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1Q 2013 Performance and adjustments to the portfolio

April 8, 2013

1 Q 2013 Performance

I can’t beat around the bush; performance was ugly during the 1st quarter. The portfolio was up about 6% while the S&P 500 TR index gained almost 11%. That’s 5% points of underperformance! I don’t want to focus on this too much (I think you can imagine why) as I belive we should be looking at how the underlying businesses fared and not Mr. Market’s mood. Not only is Mr. Market notoriously emotional but he is always interpreting last quarter’s financials, so he sees everything with a time lag.

Now for a review of individual positions. All of the largest positions lagged the benchmark index, or, at best, were up equally (in the case of AIG). Bank of America warrants, MFC Industrial, Fortress Paper, KHD Wedag, Novagold and Enzon all lagged the advancing market. Fortress Paper and Enzon shares were actually down for the quarter! There were a few bright spots; Hartford Financial warrants jumped 27% and Steel Partners Holdings closed up 15%, albeit mostly in the last few days of the quarter.

Portfolio changes

During the first quarter I made a number of changes to the portfolio. In January I sold off the remaining interest in Breitburn Energy Partners. Then in early March the entire Exelis position was sold as I continued to raise cash (too early as it turned out!). Finally, during the last week of the quarter I cut back my exposure to AIG and BAC,  reducing share count by 10% and 20% respectively, and initiated a small hedge using SPY puts. The idea overall being that the market is a bit frothy and we are approaching that period of the year when the market is historically the weakest (May through August). I’m hoping that there is a bit of market dislocation and I can use the dry powder to move into smaller cap special situations.

Subsequent to the end of the quarter, the entire position in KHD Humboldt Wedag was liquidated. This was a disappointment as I have held an interest in the company for a number of years and I sold it just above breakeven. Furthermore, the company reported a large increase in backlog at year-end 2012 which made the sale even harder. But the reasoning behind the sale was a combination of dissatisfaction with management’s actions and communications and the recent change in Chairperson. I believe I have written before about how management brought in a Chinese partner, AVIC, through a rights offering in January 2012 which disenfranchised US ADR holders. In retrospect I should have sold immediately when that happened (at a higher price!). But because I thought the business had extraordinary potential I waited to see if management could find the right path. It now seems clear to me that that path has eluded them. This past Fall, the prior Chairman departed and a new Chinese Chairwoman was voted in. I am unclear why this happened given that AVIC holds only a 20% interest in the company. However, my fears are that there will be undue meddling in the company’s strategy from a partner who is not always driven by a ‘market’ philosophy. This uneasiness is only furthered by what I consider a lack of clarity in the language of the annual report. I found the language stilted and riddled with “burocratese”. Perhaps this is only the result of a translation from the original German, but I can’t help feeling there is something purposeful in this type of obfuscation.  If management can’t explain themselves in a few concise paragraphs, I have to interpret this as meaning either they don’t really know what they are planning to do, or they don’t want to tell us shareholders. Obviously, in either case, I no longer wanted to be a shareholder!

Cash in the portfolio is now over 25%, though I did redeploy a small amount into a small position in Sandridge Energy (SD) purchased because of the turmoil surrounding the departure of its former CEO/Chairman, Tom Ward. But of this, I will write anon.

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