Lone Pine Capital’s 2014 Q3 investor letter is out. Lone Pine Capital is one of the largest hedge funds in the World. Stephen Mandel‘s Lone Cypress lost 1.9% during the first 9 months of this year. Lone Kauri fund lost 2.1%, Lone Cascade lost 0.9%, and Lone Tamarack gained 1.7% during the same period. S&P 500 Index isn’t a good comparison for partially hedged funds because it is 100% long. However, Mandel included its return of 8.3% in his investor letter, so we are sharing it. In any case, it is clear that Stephen Mandel’s picks are underperforming this year. We will share most of the investor letter below:
The U.S. stock market has significantly outpaced global markets to-date in 2014, particularly in dollar terms, and has been driven by the triumvirate of large capitalization, healthy dividend payers (Apple, Intel, Johnson & Johnson, Microsoft, Pepsi, as well as REITs, MLPs and utilities), management change/activist situations (Canadian Pacific, Family Dollar, Microsoft, Valeant) and “big dream” companies (biotech, GoPro, Mobileye, Tesla, Zillow). Our participation in these three areas has been modest. While we continue to focus on management change as one of the arrows in our investing quiver, we see the best investment opportunities coming from highly profitable new industry entrants that are disrupting large industries and rapidly gaining market share.
There is a greater degree of creative destruction occurring now across a number of businesses than at any time during our investment careers (and perhaps ever, or certainly since the industrial revolution). The internet and mobile communications are the main drivers behind this upheaval. This information and communications revolution is driving profound change across many industries, creating investment opportunity for us, long and short, as markets often underestimate the magnitude of change.
[We excluded one paragraph where Mandel discusses why he is invested in several stocks in his portfolio. We will publish this content separately.]
The challenges of short selling remain, including the lack of short rebate in a zero-interest-rate environment and the crowded nature of many shorts. While these factors are a headwind for short performance, there is an important offset. The other side of the creative destruction coin is providing many “melting ice cubes” to short, the most we have seen in our 17-year history: former market-leading companies whose market shares are being steadily, and sometimes rapidly, eroded by disruptive entrants. Examples can be found in payments, retailing, legacy technology and telephony. We have significant short exposure in each area. These should prove to be excellent multi-year short investments. However, these businesses typically are still producing significant, albeit declining, cash flow and trade for more modest earnings multiples. Therefore, in a more severe near-term market decline, these shorts are likely to fall at a lesser rate than our longs.
The broader implications stemming from the information and communications revolution are important and pose both opportunities and challenges for government, business and for us as investors. With a constant barrage of worrisome events and headlines, it is easy to overlook the positive long-term trends affecting the global economy. Technology has increased the fungibility of labor globally, creating economic opportunity for millions. The broad availability of information online has enabled billions of people, previously cut off from the rest of the world, to understand what possibilities exist for them. Globally, the human condition has never been better: the percentage of the population dying from disease or violence has never been lower, and the percentage of the global population engaged in the economy and living beyond a subsistence level has never been higher. While this technology and communication revolution does present societal challenges – the potential for populist backlash in the developed world and social unrest in centrally-controlled economies – these, in our view, are significantly outweighed by the business opportunities created.
Gabriela Costa joined us in the third quarter as a human resources associate. Our annual investor meeting will be held on May 1, 2015 at the Greenwich Hyatt. We hope to see you there. As always, we encourage you to speak to any of us with questions, comments, investment ideas or introductions to people you believe might be helpful to Lone Pine.