
Over the past five years, the fund has gained a net 63 percent, compared with 87 percent for the Standard & Poor’s 500 stock index. Over the past ten years, the fund has risen 84 percent, compared with 93 percent for the S&P 500 index.
However, the fund stacks up much better over the long haul. Over the past 15 years, it has gained 257 percent, versus 79 percent for the S&P 500. Since inception the returns are 1,068 percent versus 747 percent.
The letter is most striking for its discussion of the fund’s short-selling success because it actually names names. This is a credit to the folks at Brahman.
It is very rare for hedge funds to discuss individual short positions in their letters to their investors, who trust their hard-earned money — or their foundation’s or pension fund’s money — to the managers. Rather, hedge funds identify shorts by simply by the industry or geographic region using general references. I’ve always been amazed that investors put up with this non-disclosure.
In any case, Brahman points out in its letter that it had been bearish on iron ore for some time, which led it to extend its negative view to heavy machinery manufacturers and equipment-rental companies early this year. This includes companies such as Caterpillar and United Rentals, it says.
“These companies are heavily dependent on the capex [capital expenditure] budgets of commodity and energy companies, which we expect will be constrained for the next several years,” Brahman states in its letter.
It explains that the oversupply and depressed capital expenditures that initially played out in coal and iron ore budgets has spread to the energy industry.
For example, Caterpillar, which the hedge fund calls “a global construction bellwether,” has experienced 33 consecutive monthly declines in retail sales. Meanwhile, Brahman says Cat’s most profitable segment “is now rolling over” into the second half of 2015 and beyond. “In fact, CAT retail sales have declined in every end market and geography for most of this period,” Brahman adds.
Specifically, the hedge fund tells clients it has 650 basis points — or 6.5 percentage points — of exposure in this theme, “which has been a positive contributor to the fund.”
Looking ahead, the fund expects “continued downside for the group.”
Shares of Caterpillar plunged nearly 30 percent in the first nine months of this year. They have rebounded about 5 percent since the end of September, however.
Shares of United Rentals plummeted more than 40 percent in the first nine months. Its stock is up nearly 9 percent this month so far.
Meanwhile, Brahman continues to be negative on agricultural equipment. “During the quarter, we continued to receive corroboration on our bearish thesis regarding the agricultural equipment cycle as grain prices weakened well below break-even profitability levels for farmers,” it explains in the report. “In addition, our survey work indicated growing dealer inventory levels thanks to equipment coming off lease.”
As a result, the hedge fund firm points out that major agricultural equipment companies have reduced their earnings expectations. It notes that its three agricultural equipment shorts fell about 20 percent to 30 percent during the third quarter. However, in this case it did not name names.
Brahman adds: “We remain bearish on the sector and believe we are in year one of a multi-year downturn.”