Arrowgrass Capital 2014 Q2 Investor Letter

Insider Monkey obtained Arrowgrass Capital’s 2014 Q2 investor letter. Arrowgrass Capital was founded in 2008 by former Deutsche Bank traders. The fund’s founder CIO is Nick Niell. The other founders are Henry Kenner, James Barty, and Michael Sung Wook Chung. Arrowgrass Capital has offices in London and New York and manages more than $5 billion in three funds. Arrowgrass Capital has an annualized return of 8.2% since inception with an annualized volatility of 4.1%. The fund also returned 2.8% during the first half of 2014. Based on VaR, Arrowgrass Capital’s biggest strategies are merger arbitrage and equity special situations. Regionally the fund invests mainly in US (56%) and Europe (37%). Here are a few highlights from Arrowgrass Capital’s 2014 Q2 investor letter. Please get in touch with us to learn how you can join our exclusive Hedge Fund Investor Letters Group.

“In the coming weeks, we believe market focus will continue to be mainly on global growth prospects. Encouragingly in the US, the latest indications are that job creation is accelerating and that business confidence has rebounded, but we expect investors will also be looking at corporate earnings growth and capex spending. In the Eurozone, actual GDP growth in Q2 might be lower than expected, but we believe investors will be looking for signs that activity is picking up. Actual CPI data will remain important as they will influence future ECB policy. In China the latest business confidence surveys have improved and market participants may look for further signs that growth is stabilising.

The slight change in overall absolute gross exposure masked increased activity in our M&A strategy in particular, while exposure decreased in Volatility as a number of positions rolled off with the June expiry. All strategies were positive contributors this month, the most notable of which were Converts, M&A and Distressed. Whilst our long bias to European domestic cyclicals and financials was a drag in Equity Special Situations, a strong contribution from US TMT and thematics such as UK Housebuilders meant the strategy was ultimately positive.”

On its distressed strategy:

“The Distressed strategy saw another solid performance in June, with gains in TXU, Abengoa, Walter Energy and LyondellBasell Litigation and Creditor Trust interests more than offsetting losses in Thomas Cook, Air France and Eircom.

In Europe, Abengoa’s share price enjoyed a 9% rally following the successful US listing of its “yieldco” vehicle mid-month, thereby highlighting the value in both the concession’s portfolio and the engineering and consulting division. This was a key catalyst for us and having brought the year to date stock performance to 90%+, we decided to lock in profits by monetising the majority of our position. However, we retain some exposure as we think there is still the potential for significant value above these levels. Similarly on Eircom we continued to reduce our position, taking us below half of our peak holdings. Volumes and pricing, however, were noticeably weaker than in May and we have paid to reduce risk. We may opportunistically take the position down further over the summer as IPO timing is less clear now following the recent robust issuance calendar.

The main drag on performance was our position in Thomas Cook equity. Following last month’s sell off we had taken the risk down and further hedged the sector risk, but selling pressure remained. There were several profit warnings in the month from other operators, blaming over-capacity in the short-haul travel market and a changing relationship between online tour operators and the large low-cost carriers. We have concluded that this may not be a short term phenomenon and are concerned about ongoing disintermediation in the market. As a result, we took the decision to cut our risk completely.”

On its special situations strategy:

“Performance in Special Situations was positive and well spread across Equity and Fixed Income – the only notable detractor was the European Equity Long/Short strategy.

Within European Equity Long/Short, we were positioned long domestic cyclicals and financials ahead of the ECB meeting as we felt that the event risk was skewed to the upside in terms of the ECB providing a more dovish monetary policy framework than consensus was expecting. Whilst this view was validated by the measures that Draghi announced, the European banks proceeded to sell off sharply after the June 5th meeting and this theme was a key detractor. The market seemed to focus on more pessimistic factors such as lower margins from lower rates, litigation risk and the uncertainty of TLTRO take up, rather than positive factors such as the potential decrease in wholesale funding costs. On a more idiosyncratic level in the sector, we lost money in our long position in the Portuguese bank BES as it emerged out of its rights issue period. An unexpected announcement that the bank was seeking a new CEO turned sentiment very rapidly on its head. With the financial condition of the holding company for the family’s industrial interests deteriorating, speculation intensified that they might look to sell their only large liquid position (the stake in BES) to cover potential losses. Despite being largely ring-fenced from the financial problems at its parent we decided to close the position in BES at a loss rather than sit out elevated volatility in the share price.

In thematic positions in equities, our expression of UK reflation via a basket of Housebuilders performed well in June. Following a strong January and February, the sector had recently underperformed given concerns related to potential interest rate increases and potential new measures to cool the housing market. However, the eagerly anticipated FPC Committee meeting was relatively benign with a central scenario of a 20% increase in UK house prices over the next 3 years and mild measures to limit further increase in risky mortgage lending. We remain long expecting a further rerating as most Housebuilders should be able to generate record high returns on capital invested and return considerable cash to shareholders, well in excess of what the share prices are currently discounting. This is driven by our understanding of the following: (i) the industry is more consolidated than ever and SME competitors remain locked out, (ii) land supply is rising fast thanks to the new planning system, described by some CEOs as the best in 30 years, (iii) strategic land conversion is rising to new levels positively impacting margins, and (iv) sector ill-discipline is unlikely this time round, with a shift in long term incentive plans away from growth and towards value creation, better aligning shareholders and management.”