This Week: Hedge Fund Darlings Became Dogs
No More Excuses
It seems that since the recovery from the finical crisis of 2008, hedge funds have had a string of reasons for their persistent underperformance. First it was the fact that they were “defensively positioned” and did not capture the full rally of 2009. Then the US credit downgrade in 2011 hurt popular hedge fund trades. After that we had a fixed income shock, reversion of momentum / value factors and the energy shock that all seemed to conspire against active managers. But to the average hedge fund investor, these reasons are beginning to sound like excuses.
The latest struggle for hedge funds comes as another blow to the industry, but this time there’s no real crisis to point to in the markets. While many hedge funds have shrugged off the turbulence, many more are feeling the pain, especially in the most popular hedge fund trades. Some refer to these stocks as hedge fund “darlings,” because managers are drawn to them in large droves. After all, if one money manager discovers an attractive risk / reward trade-off for a certain stock, why should we not expect others to see it as well? But when the sentiment turns, managers can be quick to unload riskier stocks, leaving large losses in their wake.
This is exactly what’s happening now to some of the most popular trades for hedge funds. Today we’ll talk about a few such trades (two today and three tomorrow), the hedge fund darlings that suddenly turned into dogs and hurt a large number of managers on their way south.
Valeant Pharmaceuticals (VRX)
Perhaps the most talked about hedge fund stock is Valeant Pharmaceuticals ($VRX) that last week announced it was under investigation by federal prosecutors for aggressive pricing of its drugs. As of 6/30/2015 13F filings, there were around 150 hedge funds invested in VRX, but we estimate that a large number of them have traded out by now. The stock sky-rocketed 80% from $143 on January 1stto $255 a share on July 31stbut subsequently plunged 60% as of this morning, dipping below $100 today. Out of the 150 funds, the largest position belongs to Bill Ackman’s Pershing Square, a successful activist hedge fund we wrote about recently. He’s in very good company as marquee funds like ValueAct, Paulson, Lone Pine, Viking Global, Hound Partners, Ratan and Jana all held sizable positions in the stock (as of 6/30). But Ackman’s position is veritably huge, it’s his largest bet and has a Form 13D filed on March 17th, indicating activist intent. Ackman is a pure activist, meaning he invests primarily with companies in which he hopes to instigate change and bring improvements to over the long term. But it’s the short term that’s hurting right now.
While a great strategy for the long run, activist positions are notoriously difficult to get out of, especially when the stock undergoes downward volatility. As we pointed out in last week’s NY Post article, there’s major illiquidity risk with the investment. It’s likely that many of Ackman’s more nimble colleagues, including some of the ones we listed above, have left VRX in a hurry. Hard evidence will come in one month as the 9/30 holdings for hedge funds become public. We’ll report an update at that time, but judging by the recent spike in volume — record numbers of VRX shares changed hands in the last few days. For instance, yesterday alone 16m shares were traded, and on September 28th,it was almost 19.5m, the size of the entire Ackman stake — this is meaningful, given the 90-day average volume is 3m shares. Still, it’s very unlikely that Ackman sold his entire stake, or even a significant portion of it.
Despite the controversy surrounding its drug pricing, VRX might now be considered trading at a huge discount, especially if a portion of the move was due to technical selling pressures from hedge funds trying to control risk and improve monthly return numbers. We have seen stocks rebound sharply after a technical sell-off. We’ll wait and see if Ackman files an amendment to his D, but for now, simple math estimates his loss at around 50% on the name and about $2Billion in P&L since his filing. In aggregate, we figure hedge funds lost around $7B in VRX since August 1st(depending on the trading) with a large brunt of the losses falling on activist hedge funds Pershing and ValueAct.
Sun Edison (SUNE)
A renewable energy powerhouse, SunEdison seems to be imploding under a nearly $11B pile of debt and consistent quarterly losses. The company’s yieldco (dividend-paying entity created by SunEdison that uses long-term contracted assets to generate cash flow for shareholders) TerraForm is drawing criticism, described by some as a house of cards. The stock is down 6% today and lost over 70% of its value since July 1.
Well, that’s bad news for over 160 hedge funds long SUNE (as of 6/30). Amongst the largest holders of the solar powerhouse is Third Point, joined by other powerhouses of the hedge fund world such as Greenlight, Lone Pine, Glenview, Point72 (Formerly SAC), Pennant.
Dan Loeb’s Third Point has dabbled in the stock before, as this historical holdings analysis shows:
However, he built the positions recently, and we estimate his losses to be north of $150M YTD assuming he didn’t trade out of the stock.
We have repeatedly warned our clients and investors of the risk associated with crowded names. Managers must figure in a premium when buying a crowded stock such as VRX of SUNE. While we’re not saying crowded stocks should be avoided altogether, the smart hedge fund manager will use all the data available to calculate the actual cost of trying to unload one of these stocks in a down move like we’re experiencing now.
Managers and Allocators alike use Novus to understand their own exposure to the new big risk factor — crowdedness — and are actively managing that risk. To learn more, please visit our website.
Activist vs. Activist vs. Activist
One of the most polarizing strategies a hedge fund manager can employ is to be an activist investor. Carl Icahn, the largest and most renowned of activists, recently weighed in on the issue stating, “There are bad activists, and we agree that it’s bad. All they want to do is get in and rock the boat and make a quick trade.” But we have found that data speaks favorably of activist managers, or at the very least the returns they are able to generate for their investors.
Without opining on the “good” or “bad,” it’s clear that activists can be very different in the strategies they use to create value for the companies they target and their investors.
This article performs a deep-dive holdings analysis on three prominent activist hedge fund managers.
Who’s in the report?
- Novus’ Exclusive Activist Portfolio
- Value Act Capital
- Third Point LLC
- Pershing Square Capital Management
Originally published at www.novus.com on October 21, 2015.