Merrill's Charles Clough picks HealthSouth
Hospital Chains
================
Healthsouth, Tenet Healthcare, Humana
"Shortages of anything pique my interest,"
Clough says of current capacity constraints in the hospital business.
TA
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February 12, 2001
Barron's Features
The Best Revenge
For Chuck Clough, it's a 17% Return
By RICHARD KARP
Until a year ago, Charles "Chuck" Clough was Merrill Lynch's chief
investment strategist. Although he correctly predicted the bond market's
revival in the late 1990s, Clough was perceived as too bearish about the
raging bull market in stocks. So, at the end of 1999, whether amicably or
otherwise, Merrill and Clough parted company, and Clough repaired to his
home in Boston.
It didn't take long for this veteran market-watcher to regroup, however, and
on March 1 of last year he founded Clough Capital Partners. A "closed"
hedge fund established to manage his own money and that of a handful of
friends and associates, Clough Capital now boasts about $150 million in
assets. Given the financial results of this 11-month-old endeavor, many
investors might wish the fund were open to the general public as well.
From inception on March 1, 2000, through February 6 of this year, the fund
returned about 17%, net of fees and costs. During that same stretch, the S&P
500 Index declined about 2% and the Nasdaq Composite fell 44%. The
300-fund hedge-fund index of New York's Hennessee Group, a Manhattan
advisory firm, rose only 3% or so.
How did Clough do it? According to Charles Gradante, Hennessee's
managing principal, Clough's investment strategy has been "in keeping with
his bearish past." A value investor, he avoided the highflyers that ultimately
came back to earth last year, while embracing many downtrodden Old
Economy issues that suddenly found themselves back in vogue.
Table: Theme Paper1
Clough himself seems a little uncomfortable with the bear label. "The best
way to describe us is theme investors," he says. "We go long or short on an
industry's likely future scenario. Right now, 32% of our portfolio is invested
in energy stocks. And we invest in themes globally. I can buy-or short-a
Chinese energy company as well as a U.S. energy company."
Clough believes the boom in the late 'Nineties in new technologies-and
new-technology stocks-came "too soon," as the Federal Reserve flooded the
banking system with liquidity. That, in turn, created a capital-spending
bonanza, and raised investors' expectations for accelerated returns. Clough
Capital currently is 110% long and 25% short, with a "net exposure" to
equities of 85%.
The former Merrill strategist is optimistic about the opportunities in Asian
tech shares, and the firm has been bargain-hunting in economically
downtrodden Asian markets. " We are playing some of the advances in Asia,
such as flat-screen technology, which will be important in wireless
communications," he says.
In particular, Clough likes Sony and Indonesia's P.T. Pasifik Satelit. He
regards Taiwan and Korea as two of the most undervalued markets in Asia,
and points to "some great companies" in each. "We are looking out two
years for a recovery in Taiwan and Korea," he says.
This isn't a universal view. "These countries have not bounced back as much
as expected, either in the financial services or technology sectors," says
Peter Gallo, New York bureau chief for HedgeWorld, a hedge-fund tracker.
"U.S. hedge funds that have invested in Asia have not done well."
Hennessee's Gradante is more supportive. "I think Clough is right about
Asia, and I agree with his strategy-but for slightly different reasons," he
says. "Asia is a technology play combined with an energy play. I believe oil
prices will come down, and technology companies in Asia will benefit from
lower energy costs."
Clough Capital's largest position is in natural gas, although the fund has
invested in a welter of energy issues. Current favorites include Pioneer
Natural Resources, 3TEC Energy and Chesapeake Energy, as well as
Magnum Hunter Resources and Canadian producer Rio Alto Exploration.
Clough also likes a handful of oil-services concerns, including Transocean
Sedco Forex, Noble Drilling and Universal Compression. "Many
exploration and production companies are selling at only two or three times
cash flow because people think gas prices will fall," he says.
But there has been a dramatic slowdown in investment in natural gas, with
virtually no development of new fields in recent years. The number of gas
rigs might be up 50%, but gas supplies have increased by a mere 5%.
Clough believes the disconnect will draw more investors into the stocks of
gas producers, and that "these companies will not sell at two to three times
cash flow for very long."
Indeed, he says, "shortages of anything pique my interest," which helps
explain his investment in three hospital chains -- HealthSouth, Tenet
Healthcare and Humana. The industry has endured years of hospital
closures, bed shortages and tightening capacity, Clough observes.
Clough has also been buying insurance stocks, which as a group have
advanced to average price/earnings multiples in the low-teens from last
spring's "extremely cheap" P/E ratios below 10. Among his favorites are
Torchmark, Allmerica Financial and annuities specialist Protective Life. As
a result of runaway back-office costs, the industry is ripe for consolidation,
he maintains. In addition, it's likely to be a major beneficiary of falling
interest rates. The prospect of lower rates also has driven Clough to invest
approximately 14% of the firm's assets in long-term Treasury bonds.
Perhaps nothing better characterizes Clough's Old Economy bent than his
current holdings in cyclical stocks such as Canadian Pacific, Fluor and Tetra
Technologies. He also likes FlowServe, a maker of oil and gas pipes and
pumps, and Celanese, the German chemical and pulp and paper company.
"These stocks have been coming down in anticipation of a recession, but we
think they have gotten too cheap, and will hold their own, especially if the
Fed eases," he says.
According to HedgeWorld's Gallo, Clough's strategy reflects a generally
renewed interest in value investing as Internet fever subsides. "It's not
unusual to have a hedge-fund strategy that exploits cyclicals when the
glamour stocks fade," Gallo comments.
As for those erstwhile glamour stocks, Clough believes further declines
could be in store. In addition, he's extremely bearish on banks, which he
believes are attempting to paper over increasingly high loan-delinquency
rates by lending even more money and taking on greater risk. He's especially
down on sub-prime lenders such as Providian Financial and Capital One
Financial. "Consumer loans are the real-estate loans of this cycle," Clough
says. "The banks are overloaded in the consumer area, and their books will
be hit."
Clough also is shorting virtually all the publicly held employment-agency
stocks, because of an expected economic slowdown. And he maintains some
short positions in tech and telecom issues, including Nvidia; VeriSign,
which sells and verifies dot.com addresses; Inforte, an e-business services
provider, and Time Warner Telecom. Clough has trimmed his short
positions in some other Internet stocks that have declined substantially,
including Amazon.com. But in a telling echo of his days as a strategist, he
remains bearish on other richly valued technology stocks, including Siebel
Systems and Level 3 Communications, as well as the socalled Internet
incubators that invest in other dot.coms.
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FEBRUARY 12, 2001
Theme Paper
In his first 11 months as a hedge-fund manager, Chuck Clough produced a
17% return, net of fees and costs, for investors. Clough describes himself as
a theme investor; the list below groups the firm's largest long and short
positions by theme.
Picks...
Natural Gas
Pioneer Natural Resources, Chesapeake Energy, Transocean Sedco Forex,
Noble Drilling, Universal Compression, Magnum Hunter, Rio Alto
Exploration, 3TEC Energy
"Many exploration and production companies are selling at only 2-3 times
cash flow."
Hospital Chains
Healthsouth, Tenet Healthcare, Humana
"Shortages of anything pique my interest,"
Clough says of current capacity constraints in the hospital business.
Insurance
Torchmark, Allmerica, Protective Life
"The industry is likely to be a major beneficiary of falling interest rates."
Old Economy
Canadian Pacific, Fluor, Tetra Technologies, FlowServe, Celanese
"These stocks have been coming down in anticipation of a recession, but
they have gotten too cheap."
Asian Technology
Sony, PT Pasifika Satellite
"The Japanese domestic economy is turning up and that will help technology
stocks."
...And Pans
Sub-Prime Lenders
Providian, Capital One
"Consumer loans are the real-estate loans of this cycle."
Technology
Nvidia, VeriSign, Inforte, Time Warner Telecom, Siebel Systems,
Metricom, Level 3 Communications
"Further declines could be in store for high-tech issues that have not yet
discounted a recession."
Employment Agencies
Korn/Ferry, Robert Half, Paychex
Clough expects a slowdown in employment.
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