Carl Icahn, the activist investor who bet against the U.S. stock market last year, pared back the wager after the equity rally ended up reducing the billionaire’s first-quarter returns.
The 76-year-old stock picker sold a net $3.7 billion of securities, including energy and communications shares, in the three months ended March 31, according to a quarterly report filed May 1 with the U.S. Securities and Exchange Commission. That helped raise cash for Icahn to close out some of his wagers against market indexes, including the Standard & Poor’s 500 (SPX), designed to protect his other holdings.
The hedge-fund manager, who oversees $6.6 billion of net assets, began increasing his short positions in August through a strategy involving options, futures and exchange-traded funds. When the U.S. benchmark soared 12 percent during this year’s first quarter, losses on the short sales offset most of Icahn’s gains on individual stocks, leaving his investment fund up 1 percent, according to the SEC filing.
“The worst-case scenario for a strategy like this is a quickly rising market,” said Jared Woodard, a principal at Condor Options Research in New York. The short positions “will start eating into your returns,” Woodard said.
Icahn, based in New York, declined to comment. His investment fund had a return before expenses of 34.5 percent last year, compared with a 2.1 percent gain for the S&P 500, including reinvested dividends. The firm doesn’t disclose returns after expenses.
The billionaire’s primary strategy is to take stakes in companies he deems underperforming and then push for moves designed to boost their stock prices, such as asset sales or share buybacks. Icahn makes the investments through a hedge fund that relies solely on his capital, having returned money from outside backers last year.
He became more bearish in August based on his outlook for the European debt crisis and the U.S. economy, people with knowledge of his trading said at the time. He moved to protect his holdings from a potential market decline by establishing a $2 billion short position on the S&P 500.
“The guy is an activist investor first and foremost,” Chris Rich, head options strategist at JonesTrading Institutional Services LLC, said in a telephone interview from Chicago. “I could see him wanting to put a beta hedge” on the market, Rich said. A beta hedge is a trade designed to accentuate a stock picker’s skill by neutralizing the impact of market swings on returns.
Icahn carried out the trade by using financial derivatives known as futures and by selling short index ETFs, such as the SPDR S&P 500 ETF Trust. (SPY) In a short sale, an investor borrows and then sells a security in anticipation that it can later be repurchased at a lower price for return to the lender.
By year-end, Icahn had short positions on index ETFs with a face value of almost $4.5 billion, according to an annual report filed by Icahn Enterprises LP (IEP), the parent company for his hedge fund. The filing also showed that the fund had established $2.1 billion of short positions through derivatives described as equity swaps.
The stock market began climbing as personal consumption in the U.S. rose, Bouhari Arouna, director of equity derivatives strategy and structuring at BNP Paribas SA in New York, said in a telephone interview. Central banks in Europe and the U.S. provided a further boost through quantitative easing programs designed to spur economic growth through asset purchases.
“You can’t fight the central banks,” Arouna said.
The Icahn fund’s stock holdings as of Dec. 31 would have generated a 10 percent gain if left unchanged through the first quarter, according to data compiled by Bloomberg. In the May 1 filing, Icahn reported his hedge fund’s 1 percent return in the first quarter followed a 9.6 percent gain a year earlier. The latest quarter’s results included a $402 million loss recognized on equity-swap contracts.
“Gains were primarily due to our long exposure to the equity markets that were primarily driven by certain core holdings,” Icahn Enterprises said in the filing. These profits “were offset in part by our short positions,” the firm said.
By March 31, the firm had reduced its short positions on the index ETFs to $571 million. The fund simultaneously sold stocks, cutting its equity holdings to $4.8 billion as of March 31 from $7.6 billion as of Dec. 31. Motorola Solutions Inc. (MSI) said on Feb. 27 that it bought back $1.17 billion of company stock from Icahn as part of a larger share-repurchase program.
During the first quarter, Icahn also increased the short positions established through equity swaps to $4.9 billion, the filing shows. Equity swaps are derivative contracts that are similar to futures. Both tie up less capital than would short positions on index funds.
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