Barac Value Fund letter to investors for the third quarter ended September 30, 2015.
This is the Fund’s eleventh regular quarterly report to provide updates on the Partnership’s performance. The Partnership’s fund administrator, Fund Associates, LLC, is also generating monthly investment reports for each Partner, by directly and independently accessing the Fund’s electronic brokerage data.
For the three-months ending September 30, 2015, The Barac Value Fund L.P. (the “Fund” or “Partnership”) delivered net returns of negative 6.66% (after deducting fees and expenses).
Since the Partnership’s inception (on July 14, 2011), the Fund has delivered net returns of 46.56% (after deducting fees and expenses) versus a return of 40.39% for the benchmark, resulting in relative outperformance of approximately 617 basis points.
The Partnership’s returns amount to gross and net annualized returns since inception of 11.16% and 9.49%, versus 8.38% for the benchmark.
Barac Value Fund – Performance Overview
For the most recent quarter-ending September 30, 2014, the Partnership returns were negative 6.32% on a gross basis and negative 6.66% on a net basis after fees, compared to a negative 3.39% return for the benchmark. Relative performance was adversely impacted by direct exposure to European equities and the media and oil and gas sectors (all of which substantially underperformed the large-cap S&P 500 index, upon which the Fund’s benchmark is largely derived).
Top individual stock performers included Amerco/UHAL (+20% for the quarter), Best Buy (+14%), and D.R. Horton (+7%). The worst individual stock performers included Viacom (-32%), Twitter (-26%), and the Energy Sector ETF/XLE (-19%).
As discussed before, an under-performing quarter is never desirable, but it is expected from time-to-time. The value investment philosophy of the Fund entails identifying and buying undervalued assets and holding them until they approach fair value. While I believe that the Fund’s strategy of identifying and holding under-valued assets reliably improves the odds of outperformance over all time periods, short-term price movements are inherently unpredictable. As such, caution should be used when evaluating short-term performance and I hold the most conviction for the Partnership’s investment strategy over the longer-term.
The long-term performance for the Partnership remains strong with gross and net returns for the Fund since inception (in July of 2011) of 56% and 47%, respectively, versus a return of 40% for the benchmark. This demonstrates the long-term value that the Partnership has delivered and the absolute effect of the compounding of the Fund’s historically2 higher annualized returns. Going forward, the objective is obviously to improve on that performance (on both a cumulative and annualized basis) as the Fund’s strategies are allowed further time to play out.
As always, it is also important to restate that the Fund’s returns were generated without leverage (either direct or effective leverage through options), without taking highly concentrated positions, and with the headwinds of holding substantial cash balances. I also continue to “put my money where my mouth is” and most of my net worth also remains invested in the Fund along with the other Partners.
Barac Value Fund – Quarterly Commentary
The equity holdings of the Fund performed poorly during the third quarter — most notably for European equities and the media and oil and gas sectors. While the Funds positions are concentrated domestically and diversified across sectors, under-performance in those sectors was substantial enough to materially impact the Fund’s relative performance for the quarter.
For example, the broad based oil and gas ETF’s XLE and XOP (both securities in which the Fund had exposure) fell by 19% and 30%, respectively, over the quarter. Similarly, the Partnership’s media holdings in Viacom Inc., Discovery Communications, and AMC Networks fell by 32%, 22%, and 11%, respectively.
My response to these price developments was varied. I absolutely believed that there was some validity to the negative market reaction to the second quarter results announcements of media content providers and the heightened “cord-cutting” concerns (i.e. worries about Pay-TV subscribers leaving for streaming services and other alternatives). As a result, I re-allocated exposure towards what I believed was the stronger media content provider and the stock for which I felt that the sell-off was considerably overdone.
More specifically, I sold out of both AMC and Discovery (for an aggregate capital gain) and increased exposure to Viacom — whose shares had fallen by over 38% at their low point during the quarter. During the three weeks following Viacom’s second-quarter results, I added considerable exposure at an average cost of $42.71/share. This incremental investment has been profitable, as Viacom’s shares are now trading 20% above those acquisition prices (to $51.33 as of today’s market close).
Twitter was also one of the worst performers for the quarter. As with Viacom, I felt that the sell-off following Twitter’s Q2 results was overdone and added exposure at an average price $26.69/share during the quarter. Shares have subsequently increased approximately 9%from those levels (to $29.06/share as of today’s market close). While the returns for Twitter have been very volatile, I believe that risk/reward dynamics for shares remains attractive. Nonetheless, it remains a more speculative positon and, thus, amounts to less than 2.5% of assets-under-management (“A.U.M.”; as of yesterday’s close).
As opposed to the sell-offs in Twitter and Viacom, I did not see the sell-off in the oil and gas sector as a buying opportunity. Despite lowered valuations for oil and gas stocks, I felt that the risk/reward dynamics for the sector were less positive than I originally believed — as supply/demand visibility was very poor. I lowered the Fund’s exposure to the sector commensurately and direct oil and gas exposure was reduced to approximately 3.5% of A.U.M. at quarter-end (compared to almost 6% of A.U.M. at the end of the prior quarter).
Barac Value Fund – Outlook
Over the course of the quarter, industry benchmark 10-year Treasury yields declined by 28 basis points (from 2.34% to 2.06%) and lower bond yields, more broadly, led to an increase in the value of the bond index3 by 1.23%. Domestic equities, on the other hand, fell substantially with the S&P 500 equity index4 falling by 6.44% over the quarter.
I have often stated that I ultimately expect to reallocate the Partnership’s cash into more wealth-producing assets as bond yields and equity valuations shift such to warrant such a re-allocation. I believe that another good opportunity to do just that occurred during the quarter when the benefit of holding a sizeable cash balance was realized. While absolute declines in the domestic equity markets for the quarter were considerable, interim declines during the quarter were even more substantial (as volatility increased).
For example, the S&P 500 index fell by over 11% during the week of August the 18th through the 25th. I saw these declines as a good buying opportunity and put a considerable amount of cash to work that week by purchasing S&P 500 index exposure (through the SPY ETF at an average cost of $192.73/share). The equity market has subsequently rebounded and those shares have increased by over 8% above the aggregate cost basis of those purchases (to $208.83/share as of today’s market close).
On an aggregate basis at current valuations, I continue to view domestic equities as fairly valued with select individual/idiosyncratic opportunities that offer considerable value. I also continue to view bond yields as relatively unattractive relative to equities —