Billionaire activist investor Nelson Peltz dropped some hints about Trian’s new big activist target at an investment conference in New York. Peltz said Trian has two new positions that account a third of its portfolio but he isn’t ready to disclose the names of these stocks. It wasn’t clear from his statements whether one of two stocks is Pentair (NYSE:PNR). According to the latest 13D filings, Trian had about 13 million shares of Pentair and probably spent close to $800 million to acquire them. Trian’s 13F portfolio was close to $9 billion at the end of March. Assuming that Pentair is one of Trian’s two new positions, Trian must have invested around $2 billion in the other “secret” stock.
We have been hearing about these two new positions for a while now and Trian hasn’t filed any 13Ds which they have to do within 10 days of acquiring a 5% activist stake in a company. This tells us that Trian spent $2 billion on the stock yet this wasn’t enough to give them a 5% stake in the company. This means Peltz’s new target is at least a $40 billion company. Trian’s preferred set of companies is very similar to the stocks Warren Buffett likes to invest. So, we doubt that his new target is a technology or energy stock. It is probably a consumer goods, industrial, or financial company.
We don’t know which stock they are now targeting but does it really matter? One of the hottest trends in investing over the last few years is ETFs and passive investing. A large number of investors lost confidence in active managers and they have been shifting their assets into index funds. It is a fact that most active money managers can’t beat the market after fees. Our in house research have shown that the 50 most popular large-cap stocks among hedge funds underperformed the market in our backtests though they were as risky as the market. After adjusting for risk they outperformed the market by less than a percentage point annually. Mutual fund managers’ track record is even worse. So, it is clear that an average fund manager and an average investor can’t really beat the market by a meaningful margin when they actively look for large-cap stocks. However, there are a few exceptions and smart investors benefited by taking advantage of these exceptions.
One is investing in small-cap stocks. Our research have shown that the 15 most popular small-cap stocks among hedge funds outperformed the market by 0.95 percentage points per month in our back tests covering the 1999-2012 period. You will get double digit outperformance if you annualize this figure. We started tracking the performance of these 15 stocks in real time since the end of August 2012. These stocks outperformed the S&P 500 ETFs by 81 percentage points since then. The cumulative return of these stocks was 139.7% through July 14th vs. 58.7% gain for the S&P 500 ETFs (research results are here).
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The second exception is imitating the stock picks of certain fund managers. Warren Buffett is one of them. His large-cap picks handily beat the market over long-periods of time, including recent years (read the details here). Another one is Nelson Peltz. Our research indicates that Nelson Peltz’s mid and large-cap stock picks returned an average of 0.81% per month between 2008 and 2012. S&P 500 Index returned only 0.29% per month during the same period. This is an outperformance of more than 6 percentage points per year. Peltz’s stock picks were also less riskier than the market. His risk adjusted outperformance number is 54 basis points per month. Why is this important?
Historical outperformance doesn’t guarantee good future returns if they are a result of pure luck. We believe Nelson Peltz’s active involvement in the management of the companies he is invested in is the main reason for his superior performance. If this is indeed the case, it is likely that Nelson Peltz’s stock picks will continue to beat the market on average. Pentair (PNR) shares jumped about 6% after the announcement of Peltz’s involvement but the stock gave back all those gains in the last 2 weeks. Pentair shares traded at $64 right before the announcement. They trade at $64 right now. We think it is a good idea to buy Pentair right now.
