Arquitos Capital Administration commentary for the fourth quarter ended December 31, 2018, discussing their lengthy positions in Enterprise Diversified (SYTE), MMA Capital Holdings (MMAC), and WESTAIM (WED.V).
Perspective is value 80 IQ factors. – Alan Kay
Arquitos returned -31.three% internet of charges in 2018, in comparison with -Four.Four% for the S&P 500. Our annualized internet return because the April 10, 2012, launch is 21.three%. Please see web page eight for extra detailed efficiency info.
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Q3 hedge fund letters, convention, scoops and so on
Structured for Permanence
In “Perennial Seller: The Art of Making and Marketing Work that Lasts,” writer Ryan Vacation writes about artists and objectives and actuality. Why do films like “The Shawshank Redemption” or “Citizen Kane” or “The Sound of Music” endure? What about Shakespeare or The Beatles or Tiffany diamonds? Why does “Les Misérables” nonetheless play on Broadway and on London’s West Finish in any case these years?
Music offers the clearest instance. Some musicians deliberately try and create timeless works. It exhibits. Their lyrics are about love, loss, spirituality, and different enduring features of human nature. Different musicians with out that intent sing about unimportant subjects in a approach that gained’t be remembered. Or, worse, their short-sighted lyrics get mocked sooner or later.
There’s a shocking variety of forgettable songs from the 1980s and early 1990s involving lyrics about pagers, for instance. Although my physician pals nonetheless use pagers for reputable functions, I consider these songs are about illicit drug gross sales and events and never about summoning a medical physician to a affected person, sadly.
Vacation implores creators to be intentional. Deliberately produce, place, and marketplace for permanence. He should talk that intention to his viewers. To try this, first, the product have to be nice. The creator have to be targeted and should need to create significant work. Vacation references Robert Greene, who stated, “It starts by wanting to create a classic.”
What about positioning and advertising? The one factor that issues is phrase of mouth. For a piece to grow to be a basic, it should have advocates. It should have champions. It should have a core viewers that appreciates the creator’s intentions and is dedicated to the artist and the thought behind the work.
You might be asking your self, what the heck does this need to do with an funding portfolio, not to mention one which simply completed the yr with fairly depressing efficiency?
I began Arquitos in 2012 with just some buyers. I had been managing separate accounts from family and friends for a number of years previous to that. My thought was that I used to be managing a portfolio with my very own cash, and I deliberate to take action for the remainder of my life. Why not invite others to hitch? It was not necessary what number of joined or with how a lot cash they joined. What was essential was that I might give them long-term monetary safety. That they had confidence in my funding capacity, they knew the fund can be round for a very long time, and their funding time horizon matched the time horizon of the portfolio.
Experiencing robust years sometimes is inevitable. It’s a part of the enterprise. The worth of shares typically doesn’t match the underlying worth of the corporate. Inventory costs get forward of themselves at occasions. Different occasions, the operations get forward of the inventory worth.
The idea is fairly easy. Purchase when the inventory worth is reasonable in comparison with the long-term prospects of the corporate, and promote when it’s costly.
The idea can also be one of many hardest issues to do on the earth. It includes experience in evaluation, which might be discovered. Self-discipline in decision-making, which is far more uncommon. And excessive humility that the market is true more often than not and excessive confidence that, on this event, the market is mistaken. The appliance of that final one is what separates nice buyers from others. It’s a character trait, I consider, that may’t be discovered.
An investor, whether or not passive or lively, additionally should have long-term confidence in human ingenuity. The inventory market is about human progress. The businesses that make up the inventory market are about artistic destruction, effectivity, and accountability. You need to have optimism to completely respect the facility of compounding. Of, over time, the great overcoming the dangerous. The environment friendly destroying the inefficient.
Skeptics make good buyers. Pessimists don’t.
Investing can also be difficult as a result of errors are assured. A few of these errors shall be in evaluation. Some will probably be errors in judgment. Some might be psychological. That’s additionally a part of the enterprise. Add on the problem of trying to study the proper classes from a mistake. I’ve seen loads of buyers overcorrect, turning one mistake into two.
Permanence is about deliberately structuring the fund to not permit errors to destroy the fund.
I designed the portfolio to final. We’ll all the time be capable of endure volatility like we had this yr. I don’t purchase on margin, so I gained’t be a pressured vendor due to volatility. The fund has numerous buyers, 83 eventually rely. Our largest investor makes up 11% of the fund; so the liquidity wants of 1 investor can’t negatively have an effect on all the portfolio. Buyers have dedicated to me that they’re in it for the long run. This dedication and diversification amongst buyers assist forestall volatility from turning into everlasting capital loss. They assist to stop the creation of danger the place none was.
Permanence can also be about alignment of pursuits. Most of my household’s internet value is within the fund. Likewise, I search for corporations to personal within the portfolio the place there’s giant insider possession.
Identical to I don’t need debt within the portfolio via margin loans, I additionally search for corporations with a low quantity of debt and powerful stability sheets. This each protects the corporate from operational volatility and permits it to reap the benefits of alternatives which will come up. Lastly, a lot of the corporations we personal within the portfolio have been initially bought under ebook worth. At present, the portfolio is so low cost that the majority of our holdings once more commerce under guide worth, in some instances considerably so.
On the outset, I designed the portfolio and the fund to final. I deliberately sought to create the fund to be a basic. I sought diversification amongst buyers. I rejected buyers who weren’t like-minded with a view to make sure the portfolio’s resiliency.
I’m singing about love, not pagers.
Seth Godin talks about striving to be the highest 5%. Being within the prime 1%, he explains, requires luck and magical expertise. You possibly can’t management that, and, in investing, you actually solely know if the portfolio supervisor has magical expertise in hindsight.
The highest 5%, although, is attainable. It may be achieved by means of focus, effort, and want. It isn’t a contest towards others. It’s inner competitors.
“To be in the top 5%, one in twenty, is mostly about choices,” in response to Godin.
Arquitos is striving to be within the prime 5%. In long-term efficiency, not measurement or notoriety. I consider we have now completed that up to now. On a gross foundation, we have now crushed the S&P 500 by 16.7% yearly because the fund was launched greater than six and a half years in the past. General, our report is outstanding.
A Evaluate of 2018 and a Look Forward
This letter has two totally different audiences with considerably totally different experiences with Arquitos. One viewers is the 37 buyers who joined greater than 18 months in the past and, normally, have loved astronomical positive aspects over a comparatively brief period of time. Most of these buyers went by means of 2015, when the fund additionally struggled, after which loved vital returns in 2016 and 2017. These constructive returns occurred due to selections made in 2015. This viewers is aware of, and has skilled, the durations of reaping and sowing.
The opposite viewers is the 46 new buyers who joined Arquitos within the final 18 months. That have is totally different. These buyers didn’t benefit from the success created over the primary 5 years of the fund. This subsequent part of the letter is admittedly for this viewers.
To get correct context for 2018, we now have to look again at 2017. The desk under helps.
* Intrawest Resorts (SNOW), which was purchased out by one other firm in 2017, made up one other 5.Four% of features that yr.
Enterprise Diversified (SYTE)
In 2017, Arquitos returned 80.eight% earlier than charges. Of that, virtually half was generated by SYTE. We gave again a few of these features in 2018 however are nonetheless considerably forward of our unique value foundation.
Clearly this place has an outsized impact on our portfolio. It at present makes up 29% of the fund. On the finish of 2017, the inventory traded at $14.88 and a a number of of ebook worth of two.2. As chairman, I gained’t publicly present my opinion of valuation on the corporate, however it’s truthful to say that I consider the corporate is value excess of guide worth. E-book worth is inconspicuous for quite a lot of causes, chief amongst them is that it doesn’t take into consideration our relationships with quite a few gifted cash managers.
These relationships include payment shares with SYTE’s Willow Oak Asset Administration subsidiary. Because the funds develop, this offers exponential will increase in income for SYTE with no corresponding expense. These payment shares present constructive leverage with no draw back danger.
When you’re partnered with gifted managers, there isn’t a higher enterprise than funding administration. Our managers are pushed, sensible, and distinctive and have an extended runway forward of them. Plus, SYTE expects to group up with extra fund managers by means of its Fund Administration Providers in 2019. There’s loads of potential with little danger for the corporate.
Let me give one illustration. The Bonhoeffer Fund is managed by Keith Smith, who’s a SYTE director. Keith is a gifted investor who runs a differentiated portfolio. He owns stakes of corporations in South Korea, the Philippines, South Africa, Italy, and different nations.
Bonhoeffer was launched in July 2017 and at present has $14 million underneath administration. SYTE has a 50% charge share with the Bonhoeffer Fund. It isn’t unreasonable to imagine that by 2022 Bonhoeffer will get its belongings beneath administration as much as $50 million. Let’s additionally assume, as a thought experiment, that the fund returns 30% that yr. Too excessive you may say? 30% is the typical yearly return that Keith made in his private portfolio within the 11 years previous to launching the fund. (This features a 146% achieve in 2013 when Arquitos solely returned a lowly 59%).
With Bonhoeffer’s charge construction and SYTE’s charge share, SYTE would earn roughly $1.5 million in 2022. Guide worth for SYTE’s Bonhoeffer curiosity is presently $zero. The market cap of the complete firm is presently $22 million. One relationship and one yr has the power to earn 7% of the complete worth of the corporate.
SYTE additionally owns 100% of Willow Oak Choose Fund and receives a charge share from Alluvial Fund along with its direct funding. Moreover, as a part of the Fund Administration Providers settlement with Arquitos, SYTE receives a small charge share from Arquitos. This comes from the administration firm, not the fund. All of those relationships are extraordinarily worthwhile to SYTE and are carried on the books at $zero.
On the finish of 2018, SYTE traded for $eight.70 and a a number of of e-book worth of 1.1. Ebook worth grew in 2018 (by way of Q3, with This fall not but being reported). Fairly frankly, given the small print concerning the potential of SYTE’s asset administration subsidiary above, does it actually matter why the sentiment modified and the a number of of e-book decreased? Are there any authentic doubts amongst SYTE buyers that the long-term worth of the corporate far exceeds its present valuation?
MMA Capital Holdings (MMAC)
I lately put collectively an in depth presentation on MMAC and am joyful to offer it upon request. I’ve written concerning the firm a number of occasions through the years. Amazingly, the corporate is cheaper now relative to its ebook worth than it has ever been throughout our holding interval.
Estimated e-book worth on the finish of This fall 2018 is $35.31. Shares are presently round $26 and had ended the yr at $25.20. MMAC has simplified their enterprise considerably and is now primarily a distinct segment asset supervisor targeted on short- to intermediate-term lending on renewable energy-related tasks. The corporate has a big co-investment within the area and earns administration and efficiency charges from the portfolios they handle.
MMAC additionally has an enormous pile of money and equivalents relative to their market cap. Along with buying and selling at zero.7 occasions ebook worth, additionally they commerce at simply Four occasions trailing earnings and someplace between 6 to eight occasions estimated 2019 earnings. Lastly, they proceed to purchase again about 10% of their shares annually. Because of this, the truth that shares commerce at such a big low cost to e-book worth offers an enormous profit to us as shareholders.
MMAC negatively affected the Arquitos portfolio in 2018. It’s a basic instance of the inventory worth being wholly disconnected from the truth of the corporate. It’s our second largest holding. If I might purchase extra shares, I might.
I’m a member of the Guide of Concepts, a group of gifted portfolio managers and buyers run by John Mihaljevic. Guide of Concepts holds a number of idea-sharing occasions annually. I introduced MMAC a number of years in the past to the group and, simply this previous week, introduced Westaim. In case you’d wish to see the presentation, please let me know. It incorporates a fantastic interview I did with Westaim’s COO, Rob Kittel. I got here away extra impressed than ever.
Westaim is our third largest holding and very undervalued. Its guide worth is C$three.10 with a share worth of C$2.58 as of December 31, 2018, or zero.eight occasions e-book worth.
Westaim has two subsidiaries: a specialty insurer, Houston Worldwide Group; and a credit score fund, Area Group. The insurance coverage subsidiary is more likely to both be bought or strategically divested. It’s held on the books at 1.1 occasions e-book worth and is probably going value at the very least 1.6 occasions guide. It isn’t distressed in any method and, in truth, has dramatically improved its operations over the previous few years because it has gained extra scale.
Area Group is the extra thrilling of the subsidiaries. It’s made up of three entities. Area Finance is inner capital. Area Origination serves because the origination arm. And Area Buyers offers funding administration providers to 3rd events by way of pooled funds and individually managed accounts.
The worth of Area Finance and Area Buyers counts in Westaim’s guide worth, however Area Buyers doesn’t. Just like the SYTE instance I gave with Bonhoeffer Fund, Westaim’s stake in Area Buyers is extremely helpful. AUM is pushing $1 billion, efficiency has been nice, and Area has elevated its advertising actions so AUM will probably proceed to extend.
We get all of this for lower than Westaim’s liquidation worth. The market has given us a present at this worth.
Different Portfolio Holdings
Our fourth largest place trades at lower than 2 occasions EBITDA. We personal one other firm that trades for 75% of its liquidation worth. We personal an organization that has a 7% plus dividend yield and trades at 70% of e-book worth. We personal the Berkshire long-dated choices that I talked about final quarter, and we have been in a position so as to add to them at a lot decrease costs.
I hope you sense my enthusiasm on this letter and for this portfolio. I’m extra excited now than I’ve been since I launched the fund.
Howard Marks as soon as stated, “If it’s cheap you buy. If it gets cheaper, you buy more. If it’s cheaper, you buy more.”
He then half-jokingly stated, “and if you run out of money, you ask your clients for more money.”
I’m selectively reaching out to buyers to ask for extra money. If you need for me to contact you to debate a further funding, then please let me know.
I can’t predict the timing of when the shares we personal will improve in worth. I can inform you that the underlying corporations have all elevated in worth, but their inventory costs have declined. This can be a recipe for long-term constructive efficiency within the portfolio. It’s a part of the worry and greed cycle within the inventory market that occurs time and time once more. Do the other.
Worry forces out some buyers from the market when inventory costs decline. Greed brings them again in when inventory costs go up. That is the place investing is straightforward, however not straightforward in any respect and why investing is finally a psychological sport, not an analytical one.
Thanks once more in your funding in Arquitos and on your dedication.
Steven L. Kiel
Arquitos Capital Administration
This text first appeared on ValueWalk Premium