Professional Documents
Culture Documents
December 9th, 2010
Third Quarter 2010 Investor Letter
Review and Outlook
Third Point’s Second Quarter Investor Letter received a surprising amount of public attention.
Some commentators suggested it captured the Wall Street zeitgeist, characterized by frustration
with the Obama administration's anti‐business tone and policies, indicating a shifting political tide.
Others claimed the letter exemplified the elitist perspective of a hedge fund manager bitter over
potential changes to the carried interest tax. 1 One New York Times editorial writer advanced the
debate by proffering a psychological profile topped off with a personal insult, which amused me,
and I proudly accepted it as a badge of honor given the esteemed company of others he has
targeted.
In fact, the letter was intended to provide our investors with a sense of the political and economic
prism through which we look at the current investment environment. As a follow on, I thought it
might be interesting to take a further step back and share one way we think about developing our
investment ideas and general economic views. It all comes down to the basic concept of story: the
stories we hear, the stories we tell others, and the stories we tell ourselves.
We use stories to make sense of the complex and the incomprehensible, to fill in the gaps, and to
give ourselves peace of mind. Scientists tell stories to explain the origin of the universe and the
composition of the tiniest particles. Historians tell stories about our past and sometimes try to
relate those stories to our present and to predict future trends. Psychotherapists tell stories about
how our life experience shapes our personality and behavior.
The notion of story as an organizing principle is the topic of a book by Jim Loehr, who writes in The
Power of Story:2
The human brain . . . has evolved into a narrative‐creating machine that takes
‘whatever it encounters, no matter how apparently random’ and imposes on it
‘chronology and cause‐and‐effect logic’ . . . Stories impose meaning on the chaos;
they organize and give context to our sensory experiences, which otherwise might
seem like no more than a fairly colorless sequence of facts.
I was reminded of how seemingly indelible “factual” stories can circumscribe our world too
narrowly when I read recently about a NASA discovery of a new arsenic‐eating bacterium that
changes the basic assumptions of life on this planet and others:
1For the record, the letter challenged the "Enterprise Tax” – a special tax proposed in the Extenders Bill that applied
exclusively to the sale of a money management business – and not increased taxes on carried interest, which I do not
oppose.
2 James Loehr, The Power of Story (New York: Free Press, 2007) 4‐5.
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A bacterium found in the arsenic‐filled waters of a Californian lake is poised to
overturn scientists' understanding of the biochemistry of living organisms. The
microbe seems to be able to replace phosphorus with arsenic in some of its basic
cellular processes — suggesting the possibility of a biochemistry very different from
the one we know, which could be used by organisms in past or present extreme
environments on Earth, or even on other planets.3
When we are reminded that even factual stories about the building blocks of molecular life are
subject to revision, what weight should we rightly put on the prevailing narratives of economic
“science,” particularly those that are rapidly evolving to justify this eventful period we are living in
– of bubbles and busts and unprecedented government interventions? Indeed, I cannot think of a
field that lends itself better to story‐telling: stitching together “facts” with conjecture, theory,
history, legend, psychology, and fancy graphs all ridden with personal biases in an attempt to make
sense of a complex and sometimes inexplicable world, than the dismal science of Economics.
Notwithstanding the fact that it came off as a staged infomercial rather than a serious interview,
Fed Chairman Ben Bernanke's recent “60 Minutes” segment with Scott Pelley serves as a powerful
case study of personal story‐telling and steering a historical narrative. This format allowed
Chairman Bernanke to tell his story – which seemed, improbably enough, intended to
simultaneously frighten and reassure. His narrative arc posits that the global economy would have
collapsed and unemployment would have exceeded levels of the Great Depression had the Fed not
intervened to rescue the financial system. Having set the stage for how we were saved from global
financial Armageddon once before and therefore ought to trust the Fed’s intervention blindly again,
Chairman Bernanke’s next chapter states that the Fed’s latest $600 billion market intervention will
alleviate our seemingly intractable high levels of unemployment, which otherwise would continue
indefinitely.
So we have learned his story – and his conclusion that without the Fed engaging in a “carry trade” of
significant proportions to lower long‐term rates heading into 2011, we would be headed for years
of persistent unemployment and stagnation. Chairman Bernanke pointedly addressed the concerns
of naysayers, scolding those who propagate the myth that the Fed is simply printing money. He
claimed that the money supply will not be affected by these and future purchases. Perhaps he
didn’t want to strain the minds of the “60 Minutes” audience, but Pelley did not ask the obvious
question – where then does the money come from? Is it loose change the Fed keeps around for a
rainy day, perhaps stashed in a cookie jar in the Federal Reserve kitchen, or stuffed under the
mattress in the Chairman’s bedroom?
The real source of the funds for “QE2” are bank balances kept on reserve at the Fed which
otherwise would be invested in short term instruments, and a little known program with the
Treasury called the Supplementary Financing Program. The Fed is effectively borrowing short term
money and investing in long dated securities (with an average maturity of 5‐6 years and nearly one‐
3 Alla Katsnelson, “Arsenic‐eating Microbe May Redefine Chemistry of Life,” Nature Magazine 2 December 2010:
http://www.nature.com/news/2010/101202/full/news.2010.645.html.
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third of purchases in maturities between 7‐30 years).4 This strategy, when employed by the private
sector, is called a “carry trade” because the practitioner of the strategy earns the “carry” (or
differential) between the lower short‐term interest rates at which she borrows and the higher,
longer term rates that she earns. These transactions should also be known as “carry trades”
because when they go wrong, i.e. when longer term rates increase and the price of those bonds
decline sharply in value, the practitioner is “carried out” (as in on a stretcher).
Chairman Bernanke’s story serves to establish his stature as an insightful regulator whose prudent
intervention prevented a global meltdown. The only problem with his narrative is that it
contradicts certain facts and our own experience – like the Fed's admitted inability to see the crisis
coming or to regulate effectively the banks under its purview. Psychologists call the process of
rationalizing two incompatible or conflicting beliefs or observations "cognitive dissonance":
Cognitive dissonance [is] the hard wired psychological mechanism that creates self‐
justification and protects our certainties, self‐esteem, and tribal affiliations . . . the
most harmful consequences of self‐justification . . . exacerbates prejudice and
corruption, distorts memory [and] turns professional confidence into arrogance. . . .5
When asked by Pelley if there was anything he wishes he had done differently since the crisis
began, the Chairman replies with a faint smirk: "Well, I wish I'd been omniscient and seen the crisis
coming, the way you asked me about, I didn't. But it was a very, very difficult situation. And the
Federal Reserve responded very aggressively, very proactively.”6
Next, Pelley asks the Chairman: "How did the Fed miss the looming financial crisis?" Recall,
Bernanke had just made a statement that implied only omniscient people could have seen the crisis
coming, but he responds that "there were large portions of the financial system that were not
adequately covered by the regulatory oversight," 7 such as Lehman Brothers and AIG. I can only
assume that Pelley was so mesmerized by Chairman Bernanke’s answer that he neglected to ask
him about the other 90% of the financial system which the Fed did regulate and which also fell to
shreds. Adding to Chairman Bernanke's discomfort must be memories of his prior economic
forecasts, such as this one made March 28, 2007 in prepared testimony to Congress' Joint Economic
Committee. "At this juncture . . . the impact on the broader economy and financial markets of the
problems in the subprime markets seems likely to be contained."
What was most striking in the interview was Chairman Bernanke’s devotion to the righteousness of
his narrative at a time when every actor in the financial system still ought to be asking how things
went so terribly wrong. The desire to create a story that emancipates one from blame and
promises future forecasting precision must be incredibly powerful for any public servant charged
with the awesome responsibilities of the Fed Chairman. Yet it is precisely these sorts of leaders
4 See the Federal Reserve Bank of New York’s website: http://www.newyorkfed.org/markets/lttreas_faq.html
5 Elliot Aronson and Carol Tavris, Mistakes Were Made (But Not By Me) (New York: Harcourt Inc, 2007) 10.
6 http://www.cbsnews.com/stories/2010/12/03/60minutes/main7114229_page4.shtml?tag=contentMain;contentBody
7 Ibid.
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who should be the most attuned to understanding the dangers of believing too much in the stories
we tell ourselves, and instead be willing to search out facts and admit wrongdoing.8
One more consideration in analyzing our own and others’ stories are the experiences that shape
one's views and biases. Some researchers have argued that these experiences are so fundamental
that they affect our judgment on a neurological level.
The brain changes continually as a result of our experiences. Experiences produce physical
changes in the brain either through new neural connections or through the generation of
new neurons . . . This creates different convictions, habits, values and character.9
The President, before the recent national elections theorized the following: "Part of the reason that
our politics seems so tough right now, and facts and science and argument does not seem to be
winning the day all the time, is because we‘re hardwired not to always think clearly when we’re
scared, and the country is scared.” In an apparently spectacular display of cognitive dissonance
(the electorate's disaffection for the Democratic Party and his own belief in these rejected policies),
the President's statement raised an interesting question, not about the electorate's "hard‐wiring,"
but that of his own and his administration's. In particular, is this administration – with no known
participation in the free enterprise system, with no experience in innovation, management of an
enterprise or risk taking – capable at a neurological level of understanding the basic drivers of the
entrepreneur or manager, or how to spur economic growth? Based on the President's lambasting
of the opposing party following the recent tax rate negotiations with charges of "hostage taking,"
this seems to be a reasonable question to ask.
How does all of this apply to Third Point? From an investor’s point of view, our challenge is not
only to keep up with rapidly unfolding events around the world, but also to keep our perspective
fresh and differentiated from that of our competitors.10 As securities analysts we are truth seekers
and problem solvers. We must satisfy ourselves with determining ranges of outcomes and
potential scenarios rather than searching for, and ultimately fabricating, absolute truths. The only
thing we are 100% confident in is that we are fallible, we don’t have all the answers, and we will
make some mistakes. However, if we are honest with ourselves and our colleagues, remain
8As if forming an “accurate” story wasn’t hard enough, in today’s world the velocity of information and the amount of
noise is deafening and may lead to confusion and a heightened sense of anxiety. Former National Security Advisor and
geo‐strategist Zbigniew Brzezinski wrote:
Recognition of the notable acceleration in the velocity of our history and uncertainty of its trajectory is
the necessary departure for my argument. History has not ended but become compressed. Whereas in
the past, historical epochs stood out in relatively sharp relief, and one could thus have a defined sense
of historical progression, history today entails sharp discontinuities that collide with each other,
condense our sense of perspective, and confuse our historical perceptions.
In other words we live in a world today that is in fact very different from the one which we have begun
to comprehend, and by the time our comprehension has caught up with the new reality, the world is
likely to be even more drastically different in ways that today seem unthinkable.8 {Zbigniew
Brzezinski, Out of Control (New York: Touchstone, 1993) ix.}
Brzezinski makes an insightful point about the nature of our stories today. In effect, he is saying that once we have begun
to comprehend the world around us, what we understand is no longer relevant. What makes Professor Brzezinski’s
comment even more profound was that he wrote this in 1993, before the advent of the internet and the rise of China.
9 Peter Bevelin, Seeking Wisdom: From Darwin to Munger (New York: PCA Publications, 2007).
10 I recommend three other books that provide insight when thinking these issues: Geoff Colvin’s Talent is Overrated;
Michael Mauboussin’s Think Twice; and Josh Waitzkin’s The Art of Learning.
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attentive to our own biases and deceptions, focus on process, attempt to understand why we erred,
and engage in deliberate practice and self‐observation to improve our decision making ability, we
will not only minimize our errors, but also ultimately become better people and better investors.
That is our story.
Third Quarter 2010 Results
Set forth below are our results through September 30, 2010 and a brief discussion of selected
positions that impacted the portfolio during the quarter.
Third Point
Offshore Fund S&P 500 CS Event Driven
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Third Point began accumulating a stake in the company’s preference shares almost a year ago when
they traded at <6x 2010 PE, according to our forecasts. At the time, the distressed multiple was due
to the company’s extensive financial leverage and the highly levered and distressed holding
company, Lavena, which was owned by a private equity consortium and held the majority of the
company’s voting stock. At the height of the buyout boom in 2007, when the share price was ~€29,
the private equity firms raised a substantial amount of debt at Lavena to leverage their stake in
ProSieben. In 2009, as the stock price fell sharply due to concerns over the operating company’s
high leverage and expectations of a significant decline in earnings, the loan to value at Lavena began
to rise precipitously. These worries caused the stock of ProSieben, the Operating Company, to trade
as low as €1.
Our diligence suggested that the vicious circle which caused the stock to fall could be reversed into
a virtuous one as our analysis suggested that a) the fundamentals of the business coming out of
2009 were improving and earnings had troughed, b) as credit investors, we understood the Lavena
loan document to be covenant‐lite and also believed the private equity firms were committed to the
investment, and c) the shares were orphaned by equity investors who couldn’t understand the
credit angle and ignored by credit investors who were restricted from buying the equity. This led
us to accumulate not only a position in the preference shares at €7, but also in the senior portion of
the Lavena Holding Company loan at €0.55 cents. Today ProSieben preference shares trade at
~€20 and the senior loan trades at €0.82 cents. We believe there is still equity upside from the
price today as the multiple rerating has been to 10x PE only, still cheap for an asset of this type and
quality.
Absolute Return Award and Acceptance Statement
On November 18th, industry trade publication AR Magazine held its annual award ceremony
recognizing hedge fund managers who produced the best risk‐adjusted returns over the last 12
months with strong Sharpe ratios. Third Point received the award for event driven fund of the year.
I provided the following statement, which was read on our behalf:
I am honored to accept this award from AR on behalf of the Third Point team. While we are proud of
our results, we take greater satisfaction in our hard work and the development of a winning
investment philosophy, framework and process that led to the returns. Our 2009 and 2010
performance was generated by a team effort to find and implement original ideas in long/short and
event driven equities, distressed and performing corporate credit, and mortgage securities.
Our entire team, from the analysts to the business professionals, is focused on a single goal – meeting
the needs of our investors both in terms of returns and client service.
While the investment team drives results and implements the investment process, we would not be
here without the support of our top notch operations team spanning accounting, operations, legal and
compliance, risk management and technology. In addition, we are further grateful for the support of
our financial counterparties, and our investors who have taken the time to understand and become
comfortable with our idiosyncratic style.
We congratulate the other nominees in this category for an excellent year, and thank you again for
this honor.
Quarterly Investor Webcast and Conference Call
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We presented our Quarterly Performance Review and Business Update via webcast and conference
call on October 20th, 2010. Thank you to all who participated either live or by accessing the replay.
Please contact Investor Relations if you would like a copy of the slides that accompanied the
presentation
Reminder: Investor Year in Review and Due Diligence Presentations
Our annual Investor Day will be held on Wednesday, January 19th 2011. We are introducing
something new this year in the interest of increasing transparency. On the 19th, we will hold a Due
Diligence Presentation beginning in the late morning and continuing through a light lunch at the
New York Athletic Club, at which our COO, CFO and CAO will cover key issues in Finance,
Operations, Technology and Compliance. Our traditional evening presentation will review
performance in 2010, and provide our outlook for 2011. The evening presentation will be held at
the Museum of Modern Art, and will be followed by a reception. You will receive your invitations
this week.
Please feel free to contact us with questions or thoughts.
Sincerely,
Daniel S. Loeb
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The performance data presented represents that of Third Point Offshore Fund Ltd. All P&L or performance results are
based on the net asset value of fee‐paying investors only and are presented net of management fees, brokerage
commissions, administrative expenses, and accrued performance allocation, if any, and include the reinvestment of all
dividends, interest, and capital gains. The performance above represents fund‐level returns, and is not an estimate of any
specific investor’s actual performance, which may be materially different from such performance depending on numerous
factors. All performance results are estimates and should not be regarded as final until audited financial statements are
issued.
While the performances of the Funds have been compared here with the performance of a well‐known and widely
recognized index, the index has not been selected to represent an appropriate benchmark for the Funds whose holdings,
performance and volatility may differ significantly from the securities that comprise the index. Investors cannot invest
directly in an index (although one can invest in an index fund designed to closely track such index).
Past performance is not necessarily indicative of future results. All information provided herein is for informational
purposes only and should not be deemed as a recommendation to buy or sell securities. All investments involve risk
including the loss of principal. This transmission is confidential and may not be redistributed without the express written
consent of Third Point LLC and does not constitute an offer to sell or the solicitation of an offer to purchase any security
or investment product. Any such offer or solicitation may only be made by means of delivery of an approved confidential
offering memorandum.
Information provided herein, or otherwise provided with respect to a potential investment in the Funds, may constitute
non‐public information regarding Third Point Offshore Investors Limited, a feeder fund listed on the London Stock
Exchange, and accordingly dealing or trading in the shares of that fund on the basis of such information may violate
securities laws in the United Kingdom and elsewhere.
_____________________
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