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The New Year: A look back and a look ahead

January 2, 2013

About this time every year almost every investment blog tends to expound on how well their ‘picks’ did last year (assuming they did well), or how well their model portfolio performed against some appropriate benchmark. Sorry, readers, I’m not going that route. I will say that my own ‘value’ portfolio, mostly comprised of the stocks mentioned on this blog,  was up about 20% last year, or slightly better than the S&P Total Return index, but I’m not proud of it; I should be doing better. So I’m going to dedicate my attention to what I’m doing wrong.

First, let’s review why I should be doing better than the indexes. I’m a relatively small private investor so I theoretically have a number of advantages over most of the professional portfolio managers out there. I have permanent capital, i.e. I don’t have to worry about maintaining liquidity for clients who want their money back at exactly the worst time. I can keep a large portion of my portfolio in cash without clients wondering why they are paying me to manage their money. I have a relatively small amount of assets under management and thus have minimal problems with entering and exiting a position, plus I have a larger potential universe of securities to invest in because I can create a meaningful position in all but the smallest microcaps.  I have infinite flexibility to change my investment strategy on a dime, unconstrained by securities regulations or other concerns. And there are others. Of course there are also downsides to being a small private investor, such as higher transaction costs and limited research capabilities. All in all, however, I think the benefits far outweigh the downside. So I should, by all rights, be able to ‘beat the averages’ handily, however they be designated. The threshold is high, but it should be; after all its my own money I’m investing.

So with that perspective, my slight outperformance last year doesn’t seem so good does it? What’s wrong, then, with my selections or my methods? A quick look at my portfolio holdings brings an initial response. I’ve listed some of my advantages as a small private investor above. Those represent my edge over other portfolio managers. So am I making best use of my edge? Do all my positions reflect this edge? Unfortunately no. Look at my largest position, AIG; what’s my edge there? Yes, I know the company is still being shunned by many institutional investors because many of them were burned during the financial crisis of 2008 when the Treasury took a majority equity position during the bailout. Shares are still trading at less than 60% of book value, just the kind of investment I like. But I’ve got a lot of ‘company’ in the shares now. The Treasury sold its last equity interest in AIG last month (though they still own some warrants) so there are 1.5 billion shares in private hands. Hardly a narrowly held security. I don’t think my ‘size’ edge is very great here. The only thing I might be able to claim is I was in early (May 2011) when the stink factor was relatively high. But it seems to me that ‘stink factor’ is quickly wearing off and in the next six to twelve months it might be gone completely. I’m anticipating an exit sometime during that period, hopefully at 80% or 90% of book value. If the shares don’t respond as I’m predicting, I’ll be out anyway before my minimal edge completely disappears. My next largest position is Bank of America warrants. Bank of America is hardly a microcap. Yes, again I was in early (too early) when the stink factor was high, and at this juncture I have a positive return. But it has been a rollercoaster ride, and I can’t say that I took advantage of last year’s lows (12 months ago) when I should have. This was really an execution issue. This is a long term holding and I’d find it difficult to exit at this point. But I’m considering cutting back my position somewhat if the warrant price runs up substantially this year. So, in sum, my largest two positions don’t take advantage of my greatest edge, small size. My goal next year is to address this.

So my New Year’s resolution this year (like it was the last couple of years) is to be more disciplined. I want to define my ‘edge’ with each new investment. No,even more important, I want to justify each existing position with regards to my ‘edge’ and have the fortitude to make adjustments to my portfolio where appropriate. I’m going to be looking more at the microcap space and special situations.

  1. jonas permalink

    congrats on beating the s&p. it looks like you beat by alot in previous years – congrats on that also. i am looking into splp as it continues to head down. the vic writeup suggests an 18% illiquidity discount on top of any discount related to the 15% of ev stock purchase discount for management. do you agree that the illiquidity discount should be that high? i agree that on some of these stocks like gy, fair value is almost triple the market value. where do you think splp sits after factoring intrinsic value of the public stocks overall? this is an interesting opportunity to say the least given lichtenstein’s great record minus the drawdown in the crash which is offset by the complexity/lichtenstein’s self-rewarding behavior.

  2. Whether one should apply an illiquidity discount at all when valuing SPLP depends on what you think the endgame is for the LP. Is Lichtenstein going to try and take the partnership private with some kind of creeping takeunder? Based on what he did last April, taking the deferred management fee in SPLP units (though at a 15% ‘illiquidity’ discount), this is a real possibility. If this is his plan, he will do everything possible to keep the discount as high as possible as long as possible so that the cost of his final take out is as low as possible. On the other hand, he may just want to keep the LP as a permanent source of capital (and management fees). If this is the case, he may not care too much about market pricing of the units, as management fees are based on underlieing asset value, not market prices. I kind of get the feeling that he has no set plan but will act opportunisticly; if he can buy some, or even the all, the outstanding limited partnership interests back at a big enough discount he might just do it.

    It appears to me that over the past year progress has been made toward rationalizing the partnership’s underlieing assets, thus improving the visibility into their true value. I don’t think the market price of the units is reflecting this. During the past 3 or 4 trading days the units have sold off 5% or more just when the overall market was rallying (including shares in owned companies). This doesn’t make much sense from an investor’s point of view; the value of the holdings increase, but the holdco market value decreases! There must be something else at work here. Perhaps some long-term investors are just capitulating, tired of this ongoing saga, and want out. That, to me, smells of a good deal. I’m always looking for situations where sellers are selling for non-economic reasons.

    And, yes, I’m considering adding to my position if the unit price falls further.

  3. jonas permalink

    thanks for the response. my guess is that he might be manipulating it for trading profits. who knows. given efforts to increase transparency, my theory is no takeunder. i bought a little bit on friday around 11.80. wish i had bought at 11.51! so it goes. i believe this generates a k-1 – not as familiar with k-1’s. any idea if there are many gains or losses carried over going forward for tax time next year? thanks in advance! fantastic blog by the way.

    • Jonas,
      Thanks for the comment. I don’t think WL or related parties are trading in SPLP units as I haven’t seen any SEC filings. My guess is we may see something like the dutch auction for DTGC.

      Since SPLP units represent an interest in a limited partnership, unitholders receive a K-1 after the conclusion of the partnership’s fiscal year showing interest in gains and losses for tax purposes. This means a unitholder may be asked to pay taxes on partnership gains that are not passed through in the form of distributions. Furthermore, K-1s require additional bookkeeping for investors and, unfortunately, SPLP management has already stated that they will not be providing the K-1s to unitholders in timely fashion, i.e. in time to file taxes by the annual filing deadline, April 15, so its estimated taxes for all those who ventured to purchase the units last year. Just another little way of making investing in these things a bit more unattractive. I didn’t own SPLP units until last Spring so I don’t know what the K-1s looked like for 2011. I’ll be quite interested to see what they look like for 2012.

  4. jonas permalink

    on another note, forgot to mention that i’m also long aig, bac (common), and rsh. got crushed on rsh, buying near 15 awhile back – yikes! one of my worst positions ever. my big losses have generally been related to turnarounds. you still holding your target at $15? i noticed sac capital increased their position considerably recently after the drop. thanks again.

  5. jonas permalink

    looks like price is popping a little on splp. i think i’ll wait for pullback versus chasing. do you use any technical indicators at all? right now, i don’t know much about the technical side of things.

  6. Tom L permalink

    Thank you for the great blog.

    I was wondering, what is your investment thesis for EBIX?

    Tom L

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