Manager Monday: Hound Partners
Our latest Manager Monday digs into the public filings of Hound partners, discovering the source of their outperformance and latest trades.
In 2004 Jonathan Auerbach struck a deal with Tiger Management and secured their blessing and a check from Julian Robertson to start his own venture. He named the newly formed vehicle Hound Partners with his then-partner Scott McLellan, who in 2007 launched his own fund Marble Arch. There is no doubt that Auerbach has since earned his stripes. Currently, Hound ranks as the second largest Tiger Seed (those managers seeded by Tiger Management), with close to $5B in publicly filed market value.
Early last year Auerbach launched his long-only fund, following in the footsteps of his Tiger brethren. The analysis in this post is very relevant to that fund in particular since it primarily speaks to skills and portfolio characteristics on the long side.
As usual for our Manager Mondays, 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.
Having said all that, we present a detailed look underneath the hood of this highly successful manager with the detail and rigor we’re certain you haven’t seen before.
Hound Partners Performance
First, let’s take a look at the simulated performance of Hound’s long book.
Hound outperformed the general markets by a wide margin, with the majority of that outperformance occurring since 2011. In fact, since 2011 the long book has returned 182% compared to 80% for the S&P 500. The data also bodes well for the timing of the long-only fund that launched in January 2014. Since then, the long book returned 46% compared to 22% for the market.
As expected, the outperformance has a steady profile if viewed on a rolling 12-month basis. The manager outperforms by a moderate margin over long, multi-year periods. This is characteristic of a long-term fundamental long/short equity strategy versus a strategy that outperforms massively over short periods (Example).
Hound Partners Asset Growth
With good performance, asset growth often follows, and this clearly has been the case with Hound. Reported market value ballooned from just $432M in January 2011 to nearly $5B today.
What does this asset growth mean? In an earlier study we found that managers have three main levers to deal with large asset growth. The main finding was that AUM growth often leads to increased average market capitalization in manager portfolios, increased position counts, or declines in liquidity. It can also be a combination of any of those three phenomena.
Let’s test some assumptions on how asset growth affected Hound Partners’ portfolio, starting with position count and concentration. We might assume that Hound put a lot of the new money to work in new positions thereby decreasing overall concentration of the portfolio. The data shows quite the opposite. Position count dropped dramatically post crisis and has remained low since.
And concentration, while always high, has actually increased further since 2013:
It’s worthwhile mentioning that concentration has not led to higher volatility in this relentless bull market, in fact the volatility of the portfolio has cratered. This implies that the manager avoids something investors refer to as “diworsification” (too many positions hurt returns) and keeps just enough positions to control risk and downside volatility but not so much as to detract from returns.
Let’s test another assumption: perhaps the new money was invested in previously held names thus significantly driving down Hound’s ability to liquidate their holdings. Turns out this is only partially true. Liquidity, though slightly declined recently, has remained healthy. Assuming Hound is to sell no more than 20% of the 90 day average volume of all their stocks, they can liquidate 71% of their book in 30 consecutive trading days (better than average) compared to 96% of the book they could liquidate back in January 2011 (peak liquidity for the manager and top quartile for all managers).
The only lever left is moving up the market capitalization spectrum, so let’s test our final theory. The next chart is that of their portfolio’s median market capitalization.
Bingo. The way Hound dealt with the increase of assets is the way most managers deal with it: they moved up the market cap spectrum. The median capitalization of their stocks has increased from just $2.6B in 2011 to $11B today. This is partially due to organic appreciation of the names in their book as well as a conscious choice to invest in larger capitalized securities:
Hound Partners Market Capitalization
It’s fair for investors to ask if this is an example of beneficial style drift or if they should be concerned. Data shows that Mid-Caps are actually the sweet spot for this manager and that bucket has been increasing the most, while large and mega are also solid sources of returns and alpha. The manager is not losing anything by giving up on small and micro-cap names. You can see this from the following charts showing the ROIC, Contribution, Batting Average, Win/Loss and Security Selection skill for each bucket.
Batting Average – how often are you right? (13 of 13 Mega Cap positions have had positive P&L):
Win / Loss – How much you make when you are right versus lose when you are wrong. (Undefined for Mega Cap since there are no losing positions):
Average ROIC for the securities in each Capitalization bucket:
Cumulative contribution for each Capitalization bucket:
Security Selection skill high in Mid, Large and Mega:
These charts show that the style drift in market cap, if anything, is actually beneficial for the manager and their investors.
Hound Partners Sector Allocation
Performing a similar analysis on sector exposures shows Industrials, Healthcare, Financials and Consumer Discretionary make up 80% of long portfolio.
The manager has increased concentration in their top four sectors over the last few years but still keeps a generalist profile. Looking at a scorecard view of how their sectors performed since 2006, we can see a great deal of skill in the largest sectors, the Win/Loss ratio in each is 2.3x+ (above average) and in Financials it’s especially high (top quartile).
Below is the value generated by Hound Partners’ stock picking, taking out the effects of the market and sector volatility. Again, areas of strength are also areas of relatively high exposure: Healthcare, Financials, and Industrials. This indicates that the manager has an understanding of their strengths and acts on them by allocating to sectors they are skilled at. It’s also interesting to see strong skill in Energy and IT, a historically underweight area for the manager.
Hound Partners Position Sizing
One of the most valued manager skills often discussed by our clients is position sizing. If you have followed our blog, you know that many managers owe their success to being able to properly express conviction and size up their winners. This is a common trait of the Tiger Cubs, and Hound is a prime example. Take a look at their portfolio compared to a shadow equally weighted portfolio rebalanced monthly:
We can clearly see that stock selection alone was not responsible for all the return, in fact, a portfolio of the same exact stocks, but equally weighted would have underperformed Hound by a whopping 115 percentage points since 2006. Part of the reason is that Hound’s sweet spot position size bucket is quite large, 7.5% – 10%. They make $3.4 on the average winner for each dollar they lose on the average detractor in this bucket.
And a similar pattern can be seen on a pure ROIC basis as well.
Hound Partners Positions
Now, let’s shift gears for a minute and talk about actual positions that drove performance for the manager. Studying positions can yield significant insight into the investment process of the manager, as we shall see.
By looking at the positions filed on 3/31 by the manager, we can see that they have a lot in common with their Tiger Cub brethren. Their top position, Valeant is shared by nine other Cubs and has been a favorite for other hedge funds including activists. Some other large positions like Charter Communications and Fleetcor are high consensus names with the Cubs. In fact, only 3.4% of the value of Hound’s portfolio does not overlap with at least one other Tiger Cub.
High overlap to Tiger Cub consensus names is not necessarily a bad thing. In fact, those tend to be the names that outperform most often. It’s the unique names that tend to hurt several Tiger cubs. You can read more on that in our study released last year.
Over the last decade Hound invested in just 253 unique securities with 54% contributing positive P&L (average) and 67% of capital allocated to winners (average). As alluded to before, it’s the win/loss ratio that really shines for Hound. They get paid more on their winners than they lose on their detractors, and consistently so.
Below are the top contributors to Hound’s P&L over the last decade. Notice that there are eight names contributing over 1,000 basis points to their total P&L – this is good diversification of returns. The top winners come from different sectors, also good to see for a generalist manager.
On the flip side, only one detractor cost over 1,000 basis points, Petrohawk energy; a name they sold in the first quarter of 2011 and since then have done well in controlling downside for any one name.
Hound Partners’ Largest Positions and Significant Q2 Trades
Since we have already processed all of the 13F data that came out last Friday, we can see Hound’s most current public positions and largest trades. Of note is their initiation of a boxed position (Long equity plus a put) in King Digital, the makers of Candy Crush saga for mobile platforms and their exits from Salix Pharmaceuticals, Sensata Tech and Frontier Communications.
We have covered a lot in this analysis, but to summarize, the data shows that Hound has been able to tap skill and change their investment process to better fit with the skill they have. Their position sizing, stock selection and ability to re-allocate amongst sectors has proven beneficial, especially over the last five years.
If you are impressed with how much insight can come out of public data analysis, take a deep dive into the world of private data analytics and see how the world’s top investors use the Novus platform to elevate their game. We help investors large and small to continuously maximize their performance potential. Visit us to learn how and schedule a demo.
Contact the author at Stan@novus.com and on twitter @saltshuller.