Joel Greenblatt‘s Gotham Asset Management is one of the best funds to track due to its value-investing approach and consistent returns over the years. Mr. Greenblatt selects large and mid-cap companies and buys them at a large discount according to his assessment and shorts companies that trade at the largest premium compared to his assessed value. Gotham recently issued a new quarterly letter to investors in which Mr. Greenblatt presented his take on the current market situation after the August turmoil and expressed his views on the situation going forward, saying that the “valuation disparity between large and small caps should also help contribute to attractive long/short spreads in the coming year,” among other things.
We follow Gotham’s activity alongside over 700 other hedge funds as part of our small-cap strategy, which involves imitating a portfolio of 15 top small-cap ideas among these funds, and which has returned 118% over the last three years, beating the S&P 500 ETF (SPY) by some 60 percentage points. We believe that imitating hedge funds’ small-cap picks can be more profitable than buying their most popular picks overall (see more details here).
Gotham’s latest 13F revealed a very diversified equity portfolio worth almost $12 billion, with most positions from the Services and Technology sectors. Heading into the third quarter, the fund’s largest holding was represented by Gilead Sciences, Inc. (NASDAQ:GILD), in which it held 1.07 million shares. However, while the investor trimmed its holding in Gilead by 4% during the second quarter, it boosted its stakes in its other top picks. In this way, Gotham held 1.17 million shares of Bunge Ltd (NYSE:BG) and 1.73 million shares of Lannett Company, Inc. (NYSE:LCI), up by 62% and 12% on the quarter respectively. Its fourth-largest position, in Pilgrim’s Pride Corporation (NASDAQ:PPC), was inched up by 6% to 4.10 million shares, while its stake in Spirit AeroSystems Holdings, Inc. (NYSE:SPR) was doubled to over 1.53 million shares.
Overall, out of 910 positions disclosed by Gotham in the 13F, 759 holdings are in companies that have a market cap of over $1 billion. These positions had a weighted average decline of just 0.09% in the third quarter, while year-to-date the return of Gotham’s equity portfolio (calculated under the same approach) stands at a loss of 8.7%.
In his latest letter to Gotham investors, Mr. Greenblatt said that they had small long/short spread gains during August, amid a broader market correction.
“In essence, when investors start to panic they throw everything out without much discernment. Given our research into prior market periods, it is our expectation that this discernment should start to play out over the next 6 to 12 months as an appreciation for risk returns,” Greenblatt added.
The investor added that he is still confident in the companies in which Gotham has long positions, because they will benefit from a “renewed appreciation” as they have high cash flows relative to price and can generate “attractive returns on capital.” On the other hand, the companies that Gotham has shorted will underperform the market and will lag in comparison to the stocks from the long side of the portfolio according to the investor. “Over the last several years, these “hope” stocks have been priced with little concern for the risks to those high expectations,” Mr. Greenblatt said.
“As we often say, stocks are not pieces of paper that bounce around that we put Sharpe or Sortino ratios on. Stocks are ownership shares of businesses that we value and then either buy at an attractive discount to that value or sell short when they are expensive relative to value. This process often takes time to work, but this is the only way we know how to invest.”
He added that the recent market turmoil will help Gotham’s strategy to make more profits in the coming year. Another reason that will help Gotham to achieve “attractive long/short spreads” is the valuation disparity between large and small-cap stocks. Currently, Gotham’s portfolio contains long positions that are “skewed toward the cheapest stocks among the larger caps,” while its short positions are “skewed toward the most expensive smaller cap stocks within an already very expensive small cap universe.”
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