Corsair Capital letter to limited partners for the first quarter ended March 31, 2016.
Dear Limited Partner:
For the first quarter ended March 31, 2016, Corsair Capital was down an estimated 0.7%* net, after all fees and expenses. Corsair Select was down an estimated 1.7%* net, after all fees and expenses. Since inception in January 1991, Corsair Capital’s compounded net annual return is 12.7%. Since inception in January 2004, Corsair Select’s compounded net annual return is 10.7%.
“The world faces a crisis in the Middle East and the United States faces the prospect of a recession. With that in mind, I think it is important to remember that the financial markets reflect what the future will bring as opposed to what the past has been and thus, the before-mentioned concerns are already in the price of most securities. My job will be to invest in those securities where the market has over discounted such fears and to avoid those where the market has not discounted these or other events enough.” – Corsair Capital Partners Inaugural Letter, January 2, 1991
The first quarter of 2016 marks Corsair's 101st quarterly letter as we celebrate our 25th anniversary. Looking back at our long-term performance, our Corsair Capital Partners fund has generated 12.7% compounded net annual returns since inception with significantly lower volatility than the S&P 500 and Russell 2000 equity indices. Corsair has grown an initial $1 million investment since inception into over $20 million, with over 90% of the realized gains coming as long-term, tax efficient capital gains.
In short, our investors have benefitted from high quality, risk adjusted net returns for 25 years and we are optimistic about our future.
While over the course of 25 years we have seen significant shifts across our industry in strategies, technologies and regulations, we are proud to be investing in the same pool of special situation equity opportunities as we were back in 1991. Our strategy is focused on three key themes:
1) We do not use leverage. In fact, we hold a material cash balance to both protect our downside in volatile markets, but still capture significant upside when the market rallies. Corsair’s relatively low gross exposures have allowed the fund to protect itself from forced selling at the bottom of bearish markets and even allowed us to add to high conviction opportunities during those times. We believe a key measure of risk lies in the levels of gross exposure, not just net exposure.
2) We run a diversified portfolio. Sizing our core investments between 1-3% at cost allows Corsair to avoid concentration risk in any particular stock, sector or industry. While we invest with strong conviction, we also know that we do not know everything as humility is an important part of investing. Since 2005, we have had only 2 stocks negatively impact a single calendar year by 120bps or more versus 24 positively impacting attribution by the same magnitude. We believe our pipeline for opportunities remains robust and we are confident we can produce a similar batting average going forward.
3) We focus on buying companies with predictable cash flows, defensible business models and healthy balance sheets, led by activist management teams. These value creators allow us to be true partners and patient investors, providing multiple catalysts to drive a higher stock price over time.
However, the past few years have been an extremely difficult time to own value stocks, especially in the small and midcapitalization sectors. A look at event driven indices, peer returns and business headlines show a particularly unusual environment for the kind of stocks we invest in. Most of the companies we own have performed well; executing on financial targets and capital allocation initiatives. Yet, many of these stocks have not traded in-line with underlying performance. While we are not satisfied with our recent returns over the past two years, we believe we have done a solid job managing risk during this difficult period. As shown below, our risk, as measured by volatility, has been meaningfully lower than the Russell 2000 since 2014:
We think this is of paramount importance. Recent market volatility is forcing investors to reassess their portfolios relative to how much risk they have actually been taking. Corsair’s differentiated portfolio construction is built to withstand difficult equity markets that emerge from time to time. Therefore, we believe Corsair is a core equity fund that can be added to during market declines.
Corsair Capital - Taxes:
Our 25-year track record of achieving higher returns while taking lower risk is accentuated by our tax efficiency. As noted above, our investment strategy requires patience as we look for multiple catalysts to unfold for our stocks. This patience results in higher stock prices, but also in long-term capital gains for our limited partners. To illustrate our tax management, we assume an investor began with $1 million at inception:
Of course, the most exciting news for original Corsair investors is how much economic income we have generated. However, tax payers appreciate that we have done a good job with our short-term gains coming in at only 6.73%. We suppose that peers who focus on short-term trading likely have a significantly higher percentage of short-term gains. Additionally, we have recently gotten even better at tax management. Here is what an investor with a $1MM investment at inception has paid in short-term gains over the past 10 years:
Tax efficiency is a natural outcome of our investment strategy. As we consider after-tax dollars the measure of true returns, we believe Corsair has proven over the course of 25 years that our investors have a strategic advantage; they get to keep more of the dollars we have earned for them. As we look forward, we are not expecting a change in our investment philosophy and, therefore, expect to continue to generate minimal, if any, short-term gains for our investors.
Corsair Capital - Q1 2016:
Our investment pillars served us well in the first quarter of 2016 as fear and uncertainty took hold in what was a tumultuous period for equity investors. Equity indices ended the quarter mixed, with the S&P 500 up a bit and the Russell 2000 index recording a small loss. However, the ride was anything but smooth. Markets seemed to have been blindsided by reports of a much weaker financial and economic backdrop in China, which combined with plummeting oil prices and weaker global demand, led to greater concerns of a global recession. The situation was exacerbated by the fear that the Fed was discounting the financial market’s gyrations, potentially leading to higher interest rates and an even stronger dollar (negative for the competitiveness of U.S. companies). As discussed in our year-end letter, it seemed as if no one was bullish on equities and the S&P 500 started the year with its worst beginning since 2009 as fear and uncertainty took hold.
March, however, took on a decidedly more positive tone as