Updated Wednesday, July 30, 2014 as of 11:16 AM ET
Blogs - The Informed Advisor
Hedge Funds Need a Unique Thesis to Succeed
Monday, October 22, 2012

There are thousands of hedge funds competing in the marketplace. They come in all shapes and sizes, but all too often they approach investors with the same thesis.

"The things that everyone sees all the time are long/short and global macro, basically people that are saying, 'We're gonna be better than the market' because we've got XYZ experience and we're so smart or we have backtested all our results," said Nathan Anderson, co-founder and CEO of ClaritySpring, a company that aims to bring efficiency and transparency to the hedge fund industry. "That's not unique. At this point there are 13,000 hedge funds, so the burden is on the manager to prove that they have something that is focused and unique."

Before ClaritySpring, Anderson evaluated hedge fund and private equity fund managers for Blue Heron Capital. He said that he prefers hedge funds that have a particular focus over those that promote a generic thesis.

"I think the best funds are when someone has found a very specific segment of the market that has an inefficiency that has not been yet exploited by a lot of capital," said Anderson, providing an example. "There's this one fund that invests in aircraft-backed securities. It's a fixed income-type of investment."

Airlines are a volatile investment. Between bankruptcy expenses, the costs of running the business, and the fluctuating customer base, the airline sector is one of the most challenging industries in the world.

"However, air travel as a transportation medium is not going away," said Anderson. "Regardless of what happens in and out of bankruptcy court, air travel is here to stay. One of the major expenses for every airline is, of course, the aircraft. In many cases they don't own the aircraft, they lease them."

Anderson said that the fund -- which he could not name due to regulatory restrictions -- has "identified a specific inefficiency within the aircraft security because these are securities that can't really be run through a quant model too easily because each plane has completely different collateral characteristics, so the quants have kind of stayed on the sidelines."

"There aren't a lot of buyers focused on the space because airlines and aircrafts kind of have a negative connotation," he added. "So a lot of these securities are trading at a very significant discount to the liquidation and loose value of the plane."

Regardless, Anderson said that planes are "ultimately fundable assets."

"They can be leased out anywhere in the world, so if a [domestic] airline is doing poorly, but another is booming in China, it might be a Chinese airline that leases the plane," Anderson explained. "The lease revenue is relatively stable. The resale value is fairly quantifiable."

Anderson said that he has not dug into this fund too deeply. "But on the surface of it is a very unique investment thesis, and I think it's potentially compelling," he said.

A Substantial Advantage                                                                                                     

In his quest for other unique hedge fund concepts, Anderson came across a few that specialize in shorting fraudulent Chinese securities.

"In the early 2000s, a lot of Chinese companies would reverse IPO onto U.S. exchanges or came to U.S. exchanges through a reverse merger," said Anderson. "It turned out that many of these companies were complete frauds. The reason they weren't listed on the Chinese exchanges is for that reason."

Anderson said that the punishment for defrauding investors in China is much harsher than the punishment for defrauding investors in the United States. "There's no extradition and there's very little recourse, so all these companies produced phony numbers," Anderson explained. "There are a handful of long/short funds that compare the SEC filings in the U.S. with local filings in China that have investigators that will go to the factory simply to see if they're empty or operating. They will speak with competitors, and most competitors, if you ask them about a particular company, they will know something about it."

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