London based Clareville Capital is bagging big returns in its Pegasus Fund. The long/short equity hedge fund is up a whopping 54% through October of this year which outperforms the return on all hedge fund benchmarks by many times.

Twitter IPO Pegasus Fund

Pegasus down on Twitter

In the latest monthly letter, David Yarrow talks about Pegasus’ position in International Consolidated Airlines Grp (LON:IAG), the parent company of British Airways. Pegasus has several big positions in the travel sector, the fund has reaped decent profits from its stakes in easyJet plc (LON:EZJ), up 85% YTD and Thomas Cook Group plc (LON:TCG), up 260% YTD.

The fund’s managing partners, David Yarrow and Angus Donaldson refer to Twitter Inc (NYSE:TWTR)’s overvalued IPO price as the reason they never invest in initial offerings as a rule. Donaldson says that no matter how much you have worked on the company, the IPOs are always tricky, he adds,

“Inevitably no matter how much work you do on an IPO and how interested you are, the allocation you receive is at the whim of the Book Runner”

British Airways, rising to the top

IAG is the largest position of the fund and considering the lackluster growth in the airline industry, it is unusual for the fund to build up a stake at this time. Yarrow goes into the long-dated history of British Airways, going back to the Gulf war when Iraqi troops invaded Kuwait. In his opinion whatever sell-offs Biritsh Airways has faced in the past are more related to historical perceptions rather than actual shortcomings in business. The letter notes,

“It is manifestly not an easy job to run BA and it does not appear a particularly nice one either. To do it well requires a cocktail of skills but our humble contention would be that a passion for flying and a respect for pilots must be one of them. If we are right, Matthew Broughton’s (the then Chairman) appointment of the former pilot Willie Walsh as CEO in 2005 could retrospectively be regarded as a pivotal moment in the company’s troubled history. He did a good job previously at the admittedly tiny Aer Lingus and we think that Walsh is underestimated – although the recent share price appreciation suggests that our view is increasingly consensual.”

The letter calls British Airways’ exclusive use of Terminal 5 at the Heathrow Airport “the jewel in the company’s crown.” Yarrow also discusses the aspect of low cost airlines and how they can be an attractive business model in the long term. In that regard, IAG operates Barcelona-based low cost carrier Vueling, which is now flying 17 million passengers per year and competing very well with the likes of easyJet and Ryanair. Yarrow adds that British Airways can easily sell a low cost airline, it has done so in the past with ‘Go Airlines’, launched in 1998.

Yarrow notes that British Airways maintains a superior level on the North American route and beats other carriers like American Airlines. He adds that BA is getting better whereas other contenders in the industry are not keeping up. Yarrow accepts that BA may not be a direct competitor of American Airlines, due to its joint ventures, but that does not matter to the ordinary customer.

Pegasus up 5% in October

The fund was up 4.8% in October, despite of minimal returns from its top allocations. Pegasus fund had 103% gross long exposure and only 20% allocated in shorts on a gross basis. Pegasus, which exclusively invests in U.K equities, initiated a short in Burberry Group plc (LON:BRBY) in October. Donaldson thinks that the stock should underpeform now that the CEO, Angela Ahrendts is gone.

The largest stakes the fund holds are in Booker Group Plc (LON:BOK), The Weir Group PLC (LON:WEIR), International Consolidated Airlines Grp (LON:IAG), Rightmove Plc (LON:RMV) and Dixons Retail PLC (LON:DXNS).