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mod (Andy) note: "Blast from the past - Best of Eddie" If there's an old post from Eddie you'd like to see up again shoot me a message.

What is it about Citi that makes it attractive? I'm all about value investing, and three bucks a share is pretty cheap, but I had to say I was a little surprised by the substantial positions that have been taken in Citi by hedge funds over the past quarter.

120 different hedge funds, including those run by the likes of George Soros and John Paulson, have loaded the boat with a stock that certainly looks like a POS performance-wise. Paulson's fund increased their Citi holdings to over 500 million shares, Eton Park bought 138 million shares, and Soros upped his ante to about 100 million shares. What do these guys know that the rest of us don't?

Purchases of Citi by hedge funds outpaced sales by more than 10 to 1, and the various portfolios added a net 1.2 billion shares of Citi in the last quarter. Is a break-up of Citi in the works?

Quote:
Hedge funds may be speculating on a break-up of Citigroup into individual businesses, according to Diane Garnick, a New York-based investment strategist at Invesco Ltd., which manages about $400 billion.

“The sum of the parts is worth less than each individual part,” said Garnick. “It is easier for investors to assign value to a company if it is broken up into its many component parts. In this market environment people are starting to reward single business unit companies.”

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Comments (38)

  • barnone's picture

    They know nothing more than what we know. Citi shares have tangible book value of $4.20 [ they are trading at 3.30 today ] . Bank stocks usually trade at 1.5X tangible. Plus most of citi's crummy assets have been written off already.

  • HiB's picture

    Remember that hedge funds don't have to disclose their short positions, so you can't learn anything from looking at the long positions only! That's the nice thing about hedge funds... you never know.

    Just as an example, if they are short selling BoA at the same time (which they don't have to disclose), they are only betting on outperformance of Citi vs. BoA. This does not mean that Citi itself it a good investment, it might mean that it will just go down less than BoA.
    (Not that I think Citi is a bad investment, just making my point here)

  • cfaboston28's picture

    Excellent Comment HiB. Hedge Funds can make profits at the expense of common investor's emotions. This article may encourage regular Joe to buy C but he doesn't have any solid reason to buy C beside this article.

    You never know....

  • mlamb93's picture

    Citi has been deemed "too big to fail". Every hedge fund knows this. The Government wants and needs Citi to stay afloat. Takes a lot of risk out of the investment.

  • In reply to mlamb93
    adapt or die's picture

    mlamb93 wrote:
    Citi has been deemed "too big to fail". Every hedge fund knows this. The Government wants and needs Citi to stay afloat. Takes a lot of risk out of the investment.

    This is along the lines that I'm thinking. Citi clearly has a backstop and it's also really the only large financial that has yet to rebound. Additionally, the deal flow in their investment banking unit seems to be solid.

  • GoodBread's picture

    I second HiB and mlamb93's comments. However the toobigtofail argument plays out in a more long-term manner, as I don't see Citi's stock price killing it any time soon.

    I'd favor the short BofA explanation particularly since I don't see Soros or Paulson as having an investment horizon longer than 1-2 years.

  • Beef's picture

    HiB - not to be a douche here but if they wanted to be on the outperformance of C over BAC, when they expect both stocks to go down, why would they bother buying C? If they think a stock will go down, they will short it. Plain and simple.

    Wall Street leaders now understand that they made a mistake, one born of their innocent and trusting nature. They trusted ordinary Americans to behave more responsibly than they themselves ever would, and these ordinary Americans betrayed their trust.

  • cheese86's picture

    It's called a hedge.

  • ihatetaxes's picture

    Beef - You may want to read "When Genius Failed." Not the most challenging read, but a good book. Basically, there are to many unknown (i.e variables) on just betting if C will go down. However, to reduce the bet to a hedge between BoA and C, many variables are eliminated, plus you have down side protection.

    HiB and mlamb93 - Great points.

  • MKP1Investor's picture

    Agree that the thesis and logic for the long C position is probably complicated and may potentially be some sort of a hedge but Paulson is definitely not short BofA as it is his longest non-gold position according to his most recent 13-F.

  • eliteculture's picture

    It is called Pair trade. It eliminates the market risk. Go read more about pair trades.

  • ihatetaxes's picture

    Educated1 wrote:
    Agree that the thesis and logic for the long C position is probably complicated and may potentially be some sort of a hedge but Paulson is definitely not short BofA as it is his longest non-gold position according to his most recent 13-F.

    Agreed. It was just a continuation of the example HiB made.

  • In reply to eliteculture
    MKP1Investor's picture

    I was thinking that it may be a pair trade but it could also be something more complicated like capital structure arbritrage as he may also be in different classes of the capital structure. My only point was that the trade was not as simple as going long C and short BofA.

  • In reply to ihatetaxes
    drexelalum11's picture

    mlamb93 wrote:
    Citi has been deemed "too big to fail". Every hedge fund knows this. The Government wants and needs Citi to stay afloat. Takes a lot of risk out of the investment.

    That shouldn't factor in to this equation, because these are equity investments, not debt investments, and the gov't has clearly shown they are willing to let equity fall to zero, even in "systemically important" institutions.(1)

    GoodBread wrote:
    I second HiB and mlamb93's comments. However the toobigtofail argument plays out in a more long-term manner, as I don't see Citi's stock price killing it any time soon.

    I'd favor the short BofA explanation particularly since I don't see Soros or Paulson as having an investment horizon longer than 1-2 years.

    Paulson is also long BoA,(2) so I don't see how that explanation makes sense. Also, what reason do you have for feeling C is superior to BAC?

    ihatetaxes wrote:
    Beef - You may want to read "When Genius Failed." Not the most challenging read, but a good book. Basically, there are to many unknown (i.e variables) on just betting if C will go down. However, to reduce the bet to a hedge between BoA and C, many variables are eliminated, plus you have down side protection.

    HiB and mlamb93 - Great points.

    What does LTCM have to do with this? While they did have lots of relative value convergence trades, they should hardly be held up as an example of how to "hedge" risk, and most of those positions were in fixed-income (3); the equity positions they held were based on dual-listed convergence, ie Royal Dutch v Shell converging (4).

    1: http://www.marketwatch.com/investing/stock/LEHMQ
    2: http://seekingalpha.com/article/155907-bank-of-ame...
    3: http://www.erisk.com/Learning/CaseStudies/Long-Ter...
    4: Lowenstein (2000), p. 99

  • GoodBread's picture

    I'm not saying Paulson in particular is short BofA, but I can see how someone with his investment horizon could be shorting them as a hedge. I don't even think C is superior to BofA, however BofA has outperformed C since March.

  • HiB's picture

    Beef wrote:
    HiB - not to be a douche here but if they wanted to be on the outperformance of C over BAC, when they expect both stocks to go down, why would they bother buying C? If they think a stock will go down, they will short it. Plain and simple.

    Yes, it is indeed sort of a hedge. This is just a basic long-short equity investment strategy of HFs.
    Below some more intuition for the beginners about long-short. But remember, a hedge fund can do much more than just this stuff.

    Now why don't they go short on Citi if it it is going down anyway? (like beef is suggesting)
    All hedge fund managers claim to have some very specific skills when looking at stocks, and they will use hedging to capture ONLY the specific part of risk that they think they can understand and forecast, better than the market is already doing.
    In my example above, the HF manager might be an expert in looking at banking stocks and picking the best of its class. HOWEVER, this guy is not willing to put his ass on the line by just buying/shorting only 1 of the 2 stocks, because he has no clue on what the overall market will do...
    Given his special skill on picking the best in class, he just wants to get an ABOLUTE RETURN, without being exposed to market risk.

    WTF is absolute return?
    Just to clarify, the principle of trying to construct a portfolio with an absolute return means that you will get a fixed return whatever the overall market return (S&P500) will be.
    Given that this is the goal of a hedge fund, notice that my example about long Citi and short BoA makes perfect sence. Because both stocks are exposed to the market and the long-short position will cancel out the common market risk. For the clever guys amongst you, yes, maybe Citi is more exposed to overall market evolution (perhaps because of higher leverage) so you will need to adjust for the Betas of both stocks and not just short 1 dollar in BoA for every long dollar in Citi.

    Why is an absolute return the general goal of a hedge fund?
    Don't forget that HFs are highly highly highly levered and the partners will burn in hell when their position goes in the wrong direction just a little bit because of some kind of risk that they did not foresee. So again, they will be very very carefull in hedging every bit of risk that they can not understand.
    By the way, what I mean by burning in hell; every prime proker will be calling them at 3am at night to make them pay millions of dollars by lunch time tomorrow. If they can't manage that, the equity value of the fund stays below debt value and the fund will be closed down. So their little baby (the HF) will die if they don't get cash soon. That's the liquidity risk of a hedge fund. To conclude, since the partners don't want to get those calls every night and go through another near-death experience, they will avoid volatility that they can not predict.

    I hope you understand now that such a long-short strategy is a very powerfull weapon to disect the overall risk in its several components, and only bet on one of those components. Namely, the one that you think you can control.

    By the way, just for fun:
    If you are still not convinced about the concept of hedging market risk, remember that nobody can predict short term market/sector fluctuations with a high level of certainty. If you are still arrogant enough to think that you can, think again, because if you would be right, you should have been a billionair already.

    There you go guys, thanks for the nice comments above by the way.
    (silver bananas are appreciated)

  • ihatetaxes's picture

    drexelalum11 - Yes, I know LTCM was convergence trades in debt, but I was trying to illustrated "why hedge" to Beef's question. That's basically what chapter 2-4 was all about. It doesn't matter if you're in equity or debt, you can always hedge where ever you are in the capital structure.

    In addition, I replied to Educated1's post. I agreed that Paulson isn't shorting BoA/long Citi, but it was a good example to Beef's question: "If they think a stock will go down, they will short it [Citi]. Plain and simple" and a continuation of HiB's example that HF's don't reveal their short positions.

  • In reply to ihatetaxes
    drexelalum11's picture

    ihatetaxes wrote:
    drexelalum11 - Yes, I know LTCM was convergence trades in debt, but I was trying to illustrated "why hedge" to Beef's question. That's basically what chapter 2-4 was all about. It doesn't matter if you're in equity or debt, you can always hedge where ever you are in the capital structure.

    Yes, the asset class doesn't matter that much. However, my fundamental point was, LTCM relied upon a different sort of convergence trades. Your point is well taken though, and in response I offer this:

    http://www.leveragedsellout.com/2008/11/study-show...

  • In reply to drexelalum11
    HiB's picture

    Quote:

    What does LTCM have to do with this? While they did have lots of relative value convergence trades, they should hardly be held up as an example of how to "hedge" risk, and most of those positions were in fixed-income (3); the equity positions they held were based on dual-listed convergence, ie Royal Dutch v Shell converging (4).

    Always interesting to talk about LTCM, but I would actually argue they where hedging. But it depends on how you think about it.
    Because to set up a convergence bet, that means that you are betting on a very precise type of risk. Meaning that somehow you took away all other risk, so basically they were very skillfull in hedging. (hedging is not necessariy in the form of short selling)

    For example, the Royal dutch-Shell bet. To capture the spread between the two stocks at that time, they again had to long-short. So really, they are always hedging.

    Just being a pain in the ass about this, i know. Sorry for that mlamb93.

    But still great to involve LTCM here.
    Even more interesting to talk about is the liquidity risk that killed them eventually. Eventhough they were always playing on convergence bets that pay off an absolute return in the long run, they still got killed.

    So to come back to absolute returns from above. Maybe LTCM proves that absolute returns are impossible? This is an open question, but in my opinion the answer is yes. When constructing an absolute return, there will always be TAIL RISK due to liquidity issues that may arise. In the case of LTCM, that was because some of there trades diverged a little bit too much and they had to sell, which led to more divergence, and more liquidity problems etc. This vicious circle is what took one of the greatest HFs in history down.

  • In reply to HiB
    drexelalum11's picture

    HiB wrote:
    Quote:

    What does LTCM have to do with this? While they did have lots of relative value convergence trades, they should hardly be held up as an example of how to "hedge" risk, and most of those positions were in fixed-income (3); the equity positions they held were based on dual-listed convergence, ie Royal Dutch v Shell converging (4).

    Always interesting to talk about LTCM, but I would actually argue they where hedging. But it depends on how you think about it.
    Because to set up a convergence bet, that means that you are betting on a very precise type of risk. Meaning that somehow you took away all other risk, so basically they were very skillfull in hedging. (hedging is not necessariy in the form of short selling)

    For example, the Royal dutch-Shell bet. To capture the spread between the two stocks at that time, they again had to long-short. So really, they are always hedging.

    Just being a pain in the ass about this, i know. Sorry for that mlamb93.

    But still great to involve LTCM here.
    Even more interesting to talk about is the liquidity risk that killed them eventually. Eventhough they were always playing on convergence bets that pay off an absolute return in the long run, they still got killed.

    So to come back to absolute returns from above. Maybe LTCM proves that absolute returns are impossible? This is an open question, but in my opinion the answer is yes. When constructing an absolute return, there will always be TAIL RISK due to liquidity issues that may arise. In the case of LTCM, that was because some of there trades diverged a little bit too much and they had to sell, which led to more divergence, and more liquidity problems etc. This vicious circle is what took one of the greatest HFs in history down.

    Oh, I agree that LTCM certainly hedged, I just don't think you should cite them as an example for how to generate alpha through hedging - hence the quotes.

  • ihatetaxes's picture
  • In reply to drexelalum11
    HiB's picture

    drexelalum11 wrote:

    Oh, I agree that LTCM certainly hedged, I just don't think you should cite them as an example for how to generate alpha through hedging - hence the quotes.

    Still, they were professionals in generating alpha. I'm sure you agree that convergence in nearly every trade of LTCM was certain. The only question was: when will the market realize that this spread needs to convert?
    The longer it took for those spreads to converge, the more liquidity LTCM needed. That's the liquidity tail risk again.

    But still, it's not because they went out of business quite badly that they didn't yield absolute returns.
    I would rephrase it to: absolute return does not exist and always brings along lquidity risk.

    But to conclude on this issue, I agree that LTCM is still not the best example to mention when talking about succesful alpha generation (with the emphasis on succesful)

    I'll shut up now.

  • mlamb93's picture

    It doesn't matter that these are equity investments - the Government is an equity investor because it couldn't negotiate a fair deal when striking TARP. This was akin to a DIP lender agreeing to subordination. Taxpayers should be outraged at this.

    Further - the Goverment is basically guaranteeing Citi's debt and letting them borrow at 0% from the discount window. Couple that with mark-to-fantasy accounting and it's pretty clear that Citi is being given a free pass to slowly right-size its balance sheet.

    Sounds like a pretty good deal to me.

  • Barboone's picture

    read diary of a hedge fund manager all your answers are there

    "The higher up the mountain, the more treacherous the path"
    -Frank Underwood

  • FutureTrader21's picture

    Great thread. I must say...HiB got the silver banana.

    I have always understood that we cannot just guide ourselves with these long positions of the hedgies, but what I seem peculiar that was lost throughout everyones comments was that is seems that ALL the top hedge funds are betting on f'ing C. What is it? Fishy.

    More fishy is when you think these two options:
    1) Everyone knows something and they are betting on the same thing

    2) Everyone is betting differently on on this same stock (everyones' kind assumption)

    Either way, think about it....food for thought....there is something there....

  • Bodhis's picture

    Any thoughts on C? News I pulled up today, gov't may unwind sooner, rumors that SEC would ban short selling on stocks gov't have stake in (proven false atc), and sale of real-estate business.

    C Apollo Global Management signs agreement to purchase Citi's real-estate investment business -- WSJ, citing sources ($3.82)

    09-Mar-10 13:53 ET In Play Citigroup: U.S. Government may soon ease out of Citi stake - FoxBusiness (3.79 +0.23)

    C Citi trading higher ($3.81 +$0.25)
    Shares are up 6.7% today on positive comments on C by Bruce Berkowitz , who manages the Fairholme fund. In an interview with Fortune, which was out pre-open, Berkowitz notes C balance sheet as slowly improving. Berkowitz is a large holder of C shares, the article notes. Barron's recently noted C as one of his major buys in their examination of 13F filings on 20-Feb.

  • Bearearns's picture

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