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Year-end 2014: Rearranging my portfolio

December 10, 2014

This year, 2014, my portfolio has lagged the market substantially. It’s due to a number of factors but principally 1) my concentration in two large positions (AIG and BAC warrants) that lagged the market, 2) a large cash position and 3) the significant decline in Fortress Paper.  What can I say? It’s been a very disappointing year. So I’ve decided to change tactics for 2015, diversify a bit and focus more on special situations in smaller cap stocks. We’re now getting to the end-of-the-year and so its time to take advantage of  year-end tax selling … not my selling! other people selling their ‘losers’ (my future winners).

Reducing AIG position
To accomplish this rearranging I started by downsizing my largest position, AIG. I still believe AIG is considerably undervalued. It may double again in the next 5 years as it has doubled for me in the past 3… but, then again, it may not. Despite the steady operating improvement over the past couple of years investors have not rewarded the company with even a market multiple. Perhaps its the company history, perhaps it’s because a number of institutional investors were burned by the stock in 2008/9, perhaps its the ongoing Star trial and potential liabilities it could spell for AIG. For whatever reason, investors have stayed away from the stock this year and the share price has pretty much languished. Of course, that sets it up for a good 2015 were investors to have a change of heart, but I want to look for something a little bit less mainstream, so I’ve sold off 1/4 of my position so that I can diversity my portfolio and delve a bit more into special situations (well, at least smaller cap companies with some kind of catalyst for value enhancement)

Another liquidation situation
My first purchase under my new strategy was a repurchase. As I indicated in my response to Dan’s comment on my post on Winthrop Realty Trust I’ve put some money back into Gyrodyne Corporation of America (GYRO). I posted about GYRO back in 2011 (see here, here and here) and made a tidy 57% profit on the stock in 10 months. This time GYRO is in the final throes of liquidation… or is it? Last year in an effort to minimize the tax impact to shareholders GYRO management devised an extremely complicated mechanism, in effect splitting the company into two, one part that holds ownership in the properties and one that manages the properties. Only one of these, GYRO, the management company, continues to be a publicly traded company. They made it even more complicated by introducing another type of security, a Global Note, which they used to pay out last years ‘earnings’ (remember GYRO is a REIT and REITs have to pay out 95% of their income to retain their REIT status). Management seems to have shot themselves in the foot with all these gyrations (yes, pun intended);  the plan was to remerge the two ‘companies’ into an LLC before proceeding to liquidation by YE 2016. The problem is that the merger requires a 2/3 majority vote of the public company shareholders and management can’t seem to get the needed shareholder votes for whatever reason. The special meeting to approve the merger has been postponed twice so far. Shares of GYRO have been trending steadily downward since the end of December 2013 when a large cash payment ($45.86) was made and the management and operating assets were split. Right after the distributions the public company shares were trading in the $7-$8 range but have since traded down to a recent $4.10-4.40 range. My guess is that this is the result of 1) a reassessment of value based on a closer look at the remaining assets, and 2) uncertainty surrounding the timing of the liquidation that the postponement of the special meetings has introduced.

What’s great about liquidations is that management has to provide their estimate of what the liquidation distributions will be in the filings. Generally these estimates are VERY conservative as management has no interest in provoking a shareholder lawsuit. (Strangely, shareholders never sue when the liquidation distributions are GREATER than management estimates, but often do when they are LESS…) So what do the liquidation estimates tell us about the value of GYRO? Well, in the merger of GYRO, GSD (the owner of the properties) and the ownership interest of the global notes into the new entity to be known as Gyrodyne LLC, GYRO owners should get 15.2% of the ownership. The latest book value of GYRO shares at Sept 30 2014 was $5.52. However, we have to subtract from that the dividend of $.46 payable to shareholders of record at the end of September, so that leaves us with a post dividend BV of about $5.06/share. This should reflect management’s take on liquidation value, but may be overstated (or subsequently diluted) by the notes in lieu of interest that will be paid on the Global Notes distributed in December ’13. That isn’t a lot of upside from today’s price of around $4.20 but, as I said, management tends to be conservative. In any case, I think the downside is protected. The big IF is when the liquidation can be completed and when the distributions can be made.

There are a five other situations I have started positions in, but they are not yet full positions so I’ll hold off discussing them until I complete my purchases. This touches on one of the most difficult aspects of investing for me: buying, as in how to get into a full position, how many tranches to divide the purchase into and at what price. First I make an overall decision on how big a position I want to take, then I try to buy in, say, thirds or fourths. Sounds simple, right? The problem I have is that once I buy an initial stake I never want to pay more for incremental purchases. I know this is stupid and gets me into only those stocks that are declining! The ones that are trending up leave me with a partial position and a bad taste in my mouth. It’s just a psychological hang-up that I’m trying to get over. Perhaps the subject of a future post!

  1. Matt permalink

    After the 12/30 distributions, GYRO traded at an impossible to explain price for quite some time. It should have been trading at, say, $5-6, but instead traded for double that on MASSIVE volume for a couple days and took another month to drift down to a more rational price. No one I know has any clue why this happened, but anyone who knew the price was wrong, including all the institutional investors, sold their shares. And that is why the company has the problem it has today in getting votes, as they were counting on getting the institutional votes and now there are none. Retail investors just don’t turn out to vote like they should. But make sure to see Bulldog’s comments in their report a few months ago:

  2. “This year, 2014, my portfolio has lagged the market substantially. It’s due to a number of factors but principally 1) my concentration in two large positions (AIG and BAC warrants) that lagged the market, 2) a large cash position and 3) the significant decline in Fortress Paper. What can I say? It’s been a very disappointing year. So I’ve decided to change tactics for 2015, diversify a bit and focus more on special situations in smaller cap stocks.”

    I think you should consider what a concentrated value portfolio “looks like”. If one makes 10 value investments, the typical outcome is something like: 1 loser, 7 stocks which slightly lag the market, and 2 huge winners. The end result is an average which is slightly higher than a market portfolio. If you invest in small caps you expect to have both more winners and more losers, as the information is worse and the markets more volatile. However, partly by random luck and partly by macro correlations, you will usually end up with your winners concentrated in a small number of years.

    A typical concentrated portfolio might have 20 stocks, and a typical holding period of 3-5 years, so in any year, only 5 stocks provide data points. That is why you need to run a value strategy for a long time before you know if you are doing it right. E.g. 20 years to get 100 investments. In most of those years the (concentrated) value strategy will under-perform, and in a small number it will out perform by large amounts.

    In any given year most value investments underperform the market. The reason is that, even if you are right, a value investment is betting on a significant re-rating by the market, without a large change in earnings. If that happens, it will likely happen all at once, e.g Lamprell Mid 2012 was a classic value investment, trading below NAV. in 2012Q4 and 2013Q1 it rerated up by around 100%, and its share price has been broadly flat ever since, despite being relatively inexpensive.

    Anyway, my point is that a concentrated value portfolio will underperform the market a majority of years, even if you are doing it right. If you want more stable (but smaller) outperformance, you need to diversify. But if you are going to do that you might as well just buy the SPY500 Value. Get your 1% outperformance a year or so. Otherwise you just have to live with long periods of under performing the market. Just be thankful its not the 1990’s 🙂

    Its hard to find quoted returns but here is, for example, Schroder Recovery ( % returns vs its benchmark: +1 -10 +22 +24 0; So two good years, one bad year and two meh years. Thats typical. If your less diversified, you will have more bad years, and more good years, and fewer meh years.

    Finally, the other nice things about value holdings is that if you are right you can usually see that, even if the price doesn’t re-rate. This is because you are basically buying outsize FCF. If its there, it either gets returned to shareholders or it builds up on the balance sheet. So either you are pocketing hefty capital returns or you are watching their balance sheet strengthen. I guess that is what is happening with AIG though its perhaps locked up in “regulatory provisions”.

  3. Do you increase your position in Gyro? The price has dropped a bit. They have published Management Services Agreement with Gyrodyne Special Distribution (“GSD”).
    Looks like the longer liquidation takes, the lower the realised value.

    • Sorry for the delay in answering; I’ve been on blog hiatus. Yes I have been adding to my position recently around the $3.80-$3.90 level. I don’t know when the merger issue will get solved but in the meantime I don’t think the value of the properties will diminish. It’s kind of a safe place to park some funds in my opinion, though the upside is not that great (maybe 20-40%??). The common doesn’t have that much leverage as all outstanding securities will benefit equally with the eventual sale of the properties.The common share price could fall further still with continued disinterest so you’ll need some patience.

  4. Would love to know answer to Martin’s question when you get around to it.

  5. Gyro filed S-1
    Maybe we will get lower price with more upside. All the strategic cost and the expected cost of the equity offering are a drag. I expect Gyro to trade lower on the offering.

    • Matt permalink

      Won’t go down very much. Look at the math, they are going to price the rights at $3.75, so not much dilution. The reason they’re doing this is give aware shareholders and institutional investors like Bulldog a chance to buy up as much as is available through the oversubscription rights. I have zilch cash to buy any more shares right now; hopefully something presents itself for sale in my portfolio in the next couple weeks.

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