John Burbank’s Passport Global, with $1.4 billion in firm assets under management, finished 2013 with a strong 23.2% return, besting the hedge fund’s annualized return of 18.8% since its inception, according to an investor letter reviewed by ValueWalk.  The firm had net asset inflows of $58 million in the fourth quarter.

In the quarter, the fund generated a 4.5% return with a standard deviation of 11.2%.  By comparison to the MSCI AC World index, which generated at 23.5% return in 2013, had a 7.4% return with 8.3% standard deviation in the 4th quarter.  To stress test the fund’s beta exposure they use the MSCI World index at a 1% level and do not engage in purchasing put options for tail risk exposure.

Hedge Fund manager John Burbank says that “from a quantitative perspective, 2013 can be very neatly bifurcated into two parts: price action before the May 1 taper discussion, and price action subsequent.”   Until the taper discussion, the letter notes, “interest rates were low and investors were crowding into low beta securities that offered yield,” a condition correlated with low beta stocks.  After the taper discussion the this “changed dramatically” as investors recognized “interest rates could rise, investors sold low beta, higher yielding stocks and shifted into growth securities.”

Markets expected to deliver lower level of aggregate return

Looking ahead to 2014, the fund is anticipating a different market environment. Burbank makes the case that “the market’s return will be lower this year and that the aggregate level of volatility will be higher so risk-adjusted performance should be lower.”

The letter noted the effect the Federal Reserve taper process, and a generally less accommodative central bank, will have on markets and moving forward. “QE has truncated the volatility of numerous assets classes and reduced tail risk,” he wrote. “Lower volatility and pairwise correlations have made for a benign investment environment,” he said, noting opportunity in relative value stock trading strategies.  While positive market environment for stocks could change, Burbank notes that “we don’t want to make a bet that a sharp decline is imminent, but we want to take steps to mitigate the impact if it does happen.”

John Burbank: Six categories of risk

When considering market risks, Burbank breaks them down into six primary categories:

NYSE margin interest continues to make new highs: Although in and of itself Burbank doesn’t view this as a risk, the issue is that in a market pullback or full blown dislocation unwinding highly leveraged trades can be a “sensitive” issue.

Mis-specified risk models: After 18 months of benign volatility, Burbank notes that traditional models for measuring risk can “potentially become grossly mis-calibrated in an exogenous shock or regime shift,” the letter said.  “We generally assume risk models and stress tests are significantly underappreciating true risk.”

Liquidity: Burbank’s primary consideration is that during a significant market dislocation a number of factors could accentuate a move lower and make exiting a losing position difficult.  “In any major dislocation where hedge funds reduce nets quickly, the combination of high frequency trading (HFT) and less risk capital from the sell side is going to be a deadly cocktail that can greatly exacerbate what otherwise could be a minor dislocation,” the letter said.

China: Burbank expects a bumpy road over the next three to five years as China will transition from a fixed asset investment to consumption.  “Any exogenous shock out of China could likely have real global implications for markets.”

The Growth Factor:  While growth stocks were a good play for a higher interest rate environment, factor volatility has also risen modestly and “while we think growth stocks still represent the best opportunity, we are aware they are not as low-risk given aggregate positioning as they were early last year,” the letter said. 

As to Burbank’s investment thesis going forward, he makes four general observations and then dives into specifics:

* We are in a slow growth world;

* Investors are better off in equity than credit;

* The equities of developed markets will continue to outperform those of emerging markets; and

* The benefits of change and innovation are underrated, as are the changes technology will have on the global economy. As a result, investors are under-allocated to technology equities.

Debt plays into investment outlook

These macro themes translate into specific investment strategies the fund will pursue. These include a preference of equity investments over credit, developed over emerging markets. 

Passport global John Burbank

Burbank considers the level of debt relative to his investment strategy and notes, “There are lots of uncertainties in the United States around governance, debt and policies. However, with taper beginning last year, rates beginning to normalize and the United States becoming one of the rare global economic bright spots, we believe in a stronger dollar. And a stronger dollar should favor U.S. equities and the developed world, but will hurt emerging market equities.”

John Burbank: Relationship between change and GDP growth

In regards to change, Burbank makes an interesting observation relative to the rate of change and GDP growth:  “What’s unique about the present, slow GDP growth environment is that it is happening at the same time the world is undergoing rapid change. We all understand that when there’s high GDP growth, there is typically significant change. At the same time, if we look to Europe or Japan’s dismal growth, it has largely been accompanied by a notable lack of change from a cultural, policy and business perspective.”

The letter outlined the portfolio’s top holdings which include SouFun Holdings Limited (ADR) (NYSE:SFUN), making up 7% of net asset value, and CF Industries Holdings, Inc. (NYSE:CF), 6% of NAV; Cheniere Energy, 4% of NAV.

Below is Burbank’s reasoning behind why he likes the above company from his Q4 letter:

Soufun Holdings Ltd. (7% of Global Fund NAV): Soufun Holdings operates the leading real estate Internet portal in China. We believe the shift to online marketing and advertising for real estate is secular and that Soufun represents a more efficient way of selling, marketing and advertising for new houses. China’s residential real estate market was $858 billion in 2012. Leading developers spend approximately 3% on selling, marketing and advertising, translating to about $26 billion in spending. Soufun controls well over 50% of the online market, yet the revenue in 2012 was just $430 million, or only 1.7% of overall market penetration. In our view, Soufun has the potential to capture a much larger market share. In addition, the company recently announced its intention to provide online financial services for which we believe there is significant demand.

We believe the company has tremendous pricing power, given its dominant online position, and requires little ongoing capital expenditures. As a result, it has averaged 48% operating cash flow margins for the last three years. The stock currently trades at 16.0x 2014 EV/EBITDA, despite having beaten expectations 13 quarters in a row and tripling in value over the last 6 months of 2013. For comparison, Zillow trades at 58.7x EV/EBITDA and Rightmove in the United Kingdom at 21.6x.


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