Third Friday Total Return Fund letter to partners for the fourth quarter ended December 31, 2015.
Dear Fellow Partner,
Third Friday Total Return Fund – Performance
In 2015, The Third Friday Total Return Fund, L.P. (the “Fund”) earned a net return (unaudited) of +8.26% compared to -0.85% for the HFRI Fund Weighted Composite Hedge Fund Index and a +1.38% total return for the S&P 500.
Nomad Investment Partnership: Keep An Eye On The Unseen Risks
There are many ways to define risk. Warren Buffett has said that "risk comes from not knowing what you're doing." Q3 2020 hedge fund letters, conferences and more His mentor, Benjamin Graham, believed that risk should be measured as the chance of a permanent capital impairment of an investment. Seth Klarman also holds this view. Read More
In the fourth quarter, the Fund earned a net return of +3.48% compared to +0.99% for the HFRI Fund Weighted Composite Hedge Fund Index and +7.04% for the S&P 500.
Since inception in May 2007, the Fund has earned a net annualized return (audited through 12/31/14) of +7.86% compared with a net annualized return of +2.75% for the HFRI Composite Hedge Fund Index and an annualized total return of +6.05% for the S&P 500. A complete statistical analysis of the Fund’s performance since inception is attached to this letter.
We wrote you recently in view of the unusual volatility with which markets have started the year to let you know that Third Friday is weathering the storm extremely well. The Fund is well hedged and even better hedged than it was last August when the market experienced a similar downdraft.
Third Friday Total Return Fund – Strategy
Third Friday was one of the best performing hedge funds in 2015 particularly when its returns are evaluated on a risk-adjusted basis. The fund employs no leverage and ran cash positions of well over 50% throughout the year. We decided to reduce our holdings of corporate bonds at the end of the year to zero in order to maximize the capital that can be invested in options in 2016. In 2015, our return suffered by approximately 150 basis points due because our corporate bond positions not only generated a small loss but also diverted about $2.5 million of capital investments in options that were generating 10%+ annualized returns. We decided to reallocate this capital away from bonds and towards options at the end of the year in the expectation that the bond market will continue to underperform in 2016.
Third Friday was started as a family partnership and operated as such for several years until I joined the fund in November 2012 to grow it into an institutional hedge fund. The assets in the fund have grown by 20-fold since then. In addition, we had over $140 million of total assets in the strategy at year end and our growth is accelerating. We launched an offshore fund on July 1 and are in the process of preparing an insurance dedicated fund.
It should be noted that our returns should not suffer as a result of rapid growth. Unlike other strategies that encounter liquidity problems or require the generation of new ideas as they grow, Third Friday simply applies the same investment strategy to a larger number of options straddles. Furthermore, these straddles on the S&P 500 index are among the most liquid instruments in the world. Accordingly, the Fund can accommodate significant growth without any diminution in liquidity or returns. Our world class service providers – auditor RSM LLP (formerly known as McGladrey LLP), law firm HaynesBoone and administrator SS&C – and our own professional staff are focused on producing superior risk-adjusted returns for all our partners as we actively grow the Fund. The general partner is committed to reinvest virtually all of its performance fees in the Fund for the duration of its life as an expression of its commitment to our partners and our belief in the strategy.
Third Friday Total Return Fund – Market Outlook
In 2015, most hedge funds, mutual funds and other investments generated disappointing returns. I wrote in January 2015 in The Credit Strategist that the thesis that a bear market cannot occur without the onset of a bear market and aggressive Fed tightening would be questioned at the zero bound. That thesis was tested and it flunked as the stock market experienced a stealth bear market and the high yield bond market basically crashed. Today, the majority of stocks in the S&P 500 are trading 20% below their 52- week highs, the definition of a bear market. Arguments promulgated by Wall Street economists and the mainstream media last year that stocks would rise, oil prices would recover and low oil prices would benefit the economy – all of which I challenged repeatedly in The Credit Strategist – proved to be wrong. Instead, stocks struggled, oil prices dropped further, and low oil prices turned out to be bad news for the U.S. economy. Unfortunately, more of the same is likely in store for investors in 2016. Add to that an increasingly unstable geopolitical situation and you have a recipe for further market losses.
Investors in Third Friday, however, need not worry about these problems. Third Friday doesn’t generate its returns from the direction of the market; instead, it extracts returns from the volatility and time value embedded in options. While I have every confidence in my market calls, Third Friday’s returns do not rely on them being correct. Instead, Third Friday relies on execution of a strategy that has been developed and perfected over the last 20 years through many difficult markets. We proved this again in 2015 by experiencing only two negative months (one by only -0.02%) while the S&P 500 was negative in 6 of the 12 months of the year. Further, we demonstrated in our recovery from our one seriously negative month (-3.14% in August) how our strategy is designed to recover from losses by taking advantage of the rising options premiums that naturally follow bad months to generate higher returns in the subsequent months. This built-in feature of the strategy mitigates losses and protects capital.
There are very few ways for any investor, whether an institution or an individual, to earn consistent high single digit/low double digit returns in liquid strategies in any market environment. That is particularly true in today’s world. There are few if any strategies that can compete with either the risk-adjusted returns or the short-term liquidity that Third Friday offers. Most hedge funds require investors to lock up their money, invest capital in a limited number of concentrated positions, employ high amounts of leverage, pay much higher fees, and at the end of the day produce lower risk-adjusted returns with much higher volatility and much lower liquidity. And we have been doing this consistently for more than eight years in the Fund and much longer in separate accounts.
I would like to thank all of our partners and service providers for their support. We are actively seeking new investors to the fund and welcome referrals and additional capital from existing partners. If you think you know someone who would be interested in investing in Third Friday, or if you have any questions, please don’t hesitate to contact me directly at [email protected] or (561) 239-1510.
Michael E. Lewitt
Third Friday GP, LLC