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When the dust settles…

April 17, 2013

Last month I was getting antsy. The US equity markets were dancing up towards all-time highs but the underlying world economy seemed to be on a completely different tack with Europe falling into recession, the US recovery seemingly stalling and China growth showing signs of slowing. To me the most likely scenario for equity markets seemed to be a pullback, perhaps even a full-fledged 10-15% correction. So it was a bit disconcerting when the market kept on chugging higher during the first 10 days of the month. It wasn’t until the end of last week that we saw a some kind of a shift, with markets suddenly becoming more unstable. Up 1%, down 2%. And we finally now have a significant rise in the VIX (though not nearly enough, in my opinion). Perhaps I’m wrong (I’ve got a 50-50 chance, after all!) but I’m looking for some real dislocation here. We’ve been lulled into a sense of security over the past 9 months.

As I wrote last time, I added a small hedge to the portfolio at the end of March using out-of-money SPY puts. These were to be my ‘catastrophic’ insurance against a sharp market drop during the next 6 months. Cash is nice, but having puts that increase in value as the market drops through the floor helps me psychologically to be more aggressive. Of course one never knows when the market bottom is reached so there is always the problem of premature selling as well as premature investment. In any case I chose SPY puts (puts on the SPY ETF as opposed to puts on the S&P 500 index itself) more out of ease for me and abundant liquidity than anything else. My intent was to gradually ease into a full position with various strike prices. 130, 140, 145, 150 and various expirations (at least 6 months and possibly moving out to 12 or 18 months). I have to premise this by acknowledging my prior attempts at hedging have been totally ineffective if not downright hurtful to performance. So why did I think that this time would be any different? I guess I went into it with the idea that the current portfolio being so sensitive to market moves (beta significantly greater than 1 because of the large concentration in AIG, BAC warrants), I was willing to lose the entire cost of the hedge for the slight chance of major tail risk. Unfortunately, I was slow to implement, so I now only have about a 3% (but growing rapidly) position in the puts, less than the 10% I initially targeted. And because the market has become more volatile and the prices have increased commensurately with the market decline and the increased volatility I will have a hard time (psychologically) getting to my target.  So I’m still exposed, but if things really do go South from here at least I’ll have a few chits to invest.

  1. todd permalink

    it seems as if MIL has run into some problems in goa despite a ceo with a great track record. wondering what your thoughts are on this stock going forward now that price has hit 8. thanks in advance.

    • Yes, indeed. I’m sorry not to have gotten out of the position when the shares were trading north of $10 a couple of months ago. But with natural gas trending up over the last 4 or 5 months I thought that there might be some real value in the Compton assets they purchased last summer, so I held off. I still think there may be some interesting developments at MFC if gas prices continue their upward trend. I would look to sell at or close to BV, which is now close to $12 a share.

  2. Sid permalink

    Any thoughts on EBIX takeover?

    • Yes, I have a number of thoughts! Some are unprintable. Unless there is more to the game plan than the $20 offer, I am very disappointed.

      1) The price offered is ridiculously low. Even at $25/share I think GS/Raina would be ‘stealing’ the company, though I might be content.
      2) I’m suprised that Raina would look to profit from loyal shareholders rather than the shorts; I won’t be investing in any company he is associated with again
      3) The 45 day ‘go shop’ period looks just cosmetic to me; it protects the board. If Raina has partnered with GS why would any other party come in? Kind of like the Dell deal.
      4) I’m waiting to see if there is a short squeeze that pushes up the price beyond $23/share, where I would bail

      But I’m still waiting to see if there isn’t a better script that perhaps is more equitable for shareholders.

  3. brett permalink

    Any udated thoughts post earnings on AIG? BV is now $60. Thanks.

    • I still think AIG has a way to go. I’m targeting an exit price between 80 to 90% of BV, but BV should grow at a healthy pace over the next couple of years so we may see $60 on the share price before I start selling. If they reintroduce the dividend (which I don’t favor.. I would rather see a share buyback) it’s likely the share price will reach my target sooner, and if they break up the company, then we could see an extra 20% share bump. Right now everything looks positive for AIG (and I look rather stupid for having sold 10% of my position a month ago.. but the position was becoming too large in my portfolio, over 25%).

  4. bob permalink

    any idea why splp swung to a net loss in the first quarter? it looks like their stated nav on january 1st is 18.02 – a pretty good discount. each of their positions appears to have solid NOL’s going forward.

    • SPLP is a strange creature so the income statement is somewhat irrelevant to valuing the partnership. The 1st quarter loss was primarily due to losses at Moduslink (their portion, $5.1 million), where they made a significant investment during the first quarter, losses at Fox and Hound restaurant group (their portion, $5.2 million) and an unrealized loss in value of their investment in API ($9.1 million). None of this was cash flow for SPLP but is was a loss in value of some of their holdings so needs to be watched. Most of the NOLs can only be used at the subsidiary level, so income at one subsidiary can not necessarily be shielded by NOLs at another. And, yes, the partnership is still trading at a significant discount to its sum of the parts value, and some of the parts themselves are trading at a discount to their value…. still.

  5. Jeff permalink

    What are your thoughts on Fortress now?

  6. I like Fortress Paper better now at $6/share than at $20! And I’ve put my money where my mouth is by buying some additional shares at $6. That said, I was woefully wrong about the company when the stock was at $20, so take what I have to say with a (few) grain(s) of salt.

    After the sale of the Dresden mill, the company is now selling for about net cash in the bank (after factoring in indebtedness), plus they have the Landqart and Thurso mills and an ‘option’ on the Quebec (LSQ) mill, as they really haven’t sunk too much capital into this latter yet. Both Landqart and Thurso are operating at a loss, though Landqart may breakeven later this year. The big story here is the price of disolving pulp. It has gone into the toilet over the past 2 years. Is this management’s fault? Well, nobody can predict commodity prices, so I guess not really. The major problem with Fortress is that they now have all their eggs in one basket (DP) and the basket looks a bit worse for the wear at this point. For that, perhaps, you CAN fault management. So what’s the prognosis? FTP is a company that is highly operationally leveraged. From my perspective this means there is a potential multiple upside to the value of the company, as well as the possibility of zero value. I’m always looking for these kind of situations: in the case of Fortress, total loss on the one hand (downside) vs. a multiple of today’s price (4x-5x minimum) on the upside. You just have to handicap the probabilities. Things look desperate now, but if DP prices were to rise 20-30% (and that would be to a level that is below average in the past 5 years), the company would be swimming in EBITDA.

    I don’t think there will be any good news this quarter, but if DP prices regress to the mean we may see some good news in Q3. I’m still fully invested but readers should do their own handicapping.

  7. Always interesting to hear other peoples views and approaches on managing risk. As an Australian that invests in US stocks I find the exchange rate is a good tool to use to hedge risk. When the market looks like it is getting ahead of itself I simply let my portfolio have full exposure to the exchange rate. When the market falls then usually so does the AUD:USD. However when it comes to local stocks I obviously do not have this tool at my disposal and have not found a tool that I find works. The most effective tool I have found is to rebalance or sell some stocks if I think things are getting overvalued. Anyway, interesting to hear how other approach it. Thanks once again.

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