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Third Point 1Q’16 Letter – We Crowded Into Short Trades In The RMB

Third Point – Review and Outlook Volatility across asset classes and a reversal of certain trends that started last summer caught many investors flat-footed in Q1 2016. The market’s sell-off began with the Chinese government’s decision to devalue the Renminbi on August 11, 2015, and ended with the RMB’s bottom on February 15, 2016, as shown in the chart below: Click to enlarge By early this year, the consensus view that China was on the brink and investors should “brace for impact” was set in stone. In February, many market participants believed China faced a “Trilemma” which left the government with no choice but to devalue the currency if it wished to maintain economic growth and take necessary writedowns on some $25 trillion of SOE (State Owned Enterprise) debt. Based largely on this view, investors (including Third Point) crowded into short trades in the RMB, materials, and companies that were economically sensitive or exposed to Chinese growth. Making matters worse, many hedge funds remained long “FANG” stocks (Facebook, Amazon, Netflix, and Google), which had been some of 2015’s best performing securities. Further exacerbating the carnage was a huge asset rotation into market neutral strategies in late Q4. Unfortunately, many managers lost sight of the fact that low net does not mean low risk and so, when positioning reversed, market neutral became a hedge fund killing field. Finally, the Valeant (NYSE: VRX ) debacle in mid-March decimated some hedge fund portfolios and the termination of the Pfizer (NYSE: PFE ) – Allergan (NYSE: AGN ) deal in early April dealt a further blow to many other investors. The result of all of this was one of the most catastrophic periods of hedge fund performance that we can remember since the inception of this fund. When markets bottom, they don’t ring a bell but they sometimes blow a dog whistle. In mid-February, we started to believe that the Chinese government was unwilling to devalue the RMB and was instead signaling that additional fiscal stimulus was on deck (an option that the bears had ruled out). Nearly simultaneously, the dollar peaked and our analysis also led us to believe that oil had reached a bottom. We preserved capital by quickly moving to cover our trades that were linked to Chinese weakness/USD dominance in areas like commodities, cyclicals, and industrials. We flipped our corporate credit book from net short to net long by covering shorts and aggressively adding to our energy credit positions. However, we failed to get long fast enough in cyclical equities and, while we avoided losses from shorts, we largely missed the rally on the upside. Unfortunately, our concentration in long health care equities and weakness in the structured credit portfolio caused our modest losses in Q1. So where do we go from here? As most investors have been caught offsides at some or multiple points over the past eight months, the impulse to do little is understandable. We are of a contrary view that volatility is bringing excellent opportunities, some of which we discuss below. We believe that the past few months of increasing complexity are here to stay and now is a more important time than ever to employ active portfolio management to take advantage of this volatility. There is no doubt that we are in the first innings of a washout in hedge funds and certain strategies. We believe we are well-positioned to seize the opportunities borne out of this chaos and are pleased to have preserved capital through a period of vicious swings in treacherous markets. Third Point – Quarterly Results Set forth below are our results through March 31, 2016: Click to enlarge Third Point – Portfolio Positioning Equity Investments: Risk Arbitrage and Pro Forma Situations “Event-driven” and activist strategies performed poorly in 2015 and in Q1 2016. We believe that the resulting redemptions and liquidations from these strategies have helped to create today’s environment, which is one of the more interesting we have seen in many years for classic event situations like risk-arbitrage and transformative mergers. Many investors are ignoring companies in the midst of deals because catalysts are longer-dated (well into 2017) which is allowing us to buy outstanding enterprises at bargain valuations on 2017/2018 earnings. Many of these combined businesses should compound in value thanks to the benefit of synergies, modest financial leverage, and strong or improved management teams that have a history of successful capital allocation. Some of the most interesting situations are described below: Dow/DuPont We are encouraged by the latest developments in our investment in Dow (NYSE: DOW ) which announced a merger with DuPont (NYSE: DFT ) in December. In February, the company revealed that long-time CEO Andrew Liveris will be stepping aside not long after the merger’s completion. DuPont’s CEO, Ed Breen, is a proven operator and capital allocator. Breen made his mark by streamlining Tyco, a long-time industrial conglomerate, splitting the company into focused units and thus created enormous shareholder value. He brings an unbiased perspective and is not afraid to challenge the status quo, two qualities that will be essential in leading Dow/DuPont given the histories of both of these conglomerates. We continue to believe there is potential for operational improvement at Dow that would be incremental to the $3 billion announced synergy target; in aggregate, approximately $5 billion of earnings improvement could be unlocked. The merger structure preserves both companies’ strong balance sheets which, combined with fading Sadara and Gulf Coast CapEx, should allow for meaningful capital return while maintaining a strong investment grade balance sheet. Taking all of these factors into account, we believe the pro forma entity is capable of generating $5.50 – $6.00 of EPS in 2018. Given that these earnings will consist of contributions from several focused spinoffs, we also believe that multiple expansion is likely. Conglomerate structures often breed unintended consequences like misaligned incentives and suboptimal capital allocation. Going forward, segments in both companies will no longer have to compete for capital with disparate businesses. They will become liberated and empowered to create their own targets with their own incentive plans. More work needs to be done to ensure that the split results in focused, pure-play businesses, in particular because the current structure still has basic petrochemicals and specialty businesses housed together. Re-jiggering the split structure may in itself unlock incremental synergies as more specialty product businesses would benefit from being managed together. A major step forward has been achieved with the appointment of a new merge-co CEO and a strategy to split the business. Now the focus shifts toward creating the optimal split structure and ensuring the proper leadership and governance in each split entity is put into place. With the right management, structure, and a synergy target that looks conservative in light of the prospect for more sweeping change, we believe we have a compelling long-term investment in Dow/DuPont. BUD/SAB/TAP The long-awaited acquisition of SAB Miller (NYSE: SAB ) by Anheuser-Busch InBev (NYSE: BUD ) announced late last year created two interesting pro forma situations. The deal, expected to close in the second half of 2016, will combine the two largest global brewers and create an unrivaled player with strong pricing power in an increasingly consolidated global industry. It will also transform Molson Coors (NYSE: TAP ) into a stronger regional competitor following the acquisition of certain SAB assets that must be sold for anti-trust reasons. Starting with BUD, we think the stock ought to grow nicely over the next several years as the true earnings power of the new company is revealed. Part of the gains will come from improving the underlying profitability of SAB, as operational control of its assets is transferred to BUD’s highly regarded management team led by CEO Carlos Brito. Another part will come from the capture of deal-related cost and revenue synergies, as duplication is eliminated and BUD’s global brands like Budweiser, Corona, and Stella are rolled out to legacy SAB markets in Africa and Latin America. Finally, the rest should come from financial engineering as BUD’s under-levered balance sheet is monetized to help finance the transaction. We also think the new company will likely command a higher valuation as SAB’s emerging market exposure will be accretive to top line growth over time. TAP, on the other hand, stands to benefit greatly from acquiring divested assets. The company is picking up the remaining 58% share of the MillerCoors US joint venture that it does not already own, the perpetual rights to import legacy SAB global brands such as Peroni in the US, and the global rights to the Miller brand. The transaction is highly accretive for TAP given the sheer size of the acquired assets. It also gives the company full control over its most important market, something that ought to improve operational effectiveness and increase the long-term strategic value of the company to a potential acquirer as the global beer industry continues to consolidate. As is the case with BUD, we believe TAP will compound nicely over the next several years as the market more fully appreciates the earnings power and strategic optionality of the pro forma company. Time Warner Cable/Charter Communications Charter Communications (NASDAQ: CHTR ) is a domestic provider of voice, video, and high-speed data. In May 2015, Charter announced the acquisition of Time Warner Cable (NYSE: TWC ). This is a transformational deal that quadruples the company’s scale while driving substantial operating efficiencies. Importantly, the pro forma company will be led by Charter’s current CEO, Tom Rutledge, who we view as one of the best operators in the industry. New Charter is well positioned to capture market share from satellite and telco competitors given its advantaged high-speed data product. In addition, Mr. Rutledge’s track record of boosting video penetration, driving down service costs, and executing large network transformations at legacy Charter makes us optimistic about his leadership of the new entity. There are several operational benefits awaiting the New Charter. The company’s increased scale will help facilitate a continued turnaround at both Charter and Time Warner Cable and the deal also creates new revenue opportunities in business services and wireless. Additionally, Charter should have increased negotiating leverage with content providers which should deliver substantial cost savings over time. Substantial free cash flow per share growth will be driven by accelerated revenue growth, margin expansion, synergies, lower capital intensity, significant tax assets, and substantial share repurchases. As a result, we believe Charter’s share price can compound at ~25-30% over the next two years. Chubb Chubb Ltd.(NYSE: CB ) is the product of ACE Limited’s acquisition of The Chubb Corporation which closed in January. The deal combined two world-class operators that have consistently put up ~90% combined ratios – almost 900bps better than North American peers – and have compounded book value at 10%+ the past decade, more than double that of peers. The new Chubb is the largest public pure-play P and C company by underwriting income. It also has a number of factors we look for in a pro forma situation: an A+ CEO in Evan Greenberg; complementary fit across products, distribution, and geography; and a plan that is less focused on short-term cost savings than long-term strategic opportunities for growth, which are abundant. Chubb’s scale and focus on growth could not come at a better time as certain competitors scale back operations to satisfy shareholder demands. We are willing to forego short-term cost cuts or buybacks to own a franchise that is a long-term winner with the premier franchise in US high-net-worth insurance, #1 share in global professional lines, and an enviable global platform with leading A and H and personal lines in Asia and Latin America. We view Chubb as a high-quality compounder in the financials space, with double-digit earnings growth potential over the next few years. Critically, this earnings power is far less sensitive to rates and credit quality than fundamental execution. Danaher Industries Danaher (NYSE: DHR ) is a diversified multi-industrial company with an increasing exposure to life science and healthcare-oriented businesses. Operating across five different business segments and built up through over 400 acquisitions over the company’s history, the cornerstone for Danaher’s successful integration and value creation strategy has been the Danaher Business System (DBS). Adapted from Japanese principles of kaizen, DBS has evolved into a set of processes and corporate culture revolving around continuous improvement, helping to drive organic growth and annual margin improvement across Danaher’s portfolio. In May 2015, Danaher announced the acquisition of a filtration industry leader, Pall Corp. (NYSE: PLL ), as well as the subsequent split of Danaher into two companies. The split, to be effectuated Q3 2016, will highlight value at both New Danaher – a collection of Danaher’s life science, medical and lower cyclicality businesses – and the spin-off, Fortive – an industrial focused “mini-Danaher”. New Danaher, representing the large majority of post-split value, will have 60% consumables sales mix, 4% organic growth, 100bps of annual margin expansion, and > 100% FCF conversion, an algorithm that will continue the Danaher tradition of compounded earnings growth. The attractive end-market mix, earnings growth, and deep bench of DBS operators will make New Danaher a premium life sciences company that should trade at the high end of its peer group. Fortive, akin to what Danaher originally looked like two decades ago, will have greatly increased M&A optionality and the ability to deploy free cash flow into assets which have historically received less focus within the Danaher portfolio. With the same DBS roots and team of disciplined operators, Fortive will also provide a multi-year compounding opportunity. We initiated a position following the announcements last summer which mark a transformational step in Danaher’s decade-long efforts to continuously improve its portfolio of businesses. Despite Danaher’s portfolio of businesses looking more attractive than ever, its current valuation premium to the S&P 500 is modest and remains well below its ten-year historical average premium. Over the last ten years, Danaher has compounded at 2x the rate of the S&P 500. We recently added to the position after a meeting with the company reinforced our confidence not only in their operations but also in the company’s culture and importance of their values and principles in driving future success. Disclosure: None

Preferred Shares From Flaherty & Crumrine: 1 To Buy And 1 To Sell

Summary Flaherty & Crumrine is a preferred stock specialist offering five leveraged and hedged closed-end funds. There has been a strong trend of investment money moving into preferred stock CEFs as the high-yield credit market has faltered. FFC now holds a premium over 8%. Flaherty & Crumrine’s Preferred Stock CEFs There are categories of closed-end funds where I consider that a single sponsor offers a range of funds that make it the best in its class. For taxable fixed-income CEFs, my vote goes to PIMCO. Other fund sponsors offer some excellent competitors, but PIMCO’s full lineup is demonstrably the best in its category. For unleveraged equity-income CEFs, it’s hard to beat Eaton Vance’s array of option income funds. It would be hard to make a case that any other fund sponsor has the across-the-board strength in this category that Eaton Vance’s funds have. I’ve written about each of these recently ( How Safe Are The Distributions For PIMCO CEFs…? and Comparing The Option-Income CEFs From Eaton Vance ) where I give some rationale for those choices. I also have a comparable pick for preferred shares; it’s Flaherty & Crumrine. F&C offers five closed-end funds for the investor in preferred securities: Flaherty & Crumrine Dynamic Preferred & Income Fund Inc (NYSE: DFP ) Flaherty & Crumrine Preferred Securities Income Fund Inc (NYSE: FFC ) Flaherty & Crumrine Total Return Fund Inc (NYSE: FLC ) Flaherty & Crumrine Preferred Income Fund Inc (NYSE: PFD ) Flaherty & Crumrine Preferred Income Opportunity Fund Inc (NYSE: PFO ) We’ll have a look at them individually shortly, but first a few words on the category and asset class. Why Preferreds and Why CEFS? Preferred shares should be a core component of any income investor’s portfolio. They offer stable income with much less price volatility than common stock. They are, of course, interest-rate sensitive as are all income investments, but I am more concerned about volatility in common stocks than I am about volatility from interest-rate moves at this time. I fully expect the Fed will be true to its stated goal of gradual interest rate increases, and I further expect that experienced management can prosper under those circumstances. On the other hand, I am anticipating a difficult year for common stock, and those who have followed my thinking are aware that I am not usually found at the bears’ end of the spectrum. With that in mind, I continue to seek out more defensive positions in my portfolios. Thus, I consider a portfolio shift that reduces exposure to dividend-paying common shares and increases exposure to preferred stocks to be a prudent move. Note that I say “reduces,” a very different thing from “eliminates.” I will still carry a strong position in common shares, but I will also be increasing my allocation to preferreds. One can hold preferred shares in individual equities or ETFs, but it is my preference to look for exposure to this asset class in closed-end funds. It is one of the three areas where I feel CEFs offer the greatest opportunities for income-investors. Let’s explore why. Presently, the median distribution yield for the 17 CEFs that aggregator sites list for the category is 8.32%. Compare that with the two largest preferred stock ETFs, the iShares U.S. Preferred Stock ETF (NYSEARCA: PFF ) and the PowerShares Preferred ETF (NYSEARCA: PGX ); these both have a distribution yield of 5.92%. Furthermore, I suspect investors holding a portfolio of individual preferreds will be averaging something fairly close to that yield percentage as well. So if 6% is the prevailing bar for preferred stock yields, where do the CEFs find those extra two and a third points? First, they use leverage. Median leverage for the 17 CEFs is 33.58%. Notice that if we apply that 1.33x leverage factor to the ETFs’ 5.92% yields, it works out to 7.91%. While this is still under the CEFs’ median yield to their investors, it is nearly identical to the CEFs’ median yield on NAV which is 7.86%. So, it seems that the CEFs along with the ETFs and individual share holdings are all generating close to the same level of yield. The CEFs get an added kick that pushes them to even higher yields from their discounts. The median discount stands at -7.11%. This generates an additional 41bps to the market yield over the NAV yield and illustrates the importance of buying CEFs at a discount. It is the combination of leverage and discount that drives the enhanced yields for CEFs over the EFTs. Of course, leverage adds risk, primarily as a multiplier of volatility. Leverage also adds to interest-rate risk as rising rates will make leverage more costly. Why Flaherty & Crumrine? Flaherty & Crumrine has been focused on the preferred shares market for over 30 years. The firm formed in 1983 as a manager of portfolios of preferred securities for institutional investors. It introduced its first leveraged and hedged preferred securities funds in 1991. Through its experience in the preferred securities markets, Flaherty & Crumrine has developed expertise to implement portfolio- and interest-rate management strategies to obtain consistently high levels of sustainable income. This expertise is key to functioning effectively in what the firm describes as a ” wonderfully inefficient market .” When appropriate, the F&C funds employ hedging strategies designed to moderate interest-rate risk. These are designed to increase in value when long-term interest rates rise significantly, from either a rise in yields of Treasury securities or interest-rate swap yields. In general these are used when interest rates are expected to rise. From the current literature I reviewed, it is unclear the extent to which these hedging strategies are currently employed. The Funds Each of the five funds is leveraged near 33%, which is consistent with the category. Each is invested in at least 93% preferred stocks. All but DFP are wholly domestic; DFP is 77.2% domestic with the remainder of the portfolio holding positions from U.K., Bermuda, Western Europe and Australia. F&C’s funds tend to be more tax efficient than many other preferred shares CEFs. For the 2014 tax year qualified dividend income ranged from about 62 to 70% of total distributions. (click to enlarge) I have not reviewed the category for this metric, which is significant in a taxable account, but previous analyses showed other sponsors’ funds with levels of QDI generally under 50% reflecting, in part, greater exposures to REIT preferreds. Portfolios Portfolio compositions are quite similar among them. Each is most heavily invested in financials (ex. REITs) which comprise greater than three-quarters of their portfolios in a roughly 2:1 ratio for banks:insurance. (click to enlarge) PFD and PFO do not list energy or REITs separately; instead they are lumped into “other” sectors. A cursory perusal of the published portfolios indicates a significant fraction of “other” does include energy, but I have not attempted to sort out actual percentages. DFP has the largest energy holdings of the other three funds. Utilities comprise about a ninth of the portfolios of FFC, FLC, PFD and PFO, but only 2.76% of DFP’s holdings. Performance Total return for one year is shown in the next chart. (click to enlarge) And, for the past 3 months: (click to enlarge) As we can see here, there has been a strong flow into the preferred shares funds over the past quarter driving price up relative to NAV. As a consequence, discounts have shrunk and in the case of FFC, valuation has grown to a premium. (click to enlarge) The rising prices relative to NAV for the funds is shown in the 3, 6 and 12 month Z-scores which are positive except for PFD and PFO 12 month values. (click to enlarge) The discounts and Z-scores show that bargain hunters will find little to take advantage of at this time. This has been a trend across the preferred shares category which has median Z-Scores of 0.89, 1.31 and 0.14 for 3, 6 and 12 months, respectively. The shrinking discounts mean that distribution yields are somewhat lower than when I last looked at preferred CEFs in early autumn. Distributions range from 8.06 to 8.5%, in line with the category median of 8.32%. (click to enlarge) Conclusions FFC has been a favorite of mine in the recent past and it is a fund I have held for some time, adding to my position as recently as last September. But at this time its 8% premium makes it an unattractive purchase. Indeed, anyone holding the fund may want to consider trading out of it to capture that premium which I suspect is near a peak value. This is what I have done. FLC is, in my view, the most attractive of the remaining funds. It has a distribution yield better than the category median. Its -4.0% discount is less favorable than the category median of -7.1% but is the deepest discount of the fully domestic F&C funds. Total return on NAV for the past year is stronger than FFC, even as FFC’s growing premium has driving its return on market price appreciably higher. And the exposure to energy preferreds is the lowest of the three funds where that is explicitly listed. DFP, with the same yield and a deeper discount is less appealing to me. The relatively high level of energy-sector preferreds is potentially problematic for one thing. In addition, there has been a stronger trend to discount reduction relative to FLC. If one is attracted to international exposure in preferred stock CEFs, it might be worthwhile to look more closely at the First Trust Intermediate Duration Preferred & Income Fund (NYSE: FPF ) rather than DFP. Preferred shares look increasingly to present a timely alternative to the troubled high-yield credit market for income investors. Flaherty & Crumrine offers the preferred shares investor nearly three decades of experience and five funds with strong long-term records. The firm uses hedging strategies to moderate interest-rate risk, potentially an important approach in the coming year. Money flow has been moving out of high-yield bond funds; it seems that some of that flow has been moving into preferred share funds. This has meant discount reductions for the category and, in some case, such as for FFC, premiums to NAV. One might want to take advantage of the rising valuations and trade out of fund like FFC which is unlikely to sustain its premium valuation, while retaining a position in F&C’s hedged and leveraged preferred share funds by opening a position in FLC instead. While I do, as stated, like F&C in the preferred shares CEF arena, there are other funds that should be competitive. I shall be looking at a few of those shortly.

ETF Update: 5 New Funds To Be Thankful For

Summary Every week, Seeking Alpha aggregates ETF updates in an effort to alert readers and contributors to changes in the market. There were 5 ETF launches over the last 2 weeks, a slowdown from the 17 launches in the first half of November. Have a view on something that’s coming up or a new fund? Submit an article. Welcome back to the SA ETF Update. My goal is to keep Seeking Alpha readers up to date on the ETF universe and to gain some visibility, both for the ETF community, and for me as its editor (so users know who to approach with issues, article ideas, to become a contributor, etc.). Every weekend, or every other weekend (depending on the reader response and submission volumes), we will highlight fund launches and closures for the week, as well as any news items that could impact ETF investors. I hope all my American readers had a delicious Thanksgiving and a great holiday weekend. Mine is always a great event with +20 family members converging upon Chicago (I’m still celebrating the fantastic Bears/Packers upset from Thursday). However, every Thanksgiving since the beginning of my career has inevitable involved the following vague question: “So, what do you think of the market?” My solution last year was to sign questioners up for Seeking Alpha’s Wall Street Breakfast , and I must say the conversations about the economy were much more rewarding this time around. Now if only we could skip “so, who are you voting for in 2016?” Always my cue to get seconds of sweet potatoes. Fund launches for the week of November 16th, 2015 Fund launches for the week of November 23rd, 2015 Deutsche Bank (NYSE: DB ) launches a pair of multifactor smart-beta ETFs (11/24): The Deutsche X-trackers FTSE Developed ex US Enhanced Beta ETF (NYSE: DEEF ) and the Deutsche X-trackers Russell 1000 Enhanced Beta ETF (NYSE: DEUS ) track benchmarks derived from their indexes, but with a smart beta twist. According to the press release , “both FTSE Russell Comprehensive Factor indexes weight each stock within their respective underlying benchmark based on five academically-proven characteristics that influence the risk and performance of stocks: Value, Quality, Momentum, Volatility and Size.” FlexShares rolls out a fund of funds ETF (11/24): Northern Trust’s (NASDAQ: NTRS ) FlexShares Real Assets Allocation Index Fund (NASDAQ: ASET ) seeks to achieve optimal exposure to the three underlying ETFs while limiting volatility by investing in three FlexShares ETFs. This are the FlexShares Morningstar Global Upstream Natural Resources Index ETF (NYSEARCA: GUNR ), the FlexShares STOXX Global Broad Infrastructure Index ETF (NYSEARCA: NFRA ) and the FlexShares Global Quality Real Estate Index ETF (NYSEARCA: GQRE ). According to its homepage, the fund will “provide investors with a core real assets allocation that helps address their inflation-hedging, diversification, and income needs.” There were no fund closures for the weeks of November 16th and 23rd, 2015 Have any other questions on ETFs or ETNs? Please comment below and I will try to clear things up. As an author and editor I have found that constructive feedback is the best way to grow. What you would like to see discussed in the future? How can I improve this series to meet reader needs? Please share your thoughts on this first edition of the ETF Update series in the comments section below. Have a view on something that’s coming up or a new fund? Submit an article.