Conatus Capital hedge fund manager David Stemerman revealed some interesting facts about Conatus' portfolio in his fourth quarter commentary. For 2009, Conatus finished the fourth quarter up 2.86% and the year up 19.16%. You can see how the fund stacked up against other prominent hedge funds in our 2009 performance numbers post. Since its inception, Conatus has lost 1.98% compared to a decline of over 20% for the S&P over the same timeframe. Like many other hedge funds, Stemerman points out how difficult it was to make money on the short side when the whole market seems to go up nonstop.
Hedge fund Conatus identified numerous new attractive investments including Unilever (UL) and Estee Lauder (EL) as they both have new management teams on track to improve the businesses and Conatus thinks the market's valuations underestimate potential upside.
A big theme going forward for the hedge fund is cloud computing. Conatus was already long Cisco (CSCO), but now owns shares of Citrix (CTXS), VMWare (VMW), NetApp (NTAP), and Salesforce.com (CRM). In energy, Conatus also added OGX (OTCPK:OGXPY) and Schlumberger (SLB) as OGX acquired a prominent oil exploration location and SLB is dominantly positioned in the off-shore oil exploration service business.
Possibly the most notable information in Conatus' investor letter is the fact that it has completely sold out of Apollo Group (APOL) and Strayer Education (STRA), two names we've seen many 'Tiger Cub' hedge funds fond of. This becomes all the more interesting given that Stemerman's former fund Lone Pine recently detailed recently that it is bullish on education plays. Stemerman notes that Conatus exited the positions due to heightened government scrutiny and deterioration in their business prospects.
Conatus also exited Lloyds bank (LYG) as it didn't foresee the U.K. government forcing the bank to raise capital on terms that hurt shareholders. Additionally, Conatus dumped its longs in Monsanto (MON) and Mindray Medical (MR) as it overestimated their respective competitive advantages. Lastly, Conatus has trimmed many of its long positions that are reliant on emerging market demand as it no longer sees the risk/reward skew as favorable.
Another interesting point Stemerman highlighted is that regulatory risk has become much more apparent in the investing world and the fund intends to be very cautious in this regard from now on. Going forward, it will hone in on the quality of businesses and quality of management teams, among other factors.
Existing Long Positions
Stemerman highlights that its biggest gains came from internet plays in Amazon (AMZN), Google (GOOG), and Priceline.com (PCLN). He then goes on to breakdown what helped his fund generate gains with some of its longs:
Amazon has extended to general merchandise and now has a truly global footprint.
Google has a strong position in advertising given that advertising markets are recovering.
Priceline's Bookings site continued to gain European market share.
Apple (AAPL): Continued iPhone and Mac demand.
Inditex (IXD) and Urban Outfitters (URBN): Improving sales.
Cognizant Technology Solutions (CTSH): "Demonstrated the strength of its competitive position of combining strong industry expertise in developed markets with low-cost delivery in India by growing materially faster than its IT sourcing peers."
Itau Unibanco (ITUB) is the leading bank in Brazil after solid merger integration.
Brazilian Homebuilders PDG Realty and MRV Engenharia: Strong demand and government subsidies.
Prior to founding Conatus, Stemerman worked at Stephen Mandel's Lone Pine Capital so we know the emphasis will always be on solid stockpicking and that's why we track the fund. All of their top 25 winners in the portfolio were longs, while seven of Conatus' ten biggest losers were longs.
While three of its shorts hurt performance considerably in the fourth quarter, Conatus is still short them as it believes the investment theses are still intact. Conatus has sized its positions conservatively and notes that opportunities are limited and often crowded trades. Stemerman highlights that it found success shorting cash exchanges. He notes,
While the market generally appreciates that electronic competition is a threat, it has underestimated the pace at which the business is declining.
Additionally, Conatus is short
a for-profit education company with questionable business practices that has been put at risk from greater regulatory scrutiny, specialty retailers hurt by improving competition, and a traditional video game publisher displaced by on-line offerings.
Insert your best guess here as to which businesses they are referring to, but that last one sounds like it could possibly be Electronic Arts (ERTS). Their sourcing of short ideas often comes from companies that are being displaced by new technology and businesses facing competition from low-cost competitors. Head here to see what some other hedge funds are shorting.
Stemerman's hedge fund exposure levels were as follows: Net exposure around 50% and gross exposure ranging from 110-130% with the latter below its normal range of 150-200%. Stemerman outlines the rationale for its reduced exposures below:
In our third quarter letter, we identified five factors that could lead us to move away from our strong net long bias. Two of the five have come to pass - 1) convergence of market expectations for the U.S. and global economy with our more positive view, and 2) heightened risk of an increase in interest rates - leading us to bring down both our net and our gross exposure.
So, Conatus is certainly a bit more cautious going forward given macro factors at hand. The hedge fund began 2010 with $2.85 billion under management. We had previously detailed Conatus' portfolio as per third quarter disclosures and we will be updating its holdings (along with many other prominent managers) in our hedge fund portfolio tracking series. For more insight from long/short equity hedge fund managers, head to our coverage of a recent hedge fund panel on the case for global equities in 2010.