Description

This write-up will be short for 3 reasons: 1) it isn't complicated, 2) it is illiquid, and 3) many fund managers likely wouldn't want to have exposure to a stock like this for cosmetic reasons.  Nonetheless, I believe this is a good risk-adjusted return opportunity for long-term investors.  In brief, by purchasing TPOU.LN shareholders become investors in a successful hedge fund (20.2% annualized net return since inception) with a relatively liquid portfolio at a high teens discount to NAV.

Most VIC members have likely heard of Third Point and its portfolio manager Dan Loeb.  Putting aside the acrimonies letters, which seem to be a thing of the past and are basically a side show (hopefully I don't somehow incur his wrath with this post), he is an experienced investor with an excellent long-term track record.  The website link below provides a reasonable amount of information on the firm and the fund.  The one page snapshot of July is a good summary and can be found under the "Report" drop down.  At the end of July the fund had a 33.6% net long position in equities 50% net long position in credit, some risk arbitrage and "other".  Top positions included Chrysler Financial debt, PHH Corp, Bank of America, PFE/WYE arbitrage and Fortis.

http://www.thirdpointpublic.com/default.as

When hedge funds, including Third Point, could do nothing but make (and take in) money, several of them listed closed-end investment company shares on the AIM exchange in London.  This was a means to have permanent capital and to elevate the profile of the firm through a public listing.  The proceeds from the listing were invested directly into Third Point Offshore Fund Ltd, which in turn is invested in the firm's Master Fund.  There is no additional layer of fees so there is no tracking error between the movement of the company's NAV and the performance of the offshore hedge fund.

Clearly Third Point's timing was poor as it listed shares, denominated in several different currencies (see TPOG and TPOE), in the summer of 2007.  As we all know, 2008 was not kind to most hedge funds and investors generally, including Third Point, which lost 32.6% for the year.  It is worth pointing out that while Third Point faced the issues of managing large redemptions that plagued many hedge funds following the 2008 carnage, it did not implement a gate, stuff illiquid positions into side pockets, or form a special purpose vehicle.  They met their redemptions in cash and without delay. 

There are several advantages between subscribing as a limited partner directly with the manager and buying shares of TPOU:

1) The discount to the most recently weekly published NAV on August 19th is 19%.  In mid December of last year, TPOU actually traded at over a 50% discount to the fund's underlying NAV.  Prior to the tailspin in fund performance the discount tracked in the low to mid single digits.  The discounts to NAV of other listed hedge funds such as Brevan Howard and Bluecrest has come back down to the mid single digits from peaks in the low 20% range.  I believe that Third Point has yet to return to a more reasonable spread in part because the U.S. firm is not nearly as well known in Europe as it is in the U.S. and Europeans are the primary players in the market for the AIM listed hedge funds, fund-of-funds, private equity funds, etc.  Also, I would assume that the magnitude of last year's losses also spooked investors.  The other two funds I mentioned are up nicely over the last 12 month period while Third Point still has a ways to go.  In my experience, European hedge fund investors are generally not contrarians and instead chase performance.  Personally, all things equal, I would rather investor with a good investor who is rebounding from a tough period than one who is flying high. 

2) Though the shares are not very liquid, you have intra-day liquidity as they are traded on the AIM exchange.  I have been able to accumulate a position in TPOU as well as some in TPOG and TPNTF.  In contrast, limited partners are subject to a one year soft lockup then quarterly redemptions with 60 day notice.

3) Purchasers of TPOU get the benefit of the high water mark.  Third Point has a modified high water mark structure such that an investor pays 10% until the fund recoups 150% of losses, then the incentive reverts to the standard 20%.  The fund was down almost 33% last year and was up some 14% through the end of July so baring a stunning rebound in performance, an investor in TPOU will pay an incentive of 10% for a long time.  A new LP in Third Point starts off at 20%.  The management fee is 2%.

4) The company itself, the master fund, as well as the investment manager can buy back shares in the after market to help close any discount.  In May 2009, a press release reported that an amendment was made at the end of 2008 to allow eligible employees and principals can trade in the company's shares.  The holdings are subject to a one year lockup.  By the time of the press release in May, 428,750 TPOU and 245,000 TPOE shares had been purchased in the open market.   As of that date, total ownership by employees and principals, including Dan Loeb, was 4.6mm TPOU and 750K TPOE shares, which equates to 11% of the aggregate economic interest in the company and about $33mm at current prices.  I don't know the amount of the buybacks or change in holdings since that date.

5) Taxes can be better, a wash or in a few cases worse than being a direct investor in the hedge fund depending on the tax status of the shareholder (onshore or offshore being the most important distinction).  I won't go into the gory details other than to say that I am an onshore investor and am comfortable with the PFIC and other tax issues.

Risks

Investing in hedge funds is inherently risky.
The shares are illiquid.
The discount was over 50% at one point and I supposed could get there again if the world teeters on the edge of financial catastrophe again.

Catalyst

I would expect that continued strong performance of the fund in 2009 helps to stimulate enough interest to close the discount.

This is speculation, but I would guess that Dan Loeb and the rest of the team at Third Point are not pleased that the shares trade at such a wide discount and would be inclined to buy back shares either personally or via the master fund.