Analysis: Major hedge funds cut back equity risk
BOSTON (Reuters) - Even some of the savviest hedge fund managers got burned in 2008 by sticking with their hot stocks for too long as the market tumbled.
Now, with fresh signs of weakness in the U.S. economy, they are positioning to avoid making the same mistakes.
The shift, evident in second-quarter securities filings, is not as simple as leaving equities behind, as many small investors have been doing recently.
Instead, many money managers have shifted to more defensive investments like utilities and high dividend plays, according to a Thomson Reuters review of portfolio disclosures by 30 of the largest fundamentally-oriented hedge funds.
"You're not in that investment mindset of a few years ago any more, and a lot of risk has been taken off the table already," said Steve Goldman, senior market strategist at Weeden & Co in Greenwich, Connecticut. "The consumer is in dire straits, the economy's resilience has been disappointing, and everybody's bracing for it."
Among those battening down the hatches in the second quarter was Jeffrey Altman, who oversees $5 billion at Owl Creek Asset Management, one of the 30 funds included in the "Smart Money" survey.
"Our portfolio is trimmed down to include our highest conviction ideas in which we believe we have the best risk-reward payoff, and our gross and net exposures are significantly smaller than they were at the beginning of the year," Altman wrote in an August 17 letter to his investors.
Second-quarter cutbacks hit some of the highest-flying stocks that have been the most popular holdings for leading hedge funds in prior quarters. For example, funds slashed stakes in Visa (V.N), Google (GOOG.O), AutoNation (AN.N) and even Apple (AAPL.O).
Coming into favor were more stable if less flashy stocks like Exxon Mobil (XOM.N), Viacom VIAb.N, Pfizer (PFE.N) and Microsoft (MSFT.O) that pay solid dividends backed by strong cash flows.
Microsoft's share price has famously done little for the past decade. But with profits rising, the company's undervaluation has reached "insane" levels, according to some investors.
BETTING ON CELLPHONE TOWERS
Energy giant Exxon Mobil saw broad interest. Carrying a nearly 3 percent dividend yield and trading at less than 9 times expected 2011 earnings, the stock should do well in almost any market environment, said Perry Piazza, director of investment strategy at Contango Capital in San Francisco.
"Even if we fall back into recession, higher dividend players will probably outperform the market," Piazza said. "Exxon continues to grow their dividend, as they did throughout the crisis."
Smart money funds' biggest shift in sector weightings during the second quarter favored telecommunications and utilities.
Some funds turned to cell phone tower owners like American Tower Corp (AMT.N) and Crown Castle International (CCI.N).
The shifting allegiances of finicky smartphone buyers may make picking a winning handset maker tough, but all phones are using more and more bandwidth, fattening the coffers of the tower owners who supply it.
Materials, energy and financials suffered the biggest cutbacks.
As important as the overall sector allocations, analysts said, were shifts within sectors toward safer plays.
For example, the funds shifted their big financial sector bets away from Bank of America (BAC.N), which is heavily dependent on U.S. consumers and businesses, and toward the more global Citigroup (C.N), which also looked considerably cheaper by standard valuation metrics.
To be sure, the smart money group remains heavily overweighted in the technology and consumer discretionary sectors, which typically suffer in weak economic times.
But many current favorites like value-oriented department store operator Kohl's Corp (KSS.N) and Microsoft are less at risk due to their relatively lower valuations and more dependable revenues.
SHORT POSITIONS NOT DISCLOSED
Also, the securities filings used to compile the Smart Money survey leave out some critical information, noted Mark Fedenia, co-manager of the Nakoma Absolute Return Fund that uses a long/short strategy similar to many of the funds in the survey. Short positions are not disclosed on the quarterly filings.
"When you're as relatively pessimistic as we are, you tend to (use shorting to) neutralize your sensitivity to individual sectors or the market as a whole," Fedenia said.
For example, the Nakoma fund is hedging its long position in Kohl's with a short position in furniture retailer Ethan Allen (ETH.N). In the materials sector, its long positions in gold and agricultural chemicals are offset by shorts in steel and aluminum.
In the technology arena, some funds are shorting high-valuation stocks like Salesforce.com (CRM.N), a software services company, analysts said.
"Cloud computing is a great story just like the Internet was a decade ago," said Bret Jensen, chief investment officer at Simplified Asset Management who is shorting the stock. But the stock price, at 150 times trailing earnings, "is completely divorced from any sort of sane valuation based on fundamentals or growth prospects."
Overall, the stock market is in for "a long haul," Nakoma manager Fedenia said. "We're positioned for that. I'm sure a lot of long/short funds are."
(Reporting by Aaron Pressman; editing by John Wallace)
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