Volsung Management letter to investors for fourth quarter 2013.
2013 was the third best year for US equities in the past three decades. Despite lagging the broader US stock market, we are satisfied with our strong absolute performance as many of our portfolio companies’ shares gained due to specific, fundamental business improvements rather than investors simply paying more for each dollar of profit. We believe these gains will likely prove more durable over time than those driven solely by ‘multiple expansion’ independent of earnings growth, which was responsible for the majority of the broader market’s performance in 2013.
Volsung Management’s performance & exposure summary
Our performance was achieved while retaining a substantial cash balance in the long-only strategy, averaging more than 21% of month-end assets. We find it increasingly difficult to find attractive long opportunities at current valuations and hold 27% of long-only strategy assets in cash at 01/15/14. Despite the challenges presented by the current environment of exuberance and our relatively conservative positioning, the long-only strategy’s annualized performance since inception continues to exceed that of the S&P 500 Total Return Index by more than 5% per annum, net of all fees.
As expressed in last quarter’s investor letter, such a high-powered market environment is also a challenging one for short sellers to navigate. Thankfully, the most recent quarter offered us some noteworthy successes in the short portfolio, as the fundamental challenges facing several of our shorts became impossible for even the most optimistic of analysts to ignore. The long/short strategy continues to outperform the S&P 500 Total Return Index by almost 1% since inception, which we believe to be a significant achievement given that we have historically retained a net equity market exposure of just 31% in the trailing 3 years.
Volsung Management: Commentary
As the year turns, we wish to comment on some of the key issues we contend with as capital allocators in our primary investment market of the United States. Despite our misgivings, our concerns are by no means sufficient to overwhelm the value of our core business activity: the identification and purchase of relatively predictable value-creating businesses. Furthermore, we retain our conviction that, despite some steps in the wrong direction, the political-economic environment in America remains the best of any large nation, and that our companies and universities remain the best in the world. We do, however, see some causes for concern.
The arcane subject of monetary economics is today the primary topic of discussion for many investment managers, talk show hosts, journalists, bloggers, and other commentators. This seemingly bizarre fixation is the result of an unprecedented regime of monetary easing that has boosted equity markets by making most credit assets uncomfortably expensive. Policymakers continue to view aggressive monetary easing as not only favorable but continually necessary to prevent the world from further economic hardship. Opinions and interpretations of such policies vary wildly, and an in depth discussion would be beyond the scope of this letter. We will, however, state our belief that such policies rest on a dubious assumption: that manipulating certain price signals can reliably change the behavior of market participants so as to produce specific, socially-desirable outcomes.
We believe we inhabit a complex, dynamic, and inter-connected world, where capital flows from one market to another at a pace and trajectory which make explanatory clarity and precise market intervention impossible. If the Federal Reserve is, as Warren Buffet recently termed it, the “greatest hedge fund in history” , it is a highly leveraged and opaque one, which has potentially cornered several large, globally important bond markets. We believe that distorting prices to this degree, in an attempt to stimulate US employment and economic growth, is a risky and potentially dangerous exercise that creates an unpredictable potential chain of effect across asset classes and markets. We worry about the limits and unforeseen consequences of manipulating such critical price inputs.
Unfortunately, monetary policy is but one example of good intentions gone awry. While our last letter focused on state corruption and thievery among the political elite in China, we continue to be concerned by the level of political dysfunction, incompetence, and outright graft here in the United States. Continued regulatory incompetence on the part of unelected administrators and authorities saddles an increasingly large swathe of our society with incoherent and ineffectual rules which sap productivity. Rather than function as a public safeguard or a guarantor of a free and open society, such regulatory malpractice increasingly seems only to benefit departing public administrators, who are able to gain lucrative employment helping others navigate the needless complexity they have crafted. We worry that ineffectual governance is becoming an increasingly large drag on American competitiveness, and that this partisan approach to administering the law threatens our democratic institutions.
Corruption and incompetence is by no means limited to our unelected officials, sadly. As investors, we reserve a special distaste for continued Congressional attempts to protect their own ability to engage in insider trading. As citizens, we are disgusted by the routine dishonesty of high level White House officials and the apparent corruption and lawlessness within the Justice Department. Above all, however, the executive and legislative branch alike seem ill-prepared to address the myriad challenges they face. The dire financial and employment situation of our nation’s youth, the crushing arithmetic reality of pension and entitlement obligations, and floundering healthcare reform speak to the failures of American government. We worry about the prospect of political overreach as politicians seek opportunity from the justifiable outrage which many Americans feel over the state of our society.
As students of history, we are highly concerned by the critical vulnerability of the Japanese and Chinese economies, given the deep-seated historical animosity these powers have for each other and the rapidly militarizing, increasingly tense stand-off that is developing in the narrow stretch of ocean between them. We are similarly concerned by the apparent credence given to the intentions of certain elements within the Iranian regime, and worry that violent ideologues with no respect for human life cannot be trusted to play by the rules. We worry about nuclear proliferation in an increasingly destabilized Middle East, and the rising influence there of fundamentalist extremists, who view freedom and tolerance as threats which must be crushed by force.
Despite our misgivings, we believe markets move in cycles, and retain hope that the political environment does as well.
Volsung Management: The long portfolio
Our largest long positions remain Apple, Inc. (NASDAQ:AAPL) and Porsche Automobil Holding SE (ETR:PAH3) (FRA:PAH3), accounting for approximately 16% and 15% of long/short assets each, respectively and approximately 12% and 10% of long-only assets, respectively, at 01/15/14. During the quarter, we initiated a new long position in Chico’s FAS, Inc. (NYSE:CHS) and closed our long position in Cisco Systems, Inc. (NASDAQ:CSCO). Selected highlights from the fourth quarter in the long portfolio follow:
In conjunction with the announcement of third quarter earnings, Ocean Rig UDW Inc. (NASDAQ:ORIG) announced a long-anticipated plan to begin paying a dividend, and advanced plans to convert to