In a hedge fund letter from December 2013, Waterstone Capital, who suffered through a -20% year to date reversal last year, stated that while the hedge fund’s performance over last year was disappointing, the company has had a long history of their biggest losing positions becoming their biggest winning ones.

Hedge Funds Waterstone Capital

And it looks like that prediction is finally coming to fruition. Waterstone Capital’s Market Neutral Offshore Fund was the fourth best performing fund this year, according to HSBC’s last Investment Funds Performance Review, with a return of 8.62% as of February 14. The Minnesota-based fund, run by Martin Kalish and Erik Bender, was one of the worst performing funds last year.

According to the fund’s hedge fund letter of December 2013, its “horrible” performance was due to “psychology brought about by the persistently up market and the confidence that the Fed and other central banks around the world would make everything good,” which “caused investor behavior that trumped the good analysis and deep fundamental research that normally pays off for the fund.”

The fund reiterated their bearish position on the market, stating that the “speculative behavior” that has fuelled the market run up last year will be punished this year. They are particularly bearish on convertible securities, believing them to be overvalued, particularly those that currently hold an investment grade rating, are included in indices and have a large issue size. Waterstone Capital believes that fundamental valuation of these securities will catch up with hedge funds that have overinvested in them, and that Waterstone’s conservative strategy in this space will outperform others.

Waterstone Capital’s short positions

However, they reiterated their confidence in their larger short positions, specifically their position in grocery retailers New Albertson and SUPERVALU INC. (NYSE:SVU). Retailer Supervalu completely sold its stake in New Albertsons to private equity firm Cerberus early last year, at a fire sale price of $100 million. Waterstone has an event-driven short in New Albertson, where it continues to believe that a bankruptcy is inevitable.

The SVU short pits Waterstone against JANA Partners. Three sources familiar with the matter told ValueWalk that JANA is building up a big stake in the grocer retailer.

Other event-driven positions the fund has taken is a long position on pharmaceutical company Dendreon Corporation (NASDAQ:DNDN)’s distressed convertible bonds, worth nearly $28 million and due in June of this year. The hedge fund has been actively seeking out a buyer, made attractive by its patent on prostate cancer drug Provenge. The fund is long Talmer Bancorp Inc (NASDAQ:TLMR) private equity which they expect to go public this year. It is also long Doral Financial Corp. (NYSE:DRL) convertible preferred securities, which they believe could be subject to an exchange offer.

The fund is long convertible securities like agribusiness company Bunge Limited, community bank New York Community Bancorp, Inc. (NYSE:NYCB), senior health care real estate trust Health Care REIT, Inc. (NYSE:HCN) and nutrition company Herbalife Ltd. (NYSE:HLF). This strategy has averaged a 7% discount to fair value, according to the fund’s letter.

The funds short convertibles include medical devices maker Hologic, Inc. (NASDAQ:HOLX), chip-maker Intel Corporation (NASDAQ:INTC), semiconductor company Lam Research and travel booking site Priceline.com Inc (NASDAQ:PCLN), which it says average 8% rich to fair value.