"The broader market context is explicit to us. The S&P 500's median P/E ratio is 18 times. For most high quality companies we follow, it is much higher," Ubben wrote in the April 3 letter to clients. "These valuations can only be justified by assuming cyclically high corporate margins will persist, a certainty of lower corporate tax rates and a risk-free rate that stays near all-time lows. We are skeptical of all of the above."

The hedge fund will return $1.25 billion in capital to its limited partners starting on May 1. Ubben cited the higher-than-normal cash balances in the fund ranging from 10 percent to 29 percent since the end of 2015 versus the 5 percent average during the last decade.

"Over the remainder of 2017, we anticipate we will make more significant, partial sales of core positions and receive a $500 million dividend from Baker Hughes Incorporated upon the closing of its merger with General Electric's oil and gas division. Combined, these actions should adequately fund new investments, given the current market environment," he added.

ValueAct is known in the hedge fund industry for focusing on "good" businesses with pricing power and strong intellectual property positions, primarily with subscription or services-oriented business models.

Ubben maintained that he is sticking to that philosophy.

"While it has been more difficult than usual to find opportunities that meet our investment criteria, we have not relaxed our discipline and have been working hard," he wrote. "Our decision to return capital is largely based on our portfolio's construction over the past two years."

The firm has more than $16 billion of assets under management, according to its website.

— CNBC's David Faber contributed to this story.