As much prior research shows, bad corporate governance including dishonest and/or promotional CEOs is a red flag. Here is what a big hedge fund manager has to say on the topic.
Teton Capital Partners, the $1.1 billion hedge fund managed by Quincy Lee, struggled during the second quarter thanks to what it described as an “unacceptable performance” from the short book. The Texas based hedge fund, which made a name for itself shorting Chinese companies, returned -1.3% gross and -1.1% net for investors during the second quarter, taking year-to-date returns down to 3.6%. Long bets have achieved double-digit returns for the fund so far this year with US longs and International longs returning 8% and 5.8% year-to-date respectively. Shorts have returned -8% and other bets dragged returns down by another 2.2% to give a total return of 3.6%.
According to Teton’s second-quarter letter, a copy of which has been reviewed by ValueWalk, the main detractor from performance on the short side this quarter was the same culprit as Q1; a Chinese homebuilder with 12.1 times more debt than revenue.
During the first quarter of the year shares in the offending homebuilder rose 35% and momentum carried the stock higher by more than 100% during Q2. Teton blames this stock surge on “a liquidity induced short squeeze,” engineered by the company’s Chairman who directly controls 78% of the shares outstanding. Teton opines that the Chairman has “working with close friends and associates to further restrict free float.” Combined with a “rather silly story of the potential to initiate a second stock listing on more expensive Chinese mainland stock-market,” the short cost Teton and estimated 1% of capital during the first quarter. Even though the fund remains convinced that this homebuilder is a zero, Lee has decided to introduce “risk control measures by limiting the position to 2% of capital.”
- High Yield Is The Best Asset For Low VIX Environment: Goldman
- Jason Karp’s Tourbillon Capital: FAANGs Are Not Investments; Bubbles Everywhere
Find Companies With Promotional CEOs For Short Alpha
This unnamed Chinese short isn’t the only position holding back the fund. According to the second-quarter letter, the most predominant character trait of the most painful shorts in the last two-quarters is “open-ended growth stories with promotional CEOs.” These story stocks have benefited due to the “low growth/low-interest rate environment” according to Teton, which has been “a perfect environment for promotional CEOs to promise astounding future growth rates with little to no short-term progress.”
Teton is having more luck on the long side where the company profited from its 13% position in Alphabet and 11.5% position in Interactive Brokers during the second quarter. Lee and team believe that these two leaders in their respective fields are still undervalued. Regarding Interactive Brokers, Teton is waiting for stock volatility and trading volumes to normalize, to help the company’s earnings pick up. The letter argues that recent activity metrics support the view that “cyclically neutral earnings power is growing very rapidly.”
A new position the fund discusses in the letter is Schibsted Media Group, a Norwegian-based holding company that owns several global Internet classified sites. Many of these properties are losing money as they are in their initial growth stages, but Teton believes these losses are hiding the group’s true potential.
This article was originally published in ValueWalk.
Photo: Steve Jurvetson