Hedge Funds' Year of Investing Dangerously

BOSTON ( TheStreet) -- Hedge-fund managers, who get rich by skimming off a fifth of their clients' investment gains, are posting larger losses than the average American after their risky bets proved to be the wrong choices during last week's stock-market crash.

This year is turning out to be almost as bad as 2008 for hedge-fund managers, with inflows slowing at a "torrid pace," according to the latest fund flow data from research firm TrimTabs. After raking in more than $67 billion in the first several months of the year, the hedge fund industry pulled in only $1.8 billion in June and July, according to the report.

John Paulson (Paulson & Co.)

Performance, for which investors pay a premium over traditional mutual funds, has been underwhelming this year. The Barclay Hedge Fund Index was up 1.1% through July, trailing a 2.8% rise in the S&P 500. August has so far witnessed a bloodbath for equity prices, with the S&P 500 falling more than 8%, and leverage hedge funds expected to perform as badly, if not worse.

Many comparisons are being drawn between this month's selloff and the market collapse in late 2008. Hedge funds are already seeing an eerie increase in blow-ups. Hedge Fund Research estimated that by the end of the first quarter, 684 funds liquidated in the previous 12 months, resulting in the highest net increase since 2007.

Hedge funds, which tend to take on more risk than mutual fund managers, have seen their strategies undermined by unforeseen circumstances, from the earthquake and tsunami in Japan in March to the growing debt crisis in Europe and the downgrade of U.S. debt by Standard & Poor's Aug. 5. Several media reports have hedge fund manager John Paulson's Advantage Plus Fund down 31% this year as of Wednesday.

"Absent a reversal of fortune, many mangers will not collect performance fees for the fourth straight year," TrimTabs analysts write in the latest flow report. Most hedge funds charge a 2% management fee and take 20% of clients' investment profits. Most mutual funds charge only management fees amounting to less than 1% of assets.

Prior to May and June, hedge funds had not seen two losing months in a row since the financial crisis, HedgeFund.net notes. "The European debt crisis has likely resulted in lowered exposures to risky assets and losses in May and June were the result of this de-leveraging," the firm notes.

Hedge fund performance will be scrutinized more closely as today is the deadline for managers to report holdings to the Securities and Exchange Commission for the second quarter. Hedge funds that manage more than $100 million are required to disclose their equity holdings, options and convertible debt on a Form 13F filed to the SEC within 45 days of the end of a quarter. These filings can give individual investors a roadmap for where the so-called smart money is flowing.

Although investors will have to wait for the full filings to find out what some of the largest and most prominent hedge fund managers bought and sold during the second quarter, TheStreet has combed through SEC filings and investor letters to get a peek at what the full 13F filings will show. From Paulson and Soros to Ackman and Einhorn, their known moves are detailed on the following pages.

George Soros, Soros Fund Management

Soros disclosed only one move during the second quarter, adding to his stake in business-software maker MicroStrategy ( MSTR). According to a regulatory filing in May, Soros owns more than 450,000 shares of the company, up from 338,000 shares previously.

The billionaire hedge-fund manager, best known for breaking the Bank of England in 1992, made bigger waves when he announced last month that his firm will return capital to investors to avoid reporting requirements under the Dodd-Frank reform act.

Soros Fund Management will focus on managing assets for his family, according to a letter to the firm's investors. Soros will return less than $1 billion to external investors, a drop in the bucket compared to the firm's total assets of more than $25 billion.

New regulations would call for funds to report information about the assets they manage, potential conflicts of interest, and information on investors and employees. Hedge funds are required to register with the Securities and Exchange Commission by March 2012.

By returning outside investor capital, Soros will continue to operate without registering with the SEC under an exemption for what the Commission considers "family office" advisers.

"We have relied until now on other exemptions from registration which allowed outside shareholders whose interests aligned with those of the family investors to remain invested in Quantum," the fund's letter to shareholders read. "As those other exemptions are no longer available under the new regulations, Soros Fund Management will now complete the transition to a family office that it began eleven years ago."

>>View George Soros' Portfolio

Daniel Loeb, Third Point

Through June, Daniel Loeb's Third Point was up nearly 7% even as the hedge fund has cut back on its net long equity exposure. As of June 1, the fund was closed to new investors, although this is not surprising as Loeb has periodically stopped new subscriptions citing "prudence."

Loeb hasn't stopped making new purchases in the fund. According to his second-quarter letter to investors, the hedge fund established a new position in Mosaic ( MOS) during the second quarter. Third Point also increased its position in Sara Lee ( SLE) during the quarter.

>>View Third Point's Portfolio

In a separate regulatory filing in May, Third Point revealed that it increased its stake in Xerium Technologies ( XRM) to 1.7 million shares from 1.4 million shares previously. Third Point also revealed an investment in Technicolor ( TCH) in its April performance letter, according to several media reports.

David Einhorn, Greenlight Capital

It's hard to tell who's having a tougher year, David Einhorn or the New York Mets.

Einhorn's hedge fund fell 5% through the second quarter, prompting a lot of position turnover in the second quarter. The Mets, a team that Einhorn is looking to buy a $200 million stake in, is 19 games back in the standings in the National League East division.

In a letter to shareholders in early July, Einhorn announced that Greenlight Capital sold out of its stake in Yahoo! ( YHOO) at a loss following the Internet search giant's dispute over the ownership transfer of Alibaba's online-payments business Alipay.

Einhorn said his initial purchase of Yahoo! in May was "based on a sum of the parts analysis," which included putting substantial value on the company's Chinese assets. Following the dispute over Alibaba, Einhorn says the hedge fund "exited with a modest loss," saying that the finger pointing by involved parties "wasn't what we signed up for."

When Greenlight Capital disclosed its new position in Yahoo! in May, Einhorn called Alibaba the company's "most valuable asset" in a letter to the hedge fund's shareholders. Einhorn added that he "wouldn't be surprised" if the stake was "ultimately worth as much as Yahoo!'s entire current market value." Yahoo! shares plummeted in May on news that Alibaba transferred ownership of Alipay to a new company owned by Alibaba CEO Jack Ma last year. Yahoo! said it was not informed of the transaction until March 31.

During the second quarter, Einhorn sold completely out of several other positions, including Cardinal Health ( CAH), CIT Group ( CIT), Xerox ( XRX), MI Developments ( MIM) and MDC Holdings ( MDC). The fund also covered its short position in Cree ( CREE), according to Einhorn's letter to investors.

On the other hand, Greenlight built a position in Seagate Technology ( STX) with an average price of about $16 per share. At $11.89 currently, Seagate appears to be a losing position for Einhorn early into his investment.

>>View Einhorn's Portfolio

Nelson Peltz, Trian Fund Management

Nelson Peltz just can't stay away from food companies.

Known for making moves on Wendy's ( WEN) and Heinz ( HNZ), Peltz revealed in a regulatory filing that he snapped up more than 12 million shares of Kraft ( KFT) during the first quarter.

Peltz has owned Kraft shares previously in 2007 and was in the middle of the company's deal for Cadbury before dumping the stake last year. This time around, Peltz was able to keep the new position secret as the SEC allows confidentiality for holdings hedge fund managers are trading in.

The activist investor hasn't revealed his plans for Kraft yet but, given his propensity to shake things up, one can imagine what Peltz will attempt now with a $420 million stake in Kraft.

John Paulson, Paulson & Co.

John Paulson reduced his net long exposure after suffering losses in the first half of the year, cutting back positions in financial stocks like Bank of America ( BAC), according a report by Reuters last month. Paulson's flagship Advantage Plus Fund is down 31% this year, according to several media reports that cite investors in the fund.

In July, Paulson announced during an investor call that he was reducing his net long exposure to 60% from 81% previously, according to the report, with Paulson saying "we cannot operate the fund at level. I'd like to bring the risk down further to about 50%." He admitted he was "too aggressive" with some stock bets, the report said.

>>View Paulson's Portfolio

Paulson, whose Paulson & Co. hedge fund benefited substantially on his bank-stock bets following the market's rebound from the March 2009 low, called Bank of America "somewhat of a disappointment," according to a report by Reuters. Paulson admitted his team of analysts did not expect mortgage problems to grow as large as they had.

In response to the growing mortgage issues, Paulson said he was moving into financial companies with less exposure to mortgage loans, like Capital One ( COF) and Wells Fargo ( WFC).

Paulson's loss on Sino-Forest, a Chinese tree-plantation owner that trades on the Canadian stock exchange, appears more damaging to both the fund's return and credibility. Muddy Waters, a small research firm that also takes short positions in stocks it researches, alleged in a report earlier this year that Sino-Forest overstated its timber holdings. Shares of the company are down more than 70% this year.

The rapid drop in share price following the Muddy Waters report cost Paulson $107 million, according to several media reports that cite a letter to investors. Paulson dumped his stake in Sino-Forest in June.

"The biggest loss was Sino Forest. We took a nasty hit on it, but there was also other losses," Paulson said during the investor call, according to Reuters.

Bill Ackman, Pershing Square Capital

Nelson Peltz has a friend in Bill Ackman, at least when it comes to Family Dollar ( FDO).

In June, Ackman's Pershing Square disclosed an 8.9% stake in Family Dollar, making him the largest shareholder of the company. Ackman, who has shown quite an affinity for retailers like Target ( TGT) and Borders in the past, previously owned a 4.9% stake in Family Dollar. During an investment conference in June, Ackman called Family Dollar a prime target for a leveraged buyout.

Of course, Family Dollar is a favorite of Peltz's Trian hedge fund. In February, Peltz unveiled a bid for Family Dollar, offering $7.6 billion, or $60 per share, to acquire the discount retailer. The company's board has deemed the bid too low. In addition to Family Dollar, Ackman and Peltz also share interest in Kraft Foods.

>>View Bill Ackman's Portfolio

Around the same time, Ackman's firm added to its position in Fortune Brands ( FO). The hedge fund now owns more than 17 million shares, according to regulatory filings. Ackman is a proponent of breaking up the company, which has a valuable collection of brand names like Jim Beam, Master Lock, Moen, and Titleist.

Carl Icahn, Icahn Capital

Just before the end of the first quarter, Carl Icahn announced he will return $1.7 billion in outside investors' money from his hedge fund by the end of April. Like Soros' recent announcement, the move was widely viewed not as Icahn retiring but instead avoiding more scrutiny from regulators.

And while Icahn didn't disclose any major purchases or sales during the second quarter, he has certainly kept active with attempts to impose his will on companies he views as undervalued.

Icahn's biggest move recently involves a stock he has owned since December 2010. In July, Icahn proposed a buyout of Clorox ( CLX) at $76.50 per share in cash, although the billionaire corporate raider showed no interest initially in taking the company private himself. Icahn asserted that Clorox could be worth $100 per share for any buyer other than himself, and he encouraged Clorox to pursue synergistic buyers.

Clorox rejected Icahn's initial bid as well as a sweetened one for $80 per share, arguing that the unsolicited offer "substantially undervalues the company and is neither credible nor adequate." Clorox also adopted a shareholder rights plan, which amounts to a "poison pill" that protects against hostile buyers through share dilution. Icahn fired back at Clorox, calling the rejection "disingenuous" and saying the board's concerns are "misguided."

Icahn is fighting battles elsewhere as well. Most recently Forest Laboratories ( FRX) has recommended that shareholders "reject Icahn's hand-picked designees and support all ten of Forest's candidates" for spots on the company's board. Icahn has also urged Motorola ( MMI) to explore alternatives for its patent portfolio. Additionally, Icahn is still embroiled in battles with Commercial Metals ( CMC) and Mentor Graphics ( MENT).

Steven Cohen, SAC Capital

Steven Cohen's hedge fund disclosed few major moves in the second quarter, but SAC Capital may have bigger issues with a long-time holding.

During the second quarter, SAC Capital disclosed a 5.1% stake in

OCZ Technology ( OCZ), a 6% stake in retailer Children's Place ( PLCE), and a 6.2% position in Walter Investment Management ( WAC).

>>View SAC Capital's Portfolio

However, Bloomberg estimates that Cohen's $14 billion hedge fund may have a one-day paper loss of nearly $200 million after holding Dendreon ( DNDN) withdrew 2011 revenue guidance on worries of insurance reimbursements for its prostate-cancer drug Provenge.

SAC Capital has been active in the third quarter already. In July, the hedge fund increased its position in Amylin Pharmaceutical ( AMLN). Cohen also disclosed a 4.6% position in Hanesbrands ( HBI) and a 2.7% stake in Skilled Healthcare Group ( SKH) this month.

-- Written by Robert Holmes in Boston.

>To contact the writer of this article, click here: Robert Holmes.

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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