What is perhaps most stunning about Starboard Value Opportunity fund is not their 1.95% positive July performance, according to a fund performance sheet reviewed by ValueWalk. Nor, by itself, is their 8.25% year to date returns most stunning even at a time when the S&P 500 was up a respectable 6.34% as of July.
In a month when the biggest drags on performance involved Yahoo selling itself for a shell of its former self, resulting in 21 basis points of negative performance at Starboard, it was another losing position that illustrates a certain type of investing skill. The performance document revealed the fund’s “market hedge” was the number one detractor of performance, resulting in nearly -1% of negative performance. Said another way, hedging – what “hedge” funds were designed to do – took away nearly 40% of profits on the month and they were still positive.
What are the keys to Starboard’s performance?
The fact that Starboard actually has a market hedge is relatively rare among a crowd of long-only disciples. There is nothing wrong with long-only investing, but shouldn’t the point of value investing be to identify when markets are over-bought as well as over-sold?
The July monthly performance stat sheet from Jeff Smith’s $2.3 billion (market capitalization) long / short fund with an activist bent didn’t include market commentary even though it stretched 14 pages, which is (by far) the longest stat sheet we have ever seen.
Rather than the man who Fortune Magazine once described as being “the investor CEO’s fear most” writing a monthly performance re-cap, ValueWalk will write its version of the letter using not much more than their performance sheet, and assuming Smith has a dose of immodesty about him.
An Investment letter Jeff Smith probably would never write
When you look at the HFRI Event Driven (Total) Index year to date performance, up 4.36% basis July, please consider the context for our near 50% outperformance. We are a hedge fund that believes in “hedging.” Value investing for us is a two-sided coin. While we hope for the good times, we find it prudent to plan for the bad times as well.
Planning for the bad times does not automatically mean more volatility. Our 11.49% volatility – reasonably close to a common 10% moderate risk tolerance benchmark some portfolio managers idolize – isn’t that out of line considering above average 14% annualized returns performance in both our account structures.
Our Sharpe Ratio is 1.12%. That’s sexy. Yes, I know the Sharp Ratio gives equal risk weighting to upside and downside deviation. I’m a noncorrelated manager and recognize that volatility during positive price appreciation is less a risk than volatility during significant investment loss. (While I have tremendous respect for William Sharpe, I thought Dr. John Lintner should have shared the Noble Prize stage with him.) Like most most Wall Street fund managers, I leave such talk questioning the established order behind the scenes.
Hedging is a cost that should be appreciated
In regards to performance, let me start by saying ignore the headline returns at first. Returns will come and go. Over a longer period of time focus on our internals – are we consistent in hitting or risk targets? I’m not an algorithmic hedge fund, but it’s not a bad idea to keep an eye on relative volatility consistency, it speaks to detailed risk management. You can sometimes see this in several metrics including comparing worst drawdown to average drawdown and understanding how to compare upside deviation relative to beta market correlation. Consider our long short ratio management and look for alpha generation on the short side. But I digress, this is that algorithmic talk. I’m discretionary even though the units of measurement have a reasonably consistent validity across strategies.
Let’s take the level of this conversation down a few degrees and discuss core positioning.
In the face of Starboard carrying costly investment hedges and a long / short ratio that had short position’s reasonably represented, Starboard was still beating the S&P 500 year to date as the July reporting even though the smaller cap Russell 2000 is slightly ahead.
It is important to look at macro strategy risk management from several perspectives. First consideration is cost of hedges. One might wish to recognize in a world where valuations appear to be influenced by artificially induced market-based demand, and negative interest rates appears to have a desperate ring to it in the face of generally positive economic numbers, under such circumstances working with a hedge fund that actually hedges isn’t a bad idea.
As for individual exposure, Yahoo was a big disappointment. It’s not just the recent stock price dive. What they have created to a degree is interesting and important. Yahoo Finance and Yahoo Sports are standouts to various degrees. That contract paid to Katie Couric – while enhancing the platform’s image much like Marissa Mayer’s love of making the executive staff play dress up for elaborate and using image enhancing photography – was a known loser on a statistical profit basis. I should have told Yahoo to lighten up on the bread sticks as I did Olive Garden and get serious about profitability. What is most disappointing is that someone didn’t find higher value in their properties where I see clear value. Overall, it wasn’t that bad of a deal for Starboard. At least I had fun scaring the board of directors.
Yahoo was our highest individual name exposure, at 15.7%, but its also nice to see our other large exposures do well. Consider Marvell Technology Group, where we have a 7% stake, our second largest exposure, and its rewarding to see that stock contributing 1.05% to our goal. Same goes for The Brink’s Company, where we have a 6.3% stake. That exposure, our fourth largest, positively contributed 0.86%.
In the future, keep an eye on our net long exposure — traditionally near 35% — but also pay attention to the defensive nature of some of our long exposure and the nature of our hedging. Yes, the hedging costs are high and we are working on more innovative derivatives solutions, but we’re just not there yet. When I figure out the low cost hedging method I’ll let you know, but until then hedging is a cost that should be appreciated.
Not Jeff Smith
P.S. Seriously, lighten up on the salt
Starboard Value Fund did not respond to a request for comment.