Half Moon Capital, the value oriented hedge fund managed by Eric DeLamarter, returned 2.3% net of fees in the fourth quarter of 2015 and 0.4% for the full-year, compared to returns of 1.4%, -4.4% and 1.4% for the S&P 500, Russell 2000 and HFRI Hedge respectively.
The Partnership’s cumulative return since inception, in July 2011, is 52.4%, compared with the S&P 500, Russell 2000 and HFRI Hedge Fund index that have recorded returns of 70.5%, 46.1%, and 13.5%, respectively. While these results may appear poor at first glance, it should be noted that Half Moon’s result (for 2015 at least) was achieved with lower-than-average volatility (table below) and while maintaining an average 82.1% gross and 38.2% net long exposure levels.
At the end of 2015, Half Moon Capital’s portfolio was comprised of 63% long positions and 28% shorts, equating to a gross exposure of 91%, 34% net long.
Half Moon Capital: Short alpha
Half Moon Capitals 2015 performance was driven by the fund’s short book, which produced a gross return of 27.7%. Unfortunately, the long side of the fund’s portfolio failed to achieve a positive performance returning -3.4% for the year. However, as Half Moon points out in its year-end letter to investors, considering how the market as a whole traded last year, this performance is relatively commendable:
[drizzle]“We found it noteworthy how narrow the breadth of the S&P 500’s 1.4% performance was in 2015. Remarkably, five mega-capitalization technology companies drove the whole market—accounting for over 300% of the indexes return. In other words, if it were not for that handful of stocks, the market would have been down approximately 3%. Further, stocks within the S&P 500 with market capitalizations less than $10B were down an average 12.6%.”
At year end 2015, Half Moon’s largest long position was Tower International (8.5%) followed by John B Sanfilippo & Son Inc. (7.5%), Aerojet Rocketdyne (7.0%), Murphy USA (6.6%) and Headwaters (5.5%). The largest short positions were Papa Murphy’s (3.6%), Kornit (3.5%), Badger Meter (3.3%), Control4 (2.7%) and Teladoc (2.6%).
In the fourth quarter, on the long side, positive contributions from Tower International (14.9%) and Murphy USA (8%) offset negative performances from Continental Building Products (-12.5%), Graham Holdings (-13.2%) and Headwaters (-10.3%). On the short side, positions that generated greater than a 10% return included Papa Murphy’s (18.9%), Teladoc (17.3%), Control4 (12.8%) and Kornit Digital (12.2%).
Half Moon Capital’s investment strategy is simple; hunt out mispriced securities, identify why the mispricing exists, consider the fundamentals and only invest if it the fund can clearly understand what the company does and what it will take for the mispricing to be corrected. Half Moon’s fourth quarter and full-year letter goes into more detail:
“Our search for investment opportunities is a search for anomalies where the offered price has materially diverged from what we believe it worth. We benefit from being able to look across a large universe of companies and securities to find appealing prospects. Our addressable opportunity set is broad. We often find the most compelling prospects among smaller capitalization names (market capitalization less than $2B), the fundamentals of which have been blurred by an event that has no bearing on the underlying quality of the business. These mispricings typically occur because a business is either: 1) disliked and out-of-favor; or 2) overlooked and obscure. Investing in a disliked business requires contrarianism—a very important, but very difficult, position. We look for areas where the consensus opinion is not necessarily wrong, but exaggerated.”
Half Moon Capital: New positions
With the above strategy in mind, Half Moon added several new positions to its book during the quarter including two new shorts, Badger Meter and a position in a commercial building products company, and one new long, Murphy USA. Below is a summary of Half Moon’s rationale supporting BMI and Murphy:
“Badger Meter is a manufacturer of water meters for municipal utilities. This is a low return, commoditized product. All growth over the last two years has come from acquiring distributors and by taking share from a competitor that wound down its meter segment. This one-time grab has now played out. The company has blamed recent weakness on the recall from a supplier (ITRI). This excuse was not credible in Q3 and cannot be used again in Q4. There are a number of other headwinds facing the company that we believe will collectively lead to a performance shortfall and a downward revision to its current peak trading multiple over the upcoming quarters.”“Murphy USA: Spun-off from Murphy Oil in 2013. This mis-pricing exists because consensus erroneously focuses on MUSA’s lower margins and consolidated financials which include volatile, non-core segments that have been sold or are being sold. 10.1% We initially sold our shares in Q1’15 when strong financial performance and better investor understanding of the business led to the stock reaching our assessment of its fair value.Catalysts: appreciation for the on-going business’s strong EBITDACatalysts: appreciation for the on-going business’s strong EBITDA and FCF growth, attractive return profile (ROIC 2x peers) and structural advantages of the business. (see Q1’13 letter for a complete write-up and the Q1’15 letter for another update) It appears that some of the same misconceptions and confusion that surrounded the company then persists today. This presented us with another opportunity to purchase the stock at an attractive valuation in front of some near-term catalysts.”