Over the weekend, we first reported that in the first quarter, the pain for David Einhorn's Greenlight Capital reached unbearable proportions, as the iconic hedge fund manager lost 14%, one of the worst quarters in the fund's history; paradoxically, as a result of Einhorn's "bubble basket" which is a short basket consisting of high PE tech names, Einhorn should have had a great quarter as a result of the recent clubbing of the sector. Instead, the opposite happened.
Today, in a letter to investor, he confirmed the deplorable performance and explained what happened.
In a nutshell, it was not only an abysmal quarter, but one in which the billionaire fund manager still can't figure out what exactly went wrong. As Einhorn writes in the investor letter, "in our history, we've had five other quarters with a greater than 5% loss. In four of those, there were clear world or market events that provided a simple explanation, and in one, a few positions in our portfolio went wrong at the same time. This period has not been like any of these."
Instead, as Einhorn notes, there were "no events or individual positions" that stood out; instead the fund's "losses were broad throughout the portfolio, but generally shallow. We had nine positions (six longs and three shorts) that each cost more than 0.5% and only one (Micron Technology) that generated a gain of over 0.5%, despite our portfolio having a decent earnings season."
It appears that what did go wrong, is that both Greenlight's longs and short lost money. But where it gets truly vexing, is that Einhorn's long positions lost money despite posting positive earnings, while his shorts climbed despite earnings. One possible explanation: every other hedge fund has the same positions on, and since there are no incremental marginal buyers or sellers left, the only thing that matters is positioning, and specifically unwinds.
Analyzing his portfolio, Einhorn said his 20 biggest long positions fell 5.6%, and his 20 largest shorts fell 5.5%:
While there is some asymmetry in the longs versus shorts, the reaction to earnings announcements generally made sense. On the one day when investors received actual information about companies, more often than not the market prices followed the reported results. The problem was... all the other days. For the quarter as a whole, the longs that met or exceeded expectations wound up losing 4%, and those that missed fell 17%. The story on the shorts was even worse. Shorts that exceeded expectations finished the quarter up 19% and stunningly, the shorts that missed expectations also finished up 5%.
The results are summarized in the table below.
So how is it possible that one gets all the earnings directionally right and still loses money across the board? Well, Einhorn has no idea, or as he puts it: "It is difficult to fully explain what caused the results above."
As an example, General Motors (GM) entered the year with consensus EPS estimates of $6.30, $5.80 and $5.75 for 2017, 2018 and 2019, respectively, and the stock at $40.99 had an undemanding price to earnings multiple of 7x. GM reported actual 2017 EPS of $6.62, guided 2018 to be similar, and forecast that 2019 earnings should be even better. The stock advanced 6% on the day of the earnings release, before rolling over and falling 18% from its peak to the end of the' quarter.
The confusion continued:
GM's fundamentals appear favorable. Employment is strong, tax cuts are helping GM's customers, used car values are performing well versus expectations and industry scrappage rates are increasing. GM has lean inventory and a product line-up that is gaining share with pricing power. We just don't see what the market may be saying, and we believe that GM is more likely to exceed near and intermediate-term forecasts than to disappoint. Also, the company plans to return about 10% of its market capitalization to shareholders in dividends and buybacks in 2018. Time will tell whether the market is correctly sniffing out incrementally tougher prospects for GM to justify the multiple compression.
What about the bubble baket? While several tech names that Einhorn has been betting against, including Netflix and Amazon, have sold off in recent weeks, the moves did little to help his portfolio, and his fund fell a net 1.9% in March.
As we reported last month, speaking on a conference call, Einhorn said that his hedge fund was experiencing its worst underperformance ever; it was about to get evern worse. As Bloomberg notes, and as its LPs know all too well, Greenlight has posted lackluster returns in recent years as markets, especially for growth stocks, have risen while the hedge fund has stuck to its value-investing strategy.
Looking forward, Einhorn remains optimistic:
We believe our investment theses remain intact. Despite recent results, our portfolio should perform well over time. To some extent, this quarter's result stems from the continued extreme outperformance of growth over value. The Russell 1000 Pure Growth Index followed a 38% 2017 advance with another 7% climb through the end of March. The Russell 1000 Pure Value Index has declined over 3% year-to-date, retracing most of its 2017 gain of 4%.
Some other notable updates from the letter: Greenlight sold its stake in Chemours at more than four times what it paid for the shares in 2015. The hedge fund also exited the German energy company Uniper SE making a profit of more than 100% since the purchase in 2016.
Einhorn also said he covered two shorts he put on in 2016, Hexagon AB and United Rentals Inc., both at a loss. Overall, he had an average net long exposure of 29 percent.
His full letter is below: