When the 2007 annual results were released, John Burbank (Trades, Portfolio) of Passport Capital was a star. He had racked up a spectacular 219%.
He was also the person at the center of another somewhat spectacular event 10 years later: Passport’s assets under management plunged from nearly $6 billion to less than $1 billion in the first two quarters.
The bearish stance that had served him so well in 2007 had come back to hurt him.
Who is Burbank?
Burbank was a busy teenager with several jobs, according to Business Insider. It reports those jobs led his own startup, a successful student painting company.
- SPY 30-Year Financial Data
- The intrinsic value of SPY
- Peter Lynch Chart of SPY
His secondary education included an English degree from Duke University, followed by a teaching gig in China. GuruFocus says this is where he became interested in emerging markets. After that, it was business school at Stanford University, where he earned an MBA.
At around age 30, he decided on a career in finance. That began with speculation and $50,000 worth of credit card debt and ended badly. That did not deter him, though. In 2000, he started a global hedge fund, Passport Capital, with $800,000 of his own savings.
Forbes reports Burbank was researching risk issues in emerging markets when he came to realize America’s housing bubble was a problem. He responded by shorting subprime lenders in the U.S. As we now know, that was wise and worked out very well for his clients, a 219% return in 2007 (after fees and Burbank’s 20% cut). He says that worked out to 40% annualized gains for investors who had been with him since 2000.
Burbank grew into his hedge fund through useful experience as a front-line worker, as a business owner and from experience living in an emerging market country. Looking at the U.S. from the perspective of an emerging economy helped him identify the growing bubble at home.
What is Passport Capital LLC?
The San Francisco-based firm is described in the Form ADV Part 2A brochure as a global investment firm. Its advisory business is provided exclusively to privately pooled investment vehicles, registered investment companies and other pooled vehicles.
It lists Burbank as the sole managing member, and he controls 100% of the voting shares. The firm had 59 employees on the reporting date.
The objective is to “generate superior compounded returns on a risk-adjusted basis over the long-term.” Its sectoral areas of focus are consumer, credit, emerging markets, energy, financials, health care, industrials, internet/technology and resources.
Apparently, investors have not enjoyed much in the way of “superior compounded returns” in recent years. A Business Insider article from August of this year observes the firm closed its long-short fund, which had managed $833 million of assets. The article also quotes a Burbank letter to investors which reported that, firm-wide and not including the long-short liquidation, net outflows of approximately $565 million in the second quarter of 2017.
As a result, the firm was managing only $900 million at the end of the second quarter, less than half the reported $2.1 billion with which it began the year. This GuruFocus chart shows the firms equityholdings over the past decade:
Beyond what we can find in the published records, it seems there must have been significant discontent to prompt that kind of exodus from the firm. Or perhaps it may have been one client with a large volume of capital.
In its Form ADV Part 2A, the firm lists its flagship strategy as global strategy, meaning it follows a portfolio of both long and short equities sourced worldwide.
To identify investment candidates, the portfolio managers start with macroeconomics (geopolitical issues). They then narrow the field by identifying investment themes and sectors with promise.
That is followed by bottom-up, fundamental research that helps them identify stocks (or, less frequently, other securities) that fit the theme or sectors they have previously identified, or finding a security that matches their interest in exposure to certain sectors.
In addition, the strategy involves risk management, where it looks at issues such as exposure to certain sectors, portfolio liquidity, hedging as well as daily risk levels and tolerances.
As noted, the main target is equities, but they might also put capital into derivatives, swaps, convertible securities and credit instruments.
Because it is a global strategy, Burbank and his team say they think in terms of longer holding periods. Within that context, however, they may take on shorter-term trades when opportunities present themselves.
The Passport Capital system also takes in some quantitative trading strategies, where they use mathematical and statistical models to try to find mispriced assets. In other words, prices that have deviated from statistical pricing patterns.
As well as the flagship fund, Global Strategies, the firm has three other funds: Passport Special Opportunities, the Passport Long-Short Strategy (now wound down) and the Passport Liquid Long-Shorts. While these funds may own some of the same securities as the flagship fund, each has its own profile, distinguished by returns, risk, liquidity or other factors. The Liquid Long-Short strategy does most of its trading at the beginning of each month, with some rebalancing taking place later in the month.
While not covered in the Form ADV Part 2A, there is a strong bearish sentiment that seems to have lingered since 2007-08. For example, CNBC reported in 2015 Burbank had managed to avoid the correction that occurred in August of that year. He told CNBC he had been expecting the correction for “some time,” and referred to the “last couple of years”.
The next year, 2016, Yahoo Finance reported he had a grim prediction in his fund’s first-quarter investor letter. Specifically, he said they had a “strong opinion” there could be a major devaluation of Chinese currency, and a U.S. recession, within the next 12 months. Burbank thought 2016 might be a repeat of 2008, with “widespread deleveraging into illiquid markets”.
The article goes on to note Burbank made a serious bearish bid against the S&P 500 by buying 5 million puts on the SPDR S&P 500 ETF (SPY).
Of course, the market did not collapse in 2016, or even so far in 2017, despite many indications it could. It appears Burbank’s positioning is similar to those of Prem Watsa (until late last year) and John Hussman. Like them, he is paying a heavy price for safety and potential gains on shorts.
This chart shows the sectoral holdings, with a significant chunk not in common stock:
Of the 70 stocks held in all portfolios, these are the 10 biggest holdings as of June 30:
- iShares MSCI Emerging Index Fund (EEM): 18.99%
- PowerShares QQQ Trust Series 1 (NASDAQ:QQQ): 16.83%
- iShares China Large-Cap (FXI): 11.55%
- Parsley Energy Inc. Class A (NYSE:PE): 8.89%
- iPath S&P 500 VIX Short Term Futures (VXX): 4.81%
- Advanced Micro Devices Inc. (NASDAQ:AMD): 4.24%
- Canada Goose Holdings Inc. (NYSE:GOOS): 3.52%
- Alibaba Group Holding Ltd. ADR (NYSE:BABA): 3.37%
- Alphabet Inc. (NASDAQ:GOOG): 3.22%
- Wingstop Inc. (NASDAQ:WING): 2.56%
Slightly more than 30% of the portfolio is based in emerging markets and China, nearly 17% in technology (via the QQQs) and almost 5% in the VIX (the Fear Index), a common hedging instrument. Thus, the top 10 show a heavy bias to international markets and technology.
Since Burbank operates solely as a hedge fund, his firm does not file as much information as mutual funds. However, some results can be pieced together to provide a bigger picture of his returns.
As noted, he was a star of the housing bubble collapse and generated a 219% return for his clients in 2007. Since then, results have gone downhill.
Business Insider reported in August of this year the Passport Global fund had lost 16.8% (after fees) in the 12 months ending July 2017.
Institutional Investor magazine reported in April of this year the Global Strategy Fund was down 8.37% for the 12 months ending in March, after losing 17.58% in 2016. Further, a hedge fund tracking service found the fund was one of the poorest performers among all hedge funds.
Backstopping that information, the magazine puts the fund’s average annual return at 14% since inception. Without accounting for compounding or other factors, multiplying 16 years by 14% equals 224%. Now subtract 219% from 224% and that leaves just a 5% gain to be divided among the remaining 15 years. Hardly the kind of return to make investors feel warm and secure at night.
Assets under management plunged from nearly $6 billion to less than $1 billion in the first half of this year; here is the chart again:
Obviously, a large amount of capital pulled out and it seems unlikely clients would do that based on only a quarter, or even few years of underperformance.
Investors buy into hedge funds with the expectation they will enjoy above-average returns and, in many cases, pay dearly for the privilege. Unfortunately, many of those who invested in Passport funds—since 2007—probably rue that decision.
This a story we have seen before: extraordinary success by predicting the end of the housing bubble and then sticking too long or too closely to a model that emphasized insurance. The stories included those of Watsa and Hussman.
Watsa pulled back on hedging late last year, based on the November 2016 election results, and has brought up his returns as a result.
What seems to be needed is a Goldilocks strategy: hedging that is not too hot and not too cold. In other words, a middling amount of hedging that protects assets but does not cost so much that it seriously undercuts returns. Perhaps that is impossible, but it should be a holy grail of value investors.
Disclosure: I do not any shares in any of the companies listed here, and I do not expect to buy any in the next 72 hours.