What I did wrong in 2012

It’s easy to look at how one’s portfolio has performed over the past year, compare it to a benchmark, and say, “Yeah, I beat my benchmark by…” you fill in the blank (a whopping big number, a slim figure or, Ouch, not at all). But don’t just leave it there, ESPECIALLY IF YOU BEAT YOUR BENCHMARK. That’s right. Even if last year was a winner I bet in retrospect you had some bad trade, you some missed fabulous opportunity or there was SOMETHING that you could have done better. If not, STOP HERE. Don’t read any further. You don’t need this blog. In fact, you don’t need any blog about investing because YOUR SHOULDN’T BE INVESTING!

So for the rest of us that take investing seriously, let’s dive in. Rather than examine what you did right (enough patting yourself on the back) you can learn a lot more by dissecting your mistakes and trying to understand what led you to make them so that just maybe you won’t make them again.  I’ve been putting this post off for a while. It’s really never pleasant to consider your mistakes and see what a real bone-head you (or, in this case, me) have been. But it’s an excellent exercise that improves your investing skills.
So let’s start by taking a look at some of our trades last year:

I. Positions sold:

ITT spinoffs ITT and Xylem:

• ITT was sold at $22.53 in February and traded year-end at $23.46 for a gain of 4.1% while the S&P was up 6.2% over the same timeframe. Thus, not a bad trade as the overall market performed better than these particular shares.
• Xylem was sold at $27.07 and traded at year-end at $27.10 for a gain of less than 0.1% while the S&P was up 6.2% over the same timeframe. Again not a bad trade.

Gravity Ltd: We sold 50% of our position in Gravity in mid-February for about $3.00 per share and the remaining 50% in mid March for $3.47 per share (the absolute high last year… what luck!). Shares ended 2012 at $1.33. You don’t need percentages to know that we did OK on that trade. But we re-established a small position in May and increased it in August for an average cost of $1.70 per share. So the sell call was good but we were way too early on re-establishing a position. Forgot the key word ‘PATIENCE’.

Premier Exhibitions: Sold 3/4 of our position at the end of March/beginning of April for $3.48 per share and the remaining 1/4 in mid-June for $2.69. The shares ended the year at $2.71. Again we don’t need percentages to say this was a good call. What we can criticize here, though, is why the whole position wasn’t sold at the end of March. Was there a little greed going on here? Did we really think the auction of Titanic assets was going to result in a windfall? Shudda known!

Level 3: Sold our position in mid-April at $25.03. At year-end shares traded at $23.11 for decline of 7.7% while the S&P was up over that period by about 3%. Again not a bad call.

Contango Oil and Gas: Sold position in mid April at $55.27. At year-end shares were trading at $42.36 (after a $2 special dividend in December). Again, no need for percentages here; this was a well-called trade. The original thesis had played out, but the effects of the drop in natural gas prices had to a large extent offset the rebound from the hit shares took when gas properties were revalued down in June 2011.

MFC Industrial: Here’s were we get to the bad stuff. We sold 13% of the position in April and 22% in August at prices ranging from $7.60 to $8.57. At year-end shares were trading at $8.50 but have since traded as high as $10.00. The first sale was made before the Compton Petroleum acquisition was announced so we couldn’t really have foreseen that. The second, however, was after. I even wrote a post where I stated that we would be selling the entire position at $9.50. Well, as I said before, the share price hit $10 last month, shares now trade in the high $9s and we still have 65% of the original position. In retrospect, the sale of 1/3 of the MIL position was ‘a bad trade’. The original investment thesis was a ‘jockey bet’ on Michael Smith (and it didn’t hurt that the shares were trading near cash value), but, like an impatient child, we didn’t wait for the investment thesis to play out. Has the lesson been learned? Not likely, but inertia helped us here, and we will continue to hold the remaining shares until we see how the Compton acquisition fully plays out.

Gramercy Capital: Another bad one. We sold 28% of the position in February and the remainder in September, for an average price of $2.78. At year-end shares traded at $2.94 but have since traded up to the $3.70 level with the sale of the company’s financing arm (the CDOs). I don’t believe there is that much upside in the common anymore but wish we had waited it out. Also, in retrospect, a purchase of the preferreds when we first bought the common wouldn’t have been a bad investment.

Howard Hughes Corp.: Sold at $68.57 in mid-September. At year-end shares were trading for  $73.02. During this period the share price was up 6% while the S&P 500 index was down 2%. Clearly this was a bad time to exit, and, in retrospect, wish we had held on to the position. We have shares of HHC on the ‘wish list’ and would be delighted to build a position again in the low $50s.

Myrexis: Shares were sold at $2.78 in December to capture the tax loss, as it looked like liquidation value was around this level +-3%. Fast forward to January and the company announces the initial liquidation payment will be higher, $2.86, AND the company will remain in business. We left at least $.20 (7%) on the table in our haste to get the tax loss last year. We wouldn’t make this choice again. Lesson learned (I hope)!

Aberdeen International: Last but not least. A very small position that was purchased at the end of March and sold in December. Purchased at $0.594 and sold at $.32, the shares declined 56%. This was the largest blunder in terms of percentage loss last year but, because of size, it had no real impact on the overall portfolio return. It’s a lesson we will not quickly forget: Don’t purchase shares with dubious management even if they are trading at a substantial discount to IV. Management will find a way to depreciate the IV before the market reduces any discount between IV and market price.

II. Positions purchased

OK. Now let’s look at what was purchased (and not sold). Did we make any egregious blunder here? Looks like it.

Fortress Paper: Though the investment thesis hasn’t had time to pan out yet, we clearly bought this too early. At the beginning of 2012 shares traded at around $26, then climbed to almost $40 in February before gradually descending to around $7 per share in early November. Since then shares have backed up to the $8-10 range. We began buying in the $24 range in May, added some more in the $14 range in the August/September timeframe and topped up in November in the $7 range (and again in January at $8). What can I say? The company ran into the worst of all possible scenarios: a decline in DP prices, cost overruns on their mill transformation projects and continued poor performance of their security paper mill. Could we have foreseen any of these things? Not really. But should we have been a bit more patient before we first dipped our toes in the water? Quite obviously yes. Was this a truly bad trade? Perhaps, but we’ll have to wait and see how the story plays out to make a final judgement. We’re down almost 50% on this investment but I still have conviction that things could turn out nicely. There is huge operating leverage in the business.

Hartford Financial warrants: We made an initial purchase of HIG warrants in early April  at $13.47 per warrant just before the market turned down. As the warrants were in-the-money, they traded down dollar-for-dollar with the shares in May and June. We doubled down our position in June at just over $9. The shares and warrants recovered nicely in the Fall rally, and the warrants traded year-end at $13.48, just were we made our first purchase. This emphasized for me the need to ‘double down’ when shares you purchase see their ‘margin of safety’ increase significantly. My biggest gains have been on positions where, after the initial purchase, shares have tanked, I have ‘doubled down’ or more, and shares have recovered to go on to new highs. At least these are the gains that I remember best because they are the most suffered. In any case, I think the shares of HIG are still significantly undervalued and will continue to hold the warrants for the foreseeable future.

NovaGold/NovaCopper: We made a small initial purchase of NG in March in the $7.25 range, prior to the spinoff of NovaCopper in April. Shares promptly declined with the market in April and May. Then in June, Barrick Gold (owner of the other 50% interest in the Donlin Mine claim) put out a press release stating that they were unsure whether they would invest in the Donlin claim. This sank the shares down to the $4 level where they have stayed ever since. The Baupost Group purchased a sizeable interest in July post Barrick press release and added to their holdings in December when the shares again declined to the $4 level. We have added to our position in December and January at an average of $4.35/share. This is still a relatively small position and one that we intend to increase significantly if shares decline to the $4 level again. The initial purchase, it turned out, was too early. Shares had traded as high at $14 in early 2011, so at $7 we thought we were getting a nice discount. Clearly that was not the case as shares fell to $4. Note to self: Never measure current valuation based on a prior valuation by Mr. Market; he is notoriously emotional rather than analytical.

RadioShack: Another early entry with the final investment thesis yet to be proved. We purchased a small opening position in March in the $6 range and doubled the position in July at $3.50 (still a small position). Shares ended the year at $2.12, significantly below our average cost. We were waiting (and continue to wait) patiently for shares to dip to the $1.50-$1.75 range before loading up for a full position. That hasn’t happened yet and perhaps never will as share have trended up during the new year and now trade above the $3 level. It’s interesting to note that our early entry created a psychological obstacle to buying around the $2.00 level where we might otherwise have loaded up to a full position;  we wanted to be doubly certain of getting value for our money and so waited for perhaps an unreasonable (we’ll see) valuation before buying.

Steel Partners Holdings: Another early entry. We purchased units at $12.05 in May soon after they were listed on the NYSE. We had thought that once the units were listed, there might be an initial sell-off by those who were waiting for the additional liquidity of a NYSE listing. This didn’t happen, at least in the timeframe expected. However, units did decline during the Summer and we added to our position at the $10.85 level. The price dipped further in late Summer buy didn’t reach our next buy threshold. At year-end units traded for $11.79. Our position ended slightly up for the year but our gain was less than the benchmark. Despite this, it’s difficult to see how we could have used investing skill to purchase at a better average cost than we did: sometimes luck plays a large role in investing results. The investment thesis (discount to NAV narrowing) has yet to play out despite the simplification of corporate ownership achieved during the year. Patience!

Enough! This is an outsized post. There are still many other things that we might criticize about our portfolio operations during 2012, but those will have to wait for another day. The most important conclusion I come to when reflecting on last year’s investing decisions is that we were too impetuous in our purchase decisions. Perhaps a bit more patience, a longer wish list and a longer investing horizon (meaning not so many trades) would have served us well. However, I can’t yet be sure this is the right conclusion. Perhaps if I revisit this post (and the investment operations of 2012) a year from now I’ll have a better understanding of what was really achieved… or not.