(Bloomberg) -- David Einhorn’s Greenlight Capital underperformed the broader market again in the second quarter, according to a letter sent to investors.
Greenlight returned 2.8% during that period, trailing the S&P 500 Index’s 4.3% total return as the benchmark rose to record highs.
“We wonder if this is a genuine bull market,” Greenlight wrote in the letter on Tuesday, calling out a “peculiar relationship” that existed between the 20 largest stocks by market capitalization in the S&P 500 and the remaining 480 or so stocks.
“In an ‘ordinary’ bull market, a rising tide lifts all boats. Even in times when large stocks lead, smaller stocks usually also go up — just by a smaller amount,” the firm said. In the second quarter, however, this relationship “collapsed and even turned negative.”
For Greenlight, this led to a similar result as in the first quarter, when its long positions underperformed the S&P 500 and its short positions outperformed the inverse of the index.
“Ordinarily, this would indicate that we are doing a good job on our shorts and not such a good job on our longs,” Greenlight said. “However, it may just indicate that simple comparisons to the S&P 500 don’t make as much sense these days, given the outlying performance of the 20 largest stocks relative to everything else.”
Conditions have changed since then. Investors began rotating out of those large names into smaller and riskier sectors starting in mid-July. Disappointing tech earnings combined with signs that the US economy is slowing contributed to a sharp selloff this week.
During the second quarter, Greenlight exited long equity positions in Buzzi SpA, Gulfport Energy Corp., NET Power Inc. and Onex Corp., it said in the letter. The firm also exited a position in First Citizens BancShares Inc., saying the “bargain acquisition of the corpse of Silicon Valley Bank worked out well.”
In addition, Greenlight exited a short position on December SOFR futures. At the end of the quarter, the fund had an average exposure of 95% long and 52% short, the letter said.
The fund also said it is reestablishing its position in Capri Holdings Ltd. in a merger arbitrage bet that its $8.5 billion deal with Tapestry Inc. would get across the finish line despite US antitrust opposition.
In the second quarter, Greenlight Capital repurchased shares in the luxury handbag maker, which was its “only significant repurchase” for new long positions, according to its investor letter.
The proposed deal to combine the parents of Coach and Michael Kors is facing a challenge from the US Federal Trade Commission, and is scheduled to go to court in September. “Upon review of the FTC complaint and the responses from CPRI and Tapestry, we believe the challenge is likely to be defeated in court later this year,” according to Greenlight’s letter.
Capri was trading around $32.50 on Tuesday, roughly 40% below the $57-per-share takeover bid, as investors remain uncertain about deal’s outcome. Investors could get juicy returns if their wagers play out: Greenlight’s merger arbitrage bet on Black Knight last year paid off handsomely.
Greenlight acknowledged there could be significant losses if the FTC prevails, given Capri’s “dreadful results” since the deal was announced last year.
Determining the stock’s potential downside — the price it would fall to if the deal fails — has been difficult for merger arbitragers because the company’s business has deteriorated so much, part of a broader industry slowdown. An April Bloomberg survey of 20 merger-arb specialists showed respondents expected a downside price in the mid-$20s or lower.
Arb Traders See 30% Downside Risk for Capri Stock on FTC Lawsuit
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