New talent could mean new returns for this fund
What started as a small, single-office in Chicago has now evolved into a global, multi-strategy hedge fund that is stealing talent from the likes of Millenium and Citadel.
As we talked about previously, the hedge fund space is in dire need of portfolio managers and quants. To stay in line with the lack of demand, firms have been dishing out absurd contracts that only professional athletes typically see.
This firm’s London division is second for average salaries among funds and is continuing to rapidly innovate and develop a number of new strategies.
Mostly, the fund has experienced a divergence from its traditional long-short equity strategy and is shifting towards building out new quantitative strategies.
Today, we will look at the fund’s top 15 holdings and see if there are any signs of potential within its portfolio.
In addition to examining the portfolio, we include a deeper look into the fund’s largest current holding, providing you with the current Uniform Accounting Performance and Valuation Tearsheet for that company.
Also below is a detailed Uniform Accounting tearsheet of the fund’s largest holding.
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In more recent years, Dmitry Balyasny has been seen in headlines in the hedge fund talent war, actively “stealing” employees from the industry giants. Though to have people want to work for you, things must be going alright.
That’s a fair argument to be made for Balyasny Asset Management (“BAM”). And its roots started in 1994 when Schonfeld Securities gave Balyasny a chance in the world of investing.
After a dodgy first year earning no profits at the firm, Balyasny quickly sharpened up. Thereafter, he would accumulate a capital base that would warrant the firm to launch a new division for a fund where Balyasny would build out his team.
Finally with enough conviction, at just the age of 29, Balyasny and two associates from the fund decided to launch an independent entity trading primarily under a long-short equity strategy.
The rest is history. Even throughout the financial crisis and the dot-com crash BAM managed the market well and was yielding better results relative to peers. This resilience is what allowed the company to grow to $12 billion in assets under management (“AUM”) in just sixteen years.
In that same period, BAM delivered a 12% annualized return. However, 2018 was different.
In an environment hard for its long-short strategy, the company faced tough losses leading to the loss of $4 billion in AUM and a 20% job cut.
Ironically, the fund’s rapid growth led to its demise that year. Things got big too quickly, and risk management and organization were at an all-time low.
Balyasny enacted a mass restructuring of the fund’s strategies and management team, ensuring that history would never repeat itself.
2022 was a strong year for the fund returning about 10%, with its London division profits jumping from £4.5 million in 2021 to £22.7 million in 2022.
On the other hand, 2023 has been tough for the multi-strategy funds. With limited volatility in the market, the long-short strategy hasn’t been quite profitable as these plays often rely on dispersion in prices.
The PivotalPath Multi-Strategy Index, which is comprised of a wide range of multi-strategy companies, has shown an annualized return of 7.4%. As of August, this year, it was up an estimated 3.9%.
BAM is right in line with these numbers, delivering around a 3.0% return year-to-date.
This could be the reason why we have seen Balyasny indulge in such a mass hiring spree of quants. It appears that the fund is attempting to move away from its original long-short strategy and develop quantitative strategies with the assistance of all its new talent.
That said, let’s take a look at the fund’s top 15 holdings and see if Balyasny can deliver historical returns in the future.
Economic productivity is massively misunderstood on Wall Street. This is reflected by the 130+ distortions in the Generally Accepted Accounting Principles (GAAP) that make as-reported results poor representations of real economic productivity.
These distortions include the poor capitalization of R&D, the use of goodwill and intangibles to inflate a company’s asset base, a poor understanding of one-off expense line items, as well as flawed acquisition accounting.
It’s no surprise that once many of these distortions are accounted for, it becomes apparent which companies are in real robust profitability and which may not be as strong of an investment.
See for yourself below.
Looking at as-reported accounting numbers, investors would see that Balyasny Asset Management invests in fairly low-quality companies.
On an as-reported basis, many of the companies in the fund are below-average performers. The average as-reported ROA for the top holdings of the fund is 8%, which is notably lower than the 12% U.S. corporate average.
However, once we make Uniform Accounting adjustments to accurately calculate the earning power, we can see that the average return of Balyasny Asset Management’s top holdings is actually quite profitable compared to what as-reported metrics show, coming in at 21%.
As the distortions from as-reported accounting are removed, we can see that Amazon (AMZN) isn’t a 2% return business. Its Uniform ROA is 11%.
Meanwhile, NVIDIA Corporation (NVDA) seems like an 8% return business, but this large chipmaker actually drives a 26% Uniform ROA.
That being said, to find companies that can deliver alpha beyond the market, just finding companies where as-reported metrics misrepresent a company’s real profitability is insufficient.
To really generate alpha, any investor also needs to identify where the market is significantly undervaluing the company’s potential.
These dislocations demonstrate that most of these firms are in a different financial position than GAAP may make their books appear. But there is another crucial step in the search for alpha. Investors need to also find companies that are performing better than their valuations imply.
Valens has built a systematic process called Embedded Expectations Analysis to help investors get a sense of the future performance already baked into a company’s current stock price. Take a look:
This chart shows four interesting data points:
- The average Uniform ROA among Balyasny Asset Management’s top holdings is actually 21%, which is way above the corporate average in the United States.
- The analyst-expected Uniform ROA represents what ROA is forecasted to do over the next two years. To get the ROA value, we take consensus Wall Street estimates and convert them to the Uniform Accounting framework.
- The market-implied Uniform ROA is what the market thinks Uniform ROA is going to be in the three years following the analyst expectations, which for most companies here are 2023, 2024, and 2025. Here, we show the sort of economic productivity a company needs to achieve to justify its current stock price.
- The Uniform P/E is our measure of how expensive a company is relative to its Uniform earnings. For reference, the average Uniform P/E across the investing universe is roughly 20x.
Embedded Expectations Analysis of Balyasny Asset Management paints a clear picture. Over the next few years, Wall Street analysts expect the companies in the fund to increase profitability. Moreover, the market has expectations for these companies to exceed current valuations.
Analysts forecast the portfolio holdings on average to see Uniform ROA rise to 28% over the next two years. At current valuations, the market has slightly higher expectations than analysts and it expects a 27% Uniform ROA for the companies in the portfolio.
For instance, McDonald’s Corporation (MCD) returned 17% this year. Analysts anticipate its returns to increase to 19%. Similarly, the market seems to think optimistically about the company’s future and its pricing in an increase in profitability to reach a Uniform ROA of 30%.
Balyasny prioritizes investing in the big players. Looking at the fund’s top holdings, these are industry giants that are recognizable by most.
This becomes even more evident when acknowledging that the portfolio’s ROA is 21%, which is a good degree above the corporate average. Additionally, analysts and market expectations anticipate these companies to reach higher levels than their current valuations.
While this is reflective of the stability of these companies in the future, it also limits the upside as the market is pricing in notable growth of most of these companies in the portfolio.
Considering the company’s long-short equity strategy, BAM’s holding may be reflective of companies that it believes to be overvalued. As shown by the averages ROA’s, the market is pricing in growth and expansion for many of these companies which can make them expensive.
For instance Visa (V) is expected to double from an ROA of 66% up to 100%, this appears a very optimistic viewpoint considering the current macroeconomic environment. Considering its high expectations, BAM may see a firm like Visa, recognize it may be overvalued and short it to hedge any other long positions it may have.
With funds with so many different strategies, it may be hard to pinpoint the exact reasoning behind the holdings in its portfolios. However, as an investor, it is important to understand the underlying story and thesis of any holding.
By understanding the direction a company may be heading, it is easier to see which investments align well with your personal goals.
This just goes to show the importance of valuation in the investing process. Finding a company with strong profitability and growth is only half of the process. The other, just as important part, is attaching reasonable valuations to the companies and understanding which have upside which has not been fully priced into their current prices.
To see a list of companies that have great performance and stability at attractive valuations, the Valens Conviction Long Idea List is the place to look. The conviction list is powered by the Valens database, which offers access to full Uniform Accounting metrics for thousands of companies.
Click here to get access.
Read on to see a detailed tearsheet of one of Balyasny largest holdings.
SUMMARY and McDonald’s Corporation Tearsheet
As one of Balyasny’s largest individual stock holdings, we’re highlighting the McDonald’s Corporation (MCD:USA) tearsheet today.
As the Uniform Accounting tearsheet for McDonald’s Corporation highlights, its Uniform P/E trades at 25.7x, which is above the global corporate average of 18.4x, but below its historical average of 28.4x.
High P/Es require high EPS growth to sustain them. In the case of McDonald’s Corporation, the company has recently shown 3% Uniform EPS shrinkage.
Wall Street analysts provide stock and valuation recommendations that, in general, provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.
We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, McDonald’s Corporation’s Wall Street analyst-driven forecast is for EPS to grow by 19% and 8% in 2023 and 2024, respectively.
Furthermore, the company’s return on assets was 17% in 2022, which is 3x the long-run corporate averages. Also, cash flows and cash on hand consistently exceed its total obligations—including debt maturities and CAPEX maintenance. These signal moderate dividend risk and low credit risk.
Lastly, McDonald’s Corporation’s Uniform earnings growth is above peer averages, and in line with peer valuations.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research