Maglan Capital, a small hedge fund that we have talked about before, is once again beating the high end of returns. The Maglan Distressed Fund, which manages $67 million, has gained 11% through the first quarter of this year. Last year the fund was up a whopping 59%.

Maglan Capital

Maglan Capital puts money where it matters

The fund managers talked about their investment philosophy in the March letter, a copy of which was seen by ValueWalk. Maglan has high expectations for the positions it acquires – the fund targets a 30% annual return over a 2-year holding period. The letter explains that they will not buy into a company which they think cannot bring a material difference to their returns. Therefore a position should at least account for 5% of assets under management. The concentrated style of investment results in Maglan investing 80% of its assets into 6-12 core positions.

The fund seeks to benefit from the distressed cycle and suggested in an interview that betting against Chinese equities would be a good idea. Maglan’s co-founder David Tawil is particularly bearish on metal producers and some lenders, he said to Bloomberg.

Going against the herd

The firm’s founders call themselves contrarian investors who like to go against the herd-mentality. As an example, the letter discussed the practice of going long a company which has a larger short interest. In this case the short squeeze will force up the price. At other times Maglan will invest in companies that are ignored and undervalued by the market. While making a decision about buying a certain position, the fund discusses its analysis with experts of the field after performing internal due diligence, then Maglan opts for the contrarian bet in this way:

“Sometimes, in the face of conservative and compelling fundamental calculations, those professionals will react emotionally to our thoughts and their preconceived notions will ignore and override the fundamental analysis. That is a “yellow-light” for us- proceed, albeit with caution.”

The managers said that they are always in the process of protecting and maximizing their investors’ assets. They also noted that having ownership in a company puts one’s ‘skin in the game’, a quote that Nassim Taleb (author of The Black Swan) is famous for saying, the letter said,

“In contrast, we also gain confidence from investment-specific support and “skin in the game”, in the form of considerable management and board ownership of the subject company, a concentrated ownership base and meaningful company stock-buyback programs.”

Maglan Capital seeks to benefit from shifting industries

The fund is on the lookout for industries that are going through a transition, such as where there is shift in revenue and not a broad secular decline. Maglan explains the difference between the two changes by drawing a comparison between shifting dynamics of video distribution industry and the publishing industry. While the shift from paper to online publishing is a broad and endless decline, the shift from DVD distribution to electronic in the form of iTunes and Netflix is a momentary shift in revenue for video producers. Maglan thinks there are several opportunities that arise from the latter case,

“Those situations provide unique investment opportunities because while the bump is creating extreme pressure on the subject company’s capital structure and a de-levering process is being contemplated and worked out, the seeds for the industry’s revenue recovery are already being sowed. Therefore, the upswings from such situations can be dramatic and long.”

Maglan has maintained the same top three holdings through 2014 which include, FairPoint Communications Inc (NASDAQ:FRP), MGM Studios and SUPERVALU INC. (NYSE:SVU). The hedge fund was founded by Steven Azarbad and David Tawil, who worked together at Credit Suisse Group AG (NYSE:CS) where they managed fixed-income alternative assets.