Florida based Gator Capital Management is having yet another healthy year. According to the fund’s third-quarter letter to investors, a copy of which has been reviewed by ValueWalk, for the year to the end of the third quarter the fund managed by Dereck Pilecki returned 9.7%.

See also: Hidden Value Stocks 

While this lagged the S&P 500‘s total return of 14.2% over the same period, since inception (July 1, 2008) Gator has produced an annualized return for investors of 24.6%, or a total return of 666% net, eclipsing the S&P 500’s total return of 141% or 10% per annum over the same period. Additionally, Gator bogies to financial indexes being focused (almost or) exclusively on that sector.

Gator Capital Performance

Gator’s strategy is focused on the financial sector. The firm’s managing member, Derek Pilecki, specializes in financial stocks, and his picks have so far produced outstanding returns for investors. Luckily, investor sentiment towards the financial sector has made this industry a fertile hunting ground for value investors since 2008, as Pilecki described in an August 31 issue of Value Investor Insight.


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“Since I started my fund in 2008 there have been three times – the global financial crisis in 2009, the U.S. debt downgrade and European crisis in 2011, and when interest rates were bottoming in late 2015, early 2016 – when the sector has been pretty universally hated, which can, of course, create opportunity.” On top of the wider sector issues, more traditional situations such as turnarounds, spinoffs, and divestitures are fertile hunting grounds for Pilecki who tends to have “more ideas than I have room in the portfolio.”

Dereck Pilecki Strong Performance Continues As Financials Rally

At the end of the third quarter, Gator’s gross exposure was 152.2%, and net exposure was recorded at 63.4%. These figures only include equity holdings (the massive short is due to hedging of TARP warrants). As well as ordinary stocks, 5.4% of Gator’s portfolio is devoted to preferred stock.

Alternative asset managers account for around a quarter of the gross long book with KKR & Co as well as The Blackstone Group.

Ares Management also features in the portfolio and Gator’s third quarter letter goes over the investment thesis for this alternative finance manager.

There are a couple of critical points to the long thesis. Firstly, the company is not expensive compared to its peer group. Ares trades at 10.3 times 2018 estimated earnings per share, compared to traditional asset managers’ median 13.9 times EPS. Secondly, management owns 70% of the outstanding stock, meaning that they have a strong incentive to invest and generate the best returns for other shareholders. And third, there are many levers the company can pull to startup growth. Specifically, the firm has around $60 billion in Alternative Credit AUM, which is increasingly in demand by investors seeking to achieve a higher return on their capital. Further, there’s a strong demand for investors for alternative assets giving Ares scope to increase fee income. The firm’s last fund was 50% larger than its predecessor. Over the past ten years, Ares has grown AUM at a 21% compounded annual growth rate.

On the short side, Gator is betting against Franklin Resources, Old National Bancorp., Webster Financial, Iron Mountain, and Morningstar. Pilecki outlined the reasons why in his VII interview focusing on fundamentals and not the recent PR battle between Morningstar and the WSJ. Pilecki notes  that Morningstar, which is “well run, but its products cater primarily to active mutual-fund and stock investors.” The shares currently trade for “30x earnings, with no sell-side analysts following it and a bit of a cult following among buy-side holders.” He goes on to say that the firm deserves a valuation closer to that of rating agency Moody’s, which trades at 22x earnings. Dereck Pilecki does not expand much more on that short in neither interview or the letter.

This is not a new short position, as we reported earlier. Additionally, Dereck Pilecki has been short Morningstar since at least Q2 of this year.

He continues:

We’re also finding shorts in new-technology companies that promise to disrupt various financial sub-sectors, but which we believe have flawed business models. LendingClub [LC] shares are down sharply from their IPO price, but still, trade for 3x book value when we’d argue they will end up trading closer to book as the company starts securitizing loans on its balance sheet as other lenders do. In general,
we think financial services, because of the level of regulation and the number of entrenched competitors, will remain difficult to disrupt. It’s easy to lend money, but collecting on loans is hard. Companies will continue to try, and will likely raise a lot of capital to do so. For now, we see the new public companies more as a source of potential shorts than potential longs.

In the recent interview, Dereck Pilecki gives an interesting, insightful answer in response to a question regarding the most difficult aspect of managing money. :

The most-challenging part for me has been the emotional side of managing your own and other people’s money and the self-imposed pressure to perform. From the very first time you buy a stock and the jolt of adrenaline that comes with it, you
have to constantly remind yourself that it can take time for things to work out and how important it is to keep emotions out of your analytical and decision-making process.
This interview, for example, is going to present a potential challenge. I’m talking publicly about a few stocks, so will I be anchored to my publicly stated position if circumstances change, things don’t go well, or I change my mind? I’ll have to consciously think about the potential of that type of anchoring going forward and try to let it go.
Revisiting the portfolio with a clean sheet of paper on a regular basis helps me avoid getting emotionally invested in what I own. Pretend you don’t own any stocks and ask what are the 20 stocks you want to buy right now. If that doesn’t match what you own, you’ve got work to do.

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