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Emanuel Weintraub: Risk and Reward on the Long Side

Emma Trincal

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Emanuel Weintraub, a former co-portfolio manager of a $1.5 billion fund at Neuberger Berman, decided three years ago to launch his own long-only hedge fund, New York-based Integre Advisors.

The move raised eyebrows in hedge fund circles, where some consider it heretic to manage money without shorting stocks. Many in the industry view long-only managers as mutual fund pros trying to reinvent themselves as hedgies just to cash in. But Weintraub can justify his 1% management and 20% performance fees.

He has outperformed the S&P 500 Index by 8.7% over the past five years, and by 10.7% over the past 12 months. In addition, his performance fee applies only to the profits he makes over the benchmark. He agreed to talk to TheStreet.com about his investment philosophy.

What's your approach to stock-picking?

Weintraub: We invest in out-of-favor growth stocks using a risk/reward strategy, and our selection process is a mix of quantitative screens and qualitative judgments. When a company that had until recently been growing quite nicely falls out of favor with the investment community (usually due to an earnings disappointment or lowered guidance, but it could be a controversial acquisition or a government investigation), we create two distinct earnings models: an optimistic model and a pessimistic model. From those models we calculate optimistic and pessimistic stock price targets. We will only invest if we can earn a double-digit return to the midpoint of these two targets. Therefore, there is no hedging but a series of investments with better upside than downside and a disciplined process that manages the risk.

Are you a value investor?

EW: I used to be a straight deep-value person looking only for the lowest price/earnings ratios I could find. However, seeing the punishment that those types of stocks took in the Asian crisis, I shifted my focus to more stable businesses that have high returns and generate free cash flow. These businesses have some sort of unique franchise that allow them to generate these high returns and usually higher valuations. Within the universe of high-return businesses, we look for those companies that we think can grow their revenue organically high single digits or better over time (good long-term prospects) and have been unduly "punished" by the Street for reasons that we believe are transient.

Can you describe your stock selection process?

EW: A classic screen we use is for companies over a billion in market cap (so we can get in and out quickly) that have declined substantially in value (we don't disclose the formula that we use), with a pretax return on assets greater than 10%. Once a company gets through our screens, then we manually create the optimistic and pessimistic models, so it is quite labor intensive.

What sectors do you stay away from?

EW: We would avoid your typical technology firm that has not expensed options yet. These companies are in for an earnings hit, as these charges get factored into the marketplace, and we don't think the Street has fully recognized the impact.

What sectors do you like?

EW: We think the risk/reward is attractive in many medical technology names, property insurance companies, and then also we are early enough in a turning cycle to find an investment in the merchant energy space that we think is attractive.

Give us some of your favorite picks.

EW: We like the risk/reward at Cooper Cos.(COO Quote - Cramer on COO - Stock Picks), Reliant Energy(RRI Quote - Cramer on RRI - Stock Picks) and Platinum Underwriters(PTP Quote - Cramer on PTP - Stock Picks). For Cooper, there has been a recent disappointment in the context of a very strongly growing underlying industry, and we bought it after the bad news was out. We purchased Reliant Energy at a significant discount to NAV. Their cycle had bottomed in 2003. We expect them to benefit from utilization of the overbuild that occurred in the early part of this decade as well as some pricing freedom in 2007. We like Platinum Underwriters, a Bermuda-based reinsurer with strong underwriting discipline that we purchased close to book, which we view as the downside price. We expect it to profit from the improvement in insurance prices in 2006.

What about energy?

EW: The risk/reward is attractive at Chesapeake Energy(CHK Quote - Cramer on CHK - Stock Picks) and ConocoPhillips(COP Quote - Cramer on COP - Stock Picks). Most analysts assume that normalized energy prices will be substantially lower than they are today. This assumption is built into the stock, and that limits the downside.

When do you sell?

EW: When the risk/reward is no longer attractive. That can happen due to price appreciation, it can happen due to deteriorating fundamentals, or it can happen because nothing changes and the price doesn't move significantly one way or the other. Regardless, it is not worth spending too much time on, as our process is about finding new, attractive ideas, not about squeezing every last dime out of past ideas.

What's your outlook on interest rates?

EW: In terms of long rates, we are in a rising-rate environment that bottomed in June of 2003. From a risk/reward basis, rising rates are the biggest threat to equity market valuations, so we try to assume that valuations will continue to contract when we set our target prices. As for the economy, these days we are "optimists for hire"; when others are nervous and we can make a good return buying cyclicals with the assumption that there won't be a recession, we will do that. Conversely, in a period like today where the risk/reward is less favorable, we will tilt more defensively.

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