Exclusive: ValueAct invests $800 million in financial stocks in second quarter - letter

By Svea Herbst-Bayliss

BOSTON (Reuters) - Activist hedge fund ValueAct Capital Management boosted investments in financial stocks by more than $800 million during the second quarter, citing attractive risk-adjusted values of big banks, according to a client letter viewed by Reuters.

Financial companies, including Citigroup Inc (NYSE: C) and Morgan Stanley (NYSE: MS), now make up 35 percent of ValueAct's portfolio and additional investment could follow, the firm said.

"The large money center banks are safer investments than they have ever been in our lifetimes," the letter said, calling bank stocks "irrationally cheap."

If bank stocks fall during a correction in the near term, it would be a "golden opportunity" to invest more, ValueAct said.

A ValueAct spokeswoman declined to comment.

Since the 2007-2009 financial crisis, big U.S. banks have padded their balance sheets with increased capital and reduced leverage. They also have had to comply with a sweeping set of rules intended to make the system sounder.

The top 35 U.S. banks alone have added about $800 billion in common equity capital since the start of 2009, according to the Federal Reserve.

ValueAct announced in May that it had made a roughly $1.2 billion bet on Citigroup, citing the bank's low risk and reliable revenue as attractive.

The San Francisco-based firm also has investments in card services provider Alliance Data Systems Corp (NYSE: ADS), student loan company SLM Corp (NASDAQ: SLM) and Morgan Stanley, in which it disclosed a roughly $1.1 billion stake exactly two years ago.

ValueAct raised its stake in Citigroup by 55 percent and owned 25.2 million common shares at the end of June, according to a filing with the U.S. Securities and Exchange Commission on Tuesday. The firm also bought 30.2 million shares of SLM, the parent company of Sallie Mae, the regulatory filing shows.

ValueAct generated a 7.6 percent return in the first six months of the year, according to its letter, handily beating the average hedge fund's 0.79 percent return.

ValueAct, which manages $16 billion in client funds, tries to distinguish itself from other activist investors by staying behind the scenes at companies whose shares it owns.

It can take years for its investments to work out, though they often do: ValueAct has returned a net 14.8 percent, on average, per year over its 18-year lifetime.

Its second-quarter gains of 6 percent were fueled by media company Twenty-First Century Fox Inc (NASDAQ: FOXA), British engine maker Rolls-Royce Holdings PLC (NYSE: RR) and private equity giant KKR & Co Inc (NYSE: KKR).

ValueAct also wrote in greater detail about two foreign investments: U.K. company Merlin Entertainment , which owns Legoland, and Japanese medical equipment and camera maker Olympus Corp <7733.T>.

Olympus is far less expensive than peers like Medtronic PLC (NYSE: MDT), Boston Scientific Corp (NYSE: BSX) and Stryker Corp (NYSE: SYK), ValueAct said, noting that it is still recognized as a camera-maker rather than a producer a range of products, including medical devices.

(Reporting by Svea Herbst-Bayliss; Editing by Lauren Tara LaCapra and Dan Grebler)

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