Manager Monday: Passport Capital

John Burbank’s Passport Capital is considered to be one of the most-respected Hedge Funds due to its sophisticated investment process. Initially focused on macro and fundamental research, Tim Garry, who joined in December 2007, has streamlined the investment process by successfully incorporating quantitative risk management. John Burbank sees risk management as an opportunity to improve returns, and not just mitigate risk. He says, “I look at risk as enhancing returns if it keeps you out of the wrong things and helps put you into the right things.”

For this purpose of this article, we’ll analyze Passport’s long performance since February 2009 to see how well this new strategy has worked for them.

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

Passport Capital performed exceptionally well until the financial crisis, at which point Market Value tanked to less than half of its value. After the change in strategy and adding another layer of due diligence to the investment process, John Burbank has managed to revive his legacy. John’s ability to manage funds can be gauged by the fact that he started Passport Capital with $800,000 back in 2000 and currently manages $4.4 billion in assets as of October 2015. Passport Capital has consistently outperformed S&P 500 (BM1) and MSCI World NR (BM2) since 2009 until mid-year 2015, when they got hit hard on the long side of the book.

Alpha Generation

Isolating beta and alpha will give us a better insight into the returns generated.

Here we see that of the total contribution of ~14,500 bps generated since 2009, most of it has come from the market, whereas they’ve detracted ~1,500 bps on their sector selection decisions. On the contrary, they’ve added ~1,300 bps by choosing the right securities, which we attribute to security selection alpha. Below is the list of top alpha generating securities.

Alpha is largely driven by two securities, which are Riversdale Mining, an Australian mining company which specializes in coal mines in Africa, and Vipshop Holding, an online discount retailer in China.

Since February 2009, Passport has invested in 1325 distinct securities, of which ~45% (Batting Average) outperformed their respective sector level benchmarks. More importantly, ~56% of capital (Capital efficiency) was deployed to the outperformers. Win/Loss ratio is ~3.5x which means their average outperformer has generated three and a half times more contribution than their average underperformer, resulting in ~14,500 bps of total portfolio contribution.

Position Sizing

The Passport’s focus is to identify what’s subject to major price fluctuations and what’s priced incorrectly, and hence it’s important for them to size their positions strategically. The below graph shows the returns they’ve generated through position sizing skills.

The blue line is the actual returns, whereas the orange line is a representation of simulated returns where we equally weight all positions in the portfolio at the beginning of each month and hold them constant throughout the month to strip out position sizing skills. Evidently, Passport has gained an additional ~50% of cumulative return. What’s also important to see here is that the gap is continuously increasing, signifying a persistent skill.

Further analyzing ROIC by each position sizing bucket, we see that their high position size buckets have generated higher returns. This is a strong correlation between performance and conviction.

Sector Allocation

Passport Capital is highly exposed to Materials, with a ~34% average exposure since 2009. The below chart shows how their exposure in Materials and other sectors have changed over time.

Recently, they’ve trimmed down exposure to Materials. Has it been a good decision? Let’s find out in the chart below.

Historically, Passport has detracted alpha in Materials. Although Materials is a legacy sector for John Burbank, it’s the worst performing in terms of alpha generation since 2009. The above chart shows that had they invested their capital in S&P 1500 Materials TR, they would have generated ~3,450 bps, but because they decided to invest in certain securities, they detracted ~2,100 bps, resulting in ~1,350 bps of contribution. On the contrary, Energy, Informational Technology and Consumer Discretionary have generated positive alpha.

Crowdedness

Crowdedness is a new functionality that Novus has introduced in response to the recent uncertainty in the Market, especially witnessed during Q3 this year. It’s of utmost importance for Hedge Funds to understand the crowded names in their portfolios. The greater the Crowdedness, the greater the potential liquidity risk during a period of market duress. Below is the list of top 5 most crowded stocks which Passport holds. The average of 0.74 means that only 26% of all 20k securities we track are more crowded within the hedge fund industry.

Conclusion

Past performance is not always predictive of future returns, but persistent skills can be tracked and quantitatively measured to predict future behavior. Investment Managers use the Novus Platform to identify such skills, improve on their weak areas and acknowledge their strengths. We’ve seen that Passport Capital is exceptionally talented at understanding their winning names and sizing them up efficiently. However, their exposure to Materials has not generated fruitful gains since after the financial crisis, which is something for Passport to look into and potentially re-define. Crowdedness is another risk factor which needs attention, as we have seen many names in the portfolio are highly crowded.