By VW Staff. Originally published at ValueWalk.
Leon Cooperman‘s Omega Advisors gained 0.8% in the second quarter before fees and expenses. Year-to-date the fund is up 2.3%, beating the S&P 500, which is up only 1.2% year-to-date. However, Omega is lagging its wider hedge fund peer group, the Russell 2000 and Nasdaq Index, all of which have returned 4.0%, 4.1% and 5.3% respectively year-to-date, according to a letter to investors reviewed by ValueWalk.
During the second quarter, Omega’s long positions held the fund back while short positions and derivative bets produced the best returns. Specifically, Omega’s developed-country long equity positions subtracted 109 basis points from gross performance. While developed-country short positions equities, index futures, and options contributed 65 basis points to the portfolio’s return. Other positions in structured credit/distressed debt added 40 basis points of return during the quarter, and macro bets added 80 basis points to performance.
Omega Advisors’ macro positions are long bets on the Euro area and Japanese stock indices, short the euro versus the dollar, and short U.S. fixed income.
Omega Advisors: Returns
Omega Advisors notes that the difficult stock picking environment that started in 2014 has continued into 2015. Market breadth across the S&P 500 has been limited while intraday volatility has been high, and the correlation between the S&P 500’s constituents has remained high. Omega believes that factors are a direct result of macro factors influencing stock returns, making stock picking difficult as stock-specific fundamentals no longer carry the weight they used to.
The spread between sector P/E’s across the S&P 500 remains depressed. Last year the spread between the highest and lowest sector P/E hit a two-decade low of 6. The widest spread reported in the last two decades was 49.1 (1999). This year the ratio has increased slightly, although only just. During the second quarter, the spread came in at 7.4, the highest sector P/E being 21.1 and the lowest 14.2.
Omega Advisors: Tough environment for stock pickers
Omega Advisors: A wall of worry
Omega believes that US shares are scaling what it has labeled a “wall of worry”, which will present a problem for asset managers going forward.
Concerns about economic growth and macro factors, such as Greece, China equity market volatility and the timing of first Federal Reserve rate hike are causing investors to withdraw from US equity markets. According to Omega Advisors, this trend can be seen in outflows from domestic equity mutual funds and ETFs, as well as below-average hedge fund exposure to equities and the outperformance year-to-date of growth stocks compared to value stocks.
Omega Advisors: Winning and losing positions
Given the current investment landscape, and “wall of worry” that US stocks now face, Omega Advisors believes that there are now certain company characteristics that are essential to consider when building a portfolio for the near-term. These include:
- Above-average domestically-sourced revenues, given the US dollar strength.
- Above-average rates of sales growth as inflation and corporate pricing flexibility should be constrained going forward.
- Above-average rates of earnings growth given the fact that Omega believes the market’s valuation looks stretched at present levels, and investors should no longer bank on multiple expansion to drive stock appreciation.
- Companies in industries with high barriers to entry to protect profit margins at a time when the economy-wide profit margin is considerably above-trend.
- A long-term record of intelligent capital allocation between share buybacks, dividend payout, dividend growth, capital expenditures, and M&A.
Based on these five key points, Omega Advisors initiated two new positions during the second quarter.
Omega Advisors: Long Google
In mid-April, Omega Advisors initiated a position in Google Inc (NASDAQ:GOOG) on the belief that the business was not being fully appreciated by the market. When Omega started buying, Google was trading at a P/E of 16, in line with the wider S&P 500, despite Google’s strengths.
Omega Advisors notes that Google’s financial metrics are superior to the wider S&P 500 in almost every respect. The company’s revenue growth, EBITDA margin, cash flow and earnings are all far above average.
Omega also believes that Google is in the process of conducting a “tectonic shift” in the way Google treats shareholders. This change is being pursued by the company’s incoming CFO Ruth Porat. She has made it clear that proper resource allocation stretches across OpEx and CapEx and that the company is going to be focused on making efficient and effective investments across the board going forward. Further, Omega believes that Ruth is committed to maximizing shareholder value over the medium and long-term.
“While the stock has moved in our favor since initiating the position, we continue to be excited about the new approach to cost controls that GOOGL is rolling out across their organization. Cost controls coupled with a healthy core business should lead to margin expansion, revenue re-acceleration and more earnings beats…we raised our 2016 EPS estimate…to $36 and upped our multiple to 22x given the shareholder friendly approach to arrive at an $800 price target…Increasing leverage, share buybacks, tax repatriation and other one-off events represent additional
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