Southpoint Capital Advisors’ 2014 Q2 investor letter is out. John Smith Clark‘s New York City based Southpoint Capital Advisors has been around for more than 10 years but it isn’t well known. The long/short equity hedge fund has nearly $3 billion in assets under management. John Smith Clark previously worked with David Einhorn and Greenlight Capital before founding Southpoint Capital. We pay special attention to Southpoint Capital because several of its holdings coincide with the stock picks of our small-cap hedge fund strategy. Our avid readers know that our strategy returned 100.4% over the past two years and outperformed the SPY by more than 52 percentage points in two years. So, we aren’t surprised to see that Southpoint Capital had strong returns since its inception in 2004.
Southpoint Capital returned 11.3% per yer between 2004 and 2014 after fees and expenses, vs. 7.8% annual gain for the S&P 500 index. However, the fund’s monthly net exposure averaged only 48% during this period. Its long portfolio returned an average of 17.6% per year whereas its short portfolio lost 2.8% per year. This means the fund was able to generate alpha on both the long and short side of its portfolio though its alpha was much bigger on the long side. Southpoint Capital is up 4.1% during the first half of 2014.
We aren’t going to share their discussion of specific positions as we save these for our premium members, but we will share their review of their performance:
“We believe that breaking down returns by long investments versus short investments is instructive to understanding overall performance. The data shows that our team has a consistent track record of outperforming the indices with our long investments, with compounded gross returns of 17.6% for our average long versus 7.8% for the S&P 500. In only one year out of ten did the average long in our portfolio return less than the S&P 500.
The track record on the short side has been less consistent, with modest cumulative alpha generation. The annualized short loss on a gross basis has been -2.8% versus an average S&P 500 return of 7.8%. The portfolio generated alpha in the majority of years, but there have been three calendar years of meaningful underperformance. These years (2010, 2012, 2013) coincided with the early and aggressive use of the Federal Reserve’s extraordinary monetary policy of quantitative easing (QE). In these years our short investments performed worse than a theoretical short investment in the S&P 500. In the remaining calendar years our short investments outperformed a theoretical short in the S&P 500.
We strive to generate excess returns through stock selection as opposed to managing exposure levels and timing market cycles. As a result, our exposure levels have remained relatively consistent over time. The exception would be during and immediately after the financial crisis, when we were reconstructing the portfolio for a new reality. The Funds are currently running near our long-term average level of around 48% net long exposure. We believe this balanced approach geared towards stock-specific idea generation has helped our returns versus our peer group in times like 2007 and 2011, when the market volatility wrong-footed many funds who actively tried to time markets or “de-risk” right after significant market dislocations. We will continue to use modest market exposure levels and seek to generate excess return primarily from stock selection and trading around position levels when warranted.
As we think about how to build on the last ten years, we will continue to take advantage of our approach on the long side of the portfolio. We think our framework and process are a sustainable competitive advantage and will always be the cornerstone of our investment returns. We must continue to utilize the framework that has served us well over the last ten years, while adapting to different phases of the market cycle.
The greatest opportunity for our team to improve net returns and risk management is on the short side of the portfolio. Our team is focused on generating sustainable, consistent alpha with our short investments. We have taken away a number of insights from our experiences over the last ten years that should help improve the consistency going forward. We believe that our sourcing process is effective and offers distinct advantages, but we can improve upon the timing of position sizing. We will exploit a number of opportunity sets that have consistently created asymmetric short opportunities. We need to be more patient in our higher conviction positions, even when they move against us. When appropriate, we should scale into positions in a deliberate fashion, even if the investable insight appears very attractive. Finally, we will carefully limit our exposure to crowded short positions and limit concentration in aggressive, momentum short opportunities that tend to trade with a high correlation in a strong market. We believe that a balanced and conservative exposure level gives us the most opportunity to withstand and take advantage of market stress and volatility that can be destructive to long/short strategies. We will let the idea flow and opportunity set drive portfolio construction.”