Dan Loeb’s letter to Third Point investors for the third quarter ended October 2023. Read the full letter here.
Dear Investor:
During the Third Quarter, Third Point returned -0.9% in the flagship Offshore Fund.
Q3 2023 hedge fund letters, conferences and more
The top five winners for the quarter were UBS Group AG (SWX:UBSG), Jacobs Solutions Inc (NYSE:J), Vistra Corp (NYSE:VST), Shell PLC (NYSE:SHEL) and Danaher Corp (NYSE:DHR). The top five losers for the quarter were Pacific Gas and Electric Co (NYSE:PCG), Microsoft Corp (NASDAQ:MSFT), Hertz Global Holdings Inc (NASDAQ:HTZ), Bath & Body Works Inc (NYSE:BBWI) and LVMH Moet Hennessy Louis Vuitton (OTCMKTS:LVMHF).
Performance Review and Portfolio Outlook
The funds generated small losses in the Third Quarter. Our equity book modestly outperformed broader indices, and both corporate and structured credit (which are roughly 40% of overall exposure) continued to generate attractive risk-adjusted returns with less volatility than equity markets.
Markets in the Third Quarter were intensely focused on the dramatic moves in long-term interest rates, as 10-year and 30-year US treasury yields climbed 73 and 84 bps, respectively, levels last seen before the GFC. Real interest rates are now firmly positive after several years of dovish monetary policy that proved to be a boon to multiples and financial engineering.
While the moves in stocks have seemed violent at times, the market reaction to macro developments in the Third Quarter was quite rational: unprofitable growth stocks, levered companies, and bonds proxies like utilities, real estate and staples were the big underperformers. Our equity portfolio performed relatively well in this environment with shorts significantly underperforming longs for the first time this year. Our long book had limited exposure to bond proxies like staples and real estate, and while our largest equity position (PCG) is a utility, its deeply discounted valuation made it far less vulnerable to rate moves than peers, allowing it to extend its relentless period of outperformance versus the sector.
It is hard to overstate the market’s current obsession with balance sheet strength. This is a growing area of focus for the investment team, as major systematic moves generally create great idiosyncratic opportunities that can only be uncovered through old fashioned fundamental research. Distinguishing which companies have real leverage problems versus perceived leverage problems involves thorough analysis of asset sale opportunities, capital structures, and cash flow statements, all areas where Third Point has a durable competitive advantage. Our equity team’s consistent collaboration with our structured credit, corporate credit, and private credit groups provides us real time insights into the broad suite of solutions available to corporates to manage their balance sheets to create or preserve equity value.
Q3 2023 hedge fund letters, conferences and more
Corporate Credit Update
Third Point’s corporate credit portfolio has contributed 1.3% to fund returns on a net basis year to date, and outperformed the JPM Domestic High Yield Index by more than 450bps during that time period. In Q3, we continued to actively trade the portfolio and several event-driven situations either came to fruition or reached their price targets. Every significant new position we initiated was in a security with an upcoming hard catalyst.
Structured Credit Update
Structured credit remains a compelling asset class in the current market environment. The strategy’s high risk-adjusted yield and lower correlation to the broader markets allows us to invest higher in the capital structure with superior overall yields. The strategy has also contributed 1.3% to fund returns on a net basis year to date. Our mortgage portfolio outperformed relative to the 40% interest rate hedge ratio we have maintained, as home values and non-performing/delinquent loan prices improved.
As rates continue to march higher, we have seen renewed interest from various asset managers in credit, particularly structured credit loans, as unlevered yields for residential mortgages and consumer loans have moved into the 8-12% yield context. Money managers and insurance companies were the first to add exposure at the start of the year, and we are now seeing capital inflows from hedge funds and private credit/equity firms.
Given our extensive relationship with mortgage servicers, we have been working to improve our liquidation pipelines to maximize total recovery on non-performing loans, which we expect to comprise about 15% of our loan pools on average. This strategy is particularly valuable when the loan-to-value of the mortgages is around 55%, and we have seen an improvement in house prices for the sub-$350,000 home value segment in the last six months.
On the ABS side, we were proactive in selling subprime auto ABS earlier in the year and have seen default rates and loss severities increase in the last few months. We believe this is an early indication of a slow reversal in consumer performance. We have focused on more senior cashflows where the de-leveraging profile enables us to reinvest at higher yields and with more liquidity, giving us the option to rotate into distressed asset classes if the opportunity arises. We are spending more time on the commercial real estate sector and believe there will soon be emerging opportunities to invest in senior tranches from forced sellers.
Sincerely,
Daniel S. Loeb
CEO & CIO
Read the full letter here.
