Dan Loeb's Letter: Taking Advantage of Market Shocks

Dan Loeb, manager of the Third Point hedge fund, just released his second quarter letter. Third Point had a bad quarter, so Loeb had to assuage investors. For the quarter, Third Point lost 2.3 percent - just slightly higher than the S&P 500's performance, a 2.8 percent decrease. Year-to-date, the hedge fund underperformed the S&P by 5.6 percent. Loeb cited the world economy's weakness, which has included Europe's debt mess and China's slowdown, as the reason for the fund's poor performance. However, Europe was also the source of the fund's greatest successes of the quarter. From the letter:

We are often asked what "event-driven" investing means in today's environment, and whether that landscape is still fertile. We have found it to be especially so in Europe in 2012, where we have managed to make money despite the continental chaos by looking for negative events, capitalizing on dislocations they generate, and trading well around these individual situations. While Europe overall is a place where we currently have little interest in long-term investing given the circumstances, surprisingly, many of our top winners so far in 2012 are European situations.In times of turmoil, we look for "fat pitches" that come from factors like forced or panicked selling, market dislocations, or a move in the cycle away from greed towards fear. With all of the mayhem in Europe in the past 12 months, we have been able to find quite a few of these types of investments while remaining disciplined about avoiding anything in the region that falls outside of our very narrowly defined investment parameters...With the turmoil in Europe showing no signs of abating, we expect to continue seeing these types of attractive opportunities. We recently added a new position that fits these parameters through the European IG bond index known as iTraxx.

In other words, Loeb has looked for ‘blood on the streets' and bought up investments that were artificially low. That makes for a good strategy, but with the fund not planning to hold European positions long-term, it may need other sources of future growth. Loeb believes he's found that opportunity with two key investments. One is Delphi Automotives

DLPH

, a distressed auto-parts supplier that has come out of bankruptcy strong. In the second quarter, the stock pulled back, but it up 33 percent year-to-date. Around half of all auto suppliers are in the negative for the year, so Delphi looks like a standout performer. Loeb also initiated a position in Progress Energy Resources

PRQ

, a natural gas player in Canada. Progress Energy's main asset is 825,000 acres in the Montney gas play of British Columbia. Natural gas' cliff-like price dive made for a cheap price on Progress Energy. With the fuel now solidly turning around, Progress' field may prove a steal at the price Loeb paid. Loeb needs to finish the year with solid outperformance if he hopes to beat the S&P. When a hedge fund fails to so for a year or more, investors tend to head for the exits in droves.

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