(Reuters) - ValueAct Capital Management LP, the $18 billion activist hedge fund, recorded a 1.6 percent gain in the second quarter of 2015, a "difficult year" for its strategy due to falling oil prices and China's slowdown, according to a letter to its investors.
Budget cuts, a strong U.S. dollar and hiring freezes are taking a particularly heavy toll on the capital goods, aerospace, oil services, media and enterprise software companies that ValueAct invests in, according to the Aug. 24 letter seen by Reuters.
The letter was sent to ValueAct investors on the day the Dow Jones Industrial Index .DJI dropped 1,000 points, as much as 6.6 percent, before paring some of that plunge. It provided insight into ValueAct's contrarian thinking that calls for backing companies that face short-term woes but also have potential, as opposed to investing in safer companies that other investors flock to.
"We took action to position the portfolio for the long term this quarter by selling shares in our high return investments, such as Valeant and Adobe, and recycling the proceeds into building our core investments in Agrium and Twenty-First Century Fox," ValueAct said in the letter.
ValueAct's 1.6 percent gain in the quarter, though modest by its standards, was higher than the 0.2 percent rise in the S&P 500 Index .INX. For the first six months of 2015, ValueAct was up 8 percent versus a 1.2 percent rise in the S&P 500.
The impact of last month's market rout on ValueAct will be revealed in the firm's third-quarter update. ValueAct did not immediately respond to a request seeking further comment.
ValueAct, which also has investments in Microsoft Corp (MSFT.O) and Halliburton Co (HAL.N), was founded by Jeffrey Ubben in 2000 and is better known for working quietly behind the scenes with management teams of companies rather than launching the kinds of public battles and proxy fights waged by other activists.
The San Francisco-based firm's most recent stake is a 5.5 percent holding in British aerospace group Rolls-Royce Holdings Plc (RR.L). The letter laid out ValueAct's investment thesis, which stated that Rolls-Royce's civil aerospace business may be weighing on the company but has substantial long-term value.
"Our core new investment (in Rolls-Royce) epitomizes a company taking maximum short-term pain, delivering an increasing number of engines at a loss, while putting in place an aftermarket revenue stream that should yield tremendous cash and profits over twenty years," the letter states.
ValueAct is less excited about the company's non-aerospace business, which includes a nuclear division and the manufacturing of engines for land, sea and rail. The letter gave a strong hint that ValueAct would encourage the sale of this business.
"We do not model much recovery in the non-aerospace business, but believe there is portfolio value for the assets," the letter said.
ValueAct has been credited with sparking huge changes at large companies, including chief executive changes, board shake-ups and outright sales of companies it invests in.
In the letter, ValueAct said it is "very comfortable" with Twenty-First Century Fox (FOXA.O) CEO James Murdoch, who took over from his father, Rupert, on July 1, though it did cite the leadership transition as causing uncertainty among investors.
It also pointed to Fox's low stock price and said it should be a catalyst for fundamental change and could free up Murdoch from defending earnings every quarter.
"It may make sense for Fox to 'pull an Adobe'," ValueAct said, without offering more detail on what this could entail.
BlackRock Inc (BLK.N) CEO Larry Fink will attend ValueAct's investor conference on Sept. 10, the letter said, and will discuss activism at the event.
Fink, who runs the world's largest asset management firm, has been critical of activist investors, saying that their efforts to push companies to embark on stock buy backs and asset sales is sacrificing long-term strategy and spending plans for a short-term stock bump.
Reporting by Michael Flaherty in New York; Editing by Meredith Mazzilli