Posted by: Aaron Pressman on May 24, 2007
After all the hubbub over hedge fund manager Fortress Investment Group (Symbol: FIG) and private equity manager Blackstone Group LP (Symbol to be: BX) going public, it seems we’ve all overlooked some current IPOs that actually are hedge funds. Blackstone and Fortress are merely money managers like many others already public, though their fund returns may be better. Their business profiles and stock performance won’t mirror the returns of the funds they manage. By contrast, buying shares in newly-public Greenlight Capital Re or soon-to-be public Cypress Sharpridge Investments could get you returns and performance approximating a real, honest to goodness hedge fund.
Greenlight Capital Re hit the market yesterday at $19 and trades under the symbol GLRE. On first glance, this is just another reinsurance company writing a variety of insurance policies, collecting premiums and investing the proceeds. But Greenlight’s investing is done by DME Advisors, the $4 billion hedge fund firm run by David Einhorn, a superstar manager who specializes in finding deeply undervalued (and overvalued) stocks. He’s also a world class card shark who finished 18th in last year’s World Series of Poker and fifth in 2005. Einhorn’s hedge fund, opened in 1996, has gained an average of 29% a year, Bloomberg has reported.
Typical reinsurers invest in boring old bonds but Greenlight via Einhorn is looking to use long and short strategies in both equities and corporate bonds to far outperform. It’s also allowed to use derivatives like futures and options contracts to leverage its investments and magnify its gains — or losses. Greenlight Re gets a discount it seems on the industry standard hedge fund fee from DME, paying 1.5% of assets instead of 2% though still surrendering the usual 20% of gains.
Greenlight’s portfolio run by Einhorn gained 14% in 2005 versus the S&P’s 5% total return and 24% last year when the S&P gained 16%. In the first quarter of 2007, the company’s portfolio lost 4% while the S&P rose almost 1%. Largely thanks to investing gains, Greenlight Re earned net income of $2.66 per share last year and $1.24 a share in 2005. Its poor first quarter led to a loss of 61 cents a share. The return bounced back in April with a 3% gain. As of the end of March, the portfolio included $250 million of listed equities along with a smattering of options, swaps and unlisted equities. Another $141 million of listed equities were sold short.
There are two moving pieces to Greenlight, though. Even if Einhorn’s investing touch remains golden, the company also has to do a good job picking situations to reinsure and pricing appropriately for whatever risks are entailed. A big hurricane could come along and smash all the careful calculations to bits. The company’s track record on the reinsurance front is short.
The upcoming Cypress Sharpridge Investments deal seems even more directly a hedge fund. I first got to know Kevin Grant, founder of hedge fund firm Sharpridge Capital Management, five years ago when he was one of Fidelity Investment’s top bond fund managers. After a few climbs up Mount Everest without reaching the summit, Grant decided to leave Fidelity’s world and go out on his own, establishing Sharpridge to run hedged money in mortgage and asset-backed markets.
Joe Q. Public can’t invest with Sharpridge but he or she will be able to buy shares of Cypress Sharpridge, which is structured as a real estate investment trust and will trade under the symbol CYS. Again, this isn’t your typical REIT buying officer buildings or malls and collecting rent checks. Instead, Cypress Sharpridge will invest proceeds of the IPO along with prior funds raised privately in a portfolio of residential mortgage-backed securities and various other kinds of asset-backed securities including collateralized debt obligations. Some mutual funds do similar stuff but Cypress Sharpridge will also be borrowing — and borrowing big time — in keeping with its hedge fund roots: “we generally expect that the multiple of leverage compared to the amount of equity in our overall investment portfolio will be between 10 and 14 times,” it says in the company’s SEC registration statement. The year-end 2006 balance sheet shows net assets of $180 million with total assets of $2.5 billion offset by securities sold under repo agreements (a savvy Wall Street form of low-cost borrowing) of $2.3 billion, displaying a pretty hefty leverage ratio right there.
Cypress Sharpridge will pay a management fee of 1.5% to its investment advisors plus a quarterly incentive fee which is complicated but I think is 25% of the amount that net income per share exceeds a hurdle rate of either 2% of the average price at which shares were sold or 0.5% plus one-quarter of the 10-year Treasury rate and then multiplied by the number of shares outstanding. Phew.
Investment returns at Cypress Sharpridge prior to the IPO, with all funding from private placements, don’t look all that impressive with a negative total return of 3.7% in 2006. Net investment income before expenses was 7.7% Obviously there are a bunch of start-up expenses in there. But Grant declined to chat with me a few weeks ago when I phoned him about the new venture citing the quiet period around the upcoming IPO. Stay alert for future filings that may provide more info.