Opalesque Hedge Fund Magazine Profiles SML Capital
Alternative Market Briefing
The smart money is looking apprehensive about the markets – SML Capital
Monday, February 14, 2011 Print
From Kirsten Bischoff, Opalesque New York:
This week Bank of America Merrill Lynch estimated that equity long/short funds
reduced their net exposure sharply to 20% long. And for a brief while on
Wednesday, the Twitterverse was abuzz with rumors that John Paulson had called
a top to the stock market (later his PR firm Abernathy MacGregor stepped forward
to say was just an unfounded rumor).
“The smart money is probably feeling apprehensive about the markets,” Scott
Schneider, Managing Director at New York-based SML Capital commented
to Opalesque. Schneider manages the event-driven, activist arbitrage fund the
Sawmill Capital Fund, which capitalizes on the price spreads created by activist and
value investors. By the nature of his strategy, which looks to gain investors
exposures to multiple activist/value investor managers, the fund’s cash holdings can
be reflective of the broad feelings of managers in that space.
“In January we had very few holdings. Usually we average 30 and right now we are
at 10, which is reflective of the positions of the big funds,” he says. The Sawmill
Fund is currently 66% in cash.
Launched in January 2009, Schneider, and his partners Chief Risk Officer David
Lifchitz, and COO Henry Schneider developed the strategy after reading a 2007
study by Morgan Stanley’s Michael Schor and Harvard Business School’s Robin
Greenwood on Investor Activism and Takeovers. Briefly, the paper shows that
returns on equities are higher during times when they are targeted by activists or
value investors. Focusing on the evidence of this rise in stocks based on investor
activism, the team put together a strategy that is a “heavily managed quant model”
that uses 13D and 13F filings to determine a pool of investments that Schneider
then picks for positions within the fund. Since its launch the firm has returned an
average annual +26.36% per year to investors.
The focus for the portfolio is to cover every opportunity that meets their risk
requirements, the funds gains are driven largely by the spreads that occur when a
big name investor files a 13D form and there is a rush to market. However, with an
average less than 3 months holding time on positions, the team also looks to
participate in additional profits when deals go through, however, participating in the
end game ramps up risk significantly.
The fund does not short positions against equities being targeted by activists. It
does utilize a hedge overlay that the team added when in pre-launch phase during
the market drop of 2008. “We don’t ever want to be unprotected in markets like this.
So we built an overlaythat tracks the S&P and trades momentum, moving back long
or short and whenthere is an uptick or a downtick it will ride that wave and make a
good profit,” says Schneider.
The hedge has proven to perform best during downtrends, and it represents about
12% of the portfolio. During 2010 there was a great deal of volatility in the markets,
and they did not trend one way or the other for multiple days, meaning the overlay
did cost the fund a slice of profits, but Schneider stresses the importance of
protecting the fund against major market pullbacks or a double dip.
Looking forward to the year ahead, Schneider told investors in recent
correspondence that the team’s expectations are for stock buybacks from cash flush
firms, increased leverage available from PE firms, and low stock valuations will
make for an exceptional year in the event driven space.