Dane Capital Management Fund annual letter too partners for the year ended December 31, 2015.
Given the late timing of our 4th quarter and year-end 2015 letter, we will address both our 4th quarter, and more recent 1st quarter developments.
In the 4th quarter Dane Capital Management Fund (the “Fund”) returned 4.3%, net of fees and expenses, bringing the Fund’s full-year 2015 performance to 0.5%. While this is marginally better than the (4.4%) return of the Russell 2000 (including reinvested dividends), and superior to the returns of many small cap value strategies, this result is far from satisfying. As we have previously stated, we believe our success should be measured over years, and not months or quarters. And even the measure of years, as Nassim Taleb explains in Fooled By Randomness, may not fully reflect an investor’s talent. We remain confident that our disciplined, long-term, value-oriented approach, will reward our Partners for their patience, and that Dane Capital will outperform markets over time.
Despite our focus on the long-term, the first two months of 2016 have been exceptionally frustrating. Our year-to-date portfolio performance has been poor. While the Fund’s performance has been disappointing, there has been no specific factor that has caused the material price declines we’ve experienced in many of our largest positions. We take this as a double-edged sword – on the one hand we don’t believe our positions are impaired, in fact, in our opinion the distance between market value and intrinsic value has materially widened. Still, it’s frustrating, and we have spent significant time checking and re-checking our assumptions, via calls, channel checks, etc. However, our confidence remains strong, especially since several companies have already reported strong results and outlooks, and in many cases we have added to our highest conviction ideas.
As we will detail below, none of our major positions have had a material (or even immaterial) blow-up in fundamentals year-to-date. That said, we have significantly cut our holdings in ChipMOS, a company and management we know well, not because of a loss of confidence in fundamentals or a narrowing of the significant price disparity between IMOS (the US listed shares) and 8150.tw (ChipMOS Taiwan), but because management’s poor treatment of US shareholders concerns us that the price gap when IMOS converts to an ADR simply may not close. While we’re disappointed by ChipMOS management, this has had little impact on Dane Capital's year-to-date performance. The point is simply that if and when facts change, we will not hesitate to reduce exposure to or fully exit a position. However if a thesis remains intact and the stock price drops, we will likely add.
We note that among our largest positions, we do not have exposure/dependence on rapid growth in China, nor do we have exposure to commodity prices. If anything, most of the stocks we own stand to benefit from lower commodity input costs. Most generate the majority of sales from US consumers or enterprises, are inexpensive both on relative and absolute terms, and have engaged in buybacks (either by management and Board members, or at the corporate level). Few, if any, of our holdings are in cyclical industries and we don’t believe the companies in our portfolio generated peak earnings in 2015 – in fact many should see business accelerate in 2016 and beyond.
Our portfolio companies also have relatively limited industry overlap. The one commonality is that many/most are small cap. While there clearly has been a market de-risking, a trend which appears to have turned around the past few weeks, most of our portfolio companies have low valuations – low enough that we’ve been surprised by their downside moves.
Dane Capital's stated goal is to identify materially mispriced securities where we believe we have a unique and differentiated perspective that will generate strong investment returns over time. After 20 years in the investment industry, we have learned that cheap can often get cheaper – which we have attempted to avoid by identifying relatively near-term value-creating catalysts that should result in a stock’s market value and intrinsic value converging over a relatively short period. Despite our less than sanguine view on the global economy entering 2016, we thought we were entering the year positioned to dodge major land mines. While, from a fundamental perspective, we’ve avoided land mines, we’ve been surprised by the pronounced declines in several of Dane Capital's holdings. That said, we’re neither market timers, nor macro-economists, although our view on the macro environment certainly impacts our analysis.
Following the sell-off in many small-caps in 4Q 2015, including several of our holdings, which we attributed to tax-loss selling and fund redemptions, we’ve been amazed by the further (often significant) declines in many of our stocks, despite no identifiable bad news (in fact several of our holdings are experiencing accelerating positive fundamentals). We are largely exposed to companies that are extremely inexpensive (i.e. free cash flow yields in the double-digits, based on current/trend, not peak earnings) in secular growth industries, with managements that have exhibited their confidence in their businesses either by corporate or personal share repurchases.
We attribute the majority of stock price declines in our portfolio to a general decline in micro/small-cap stocks. In many cases, there simply has been no bid. We have continued to perform due diligence on our core holdings, have been in contact with every management team of our major portfolio companies, and have assessed (and reassessed) what we could be missing. We are confident that the fundamentals of our core holdings have not deteriorated – and, as we previously stated, in several cases have improved. While it provides us with little short-term satisfaction, we believe for many of our holdings, the distance between market value and intrinsic value has widened, even considering a negative multiple re-rating as the world goes “risk-off”. However, when our analysis proves accurate, as we expect it will, and investors once again step into small-caps, we are optimistic Dane Capital's positive performance could be dramatic. We’re pleased and gratified that despite our year-to-date performance, several of our investors agree with our perspective and have added to their partnership interests in Dane Capital with increased AUM in both March and committed for April.
Many larger-cap companies have seen similar year-to-date stock price declines (Amazon down 14.9%, Netflix down 11.1%, Tesla down 16.2%, and the list goes on), but many of these companies trade at 20x or 30x (or far more) earnings and 10x revenues – unfortunately we’ve been inadequately short this group of stocks (again, we’re not market timers, and had we been short this group in 2015 it would have been a disaster). Our portfolio has experienced similar declines, but with our holdings it’s largely been with companies that now have double-digit free cash flow yields and are enjoying accelerating fundamentals in secular growth industries.
We worked on Wall Street during the downturns of ’98, ’00, and ’08 and are cognizant of current global uncertainty. With those years in mind, we are reminded that owning well-run businesses, in secular growth segments, at compelling multiples, with well-aligned managements is a formula for producing outsized returns over time (we recognize that we say “over time” frequently, but in our view patience is the most consistent path to long-term wealth/value creation).
To be clear, in