Dichotomy Partners annual letter to investors for the year ended December 31, 2015.
Humbling is probably the word that best describes 2015. Just about nothing worked on the long side as multiples compressed and fundamentals deteriorated into a crumbling high-yield market that was marked by lower liquidity, higher costs, and general despondency. A bright note was the short book, which performed very well across a number of names.
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While frustrating, the long-term outlook is quite rosy. Valuations have come back down to earth for a number of companies and the opportunity set is quite wide. Indexing, which has exploded in popularity is causing dislocations in a number of names. So, while valuations have come down dramatically for many smaller names, large cap valuations remain stretched, a factor I believe is being influenced by the proliferation of ETF indexing. A true long-term alpha hunt can begin as the Fund picks up the remains of liquidating funds and continues to short the exuberance out there.
2015 marks the third year for the Fund and overall, I think we are on the right path, despite the performance this year. Any single year is a poor indicator of overall ability, and I think five years is the minimum time to assess true alpha. With that stated, we are a little over halfway there.
I still believe in transparency and a clear research process. I have had the pleasure of cultivating a great investor base that provides feedback to my research in a controlled rational manner. The criticism, questions, and comments are greatly appreciated. With almost all of my net worth in the Fund, nobody hurts more from an incorrect thesis than I do. Finally, I have set up a fee structure that allows me to invest rationally over a multi-year horizon.
This letter will start by outlining our results and the portfolio composition. From there I will dive into the long book and the short book, examining a few key positions and thoughts. Following that, expectations for 2016 will be laid out, what I believe to be the opportunity set today, and general discussion. Bring it on 2016.
Dichotomy Partners - Results and Portfolio Composition
During 2015, the Dichotomy Partners Fund returned -4.3% net of all fees, underperforming the S&P’s return of 1.3%. Monthly returns can be found in Appendix 1. Since inception, the Fund has returned 62.9% net of all fees compared to the S&P’s return of 50.5%. The Fund’s basic statistics can be found in the table below.
Table 1. End of Year Fund Snapshot
There were limited opportunities in 2015 for large investments, and thus gross and net exposure were both kept low. As planned, the Fund diversified holdings in 2015. With the benefit of hindsight, the core long holdings should have been reduced even more. The trend for exposure can be seen in the table below.
As far as segment exposure goes, the Fund has slowly decreased net exposure to Financials. As of 12/31/2015, Financials were 22.1% of the Fund, down from more than 46% at the start of the year. Some of this was due to selling of longs such as United Insurance; some was due to increased short exposure to financials.
Exposure to utilities was increased throughout the year. The Fund entered January 2015 short a single utility name. By the end of the year, five utilities were in the portfolio, comprised of two shorts and three longs.
The peer-to-peer (P2P) book continues to be liquidated and will be completely closed out by the end of 2016. Technically, the P2P book is “hedged” with our short of Lending Club.