When he was chief investment officer at Perry Capital, David Russekoff was familiar with managing volatile investments. Russekoff reportedly earned Perry nearly $2 billion by betting against the housing market leading up to the 2008 financial crisis. Then he bet $15 billion on Greek and Argentine bonds, which had defaulted. Now at the newly formed Smith Cove Capital, Russekoff isn’t letting up on the gas pedal, as his Long / Short strategy is mixing volatile investments, a Q2 letter to investors dated July 25th, a copy of which was reviewed by ValueWalk, reveals.

Venezuela Smith Cove Capital
By Jsnake17 (Own work) [CC BY-SA 4.0], via Wikimedia Commons

As Venezuela burns, Smith Cove likes investment potential

The key to investing in potentially volatile investments can be found in the somewhat difficult task of managing fat left tail risk. The objective is to select investments that have core performance drivers that respond to different market environment factors. In this regards, Russekoff’s investments in Banco Popular, Bank of Cyprus, Greek government bonds and the nation’s lottery system, as well as troubled Venezuelan sovereign debt, state-owned oil
company PDVSA debt, are volatile correlation factors to monitor.

Looking at Venezuela, currently in the throes of an autocratic takeover of a democratic system, the heart of volatility management becomes apparent. The concept is not necessarily picking the exact bottom, but generally come into the market when emotion and “the market” is running for the exits.

“The economic distortions generated by the policies of the Maduro government and the billions lost annually to corruption and theft have paralyzed the economy and impoverished large portions of the Venezuelan population,” Russekoff noted, pointing to a base case the cash-strapped country will restructure its debt.

Just as the oil rich nation was in the midst of concerns over their ability to pay April debt, Russekoff stepped in to buy based on a thesis the nation’s oil wealth provides unique “credit support” and that creditors will have enhanced leverage during the restructuring process. The outlier is that regime change occurs, but “almost all lead to higher valuations for holders of longer dated bonds.”

Smith Cove Capital – Greece looks good, as does Bank of Cyprus and Spain’s Banco Popular and the former Yahoo!

In debt-strapped Greece, once the concern of international financiers and cause of significant discord between the International Monetary Fund, European Union and European Central Bank, such concerns were pushed aside for the initial investment. But now that the evidence suggests a turning of a corner, the trader takes profit.

Noting that Greece recently reached an agreement with its creditors and received €7 billion of credit, the good news was used to reduce their exposure. But with an improving economic environment, Russekoff invested in Greek equities, including local banks, as well as the Greek lottery company OPAP, a former hot value investment. After winning the lottery in one volatile investment, they are moving to another.

Nearly four years ago, the Bank of Cyprus was forced into a “bail-in” that resulted from bad credit decisions. Today, the bank is shaking its non-performing loans and delivered strong first quarter results, selling a 9.6% ownership stake that  Smith Cove Capital notes was “extremely well received.”

Hop scotching from regions that were economically troubled in the past, the Smith Cove looks to Spain, where it recently purchased Banco Popular Tier One securities. Like Bank of Cyprus, Banco Popular has a non-performing loan problem, but as the economy and by extension the real estate market improves, so too does this investment.

Often times highly volatile investments have low market beta, which Russekoff currently tracks to near 11%. But correlations are also important to build a noncorrelated volatility schema. Here the assets have a correlation of just 15% in the hedge fund’s first four months of exposure, which is benchmarked by long exposure of 79.9% and relatively balanced short exposure of 66.4%.

Smith Cove Capital also recently added exposure to international insurance company Ageas and Altaba, formerly known as Yahoo!

Operational

The hedge fund hired Chetan Gulati from Perry Capital. Russekoff credits Gulati with helping him with the short subprime idea  before the bubble blew up in 08.