Manager Monday: Fine Capital Partners

Has Fine Capital Partners lost its mojo? After a stellar run coming out of the financial crisis (based on publicly filed data), the equity long-short fund run by Debra Fine has had trouble navigating the turbulent markets of the past couple of years. In this article, we’ll dig into what’s changed, and see if there are any silver linings to indicate an easier road ahead.

About Our Data

Everything mentioned in this post is sourced exclusively from public data, including the manager’s profile, simulated performance and all other analysis and commentary. The data used here omits the short side, non-equity securities, many non-US securities and all non-public information such as actual fund performance. To simulate performance and determine portfolio attributes such as liquidity, we combine public holdings data with market and pricing data and make simple assumptions.

Performance

Fine has annualized at 6.5%/year since 2006, underperforming the S&P 500 (BM1 above), but beating the MSCI World (BM2 above). They bounced back impressively after their previous extended drawdown in 07-08, which is something investors will be banking on after the performance of the past two years.

Key Statistics

Based on publicly filed market value, the firm has experienced significant growth since its initial filing in Q4 2005 (with the lion’s share of that growth coming since 2010):

Accompanying this asset growth has been none of the levers we see managers pull, including a rise up the market cap spectrum…

…or increase in # of issuers that one would expect to see.

In fact, the fund has actually become significantly more concentrated, both in number of issuer terms (as seen above), as well as the percentage of the portfolio made up by the ten largest positions (later on, we’ll explore whether this increase concentration has been a good thing):

Unsurprisingly, given that neither of these typical levers have been pushed to accommodate asset growth, the fund’s 30day liquidity has fallen pretty drastically over this time period, from 90% of the portfolio back in mid-June 2014, down to less than half today. For obvious reasons, this is a red flag to monitor closely.

Attribution

Over this entire time period, 59% of the fund’s securities have proven to be winners, with 57% of capital having been deployed into these winning names. Worryingly, the average winner has contributed about as much as the average loser has detracted (1x W/L ratio), indicating some issues with sizing up winners and cutting losers. As the great George Soros once said, “it doesn’t matter how often you’re right or wrong – it only matters how much you make when you are right versus how much you lose when you are wrong”.

Another worrying trend is apparent when we dig into the portfolio’s biggest winners and losers over this time period. Can you spot what it is?

Winners

Losers

Of the fund’s 15 biggest winners, not a single one was entered after Q4 2010. Meanwhile, 7 of the 15 biggest losers were entered in the last five years. To make matters worse, substantively all of the 6,385bps generated by the portfolio can be accounted for by the top three winners (AGO, POL, STRZA), the latest of which was entered in Q2 of 2008.

The data makes sobering reading when looked at on a relative basis. Had Fine just bought the S&P 1500 over this time range, they would have been up 14,065bps. Their sector picks cost 846bps, but most jarringly, security selection + trading cost 5,156bps.

Additionally, while the firm’s previous severe drawdown in 07-08 was much steeper than the current one, it did happen during a terrible spell for all hedge funds. This is evidenced by the fact that of the 6,075bps that fund detracted from Jan 07 – Dec 08, only 43% was due to security selection.

During the current drawdown, that figure is almost 130%. Put another way, had Fine just bought the S&P 1500 instead of picking individual stocks, they would have actually be up 1,273bps. Their sector and security selection decisions have cost the portfolio more than 4,500bps.

Sector Analysis

The Fund’s core exposure over its entire history has been to consumer discretionary names. Since the crisis, the large allocation to tech names has been replaced by an even larger allocation to financials.

This financials exposure has been the only segment (with the exception of the small Industrials allocation where nearly all alpha has come from one name, POL) to generate alpha for the fund. Consumer discretionary stock picks have cost 2,820bps. This can be seen in the chart below, where the lighter colour represents the “relative contribution” (market + sector), and the darker colour represents the security selection contribution:

An interesting observation is that through 2013, Consumer Discretionary was actually a huge alpha generator for the portfolio — see below for the breakdown from Dec 05-13:

What this means is much of the portfolio’s poor performance in the past couple of years can be attributed to Fine’s previous Midas touch in Consumer Discretionary deserting them.

Market Cap Analysis

Digging into the portfolio on a market cap adjusted basis, we find that small caps, while always a core segment of the book, have increased since mid-2014 become the largest exposure. Meanwhile, mid-cap exposure has been slashed.

This shift across the market capitalization spectrum is a trend to be closely watched: Mid Caps have been the only real alpha generating market cap segment in the portfolio (as measured by performance against the relevant market cap benchmarks), while Small Caps have detracted 5,500bps of security selection.

Micro Caps have performed even worse on a return-on-invested-capital (ROIC) basis, but this is skewed due to the fact that Fine rode a number of their names all the way down (they were MF Global’s fourth-largest shareholder when the doomed firm went under).

Position Sizing Analysis

As we pointed out earlier, Fine’s portfolio has consistently become more and more concentrated over the years. This increase in the firm’s high-conviction names may turn out to be good thing: there has historically been a clear connection between conviction and performance, as measured by win/loss ratios.

Indeed, since 2014, the highest conviction names have been the only positive contributors to the portfolio.

In other words, when the firm is convinced a position is going to outperform, it generally does. If Fine can continue to find names they can really get behind (and as the increased concentration of the portfolio shows, this does seem to be the direction they are heading), there is no reason they can’t bounce back from this drawdown in a similar way to how they did in 2009.

The Hedge Fund Survival Guide: Volume One

While the reasons may be disputed, most will agree that the past few years have presented enormous challenges to hedge fund managers and active managers in general. As evidence, we’re beginning to see higher-than-normal closures and redemption suspensions from previously successful managers. It feels like it’s more than just a string of bad bets. It feels like the current market regime isn’t conducive to the fundamental research and value investing that has served managers for decades.

Incredibly, we’ve seen some of the most celebrated, marquee hedge funds struggling in situations like Valeant, Community Health, and Sun Edison. In this environment, it’s no longer enough to be a great stock picker. Managers need to evolve.

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