The Other Reason Long-Short Managers Are Lagging This Year

December 16, 2013   Stephen Taub

Managers have blamed the difficulty of shorting in a rising market for their underperformance this year. But they also missed some of the year’s top stocks.

Pity the poor long-short manager.

While most equity indexes are up 30 percent or more this year, the average hedge fund manager that simultaneously bets on stocks that go up and down is up a mere 9 percent or so through the third quarter. Many of these managers are beating or coming close to matching the stock indexes in their long portfolios but are understandably suffering sizable losses in their short books.

But another major reason long-short managers are greatly lagging the stock market indexes — an issue most of them don’t address in their quarterly letters to investors — is that they have mostly missed the hottest stocks of the year. More than a half dozen stocks doubled or more this year, yet virtually no hedge fund had a sizable stake in these companies throughout the year’s run-up. Most of these stocks steadily rose in price throughout the year, giving investors plenty of opportunities to hop aboard sometime along the way. Yet few hedge funds were enticed.

These stocks include Best Buy, Tesla Motors, LinkedIn Corp., Netflix, Yahoo, Hewlett-Packard, Facebook and Shutterfly. Most of these companies flourished in the face of widespread skepticism this year. Several of them began their ascent last year, while others either dropped earlier this year before surging, or surged earlier this year before falling back in recent months.

One of the best examples of missed opportunities remains Best Buy, which we highlighted earlier this year when we first took a look at ignored home runs. A year ago the electronics retailer was viewed as a dying dinosaur that was being used as an expensive showroom by online shoppers. The stock is up nearly 250 percent this year, but its climb resembles a slightly tilted ramp all year long rather than a quick spike followed by a leveling off.

Yet you are hard-pressed to find a hedge fund manager who has been in this stock all year in any meaningful way. No hedge fund firm ranks among the top 25 holders, and the handful of funds with positions in the electronics retailer have small stakes relative to their total assets.

Tesla Motors has drawn an enormous amount of attention, partly because of its stock price’s rise and partly due to the fires that have engulfed a few of its electric cars.

The stock has more than quadrupled this year. Yet no hedge fund firm ranks among the top 20 holders. And although several big name firms do own shares — including Chicago-based Citadel; New York–based Blue Ridge Capital, Coatue Management and D.E. Shaw; and San Francisco–based Farallon Capital Management — the stock does not rank among their top ten holdings.

LinkedIn’s stock has more than doubled this year, yet no hedge fund ranks among the top ten holders of the online business networking company. And while London-based Lansdowne Partners and Coatue are the 17th- and 20th-largest holders, respectively, neither of them counts the stock among its top ten holdings. Otherwise, hedge funds have made themselves scarce in this stock.

Several of the year’s hottest momentum stocks do have a very small hedge fund following, but clearly most of the so-called smart money set has chosen to sit them out. Take Netflix. Activist investor Carl Icahn accidentally made a bundle on the company after it spurned his activist bid. The stock has quadrupled this year alone, while Icahn had notched a 457 percent gain in the online and DVD rental company when he reported selling more than half his shares back in October, nearly a year after he reported his large stake. But no hedge fund firm ranks among the company’s top ten holders. And while Coatue is now the 11th-largest investor, the stock is the firm’s 13th-largest holding in a portfolio that usually allocates nearly half or more of its assets to its top ten holdings.

Investors are only recently catching on that Yahoo was a good stock to own this year. Sure, Daniel Loeb’s New York–based Third Point — whose activist agitation catalyzed the changes that led to the July 2012 hiring of Marissa Mayer as president and chief executive — remains the company’s tenth-largest shareholder. Otherwise, hedge funds have avoided the shares for most of the year even as they climbed nearly 100 percent. Finally, in the third quarter, Tiger Cubs Viking Global Investors, based in Greenwich, Connecticut, and New York–based Tiger Global Management took new stakes, with Yahoo becoming the latter’s sixth-largest holding. But we don’t know whether the firms started buying in early July, late September or steadily throughout the quarter.

Investors also remained skeptical of Hewlett-Packard’s rally all year. As they did with Best Buy, investors think HP is in the dying businessof selling printer ink and personal computers. Yet the stock has just about doubled throughout the year. Still, hedge funds have mostly avoided the stock. No hedge fund ranked the company among the top 25 holdings in each of the past two quarters. And the only meaningful investor in the first quarter, Viking, unloaded its entire 10.4 million–share stake in the June period. Obviously, fund managers underestimated president and chief executive Meg Whitman’s turnaround efforts, which have not been completed.

Then there is Facebook, whose stock sank like a rock when it went public last year. The stock has doubled this year. But in this case investors had time to ponder. After the stock fluctuated for the first half of the year, in late July investors had a chance to get in at the same price the stock traded at when the year began and still enjoy the doubling of the price. Most hedge funds remained skeptical all along about the long-term prospects of the social media giant, however. The biggest hedge fund investor is D.E. Shaw, and it is just the 25th-largest shareholder. Two prominent Tiger Cubs did make big bets in the third quarter: Coatue — Facebook is now its fourth-largest holding — and Norwalk, Connecticut–based Discovery Capital Management. At the same time, Greenwich, Connecticut–based Tiger Cub Lone Pine Capital heavily cut its stake. Otherwise, there is little meaningful hedge fund ownership.

Shutterfly is also an interesting situation. Shares of the online photo company doubled this year through August 1. Since then the stock has fallen about 20 percent.

However, one is hard-pressed to find a hedge fund holder of the stock at the end of the third quarter. George Soros was the fifth-largest holder at the end of June, but Shutterfly was a small part of his portfolio (and he no longer manages money for outside investors). Soros dumped all of his shares in the third quarter, although we don’t know whether he did this before or after the stock peaked.

So the next time you hear a hedge fund manager whine about how many lousy companies went up in price in 2013, check whether he also owned some of these best-performing stocks.

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