Kleinheinz Capital Partners is a global macro hedge fund established by John Kleinheinz in Fort Worth, Texas in 1996. John started his career as an investment banker with Nomura Securities after graduating from Stanford University in 1984. He worked in the Corporate Finance and Mergers & Acquisitions practices of Nomura in Japan before joining Merrill Lynch. John moved to San Antonio Capital – a hedge fund management company started by Dana McGinnis in 1990, as the second principal in 1993. However by 1996, John had decided to float his own fund and Global Undervalued Securities Fund, L.P was launched in February. By the end of the year, John was managing $25 million in capital and his fund was up a whopping 130%.
John’s performance between 1996 and 2010 had been spectacular. Except for 2000 – when he lost 4 per cent, his fund had witnessed a compound annual growth rate of 26.6 per cent. Global Undervalued Securities Fund – as the name suggests, invests in global value situations. John has invested in varied opportunities over the years including internet stocks, Japanese equities, emerging market debts, healthcare stocks and Russian equities. The fund is currently focused on China, Brazil, Russia and Africa and believes Russia is the cheapest emerging market. In China, he’s focused on telecom, healthcare and technology.
John describes his investment philosophy as contrarian, value-oriented and opportunistic. In an interview with hedgefundnews.com in 2004, he said he takes the global long-short approach for opportunities offering maximum returns for a certain level of risk. The firm focuses on companies that offer compelling business franchises and business sectors where the fundamentals are improving. Companies that have large market shares, pricing power or natural monopolies are preferred.
The company relies on five areas for investment research, areas where they have expertise and contacts. Japan is a preferred geography since John had worked there before, and Russia – since he used to run a Russia fund in the mid 90s. Energy, telecom and healthcare are three other industries where the company has developed competence and contacts over the years. Till 2004, eighty percent of the company’s profits came from these five segments. The company runs its own independent research within these five areas and would contract experts rather than using Wall Street brokerages.
Kleinheinz Capital primarily focuses on global long-short equities even though it takes macro positions involving currencies and commodities depending on market conditions. To mitigate risk in equities, the firm trades in government bonds and can be 100 per cent long in their portfolios in US Treasury bonds or specific European government bonds as a natural hedge. The strategy had worked effectively during the 1998 Russian crisis when the rouble crashed, but the losses were covered after the ‘flight to quality’ resulted in US Treasuries jumping by 20 points. However, the firm sold out most of its bonds positions in Q3, 2010 since it believed the bull-run for the US Treasuries were over. “(We are) tactically shorting bonds … until we become more certain about the timing and magnitude of a secular decline in longer dated bonds,” the fund observed in its Q3, 2010 investor letter.
The market rally at the end of 2010 had hurt the fund’s short positions in the energy sector – especially the high beta natural gas producers. John believes Russia is the cheapest emerging market and is focused on Russian utilities and energy companies.
The fund is typically 50% to 55% net long in a bearish market and about 90% long when the economy is booming. To mitigate loss risk, ‘put’ options are added to portfolios that can protect a 75% downside after the market falls 5% or 10%. Exposures are reduced on both long and short positions if a portfolio is down 5% from the month-end value, to cut further losses and be in the game. It sells losing positions every quarter and more aggressively at the end of the year. The firm carries out a fair amount of trading, particularly around the short positions. Portfolios do not hold more than 15% in any country on regional basis – in most cases it is about 7% to 8%, except for the US where the holding may go up to 40%.
Kleinheinz Capital doesn’t have any fixed investment horizon, but prefers long duration investments. The company doesn’t have any theme either, but is careful that it doesn’t miss directional movements. For example, energy has been a big theme for the fund for some time. Also, healthcare remains under the scanner because of the changing demographic mix.
John is in the game for the long-haul and believes in growing the business gradually – mainly from investment gains. He aims to grow the client base 10% to 15% every year since fast growth can prove suicidal for any hedge fund, he notes. A measured growth will ensure that the fund grows bigger in the long-term rather than growing fast in the short-haul.
SHAREHOLDER LETTERS
MEDIA
Kleinheinz Capital Bullish on These Stocks in Latest Quarter (Forbes – September 30, 2011)
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QUOTES
“In summary, while the near-term case for uranium equities has been significantly weakened as investors take a wait-and-see approach, we believe that in the long-term nuclear power will provide as essential component of the world’s energy consumption. Therefore, the Fukushima accident is unlikely to cut short the nuclear power growth story the way Chernobyl did twenty-five years ago, because even in the worst case scenario Fukushima would remain a narrowly localized problem with limited radiation beyond the immediate area surrounding the plant. Additionally, twenty-five years ago, growth in nuclear power was driven mostly by societies in Western Europe and North America, while future growth is expected to come from emerging markets such as China, which has a more centralized decision making process and a very large population with rapidly growing needs for electricity. China, Russia, India, and South Korea account for about 75% of the projected nuclear build-out and those countries have a constructive view on nuclear power.”
“It is an iterative process. In Russia, for instance, we have had much success in individual stocks, picking Russian cellular companies, shorting Yukos at the end of last summer and being long Lukoil. In Japan on the other hand, we haven’t had the time to do a lot of work, so many of our picks are blue chip market-driven names. Sometimes, we even buy ETFs in Japan. A lot of the stock picking process is serendipitous. We may hear about a company from another portfolio manager or an executive at a company we visit, and a trading opportunity may occur to establish a position. We have several core positions in our fund that have been there for more than five years but it takes a long time for a company to become a core position. We need to own it, do research on it, visit the company and understand it thoroughly and that is very much an iterative and long-term process.”
“From time to time we put on macro trades that involve positions in currencies or commodities, but eighty-five percent of our activity is global long-short equities. One of the things we do, however, is trade government bonds against our net equity risk and, depending upon how we see the economic environment, we might be long as much as 100% of our portfolio in US Treasury bonds or European government bonds as a natural hedge against our equity risk. That is a trade we used very effectively in 1998 during the Russian crisis when we got hurt in our Russian and emerging markets positions but were very quickly bailed out by the flight to quality and the 20 point rally in U.S. treasury bonds. Most of the time, you don’t make or lose money owning bonds except when the world looks like it is about to fall apart. We bought bonds again at the beginning of 2000 and held them until the second quarter of 2003, when we decided that the economy was growing too quickly for bonds to be a useful hedge against our equities.”
“There are five areas where we think we have a considerable knowledge base and contacts: Japan, where I used to work, Russia (I used to run a Russia fund in the mid 90s), telecom, healthcare and energy which are three industries where we have developed contacts and a knowledge base over the years. Eighty percent of the profits we have made since we started have been made in those five areas. Within those areas, we are very committed to independent research; we don¿t use a lot of standard brokerage house research and would rather use people who are good enough to be out on their own and away from Wall Street. We like people like Ed Hyman who runs ISI and a number of other industry research people and contacts we have in our areas of interest.”
“We are contrarian, opportunistic and value-oriented. We are a macro firm in that we think about where we are being best paid to take risk and we mostly manifest that macro theme through a global long-short equity approach. We try to buy quality companies with great business franchises at inexpensive prices. We don’t buy things just because they are cheap. We try to invest in companies in industry sectors where the fundamentals are improving. We like companies that have pricing power, natural monopolies or large market shares. We like bigger companies that are first or second in their category. We look at regions of the world similarly. For instance, we got very excited about Russia in 1999 and 2000 because oil prices were moving up quickly and global economic growth was strong . There was a big disconnect between the perception of Russia and the fundamentals which were improving dramatically. Last year in Japan when the Nikkei was hovering around 8000, we looked at the situation in Asia. We saw that there was a lot of excess capacity and that Japan was going to be a supplier of goods to China and the rest of Asia and the economy would improve.”
(On shorting Japanese Yen in Q3, 2010): “Simply put – because Japan cannot afford to let its interest rates go higher, its currency will likely go lower to adjust interest rate differentials, slowing trade surplus and dwindling savings.”
