Michael Campbell: The market is anticipating some problems so oil traded at $106 on Friday, yet you say the fair market value is $70. Are you suggesting locking in some of the profits, raising some cash, reduce risk and exposure so you have some cash to reinvest again on a correction?

Opportunities in Energy

Read Part I of Michael Campbell’s interview with Joseph Schachter HERE

Michael Campbell: Joseph Schachter of  Schachter Asset Management is with me, and we’re talking the energy markets. Joseph, worries about the domino effect, worries about problems in the Mid East expanding into something serous, like Algeria you mentioned, Iran, Iraq, etcetera. The market is anticipating some problems so oil traded at $106 on Friday, yet you say the fair market value is $70.  Does that render virtually all the stocks speculative at this point? What should we look for and have on our radar screen, maybe some opportunities if we get a price to climb?

Joseph Schachter: Yes, I think that the market is discounting to some extent these higher prices; maybe not $106 but definitely more than fair value. So I think that we’ve had a decent move in the oil and gas sector in Canada. The natural gas stocks deserve it because the long term commodity price for natural gas has to be more like $5 or $6 to justify new capacity, and the natural gas stocks like Delphi  Energy is one of the names, we talked about it at the conference, the stock at the time was trading just over $2, it’s gone up over 20% just a month since the conference.

There’s been some very good moves in the natural gas stocks, which is justified because the natural gas price was way undervalued relative to commodity prices, while  some of the oil stocks have gone up a little bit more because of Japan and also the new money coming in at the beginning of the year from pension funds and RSP’s etcetera. But the stocks probably are vulnerable on the downside, especially the oil names.Potentially the most downside is probably in the tar sands names because these guys have a cost structure that keeps on going up so if you take $20, $30 off the price of oil, their margin for profitability goes down. Tar Sands names are probably the stocks that are most vulnerable at this time.

Michael: Many Energy names you mentioned at the conference just over a month ago have done really nicely, so are you suggesting locking in some of the profits, raising some cash, reduce risk and exposure so you have some cash to reinvest again?

Joseph: Right, and again each person should sit down with their investment advisor and decide what is appropriate for them. Depending on  own risk tolerance you may want 10% cash reserves,  or  a trader may want to see the 20 or 25% cash reserves to take advantage of it. The resource sector has done very well in the last six months, take some of the profits off the table and sit there with the cash in your portfolio waiting to able to take advantage of some of the bargains because a couple of times a year we always shake outs. Take advantage of them rather than being frightened of them, The reality is you should sell when the euphoria is on, and we’ve got a lot of sentiment indicators that  indicate you want to go to the sidelines. One indicator has the  S&P is sitting at over 80% bullish, On the TSX, all of these sentiment indicators are near the extreme. When they get below 20% that’s usually bullish, and interestingly in Q1 of 2009 we had 0% bulls on the Dow and the S&P 500. Now that we’re speaking the high 80s, we’re way up.

In a second sentiment indicator, insider selling is now at record levels, it’s like three sales for every buy. When you go back to the first quarter of 2009, we were probably one to one, so usually when you get two to one it’s usual a warning signal; when you get to three to one, which is almost a record level, that tells you that the insider is saying the best that’s happened is here, our stocks have done really well, we’re taking some of our money off the table. That should be a warning for most investors out there when the insiders begin to sell at that kind of a level.

Michael: Do you have a couple of names of senior Energy Stocks that we should put on the list?

Joseph: On large cap weakness, again this thing may take a couple of months to unfold in terms of the correction, but Canadian Natural Resources, Talisman Energy, Niko Resources are large cap names that we think you want to own in your portfolio for the long term.

Michael: And what about the oil sands stocks like Suncor or any others?

Joseph: Suncor is an attractive name, but I like Canadian Natural Resources better because I think CNQ has got exposure to the tar sands, exposure to heavy oil and they also have their balance sheet getting very strong again because they’re paying down debt after the major construction cycle that they’ve had up north. Once their balance sheet gets in order they will be then ready to start growing again with acquisitions, and they have been a very good and astute investor buying companies at the right time and they have added materially. So they have a very strong Western Canadian base inconventional, they have a big position in tar sands, and they already have opportunities overseas but that part of it is the smallest part of the business.  The International could expand materially which would make it one of the real classic investment oil and gas companies in the country.

Michael: Let‘s talk mid tier for a second.

Joseph: In the mid tier companies in that 300 to 500 million.dollar rang we’ve liked Delphi Energy, we like Galleon Energy, we like Orion Oil and Gas, we like Vero Energy. Again, buy them on weakness, the stocks have done well in the last couple of months so wait till things quite down during the period of disruption in the market.

Michael: And the environment for juniors?

Joseph: The juniors are where you want to go for the exploration stories, companies that are drilling high impact wells and if they’re successful the company can have a material change in it valuation.We like companies like Sea Dragon, Western Zagros, Forent Energy, and Vulcab Mineral. Names like that that are involve either in Canada or internationally.These guys have either joint ventures or they’re dealing with other large companies,so any success with the drill bit could mean material difference to investors and we’ve seen that happen in the past with many companies, Centurion Energy for example was in Egypt, and that company went from $0.66 to a $12 takeover by Dana Gas. So those are the kinds of stories you want to be involved in, but it’s a patience game. When you buy into this you want to own them and keep three to five year time horizon.

Michael: Great as always Joseph, we really appreciate you making the time for us here and across the country on The Chorus Network. We look forward to talking to you again in the near future Joseph.

Joseph: My pleasure.

Interview with Joseph Schachter, Schachter Asset Management. L

Meet five powerful players who move the global investment markets

Knowing what stocks are held by top hedge fund managers is a useful source of investment ideas and an important risk factor for individual investors to consider.

But the data is dated, limited and can be misleading, so investors shouldn’t rely on it too much.

“There is indeed weak — but profitable — information in the holdings data,” said Ted Aronson, founder of investment firm Aronson+Johnson+Ortiz. “As with most stock market information, it is noisy and sloppy, but there is insight to be gleaned.”

Yet even with $20 billion in assets and 38 employees, AJO struggles to gather profitable information from hedge fund holdings, so there’s “not much left for the ‘great unwashed,’” Aronson noted.

Starting point

Despite the limited benefit of such efforts, some of the biggest firms on Wall Street, including Goldman Sachs Group Inc. (GS 156.35, -0.12, -0.08%)  , Bank of America Merrill Lynch (BAC 13.36, -0.01, -0.08%)   and Credit Suisse Group AG (CS 42.69, +0.21, +0.49%)   expend substantial energy tracking hedge fund holdings.

That’s because the hedge fund industry is an influential part of the market. Assets under management are almost $2 trillion, up from $539 billion in 2001, according to Hedge Fund Research Inc.

That amount of money can move markets, so big brokerage firms keep tabs on the top players and what they may be thinking.

Hedge funds often trade a lot too, so they’re an important source of brokerage commissions. That gives them access to some of the best investment ideas Wall Street generates.

For other investors, tracking hedge fund holdings may be a good way to start investigating such valuable ideas.

“It’s not a bad starting point,” said Vladimir Belinsky of Hermitage Advisors Ltd., which advises wealthy people on investments including hedge funds. “If you have 10 top hedge funds owning the same position, it’s got to tell you something. You’re benefitting from all the work and research these firms have done.”

Goldman’s VIP list

Goldman started tracking hedge fund holdings in 2006, at the height of the hedge fund boom. Analysts at the firm currently track almost 700 hedge funds with gross equity assets of $1.2 trillion.

They compile a Hedge Fund Very Important Position, or VIP, list each quarter — a basket of the 50 U.S. stocks appearing most frequently among the top 10 holdings of long/short equity hedge funds.

….view Goldman’s Hedge-Fund VIP List and read more HERE

The hedge fund industry’s strong rebound from the credit crisis has prompted investors to ask whether some funds have grown too large and inflexible to keep delivering bumper returns for which the sector is famous.

The growth of big funds — helped by strong returns during the credit crisis and some clients’ belief that risks are lower than in start-ups — helped push industry assets to $1.92 trillion at end-December, close to the all-time high in 2008, according to Hedge Fund Research.

However, with the growth of big funds has come the old question of whether they could be stuck if another crisis hits, whether liquidity forces them into less profitable markets and whether their prized trade ideas will be discovered by rivals.

“By definition a supertanker can’t be as nimble as a speedboat,” said Ken Kinsey-Quick, fund of hedge fund manager at Thames River, part of F&C, who prefers to invest in funds below $1 billion in size.

“They won’t be able to respond to market conditions, especially as markets become illiquid. They can’t get access to smaller opportunities, for example a new hot IPO coming out of an investment bank — if everyone wants it then you’ll only get a few million dollars (worth).”

Funds betting on bonds and currencies, and CTAS — which play futures markets — in particular have grown strongly.

Brevan Howard’s Master fund, which is shut to new clients, has grown to $25 billion after gaining around 20 percent in 2008 and 2009, while Man Group’s computer-driven AHL fund is now $23.6 billion, helped by a 33 percent return in 2008.

Meanwhile, Bluecrest’s Bluetrend fund, which has temporarily shut to new investors in the past, has nearly tripled in size since the end of 2007 to $8.9 billion after a 43 percent gain in 2008. And Louis Bacon’s global macro firm Moore Capital has grown to $15 billion after a good credit crisis.

LIQUIDITY

While capacity varies between strategies, some clients worry about the time it can take a big fund to sell a security in a crisis. Even in today’s markets a small fund can sell a position with one phone call while it may take a big fund a morning.

“It’s even more difficult than before the crisis to turn around your portfolio. Liquidity in the market is not back to where it was. A fund of $20 billion in 2007 was easier to manage than it is now,” said Philippe Gougenheim, head of hedge funds at Unigestion.

“Because of poorer liquidity you’re paying a higher price to get in and out of positions. Given the current political and macroeconomic environment it’s important to be able to turn around your portfolio very quickly.”

Big funds may find it hard to keep trades secret long enough to implement them, especially when buying or shorting stocks.

One hedge fund executive told Reuters his firm’s flagship fund, once several billion dollars in size, used to break up trades between a number of brokers or initially sell a small amount of the stock — which could give the market the impression it planned to sell more — before buying heavily.

Meanwhile, Unigestion’s Gougenheim said fixing a meeting with managers of big funds can be hard — if a manager runs most of the money they can be hard to pin down, while if they run a small part it can be hard to find out who runs the rest.

“NOT AN ISSUE”

However, fund executives say markets are liquid enough.

“Size is not an issue whatsoever,” Nagi Kawkabani, founding partner at Brevan Howard, told Reuters, adding that the fund’s gross exposure — the sum of bets on rising and falling prices — was lower than at the start of 2008.

“Markets are much bigger and deeper than they were five or 10 years ago.” Brevan would return money to clients if funds became too big, although there are no plans at present, he said.

Thames River’s Kinsey-Quick said big CTAs could find it hard to trade smaller markets, although they may take small bets in these markets to show clients they can play them.

An AHL spokesman said size was “a major advantage… It gives us great purchasing power with brokers which translates into tighter spreads whilst paying pay lower commissions.”
Hedge funds are one of my favorite topics. One of the best jobs I ever had in the pension industry was working with Mario Therrien’s group at the Caisse de dépôt et placement, allocating to external hedge funds. I was the senior analyst responsible for analyzing and covering directional hedge funds: Long/Short equity, short sellers, global macro and commodity trading advisors (CTA) funds. It was a fun job because I got to meet a lot of managers from different backgrounds and talk markets with them. I also learned about their strategies and the differences between directional and market neutral alpha strategies.

No matter who was sitting across the table from me, I never shied away from asking tough questions on their organization, operations, investment process and risk management. Allocating money to hedge funds isn’t a job for the shy and timid; you got to be able to grill them when you need to. But I also listened carefully to their responses, paying close attention to how they addressed difficult periods. The best hedge fund managers are not uncomfortable talking about periods where they lost money and how they coped. Anyone can talk up a great game when they’re making money but very few managers have the self assurance to talk about the difficult periods. For me, those discussions were crucial and told me a lot about the manager, and more importantly on the organization’s culture and depth. The toughest part of that job was the constant traveling which takes its toll.

Getting back to the article above, there are several things I want to bring to your attention. First, back in September 2008, I wrote a comment that the shakeout in the hedge fund industry will be brutal. Then last March, I wrote on their incredible comeback as institutions were increasingly horny for hedge funds. And institutional funds keep pouring billions into hedge funds. According to a recent survey by Preqin, an independent research firm focusing exclusively on alternative assets, there was a 50% rise in public pension plans investing in hedge funds over the past four years:

Preqin research shows that the number of public pension systems investing in hedge funds has increased significantly over the past four years. There are now 295 public pension plans worldwide known to be allocating to hedge funds, up from 196 in 2007. The mean allocation to the asset class has also grown in the same period from 3.6% to 6.6%; it is now one percentage point higher than the average private equity allocation of these investors.

Public pension systems and hedge funds:

• Pension systems generally invest in hedge funds for capital preservation and portfolio diversification purposes.
• They seek absolute returns of 6.1%, lower than the average expectations of other investor types which stand at 7%.
• Funds of hedge funds are popular with pension funds – four-fifths of public pension systems that made their first hedge fund investments in 2010 did so through multi-manager allocations.
• 70% of all pension funds investing in hedge funds have funds of funds commitments in their portfolios.
• The top 10 public pension system investors in hedge funds have a collective $836bn in AUM

Public pension systems’ hedge fund portfolio performance:

• As of Q2 2010, hedge funds showed positive one-year returns.
• Hedge funds have outperformed listed equities over a three- and five-year period.
• Hedge funds have outperformed public pension funds’ average annualized return expectations of 6.15% by producing average returns of 9.8%.
• Despite negative returns over a three-year timeframe, public pension system investors have increased their allocations to the asset class; this is in stark comparison to the many high-net-worth counterparts that have reduced their hedge fund commitments during the period.

You can download the full Preqin report by clicking here. I’m not shocked to see public pension plans allocate aggressively into alternatives, which include hedge funds, private equity funds, real estate funds and infrastructure funds. Why are they doing this? Many plans are underfunded so to make up for the shortfall, they’re reducing their fixed income allocation and going into hedge funds and other alternatives. As the big beta boost in the stock market matures, pension funds are focusing more on alpha strategies that can deliver returns in turbulent markets. Also, many pension funds have investment policies that limits the amount of leverage they can take internally, which is why they allocate to external hedge fund and private equity managers to increase their leverage.

Not surprisingly, the bulk of the assets have been going to liquid hedge fund strategies like global macro, CTA and L/S equity. It was two years ago when I wrote a comment on the death of highly leveraged illiquid strategies. Nothing has changed; they’re still dead. Post 2008, there is a premium for liquid alpha strategies and most of the smarter institutional investors are managing their liquidity risk very carefully.

Some public pension funds know what they’re doing, scoring big with hedge funds. I cringe, however, when I read that Preqin finding that four-fifths of public pension systems made their first hedge fund investments in 2010 did so through multi-manager allocations and that 70% of all pension funds investing in hedge funds have funds of funds commitments in their portfolios. I’m not a big fan of funds of funds which add another layer of fees. If by “multi-managers” Preqin meant mutli-strategy hedge funds, then that’s fine (standard 2 and 20 fee structure). Keep in mind, fund of hedge funds were facing extinction in December 2008. It’s amazing how fast things have turned around.

It’s true, the top hedge fund managers know about making money, generating huge brokerage commissions that gives them access to some of the best investment ideas Wall Street generates. But even the best hedge fund managers can experience a serious hiccup (witness Philippe Jabre’s recent $300 million Japan mistake). And I get really nervous when I read that GAM just launched a retail fund of funds. Just tells me things are getting frothy again in hedge fund land, but it also confirms my suspicion that we’re heading towards another 1999, as all this liquidity finds its way into stocks, bonds, currencies and commodities.

Have hedge funds grown too large? Maybe, we’ll see during the next crisis, but I still favor liquid over illiquid alternatives. I would however look at allocating more to market neutral funds in this environment but be careful with the leverage they’re taking. Moreover, institutional investors, especially those with little or no experience with hedge funds, should strongly consider the merits of managed account platforms that allow them to control operational and liquidity risk. The last thing you need is to invest in some fake hedge fund that defrauds you.

Buffett: Avoid Long-Term Bonds Tied to Dollar

Warren Buffett, the billionaire who urged Congress in 2009 to guard against inflation, said investors should avoid long-term fixed-income bets in U.S. dollars because the currency’s purchasing power will decline.

“I would recommend against buying long-term fixed-dollar investments,” Buffett, chairman and chief executive officer of Berkshire Hathaway Inc., said in New Delhi. “If you ask me if the U.S. dollar is going to hold its purchasing power fully at the level of 2011, 5 years, 10 years or 20 years from now, I would tell you it will not.”

Buffett, 80, has shortened the duration of Omaha, Nebraska- based Berkshire’s bond holdings since 2009 as the U.S. Federal Reserve eased monetary policy to stimulate the economy. Over the same period, he has added to cash holdings and committed more than $35 billion to company takeovers.

“I would much rather own businesses,” he said. “It’s very easy to take away the value of fixed-dollar investments.”

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The Fed and U.S. Treasury Department have pumped money into the economy since the financial crisis through bank bailouts, government stimulus and near-zero interest rates. Buffett said in an August 2009 op-ed in the New York Times that the government must address this “monetary medicine.”

Outlook for Inflation

Inflation expectations among consumers rose in March to the highest level since August 2008, according to the Thomson Reuters/University of Michigan final index of consumer sentiment. Consumers said they expect inflation at 3.2 percent over the next five years, compared with 2.9 percent last month.

Buffett, traveling in India to review Berkshire’s operations and scout opportunities, took questions at a meeting with insurance customers and spoke on topics from the economy to investments. Buffett, who built Berkshire through stock picks and takeovers, advised investors to be wary of valuations for social-networking websites as some of the industry’s biggest companies prepare to sell shares.

“Most of them will be overpriced,” Buffett said. “It’s extremely difficult to value social-networking-site companies,” he said, without naming firms. “Some will be huge winners, which will make up for the rest.”

Buffett has shunned technology investments in favor of industrial, financial and consumer-goods holdings in his four decades at Berkshire. As of Dec. 31, the company owned about $61.5 billion of stocks, $34.9 billion of fixed-maturity securities and $23 billion of “other investments.”

Berkshire’s securities maturing in more than 10 years fell 31 percent to $2.72 billion in the 18 months ended Dec. 31, according to regulatory filings. In that span, the company’s cash holdings surged 56 percent to $38.2 billion.

Buffett completed his biggest takeover, the $26.5 billion acquisition of railroad Burlington Northern Santa Fe Corp., last year. On March 14, he agreed to buy Lubrizol Corp., the world’s largest producer of lubricant additives, for about $9 billion.

Editor’s Note: Billionaires are fleeing the market in droves. Bill Gross: “There really is no way out of this trap.” Find out how you should prepare — Click Here Now.