Christopher Tsai says his primary responsibility in managing money is “not to lose it.”
In the 14 years since he established Tsai Capital, he’s taken that responsibility to heart: his firm’s long-only separate accounts have generated a 45.30% net return for the 10-year period ending December 31, 2010 compared to 15.07% for the S&P 500 Index.
Today, though, to continue protecting investor money, he feels something other than a long-only approach is called for—which is why he’s launching his first hedge fund.
“Downside protection is very important,” Tsai told FINalternatives in a recent phone interview. “We’ve had a good track record in managing downside risk. As you know, because of quantitative easing and other factors, the U.S. market has increased by approximately 100% from the bottom and global markets, particularly emerging markets, have increased even more. In the long-only format that is dangerous. We’ve captured wonderful gains and we’ve delivered alpha but I have become extremely risk-averse, given the run-up in prices, and I think that now is the right time to launch a long/short fund that has the flexibility to capture gains on the downside, to hedge risk on the downside and to invest in a variety of other asset classes besides just equities.”
Designed as a core holding for high-net-worth individuals and institutions, the Tsai Capital Fund has launched with $20 million from existing clients. Tsai says it will hew closely to the strategy that has served him well to date.
“Global equities will be the focus of the fund,” he says. “The long positions will not deviate from what I have done for 14 years, that’s where I think we’ve developed an edge. The focus on the long side is to identify undervalued growth companies that are multinational in nature, have exposure to emerging markets, [and] that deliver consistent results.”
The short side, he says, will be “exactly the opposite.” There he’ll be looking for overvalued companies with deteriorating fundamentals, without competitive advantages, without large insider ownership, where accounting “might be aggressive.” In particular, he says, he’ll be looking for cyclical companies.
“That’s really the key,” says Tsai. “I learned this very early on in my investing career. I had the fortune of working for my father, Gerald Tsai Jr., who was a pioneer in the fund business. He launched the first momentum fund, and one of the things that he said to me when I was very young was that if you have a growth company and you make a mistake and you overpay, over time, the growth of the earnings of the business will lift the stock price. And he’s absolutely right, so long as you don’t pay astronomical valuations. If you wind up overpaying by 5 or 10% that’s unfortunate but as the company grows you’ll get your cost back.”
“On the flipside of the equation, on the short side, the reason why I want to focus on cyclical companies is because the same is true in that…if you get the timing wrong, you short too soon and the price runs up, at some point, time will work in your favor, the cycle will change and you’ll get your cost back. So the short side is a mirror of the long book.”
Tsai anticipates that, once the fund is more invested, two thirds of revenue and earnings will come from outside the U.S. and one third from within. “That could mean we own companies that are based here but operate mostly outside of the states—for example, Colgate Palmolive does about 80% of their business outside of America—and it could mean that we own a company in Hong Kong that doesn’t have any exposure in North America. So it’s going to be a combination of various multinational companies.”
In addition to equities, Tsai says the fund will be able to invest in commodity-related exchange traded funds and fixed-income related securities while also having “the flexibility to invest opportunistically in private equity.”
The fund carries a minimum investment of $1 million and Tsai is now raising external capital. BNY ConvergEx’s NorthPoint Trading Partners serves as the fund's prime broker and JP Morgan Chase Bank the fund’s custodian. As for the optimal size of the vehicle, Tsai says:
“I do not see any reason why we would want to cap the size of the fund until capital became an impediment to performance, and as you know, the wonderful thing about focusing on highly liquid, large-cap names is that you don’t wind up with any liquidity issues or size constraints for quite some time….Our first goal is to take it to $200 million and then, from there, you can ask me at that time,” he laughs.