Kleinheinz Capital Partners, January 2004

I ran into this quick interview with John B. Kleinheinz by site Hedge Fund News.
It is brief, it speaks of investment process, but as you read many of these over the years  you accumulate ideas that you start to test with your own portfolios and you see that they do increase your risk-adjusted returns.

As I mentioned in this blog many times, this is key if one wants to make money for years and years.

Profile of John B. Kleinheinz

Born: 1961 in Wisconsin
Education: BA in Economics, Stanford University
Family: Married, three children (two teenagers)
Last vacation: Hawaii
Last book read: The Da Vinci Code by Dan Brown
Hobbies: Skiing
Favorite quote: "Ninety percent of life is just showing up", Woody Allen
How he best describes himself: Resilient and competitive.



JOHN B. KLEINHEINZ, KLEINHEINZ CAPITAL PARTNERS - JANUARY 2004

After graduating from Stanford University in 1984, John Kleinheinz started his career as an investment banker doing corporate finance and mergers and acquisitions work for Nomura Securities and Merrill Lynch in Tokyo, New York and London. In 1993, he became the second principal of San Antonio Capital Management, a hedge fund management company started in 1990 by Dana McGinnis. In February 1996, he hung his own shingle in Fort Worth where he launched the Global Undervalued Securities Fund, L.P. By the end of 1996, the fund was up 130% and had $25 million in capital. Since then, John¿s record has been nothing short of remarkable, multiplying the original dollar invested by a factor of more than 15 in 8 years. As the name indicates, the Global Undervalued Securities Fund focuses on value situations on a global basis. Over the years, the fund has shifted its focus to countries or industry sectors as varied as Russian equities, internet stocks, Japanese equities, healthcare stocks and emerging market debt. John¿s conviction style of investing is not for the faint of heart, as he has occasionally suffered significant drawdowns. However, on a calendar year basis, he lost less than 4% in his only down year (2000). John has paid careful attention to matching his investor base with his investment style and limiting the amount of capital managed by closing to new investors (the fund is currently closed). Presently, he manages $750 million, of which half has come from Texas-based investors.


John Kleinheinz spoke to HFN publisher, Antoine Bernheim, in late January 2004.

Q. Could you describe your investment philosophy?

A. We are contrarian, opportunistic and value-oriented. We are a macro firm in that we think about where we are being best paid to take risk and we mostly manifest that macro theme through a global long-short equity approach. We try to buy quality companies with great business franchises at inexpensive prices. We don¿t buy things just because they are cheap. We try to invest in companies in industry sectors where the fundamentals are improving. We like companies that have pricing power, natural monopolies or large market shares. We like bigger companies that are first or second in their category. We look at regions of the world similarly. For instance, we got very excited about Russia in 1999 and 2000 because oil prices were moving up quickly and global economic growth was strong . There was a big disconnect between the perception of Russia and the fundamentals which were improving dramatically. Last year in Japan when the Nikkei was hovering around 8000, we looked at the situation in Asia. We saw that there was a lot of excess capacity and that Japan was going to be a supplier of goods to China and the rest of Asia and the economy would improve.

Q. Could you describe your research process and where you see your edge?

A. There are five areas where we think we have a considerable knowledge base and contacts: Japan, where I used to work, Russia (I used to run a Russia fund in the mid 90s), telecom, healthcare and energy which are three industries where we have developed contacts and a knowledge base over the years. Eighty percent of the profits we have made since we started have been made in those five areas. Within those areas, we are very committed to independent research; we don¿t use a lot of standard brokerage house research and would rather use people who are good enough to be out on their own and away from Wall Street. We like people like Ed Hyman who runs ISI and a number of other industry research people and contacts we have in our areas of interest.

Q. What is the mix between macro factors and bottom-up analysis in your investment decisions?

A. From time to time we put on macro trades that involve positions in currencies or commodities, but eighty-five percent of our activity is global long-short equities. One of the things we do, however, is trade government bonds against our net equity risk and, depending upon how we see the economic environment, we might be long as much as 100% of our portfolio in US Treasury bonds or European government bonds as a natural hedge against our equity risk. That is a trade we used very effectively in 1998 during the Russian crisis when we got hurt in our Russian and emerging markets positions but were very quickly bailed out by the flight to quality and the 20 point rally in U.S. treasury bonds. Most of the time, you don¿t make or lose money owning bonds except when the world looks like it is about to fall apart. We bought bonds again at the beginning of 2000 and held them until the second quarter of 2003, when we decided that the economy was growing too quickly for bonds to be a useful hedge against our equities.

Q. How do you pick individual long and short positions?

A. It is an iterative process. In Russia, for instance, we have had much success in individual stocks, picking Russian cellular companies, shorting Yukos at the end of last summer and being long Lukoil. In Japan on the other hand, we haven¿t had the time to do a lot of work, so many of our picks are blue chip market-driven names. Sometimes, we even buy ETFs in Japan. A lot of the stock picking process is serendipitous. We may hear about a company from another portfolio manager or an executive at a company we visit, and a trading opportunity may occur to establish a position. We have several core positions in our fund that have been there for more than five years but it takes a long time for a company to become a core position. We need to own it, do research on it, visit the company and understand it thoroughly and that is very much an iterative and long-term process.

Q. Could you describe the typical structure of your portfolio?

A. We have about 80 longs and 50 shorts. We have four or five positions that are 4% to 6.5% of the portfolio. During the bear market of 2000 to 2003, we were on average 50% to 55% net long and we also had the bond hedge I spoke about. We currently are 90% net long, 130% gross long and 40% gross short, although we have puts underneath that would protect us on 75% of the downside after the market falls 5% or 10%. We are probably near the top of our potential gross exposure. We trade a fair amount, particularly around our shorts. In regional terms, apart from the U.S. where our exposure can get up to 40%, we tend to be no more than 15% in any country and in most cases 7% or 8%. We are about 14% in Russia and 13% in Japan currently.

Q. What is a typical duration of a trade or theme for you?

A. The longer the duration the better but there is nothing typical. One of my principles of investing is that you don¿t want to miss big investment themes. You can miss individual stock ideas but you don¿t want to miss the three or four big themes you get in an investment career. In my lifetime, I think people will look back and say Russia¿s convergence from a communist country to a capitalist society was a major investment theme. I have been investing in Russia since 1994 and I think we probably have four or five more years before Russia is fairly priced. Themes go in big cycles and we don¿t have to always be long Russia but as long as it is a market we are interested in we are going to be there on one side or another. The trick is to get the big directional moves approximately correct. The huge growth of telecommunications technology is another theme you would not want to miss. Energy is a theme that has been prominent for us for a long time. Unfortunately, we have not done as much in energy because it overlaps with Russia. Healthcare is another theme that will be increasingly important as a result of demographic changes.

Q. What is your approach to cutting losses when a position or a theme goes against you?

A. We routinely do two things: first, we sell losers on a quarterly basis and more aggressively at the end of the year. I started to do that for tax reasons and it turned out to have very positive implications on risk management. Secondly, I reduce exposure, both long and short, if we are down 5% from a month-end value. Five percent seems to be a number that suggests something is going against you and that our analysis may be wrong. It is better to cut risk and stay in the game than to press the bet and get hurt badly and be out of the game. I adopted that rule after 1998 and the first time I used it was in March 2000. We continued to lose money in April and May too, but after we got hurt our losses were smaller and smaller and then we started treading water and were able to make money again toward the end of the year. It also happened during the September 11th tragedy.

Q. Can you describe how your organization functions?

A. We are eleven employees, three portfolio managers, two analysts, two traders and four individuals for settlement, administration and client relations. I am a real believer in small organizations and I want to spend my time managing money and not people. The two other portfolio managers are individuals I have known for a long time and I can let them operate independently, managing a part of the portfolio with their own P&L. They now manage approximately 20% of the portfolio. I manage the rest and we interact with each other when we see something of mutual interest.

Q. What are your goals for the future?

A. My principal goal is longevity. I want to be doing this for as long as I can, and part of that equation involves growing very gradually, and predominantly from investment gains. We try to grow our client base 10% or 15% a year and add one or two employees each year. I think that growing your organization or growing your investor base too quickly are the two single biggest mistakes a hedge fund can make. If we can grow gradually, I think we will be able to be bigger in the long term than if we double the size of the assets or the organization tomorrow. 

*Disclaimer: charts and data are presented as I receive/see them. Sources are usually not checked for validation and my own calculations are of 'back of the envelope'-type. I am aware that some math that I do myself might be wrong and/or misleading to some extent. In financial markets the rate of change of economic data is often more important than the actual level and the perception of 'what is priced in' is more important than 'what is actually going to happen'. This is actually the way people pick entry and exit points. So... yes, sometimes you might say 'This guy is an idiot, this is way wrong!' with a high conviction, being right. Not to worry. Markets are made of expectations and the clash of conviction between its participants. Portfolio managers know that being an idiot is sometimes profitable and being smart is often a bad choice. It is all reality, sometimes good, sometimes bad. By the way: corrections to my analysis and intelligent debate is welcome. theintriguedtrader AT gmail do com