| O. Andreas Halvorsen, Viking Global Investors (Bloomberg) |
When Viking Global Equities posted an 8.8 percent loss in the first quarter of 2016, O. Andreas Halvorsen swung into action.
The co-founder of Viking Global Investors — the Greenwich, Connecticut firm that manages VGE, a long-short equity fund — told clients in the firm’s first-quarter letter he was “unhappy” with the results but assured them that the firm’s investment team “remained confident” in their investment approach.
At the same time, Halvorsen, who in recent years has devoted much of his time to capital allocation, risk management and general strategic planning, told clients he has been spending “an increasing amount of time with the investment team,” stressing that after significant drawdowns in a position or a portfolio he meets with the key portfolio manager and analyst.
In fact, in the first quarter there were 34 drawdown meetings, exceeding the full-year average for the past three years. “These meetings form an integral element of our investment process,” Halvorsen added in the letter, which was obtained by Alpha.
Halvorsen stresses in the letter that he does not exactly welcome the losses that lead to these kinds of meetings, but he also asserts that if there are no drawdowns at all it would be a sign that the investment team is not taking the appropriate risks.
“The meetings represent a constructive check-in where we discuss what new information has come to light and how the analyst and portfolio manager think about the upside and risk going forward,” the Norwegian native explains.
Sure enough, in May VGE surged 5.7 percent, cutting the fund’s loss for the year to 3.4 percent. The firm’s Viking Long Fund gained 3.9 percent last month and is now only down 1.6 percent for the year. Viking did not comment on the results or the letter.
Just as one bad quarter does not suggest a top-notch hedge fund has lost its touch, two good months don’t signal that all is well.
Still, the letter provides a rare insight into how one of the most respected hedge fund firms responds to adversity within its funds. In fact, when you talk to other hedge fund managers, investors and consultants, they mostly agree that Viking has one of the deepest management teams and processes among all hedge fund firms — one reason why the firm has among the best long-term records and has become the eighth-largest hedge fund firm in the world.
In the letter, Halvorsen stresses that in the meetings he does not mandate that managers liquidate specific positions. Rather, he wants to make sure the investment thesis “is solid” and the analyst and portfolio manager are making “reasoned decisions.”
He points out that these reviews can result in many outcomes, ranging from a reduction in risk to additional commitments. In fact, Halvorsen says that over the past three years, on average four of 10 of these drawdown meetings have led to increased exposures “within a week of the drawdown being triggered.” Interesting.
In any case, from year-end 2015 to the end of the first quarter of this year, Viking trimmed its gross exposure from 161.5 percent to 151.3 percent and cut its net exposure from about 42 percent to around 32 percent.
However, Viking does interestingly point out that a lot occurred in between. After the market’s selloff in January, it added to several long positions. Sometime in the first few weeks of the year it also raised the gross exposure to 182 percent. However, by the first week of February it cut leverage, reducing the gross exposure to the mid-150s.
“This is only the second time in the last decade that risk management considerations have prompted us to reduce leverage,” Halvorsen tells clients.
The other time was the period leading up to and during the financial crisis, when gross exposure was brought down to just 70 percent. That proved to be a savvy, shrewd move, enabling VGE to lose a mere 0.9 percent in 2008, when a large percentage of hedge funds were posting sharp, double-digit losses. Viking gained 40.5 percent the year before and nearly 20 percent the year after the crisis.
Drilling further down, Viking continued to cut its exposure to health care stocks. At the end of the first quarter, its gross exposure to the sector was 38 percent and its net was just 9.9 percent. This is down from a net exposure of 15.2 percent at year-end and down from 19.6 percent at the end of the second quarter of 2015. Its net exposure to pharmaceuticals and biotech stocks alone dropped to 7.6 percent from 8.7 percent the prior quarter and from 21.3 percent at the end of 2014.
On the other hand, Viking has boosted its bet on certain kinds of technology stocks. Its net exposure to software and services was ramped up to 19.5 percent from 6.1 percent just the prior quarter. At the same time, the hedge fund cut its net exposure to semiconductors from 8.4 percent to 3.8 percent.
Its largest position in both VGE and VLF was Alphabet. Both classes of stock accounted for 7.8 percent of the long-short fund and 8.6 percent of the long-only fund as of the end of the quarter. It was followed by Facebook — a new addition to the top-ten holdings list — and Amazon.com. Chip giant Broadcom was the fifth largest position. The fourth and sixth largest positions were drug makers Teva Pharmaceuticals and Allergan, respectively.
