| John Burbank III, Passport Capital (Bloomberg) |
It’s no secret by now that John Burbank III’s Passport Global is one of the best hedge fund performers of the year.
However, the performance of the San Francisco hedge fund, a major part of Burbank’s firm, Passport Capital, is not necessarily the most interesting or remarkable development — it’s how it got there.
The hedge fund, which manages $2.2 billion — up from $1.7 billion at the end of 2014 — of Passport Capital’s total $4.2 billion in assets under management, lost an enormous amount on its longs in the third quarter, which was not kind to stock pickers in general. However, Passport Global’s shorts performed so spectacularly that they more than offset the loss from the longs.
As a result, the hedge fund surged 6.7 percent in the third quarter, boosting its gain for the year to 18 percent. (Passport did not return calls for comment.)
The dramatic performance difference in the two books underscores the volatility in the overall market as well as the beneficial role short-selling is playing in many hedge fund portfolios this year.
Last year Passport Global was up only 0.9 percent. Entering the year, the fund was 37 percent net long. “We believe this is a year to be aggressive on idiosyncratic shorts over indices,” the firm told clients in its fourth-quarter 2014 letter.
In fact, this year Burbank has benefited from being mostly bearish, especially on emerging markets and commodities, including oil, which have been hurt by the rising U.S. dollar. Burbank was long the dollar heading into 2015.
In his third-quarter letter Burbank was clearly worried about China. “We believe the big risk for global markets over the next several months is a worsening in China’s economy,” he wrote, especially what he deemed were nonperforming loan issues. This could lead China to “de-peg” its currency from the U.S. dollar, reduce interest rates and “force the liquidation of risk assets around the world.”
So, Burbank warned investors that they should prepare for a “worsening global economic environment and the potential for recessions in both the U.S.” and elsewhere around the world.
“Market illiquidity, by our measure, is only getting worse,” Burbank asserted. “That has led us to run with a lower gross and a low net exposure.”
Passport Global seems well prepared for this. The fund is now 84 percent long and 100 percent short, for a 16 percent net short exposure. This reflects a swing of 53 percentage points in sentiment in just the past nine months.
Burbank does assure investors that U.S. equities and the Standard & Poor’s 500 stock index in particular “appear much safer” than emerging-markets equities and even those of most other developed markets. However, within the S&P 500, Burbank sees a transitioning to more defensive, liquid and larger-cap stocks.
“This is a time of dislocation, disorientation and potential liquidation as we head into what we believe could become a global downturn that leaves no region safe, including the United States,” Burbank told investors.
In this type of environment, it is more crucial than ever for hedge fund managers not to rely on being long equities. And Burbank will be the first to tell you that.
In the third quarter Passport Global enjoyed a 3.7 percent return from nonequity markets. Of that, it made 1.1 percent gross from crude oil shorts and 2.6 percent from interest rate swaps.
The rest of the gains resulted from Passport Global making more money on its equity shorts than it lost from its equity longs.
According to Passport Global’s third-quarter letter, the fund’s equity longs lost 23.3 percent in the quarter alone. That is not a typo, folks.
However, the shorts were up 27 percent.
As a result the long-short equity portfolio was up 3.7 percent, on a gross basis.
These are staggering numbers for a three-month period.
Nine of 12 sector groups that Passport Global identifies lost money on their longs, led by energy issues, down 4.9 percent. Utilities, basic materials and Internet/technology each lost between 3 percent and 3.5 percent.
The longs among the other three of 12 sector groups were roughly flat.
On the short side, 11 of the 12 sector groups made money, while one sector was flat.
The clear winner, however, was basic materials, where the shorts surged 13.6 percent. We just don’t know which specific stocks performed the best. Altogether, the firm enjoyed a net gain of 10.3 percent from the group based on its losses from the long positions and profits from the shorts.
This was followed by a 4.8 percent gain from its energy shorts. However, the sector’s longs and shorts combined wound up costing the fund a slight, 0.1 percent loss.
Other profitable sectors on the short side included Internet/technology stocks, which made 2.3 percent, and industrial stocks, 2.1 percent.
Keep in mind that Passport maintains a very diversified portfolio. At the end of the third quarter, it had 108 public longs and 179 public shorts.
