In this piece, we'll look at Kensico Capital Management to understand how a manager can increase AUM while maintaining outperformance.
The ability to effectively handle an increasing asset base is an important skill investors look for in managers. We previously wrote about the challenges AUM growth poses for managers, as infusing too much capital to a portfolio too quickly could be detrimental to long term performance. It might create undue pressure to deploy the new capital to existing names and hurt liquidity, settle on ideas that would not have been pursued before, or generally drift from the elements which made them successful in the past. In this post, we highlight one manager who avoided the pitfalls of a rapidly increasing asset base by elegantly scaling their strategy, while consistently generating alpha and not compromising liquidity.
All of the following data and analysis is based on publicly filed positions via 13Fs. This means that shorts, non-equities, and many non-U.S. names may be excluded depending on the nature of the manager and their filings.
Kensico Capital Management was founded by Michael Lowenstein and Thomas Coleman in 2000. The Equity long/short and historically sector-diversified Connecticut-based hedge fund experienced a meteoric rise in assets under management post financial crisis—reported market value grew from $855m in January 2009 to over $5.2b as of March 2016, based on SEC 13F filings.
As assets dramatically increase, managers face an inevitable trade-off between liquidity deterioration and style change. Accommodating additional capital by increasing the number of positions or investing in companies with larger market caps will boost the portfolio’s overall liquidity, but requires a broader and more robust idea inventory as well as stock picking aptitude in large and mega cap companies, areas some managers don’t necessarily have a proven track record in. Alternatively, deploying more capital to existing names or sticking with a smaller portfolio market capitalization will diminish the portfolio’s liquidity.
Kensico chose to deploy the additional capital by moving up the market cap spectrum, as evident by a parabolic increase in the portfolio’s median market capitalization from Jan ’09 to March ‘16. For context, the fund has previously focused almost exclusively on small and mid-cap companies. At no point during its filing history did the fund have less than 70% of the book allocated to those buckets, with a combined average exposure of 85% during the period.
Small and mid-cap stocks comprised close to 85% of the Long book in Jan 2009, led by CKH, FISV, TKLC and SUG, with over 50% in small-cap names alone. But within two years, the two buckets represented only 45% of the book, with allocation to small caps dropping to low single digits as exposure shifted towards blue chip stocks such as WMB, PM, V, KO, and EBAY. The trend became more pronounced over time, as small caps were de-emphasized, while mid-caps were scaled back and mega and large-caps took center stage. Since 2014, average exposure to large and mega-caps is at 78%, and 71% as of recent Q1 filings, led by STZ, AIG & MSFT, with 22% in mid-caps and a minor allocation to small-caps.
Kensico completely changed their market cap profile over the years and has demonstrated tremendous skill in the process. From Jan ’09 to March ’16, the fund added about 9,000bps of security selection alpha in large and mega cap stocks, led by STZ, LNG, V, EBAY, WMBI, and ATVI. The fund continued to have success in mid-caps as well, with SUG, STRZA, WMBD, and MFS driving over 2,400bps of alpha during the period. The strong security selection numbers are accompanied by equally impressive ROIC numbers across core sectors and more than 35,000bps of total contribution.
Overall, Kensico ranks in the top 30* of our entire Hedge Fund Universe based on cumulative security selection contribution from 2011-2015, and has added security selection alpha every year since 2009 (with the exception of 2012).
(*For more information on rankings within our HFU, please contact Novus here.)
Kensico successfully scaled its strategy and enhanced the portfolio’s liquidity profile at the same time. From a dollar liquidity standpoint, 73% of the book is invested in names with an ADV greater than $100m compared to 18% in Jan ‘09. The fund’s 30-day liquidity—assuming 20% of trailing 90 day ADV can be traded in a single day—materially trended upwards during the period as well, averaging 88% since 2011 compared to 70% in Jan 2009. In a period of declining liquidity across the HFU, Kensico’s 91% 30d liquidity as of March 2016 stands out positively.
The fund has done a good job of controlling its risk in less liquid names. Only 11% is allocated to securities with an ADV below $25m, and no such position exceeds 150bps with the exception of MFS, which has been an alpha driver for the fund over the years. Kensico also manages its crowdedness risk factor exposure relatively well. Only 3 of its top 10 holdings have a crowdedness rating above 0.90, and its asset-weighted portfolio level crowdedness score of 0.84 is around the HFU average.
Kensico is a case study in prudently adjusting portfolio characteristics to accommodate growing assets without sacrificing liquidity, while delivering investors excellent performance, impressive stock selection alpha, and a proven ability to invest in larger companies.Published on June 1, 2016