The S&P 500 index fell 3% during the month of August, but billionaire David Einhorn’s Greenlight Capital managed a 1% gain for the month according to results from the fund. Greenlight’s performance last month demonstrates why one of the most common recent criticisms of the hedge fund industry- that hedge funds tend to earn lower returns than the index at least during a bull market- is incredibly oversimplified. Much of the value of hedge funds is the benefit to large institutional investors of an asset class which features a low correlation with the stock market. If run properly, true hedge funds should underperform the market when it is up strongly but outperform during down markets and possibly even eke out positive returns (as Einhorn and his team did last month).
Year to date Greenlight’s 12% returns slightly trail an S&P 500 which is up 15%, but many diversified institutional portfolios prefer to give up a little extra returns in a portion of their portfolio for the benefits of an alternative investments portfolio. And, as a bonus, Einhorn has easily beaten the market over time particularly in his small-cap and mid-cap picks (read more about Einhorn’s small cap and mid cap picks). At the end of August, Greenlight’s investment portfolio which was about 30% net long.
We can get more insight into the fund’s recent picks and how it outperformed the market by consulting Greenlight’s 13F filing for the second quarter of 2012. We maintain a database of these quarterly filings from hundreds of hedge funds as part of our work developing investment strategies; we have found, for example, that the most popular small cap stocks among hedge funds generate an average excess return of 18 percentage points per year. Our own portfolio based on these findings, which we began trading in August 2012, has since outperformed the S&P 500 by 33 percentage points. Of course, we can also use this database to track individual managers’ holdings over time (see the full list of stocks Einhorn reported owning).
At the end of June, Greenlight owned 2.4 million shares of Apple Inc. (NASDAQ:AAPL). Apple Inc. (NASDAQ:AAPL) gained nearly 8% over the course of the month as speculation increased that the company had reached a deal with China Mobile Ltd. (ADR) (NYSE:CHL) to sell new iPhones on the largest mobile network in China. While the overwhelming majority of China Mobile Ltd. (ADR) (NYSE:CHL)’s customers cannot afford iPhones, or even smartphones in general, the subscriber base is large enough to add some needed juice to Apple Inc. (NASDAQ:AAPL)’s revenue numbers. Any good news is very good news when a stock is trading at a trailing P/E in the 12-13 range with cash accounting for nearly a third of the market cap. In addition, investors may be thinking that billionaire activist Carl Icahn may be successful in convincing CEO Tim Cook to return more cash to shareholders.
Einhorn and his team had also been long gold, which has been a money losing asset so far this year but rose 5% in August. Many investors have been bullish on gold on the theory that the Federal Reserve’s activities would lead to higher inflation. Gold prices had fallen recently, however, and likely rose last month on concern over military involvement in Syria.
A third winner for Greenlight was Vodafone Group Plc (ADR) (NYSE:VOD); Einhorn had called for the company to sell its minority stake in Verizon Wireless to Verizon Communications Inc. (NYSE:VZ) earlier this year, believing that the market was undervaluing this asset. Vodafone Group Plc (ADR) (NYSE:VOD) rose 8% for the month as the two companies looked set to actually close the deal, and has risen further in September. We’d also note that one of Einhorn’s losers from last month- Oil States International, Inc. (NYSE:OIS), which was down 8%- has rebounded somewhat this month after the company agreed to sell its tubular products business.
Note that these big wins were more “special situations” plays than stocks which were tied to the overall market. Vodafone Group Plc (ADR) (NYSE:VOD) was actually a situation where Einhorn himself identified the potential for value creation, and Apple Inc. (NASDAQ:AAPL)’s stock price has also risen on factors which require more fundamental research as opposed to simply riding market conditions. While Einhorn still lags the market slightly even after a good August, this demonstrates that there’s good reason to believe that his results will continue to show a low correlation with the market. As a result, as long as Greenlight- or any other hedge fund which is similarly independent of the indices- continues to deliver decent returns it can easily prove an attractive investment for many wealth managers.
Disclosure: I own no shares of any stocks mentioned in this article.
