Daniel Loeb and Third Point’s Returns and Alpha

Daniel Loeb, founder of New York based hedge fund Third Point, has more than $3.5 Billion in assets under management (AUM). He’s a very outspoken investor and a pioneer in activist investing. He made $150 Million in 2005, $200 Million in 2006, and $270 Million in 2007. Insider Monkey, your source for free insider trading data, compiled Dan Loeb’s Third Point Offshore Fund’s returns starting from July 2007. We wanted to have an idea about Dan Loeb’s investment style and skill.

We used Carhart’s four factor model with Kenneth French’s factor returns to calculate Loeb’s alpha. Previously we calculated Warren Buffett’s alpha using the same method and showed that it’s been almost zero over the past decade. This was despite the fact that Berkshire managed to beat the S&P 500 index by around 6% annually. Beating the market does not necessarily imply alpha. If a manager derives his returns by investing in well known styles, then our methodology logically calculates a zero alpha for that manager. This is because you can replicate that manager’s returns simply by imitating his investment style. (See How to calculate alpha and beta)

Loeb returned an average 0.42% per month during the past three years with a monthly standard deviation north of 5%. Our regression results show that Daniel Loeb has a monthly alpha of 61 basis points. But this number isn’t statistically significant because of the high volatility in monthly returns. Loeb’s market beta is 0.63, higher than his historical beta. Since its inception in 1996, Third Point has had a correlation coefficient of 0.41 with the S&P 500 index. Our results show that the correlation with the market increased to 0.58 during the past three years. The coefficient on the size effect is -0.29, meaning that he is deriving his returns from small cap stocks. The coefficient on the value effect is -0.1, meaning that he is not a value investor either. On the other hand, the coefficient on the momentum effect is 0.16 (Third Point has a small momentum tilt).

Third Point returned 25.2% during the first 10 months of 2010 and it’s quite possible that Daniel Loeb will make another $100+ Million this year. Dan Loeb takes 2% of assets and 20% of the performance as most hedge fund managers do. Warren Buffett expressed strong opinions against hedge funds. He said they benefit from the rising tide and investors picking hedge funds will be poorer in the end. Dan Loeb definitely benefits from the rising tide with a market beta of 0.63.

Do you think Warren Buffett is right in this case?