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Third Point 1Q’16 Letter – We Crowded Into Short Trades In The RMB

Third Point – Review and Outlook Volatility across asset classes and a reversal of certain trends that started last summer caught many investors flat-footed in Q1 2016. The market’s sell-off began with the Chinese government’s decision to devalue the Renminbi on August 11, 2015, and ended with the RMB’s bottom on February 15, 2016, as shown in the chart below: Click to enlarge By early this year, the consensus view that China was on the brink and investors should “brace for impact” was set in stone. In February, many market participants believed China faced a “Trilemma” which left the government with no choice but to devalue the currency if it wished to maintain economic growth and take necessary writedowns on some $25 trillion of SOE (State Owned Enterprise) debt. Based largely on this view, investors (including Third Point) crowded into short trades in the RMB, materials, and companies that were economically sensitive or exposed to Chinese growth. Making matters worse, many hedge funds remained long “FANG” stocks (Facebook, Amazon, Netflix, and Google), which had been some of 2015’s best performing securities. Further exacerbating the carnage was a huge asset rotation into market neutral strategies in late Q4. Unfortunately, many managers lost sight of the fact that low net does not mean low risk and so, when positioning reversed, market neutral became a hedge fund killing field. Finally, the Valeant (NYSE: VRX ) debacle in mid-March decimated some hedge fund portfolios and the termination of the Pfizer (NYSE: PFE ) – Allergan (NYSE: AGN ) deal in early April dealt a further blow to many other investors. The result of all of this was one of the most catastrophic periods of hedge fund performance that we can remember since the inception of this fund. When markets bottom, they don’t ring a bell but they sometimes blow a dog whistle. In mid-February, we started to believe that the Chinese government was unwilling to devalue the RMB and was instead signaling that additional fiscal stimulus was on deck (an option that the bears had ruled out). Nearly simultaneously, the dollar peaked and our analysis also led us to believe that oil had reached a bottom. We preserved capital by quickly moving to cover our trades that were linked to Chinese weakness/USD dominance in areas like commodities, cyclicals, and industrials. We flipped our corporate credit book from net short to net long by covering shorts and aggressively adding to our energy credit positions. However, we failed to get long fast enough in cyclical equities and, while we avoided losses from shorts, we largely missed the rally on the upside. Unfortunately, our concentration in long health care equities and weakness in the structured credit portfolio caused our modest losses in Q1. So where do we go from here? As most investors have been caught offsides at some or multiple points over the past eight months, the impulse to do little is understandable. We are of a contrary view that volatility is bringing excellent opportunities, some of which we discuss below. We believe that the past few months of increasing complexity are here to stay and now is a more important time than ever to employ active portfolio management to take advantage of this volatility. There is no doubt that we are in the first innings of a washout in hedge funds and certain strategies. We believe we are well-positioned to seize the opportunities borne out of this chaos and are pleased to have preserved capital through a period of vicious swings in treacherous markets. Third Point – Quarterly Results Set forth below are our results through March 31, 2016: Click to enlarge Third Point – Portfolio Positioning Equity Investments: Risk Arbitrage and Pro Forma Situations “Event-driven” and activist strategies performed poorly in 2015 and in Q1 2016. We believe that the resulting redemptions and liquidations from these strategies have helped to create today’s environment, which is one of the more interesting we have seen in many years for classic event situations like risk-arbitrage and transformative mergers. Many investors are ignoring companies in the midst of deals because catalysts are longer-dated (well into 2017) which is allowing us to buy outstanding enterprises at bargain valuations on 2017/2018 earnings. Many of these combined businesses should compound in value thanks to the benefit of synergies, modest financial leverage, and strong or improved management teams that have a history of successful capital allocation. Some of the most interesting situations are described below: Dow/DuPont We are encouraged by the latest developments in our investment in Dow (NYSE: DOW ) which announced a merger with DuPont (NYSE: DFT ) in December. In February, the company revealed that long-time CEO Andrew Liveris will be stepping aside not long after the merger’s completion. DuPont’s CEO, Ed Breen, is a proven operator and capital allocator. Breen made his mark by streamlining Tyco, a long-time industrial conglomerate, splitting the company into focused units and thus created enormous shareholder value. He brings an unbiased perspective and is not afraid to challenge the status quo, two qualities that will be essential in leading Dow/DuPont given the histories of both of these conglomerates. We continue to believe there is potential for operational improvement at Dow that would be incremental to the $3 billion announced synergy target; in aggregate, approximately $5 billion of earnings improvement could be unlocked. The merger structure preserves both companies’ strong balance sheets which, combined with fading Sadara and Gulf Coast CapEx, should allow for meaningful capital return while maintaining a strong investment grade balance sheet. Taking all of these factors into account, we believe the pro forma entity is capable of generating $5.50 – $6.00 of EPS in 2018. Given that these earnings will consist of contributions from several focused spinoffs, we also believe that multiple expansion is likely. Conglomerate structures often breed unintended consequences like misaligned incentives and suboptimal capital allocation. Going forward, segments in both companies will no longer have to compete for capital with disparate businesses. They will become liberated and empowered to create their own targets with their own incentive plans. More work needs to be done to ensure that the split results in focused, pure-play businesses, in particular because the current structure still has basic petrochemicals and specialty businesses housed together. Re-jiggering the split structure may in itself unlock incremental synergies as more specialty product businesses would benefit from being managed together. A major step forward has been achieved with the appointment of a new merge-co CEO and a strategy to split the business. Now the focus shifts toward creating the optimal split structure and ensuring the proper leadership and governance in each split entity is put into place. With the right management, structure, and a synergy target that looks conservative in light of the prospect for more sweeping change, we believe we have a compelling long-term investment in Dow/DuPont. BUD/SAB/TAP The long-awaited acquisition of SAB Miller (NYSE: SAB ) by Anheuser-Busch InBev (NYSE: BUD ) announced late last year created two interesting pro forma situations. The deal, expected to close in the second half of 2016, will combine the two largest global brewers and create an unrivaled player with strong pricing power in an increasingly consolidated global industry. It will also transform Molson Coors (NYSE: TAP ) into a stronger regional competitor following the acquisition of certain SAB assets that must be sold for anti-trust reasons. Starting with BUD, we think the stock ought to grow nicely over the next several years as the true earnings power of the new company is revealed. Part of the gains will come from improving the underlying profitability of SAB, as operational control of its assets is transferred to BUD’s highly regarded management team led by CEO Carlos Brito. Another part will come from the capture of deal-related cost and revenue synergies, as duplication is eliminated and BUD’s global brands like Budweiser, Corona, and Stella are rolled out to legacy SAB markets in Africa and Latin America. Finally, the rest should come from financial engineering as BUD’s under-levered balance sheet is monetized to help finance the transaction. We also think the new company will likely command a higher valuation as SAB’s emerging market exposure will be accretive to top line growth over time. TAP, on the other hand, stands to benefit greatly from acquiring divested assets. The company is picking up the remaining 58% share of the MillerCoors US joint venture that it does not already own, the perpetual rights to import legacy SAB global brands such as Peroni in the US, and the global rights to the Miller brand. The transaction is highly accretive for TAP given the sheer size of the acquired assets. It also gives the company full control over its most important market, something that ought to improve operational effectiveness and increase the long-term strategic value of the company to a potential acquirer as the global beer industry continues to consolidate. As is the case with BUD, we believe TAP will compound nicely over the next several years as the market more fully appreciates the earnings power and strategic optionality of the pro forma company. Time Warner Cable/Charter Communications Charter Communications (NASDAQ: CHTR ) is a domestic provider of voice, video, and high-speed data. In May 2015, Charter announced the acquisition of Time Warner Cable (NYSE: TWC ). This is a transformational deal that quadruples the company’s scale while driving substantial operating efficiencies. Importantly, the pro forma company will be led by Charter’s current CEO, Tom Rutledge, who we view as one of the best operators in the industry. New Charter is well positioned to capture market share from satellite and telco competitors given its advantaged high-speed data product. In addition, Mr. Rutledge’s track record of boosting video penetration, driving down service costs, and executing large network transformations at legacy Charter makes us optimistic about his leadership of the new entity. There are several operational benefits awaiting the New Charter. The company’s increased scale will help facilitate a continued turnaround at both Charter and Time Warner Cable and the deal also creates new revenue opportunities in business services and wireless. Additionally, Charter should have increased negotiating leverage with content providers which should deliver substantial cost savings over time. Substantial free cash flow per share growth will be driven by accelerated revenue growth, margin expansion, synergies, lower capital intensity, significant tax assets, and substantial share repurchases. As a result, we believe Charter’s share price can compound at ~25-30% over the next two years. Chubb Chubb Ltd.(NYSE: CB ) is the product of ACE Limited’s acquisition of The Chubb Corporation which closed in January. The deal combined two world-class operators that have consistently put up ~90% combined ratios – almost 900bps better than North American peers – and have compounded book value at 10%+ the past decade, more than double that of peers. The new Chubb is the largest public pure-play P and C company by underwriting income. It also has a number of factors we look for in a pro forma situation: an A+ CEO in Evan Greenberg; complementary fit across products, distribution, and geography; and a plan that is less focused on short-term cost savings than long-term strategic opportunities for growth, which are abundant. Chubb’s scale and focus on growth could not come at a better time as certain competitors scale back operations to satisfy shareholder demands. We are willing to forego short-term cost cuts or buybacks to own a franchise that is a long-term winner with the premier franchise in US high-net-worth insurance, #1 share in global professional lines, and an enviable global platform with leading A and H and personal lines in Asia and Latin America. We view Chubb as a high-quality compounder in the financials space, with double-digit earnings growth potential over the next few years. Critically, this earnings power is far less sensitive to rates and credit quality than fundamental execution. Danaher Industries Danaher (NYSE: DHR ) is a diversified multi-industrial company with an increasing exposure to life science and healthcare-oriented businesses. Operating across five different business segments and built up through over 400 acquisitions over the company’s history, the cornerstone for Danaher’s successful integration and value creation strategy has been the Danaher Business System (DBS). Adapted from Japanese principles of kaizen, DBS has evolved into a set of processes and corporate culture revolving around continuous improvement, helping to drive organic growth and annual margin improvement across Danaher’s portfolio. In May 2015, Danaher announced the acquisition of a filtration industry leader, Pall Corp. (NYSE: PLL ), as well as the subsequent split of Danaher into two companies. The split, to be effectuated Q3 2016, will highlight value at both New Danaher – a collection of Danaher’s life science, medical and lower cyclicality businesses – and the spin-off, Fortive – an industrial focused “mini-Danaher”. New Danaher, representing the large majority of post-split value, will have 60% consumables sales mix, 4% organic growth, 100bps of annual margin expansion, and > 100% FCF conversion, an algorithm that will continue the Danaher tradition of compounded earnings growth. The attractive end-market mix, earnings growth, and deep bench of DBS operators will make New Danaher a premium life sciences company that should trade at the high end of its peer group. Fortive, akin to what Danaher originally looked like two decades ago, will have greatly increased M&A optionality and the ability to deploy free cash flow into assets which have historically received less focus within the Danaher portfolio. With the same DBS roots and team of disciplined operators, Fortive will also provide a multi-year compounding opportunity. We initiated a position following the announcements last summer which mark a transformational step in Danaher’s decade-long efforts to continuously improve its portfolio of businesses. Despite Danaher’s portfolio of businesses looking more attractive than ever, its current valuation premium to the S&P 500 is modest and remains well below its ten-year historical average premium. Over the last ten years, Danaher has compounded at 2x the rate of the S&P 500. We recently added to the position after a meeting with the company reinforced our confidence not only in their operations but also in the company’s culture and importance of their values and principles in driving future success. Disclosure: None

Are Buy-Write Funds Good Buys?

This article first appeared in the May issue of Wealth Management Magazine and online at WealthManagement.com Equity markets stalled in 2015 after a relentless six-year rise from the depths of the Great Recession. Last year’s stagnant market, even with its bearish tilt, was a perfect set-up for buy-write plays. A buy-write is an option strategy featuring a stock purchase (that’s the “buy” part) along with the sale (a “write”) of a related option. Typically, these are call options. Deemed “covered calls,” they offset the otherwise unlimited liability associated with selling options through ownership of the underlying stock. The object of the strategy is income production. The premium earned for selling the options is retained if the contracts remain unexercised-a likely occurrence in a flat-to-bearish market. That’s not to say there’s no risk. If the market value of the stock spikes, pushing the options into the money, shares may be called away at the strike price, leaving the writer with just the premium and perhaps a bit more. What’s at risk is the upside potential of the stock, a sort of opportunity cost. Should the value of the underlying stock decline instead, the call premium provides a modicum of downside protection. A number of exchange traded funds engage exclusively in buy-writes. Most use call options. A couple, though, feature puts. Selling puts rewards investors in a stagnant or rising market if the underlying stock’s market price exceeds the put’s strike price; a downtrending market is anathema to this particular variation on the strategy. It’s worth a look at these ETFs to see how successful they’ve been in providing income and limiting risk. The PowerShares S&P 500 BuyWrite Portfolio (NYSEARCA: PBP ) writes at-the-money calls on its portfolio of S&P 500 securities. Launched in 2007, PBP is well established with $308 million in assets and an average daily volume of 109,000 shares. Over the past two years, PBP’s maximum drawdown was significantly less than the biggest hit taken by the SPDR S&P 500 ETF (NYSEARCA: SPY ) , a proxy for the blue chip index. Drawdowns represent peak-to-trough losses sustained before new price peaks are attained (see Table 1). Another metric of downside risk, Value at Risk (VaR), typifies the expected loss within a given timeframe. Essentially, VaR depicts a worst-case scenario. Based on the past two years’ returns and within a 95 percent confidence level, PBP can be expected to lose 1.12 percent on a bad day. Compared to SPY, with a daily VaR of 1.44 percent, PBP appears less risky than holding the index portfolio outright. A final comparative metric, M-squared (M 2 ), depicts the fund’s risk-adjusted return. Simply put, M-squared estimates what the fund would return if it took on the same level of risk as its SPY benchmark. PBP would have earned 3.82 percent-86 basis points more than its actual total return-if it was as volatile as SPY. If the M-squared return was lower than the fund’s actual return, the PBP portfolio would be more risky than the benchmark. So what about income? PBP boasts a dividend yield more than twice as high as SPY’s. Still, the buy-write fund’s total return is just a third of the level of the index fund-testimony to the effect of having assets called away as the market rose prior to leveling off. Click to enlarge Another ETF based on the S&P 500, the Horizons S&P 500 Covered Call ETF (NYSEARCA: HSPX ) , pursues a more aggressive call-writing strategy. HSPX sells out-of-the-money options, which, all else equal, typically produce less income. The fund, however, writes more calls than PBP-up to 100 percent of each stock position. This affords more equity upside. But there’s a trade-off for this-namely bigger drawdowns and a higher VaR compared to PBP. Despite the risk disparity, both funds earned the same M-squared return over the past two years. Chart 1 depicts the day-to-day performance of the buy-writes versus the SPY benchmark. Click to enlarge First Trust Advisors runs two actively managed buy-write portfolios, one geared to maximize income, the other designed to minimize volatility. The First Trust High Income ETF (NASDAQ: FTHI ) relies on a universe of large-cap stocks paying high dividends to underlie its call writing and rewards its investors with an attractive total return and dividend yield. The cost for this is higher risk, reflected in all three metrics: drawdown, VaR and M-squared. A sibling fund, the First Trust Low Beta ETF (NASDAQ: FTLB ) writes calls on the same portfolio as FTHI, but also buys put options to reduce volatility. The put premiums create a drag on performance, reducing both total return and dividend yield, but pay off with lower drawdowns and VaR compared to FTHI. Yet another actively managed portfolio, the AdvisorShares STAR Global Buy-Write ETF (NYSEARCA: VEGA ) , is even more expansive. A fund of funds, VEGA is presently made up of equity sector ETFs and bond ETFs in addition to broad-based ETFs like SPY and the iShares MSCI EAFE ETF (NYSEARCA: EFA ). The extensive call-writing base hasn’t produced capacious returns or dividend yields, though. A fund [1] that writes puts rather than calls is a standout, but not in a good way. The ALPS US Equity High Volatility Put Write ETF (NYSEARCA: HVPW ) selectively sells out-of-the-money puts on high-volatility large-cap stocks, aiming to maximize income. HVPW succeeds on that front. Its dividend yield is high, but volatility torpedoes the fund on a total return basis. HVPW, in fact, is the only ETF surveyed that produced a negative total return over the past two years. One other ETF requires special attention. Rather than being focused on the large-cap stocks populating the S&P 500, the Recon Capital NASDAQ 100 Covered Call ETF (NASDAQ: QYLD ) buys the stocks populating the Nasdaq-100 Index, a compendium of the largest nonfinancial issues listed on the Nasdaq marketplace. As you can see in Table 2 and Chart 2, QYLD shows the dramatic trade-off between total return and dividend yield. Compared to the PowerShares QQQ ETF (NASDAQ: QQQ ) , a portfolio that tracks the Nasdaq-100, QYLD produces a much bigger dividend yield, but a significantly lower total return. The risk metrics of the QYLD fund show the benefit derived from call writing. Click to enlarge Click to enlarge The Bottom Line Call-writing funds more often than not compensate for their relatively low returns with high dividends, making up for losses incurred over the past two years. Most of the funds, too, mute market volatility, providing higher risk-adjusted returns. Put writing, though, has been a vexation. The hefty premiums received for put sales just couldn’t cover the capital losses incurred as the options were assigned. Investors looking for high levels of current income and hedged exposure to the equity market might very well find call writing funds attractive alternatives in a flat-to-slightly bearish market. If, however, an investor or advisor believes stocks are poised for another sustained upward surge, less costly and mechanically simpler exposures are more suitable. [1] Another ETF, the ALPS Enhanced Put Write Strategy ETF (NYSEARCA: PUTX ) also pursues a put-write strategy, but was only launched in 2015, making it too young to include in our two-year study.

6 Mutual Funds To Buy As Russell 2000 Outperforms

Over the past one-month period, the major U.S. benchmarks witnessed a positive trend that helped most of them to register gains. Among these, the Russell 2000, which tracks the performance of small-cap stocks, clearly emerged as the top performer in the last one month. While the Dow, the S&P 500 and the Nasdaq gained 2.6%, 2.7% and 2.6%, respectively, in the past one month, the Russell 2000 increased 6.5% during the same period. In line with the performance of the small-cap index, the small-cap mutual funds also registered healthy returns – higher than the large- and mid-cap ones. Small-cap mutual funds posted an average return of 6% in the last one month, while the large- and mid-cap funds registered average gains of 3.3% and 4.4%, respectively. Moreover, small-cap funds have gained 2.4% in the year-to-date frame, beating their large-cap counterparts, which gained only 1.7%. Against this backdrop, investing in small-cap funds may prove to be a profitable strategy for risk lovers. Factors Boosting Small-Cap Funds Oil Rally Despite the disappointment in the Doha meeting, crude prices continued their rally, which emerged as one of the major reasons for the impressive performance by the U.S. benchmarks. Though the much-vaunted meeting of the major oil producing countries in Doha on production freeze failed to produce favorable results, its impact on crude was lesser than expected. Continuing decline in the U.S. rig count and oil production helped oil prices to post gains for the third straight week. Recently, Baker Hughes (NYSE: BHI ) reported that U.S. oil rig count posted its fifth straight weekly drop, declining from 351 to 343. Meanwhile, the U.S. Energy Information Administration (EIA) reported that domestic crude output fell by 24,000 barrels per day (bpd) to 8.953 million bpd for the week ended April 15. U.S. crude output declined for the sixth consecutive week. Encouraging Economic Data Moreover, some of the encouraging economic data had a positive impact on investor sentiment. The ISM manufacturing index increased from 49.5% in February to 51.8% in March, surpassing the consensus estimate of 50.8%. The ISM Services Index increased from 53.4% in February to 54.5% in March, witnessing its highest level in the last three months. Meanwhile, better-than-expected jobs addition, rise in wages and falling initial claims point to continued improvement in the labor market. While the U.S. economy generated 215,000 jobs in March and average hourly earnings increased 0.3% last month to $25.39, initial claims for the week ending April 16 continued to decrease to reach a record low since 1973. Separately, the Consumer Confidence Index advanced to 96.2 in March from 92.2 in February and was also higher than the consensus estimate of 94.9. Meanwhile, each of the 12 districts indicated moderate growth in economic activity, according to the Fed’s Beige Book. These positive economic data indicate that the U.S. economy is on a path of recovery. 6 Small-Cap Funds to Buy Though small-cap funds are believed to have a higher level of volatility compared to their large- and mid-cap counterparts, they show greater growth potential when markets see an uptrend and continued domestic economic improvement. This is because small-cap stocks are closely tied to the domestic economy and have less international exposure, making them safer bets than their large- and mid-cap counterparts in a sluggish global growth environment. Hence, risk-loving investors can pick these funds to gain from the current encouraging environment. In this scenario, we highlight two mutual funds from each of the three small-cap categories – growth, blend and value – that either have a Zacks Mutual Fund Rank #1 (Strong Buy) or #2 (Buy). We expect these funds to outperform their peers in the future. Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but also on the likely future success of the fund. Besides having impressive one-month returns, these funds also have strong three-year annualized returns. The minimum initial investment is within $5000. Also, these funds have a low expense ratio and carry no sales load. Small-Cap Growth – One-month return of 6.9% Ivy Small Cap Growth Fund (MUTF: WSCYX ) invests a large chunk of its assets in common stocks of companies having market capitalization similar to those included in the Russell 2000 Growth Index. Currently, WSCYX carries a Zacks Mutual Fund Rank #2. The product has one-month and three-year annualized returns of 8% and 9.4%, respectively. Annual expense ratio of 1.30% is lower than the category average of 1.31%. Oppenheimer Discovery Fund (MUTF: ODIYX ) primarily focuses on acquiring common stocks of domestic companies having impressive growth prospects. Currently, ODIYX carries a Zacks Mutual Fund Rank #1. The product has one-month and three-year annualized returns of 7.2% and 9%, respectively. Annual expense ratio of 0.86% is lower than the category average of 1.31%. Small-Cap Blend – One-month return of 5.6% Fidelity Stock Selector Small Cap Fund (MUTF: FDSCX ) invests the lion’s share of its assets in common stocks of companies with market capitalization within the universe of the Russell 2000 Index or the S&P SmallCap 600 Index. Currently, FDSCX carries a Zacks Mutual Fund Rank #1. The product has one-month and three-year annualized returns of 5.5% and 8.3%, respectively. Annual expense ratio of 0.76% is lower than the category average of 1.22%. USAA Small Cap Stock Fund (MUTF: USCAX ) invests most of its assets in equity securities of domestic small-cap companies. Currently, USCAX carries a Zacks Mutual Fund Rank #2. The product has one-month and three-year annualized returns of 5.9% and 7.8%, respectively. Annual expense ratio of 1.15% is lower than the category average of 1.22%. Small-Cap Value – One-month return of 5.5% American Century Small Cap Value Fund (MUTF: ASVIX ) invests heavily in securities of companies having market capitalization identical to those listed in the S&P Small Cap 600 Index or the Russell 2000 Index. Currently, ASVIX carries a Zacks Mutual Fund Rank #2. The product has one-month and three-year annualized returns of 7.4% and 8.4%, respectively. Annual expense ratio of 1.24% is lower than the category average of 1.31%. CornerCap Small-Cap Value Fund (MUTF: CSCVX ) invests a major portion of its assets in equity securities of small-cap companies located in the U.S. Currently, CSCVX carries a Zacks Mutual Fund Rank #1. The product has one-month and three-year annualized returns of 7% and 13%, respectively. Annual expense ratio of 1.30% is lower than the category average of 1.31%. Original Post