Foundry Value Master Fund March 2016 Commentary and Q1 Letter
The following is fromFoundry Value Master Fund''s latest letters to investors. The hedge fund was profiled in our first issue. Some macro, great returns and discussion of positions. If you would like to talk to the portfolio manager about any positions feel free to contact below.
Troy Marchand
317-402-1563
[email protected]
Troy Marchand's Foundry Capital Group letter to partners for the first quarter ended March 31, 2016. Dear Partners, “Value investors…have as a primary goal the preservation of their capital. It follows that value investors seek a margin of safety, allowing room for imprecision, bad luck, or analytical error to avoid sizable losses over time. A margin of safety is necessary because valuation is an imprecise art, the future is unpredictable, and investors are human and do make mistakes.” -- Seth Klarman For the month of March, the Foundry Capital Fund declined by 2.5%, bringing the quarter and year to date return to negative 12.15%, with inception return to date negative 21.93%. For the quarter, the fund lagged the Russell Microcap Index and the Russell 2000 Index, which posted negative returns of 5.43% and 1.52%, respectively. While we are undoubtedly disappointed with the first quarter and our returns since inception, we still believe longer term our strategy will work itself out. Investing is hard enough on its own, and combine starting a business, launching a fund, and emotions can play a large role. The ability to limit outside externalities is key to performing. Our largest position Internap (INAP), did not come to fruition, resulting in a drag on performance. Excluding that name, we performed roughly in line with the micro-cap index and now have a hole to dig out. The good news is, over the last month, we have assembled a portfolio positioned well to dig us out of that hole. Previously, in our search for catalysts, we did not put enough emphasis on our downside protection, i.e. “margin of safety”. Our core investment tenant has always been investing with a margin of safety, and we are disappointed to say we let it take a back seat to finding value catalysts. What does this mean for the portfolio? It means we have sold a few positions, taken our lumps and moved on, in particular, INAP. INAP had all the makings to be a perfect activist play, checking all the boxes an investor could want, except for margin of safety. It was never stupid cheap, and the cash flows didn’t justify the outlandish valuations that other activist investors had targeted in public letters. We by no means are trying to indicate future positions can’t lose money, but we will not fall into the same trap again. We have also reduced some position sizes and increased portfolio diversification because we don’t see any absolute lay-ups that warrant investing a large stake of the Foundry Capital Fund in one position at this time. We have used some of the cash to buy companies selling at a discount to liquidation value (in this case they are actually liquidating), along with companies trading at a negative Enterprise Value (Market Cap – Cash + Debt). Currently, we are finding significant value in nano-cap companies (< than $50 million market cap), with the weighted average market cap of the portfolio currently below $200 million. In our search for margin of safety, we have looked at significantly more international companies trading at deep discounts, in countries such as Canada, Norway, and Sweden. We feel the portfolio is now in line with how we have made money for the past eight plus years; asymmetric investing, where our downside is very limited with potential for real upside. We will not overpay for growth or catalysts and surely view the future as uncertain. Our principle has always been to invest where simple math made a lot of sense, to take advantage of tiny companies where the “big boys” can’t and won’t participate, and then concentrate on downside risk, first and foremost. While writing this letter, Horizon Asset Management had some interesting comments in their most recent note regarding value investing, cash, and why it is so hard for investors to wrap their mind around buying stocks that have disappointed the most in the past. Horizon goes on to say: “It is also an unfortunate fact that the traditional Graham & Dodd value metrics, such as low P/E, low price-to-book ratio, companies with net/net balance sheets, or liquidation value investments, do not back-test well. This is because to have these desirable attributes a security must first exhibit poor performance and high volatility. Since one cannot market a back-tested index of poor performance, the traditional metrics and investment opportunities are discarded.” These reasons make it hard to market a deep value strategy, where a manager cannot show back tested positive results from poor past performers. While we remain cautious on the overall stock market, ie the S&P 500 and those stocks in an index, we firmly believe stocking picking will come back and those with the ability to invest outside the indexes will outperform over the next five and 10 year periods. Michael Burry, who was portrayed in the movie, “The Big Short”, once said in his 2000 letter to investors something I think still rings true to this day: "Regardless of what the future holds, intelligent investment in common stocks offer a solid route for a reasonable return on investment going forward. When I say this, I do not mean the S&P 500, the Nasdaq Composite or the market broadly defined will necessarily do well. In fact, I leave the dogma on market direction to others. What I rather expect is that the out-of-favor and sometimes obscure common stock situations in which I choose to invest ought to do well. They will not generally track the market, but I view this as a favorable characteristic." The Foundry Capital Fund was unable to execute on the PIPE we discussed in the 4Q2015 letter. The Company decided to go another direction. We are still searching for another similar opportunity to execute our strategy.
Foundry Capital Group - Position Update:
We will no longer be announcing our positions in this letter or the monthly report, other than the top 5 holdings, due to the small, illiquid nature of the majority of them. There is a potential we may want to increase existing positions and think the new ideas are so compelling, others might pile in and cause the price to exceed our buy limit. Companies going through liquidation (not bankruptcy) tend to be very small companies (<$20M market cap). Thus, we just can’t share. If you would like to discuss any positions, please feel free to call. One final thought to leave you with regarding holding above average cash levels comes from Horizon Asset Management: “Holding cash is not a market timing decision. Nor is the cash intended to protect a portfolio during the market downturn that we anticipate, because it won’t make that much difference. The cash is to provide the flexibility to capitalize on the opportunities that present themselves every handful of years or every cycle. True opportunities. The kind that gives multi-year benefits. But, we’ve heard some questions, in some cases rumblings, about the cash. First, the market has been up in the last few months, the cash is just sitting there, how long will this go on? Patience is wearing thin. It feels very much like the almost two full years, all of 1999 and most of 2000, during which we stayed far away from the tech bubble stocks. That was also the last time we had this much in cash reserves. For us, and for our clients, it seemed an endlessly long time, interspersed with long, unsatisfying explanations. When it all turned, though, the rewards for remaining sober and having fidelity to our fundamental value-oriented approach were well worth the interim purgatory.” As we continue to transition the portfolio, we will be selling stocks we don’t feel comfortable holding, trimming existing positions, holding cash, and buying where we find absolute value. The transition has all taken place after the quarter ended and will continue for the foreseeable future. We want you to remain confident we are not just simply drifting with the wind, but truly getting back to our core roots! If you would like to discuss the portfolio or strategy in more detail, please give Troy a call at 317-402-1563. “Once you adopt a value-investment strategy, any other investment behavior starts to seem like gambling.” -- Seth Klarman Regards, Troy Marchand Foundry Capital Group
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The Foundry Value Master Fund was down 2.55% for the month of March, while the Russell Microcap Index was up 7.09% during the same period. This brings our year-to-date return to -12.15% compared to -5.43% for the Russell Microcap Index. This was another disappointing month, especially in comparison to the overall market overall rally. While we are absolute investors, not relative, our stocks are typically not held in any market index, it still never feels good to miss out in a market rally. The portfolio is now positioned with a “margin of safety”, which is more defensive in nature, but positioned well to outperform the greater market over the next several years. For additional details, please see our quarterly letter which will be out shortly.
Foundry Value Master Fund - New Position:
Support.com (SPRT) – trading at a negative $20M enterprise value (market cap – cash + debt) with several activists owning almost 15% of the stock. The activist group will soon win five board seats and have essential control of the Company. SPRT also has nearly $125M in net operating losses (NOL’s), which could be used to shield profits from taxes in the future.
Added too:
AdCare Health Systems Inc - Preferred (ADK PRA) – we still believe Adcare will sell soon, and we will be paid a double digit dividend yield to wait.
Sold:
Aralez (ARLZ) – this was a mistake. We know nothing about biotech companies, and even with a complicated situation, this did not pan out as expected. Valeant (VRX) blowing up did not help any company in the space! Omega Protein (OME) – we rode the stock up from $17 to $25, in a short amount of time and sold half of our position, in hindsight, we should have sold the entire thing. Unfortunately we thought and still think the company can sell itself, but they put up a terrible quarter and the activists have moved on. We sold the remaining lot below our original cost basis, which is never enjoyable. With fundamentals deteriorating, we felt the “margin of safety” had declined too significantly.+
Investment Objective
The goal of the Foundry Value Master Fund, LTD. (“FVMF” or the “Fund”) is to generate portfolio alpha over market cycles, while minimizing market risk. We focus on companies trading at a deep discount to intrinsic value with a catalyst on the horizon, where we believe we truly have a “margin of safety”. We invest where valuations are irrational and catalysts misunderstood to achieve superior performance over time. The Fund will only hold our “best ideas”, resulting from deep, fundamental analysis and engagement with a wide network of industry contacts. While we intend to hold positions for a 1-3 year time horizon, we occasionally will invest to exploit shorter term opportunities. In certain situations, the Fund will utilize public activism strategies in to unlock value for all shareholders.
