Barac Value Fund letter for the first quarter ended March 31, 2016.
This is the Barac Value Fund's thirteenth 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.
What can past market crashes teach us about the current one?
For the three-months ending March 31, 2016, The Barac Value Fund L.P. (the “Fund” or “Partnership”) delivered net returns of 1.25% (after deducting fees and expenses) versus a return of 2.11% for the benchmark1.
Since the Partnership’s inception (on July 14, 2011), the Fund has returned 51.24% (after deducting fees and expenses) versus a return of 49.11% for the benchmark.
The Partnership’s returns amount to gross and net annualized returns since inception of 10.83% and 9.17%, versus 8.84% for the benchmark.
Barac Value Fund - Quarterly Performance
For the most recent quarter ending March 31, 2016, the Fund returned 1.64% on a gross basis and 1.25% on a net basis (after fees), versus 2.11% for the benchmark. Underperformance for the quarter was driven by an underweight position in bonds and an overweight position in stocks (as bonds substantially outperformed equities during the quarter).
Top individual stock performers included Adidas A.G. (+20% for the quarter), Gap (+20%), Target (+14%), and Berkshire Hathaway (+7%). The worst individual stock performers included Twitter (-28% for the quarter), Charles Schwab (-15%), Ralph Lauren (-13%), and Wells Fargo (-10%).
The longer-term performance for the Fund remains solid with gross and net returns since inception of 62.42% and 51.24%, respectively, versus a return of 49.11% for the benchmark.
As always, it is also important to re-state that the Fund’s returns were generated without leverage (either direct or effective leverage through options), without taking highly concentrated positions, and while 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.
Interest rates declined considerable over the course of the quarter, with the benchmark 10-year Treasury note falling by almost 50 basis points (from 2.27% to 1.79%). Largely as a result of lower interest rates, bonds performed very well during the quarter. In fact, the return of the bond subcomponent2 of the Fund’s benchmark was over twice that of the equity subcomponent3 (3.03% versus 1.35%). Because the Fund was substantially underweight bonds, the relative performance of the Fund was constrained by this allocation mix.
With respect to individual winners and losers, let’s avoid typical investment marketing spin (i.e. highlight the winners and downplay the losers) and focus on the biggest loser. In that regard, Twitter was down 28% for the quarter (and down another 12% this month following a weak earnings announcement this past Tuesday).
So, what has gone wrong with Twitter and has this sell-off created a further buying opportunity?
To begin with let’s revisit the Fund’s history with Twitter, as this is not the not the type of stock typically targeted by the Partnership (i.e. speculative with substantial growth already priced into the shares).
As detailed in an earlier Partnership letter, the Fund first bought shares of Twitter in May of 2014 after the shares had declined by over 50%. At that point, the company’s valuation had fallen such that I viewed a small position as an attractively priced option on the company’s ability to monetize their user base and/or realize takeover upside. In less than a year after the purchase, the stock price increased by over 50% and I became less comfortable with the risk/reward dynamics of the shares (thus, selling a third of the shares at a considerable profit in April of 2015).
Tax considerations temporarily prevented me from selling more (i.e. the position was still a short-term unrealized capital gain) and this proved unfortunate. Since that time, earnings results have disappointed and the share price has fallen considerably. More specifically, as of today’s close Twitter’s shares are down approximately 58% from the Fund’s original entry price (and down approximately 80% from the share’s all-time high).
These are huge percentage moves, but let’s put it all into perspective. Twitter accounted for about 1.8% of the Fund’s assets-under-management (“A.U.M.”) going into the 1st quarter. Twitter has always been (and remains) a small position for the Fund and I estimate that combined realized and unrealized losses for Twitter (through today’s close) are equal to approximately 1.0% of the Fund’s A.U.M.4.
While this is a material loss and disappointing, it is a relatively small loss in the context of Twitter’s substantial share price decline. The reason that Twitter’s dramatic fall has not had a larger negative impact on the Fund’s performance is because the position was speculative and sized appropriately to the risks.
Moving forward to today, I do not believe that the sell-off has provided an improved investment opportunity because the news flow has actually been as bad or worse as the resultant share price collapse. Sell-offs only provide for opportunity when they are overreactions and I don’t believe that to be the case here.
With Tuesday’s earnings announcement, Twitter guided for sequential and year-over year revenue growth for the next quarter of only about 1% and 19%, respectively. By way of comparison, sequential and year-over-year revenue growth for the same quarter in 2014 (around the time that the Fund first entered the position) were approximately 25% and 124%, respectively. To be fair, a deceleration of growth was expected and is inevitable for a large and rapidly growing company like Twitter. That said, the degree of the deceleration has been disappointing.
While I do not believe that the sell-off has provided an improved investment opportunity, at Twitter’s current $10bn valuation (further diverging from Facebook at $342bn)5 I still view the shares as a modestly attractive option on the ability of the company to better engage and monetize their user base and/or realize takeover potential. Because of the nature of the current circumstances, however, I believe the shares are even more speculative than before (thus, I sold shares after the Q1 results) and Twitter now accounts for only about 1% of the Fund’s A.U.M.
Barac Value Fund - Outlook and Positioning
I believe that domestic stocks remain modestly attractive when considering current earnings valuation multiples and forward growth expectations. I also continue to believe that high-grade bonds are substantially overvalued and don’t adequately compensate investors for interest rate and inflation risks.
At a yield of 1.84%6, 10-year Treasuries are yielding less than both the Federal Reserve’s inflation target and the dividend yield of the S&P 500. Hardly bargain pricing. In fact, absent the diversification and short-term hedging benefits (vis-a-vis equities), I believe that there is little incentive to own high-grade bonds.
The Partnership remained substantially underweight fixed-income at quarter-end (22% of A.U.M. versus 40% for the benchmark) and equal-weight equities (60% of A.U.M. versus 60% for the benchmark). In order to mitigate credit and interest rate risks, the majority of the Fund’s fixed-income investments are in U.S. Treasuries and most of the positions have fixed maturities of less than 5 years.
Given my bearish long-term view for bonds and the continued risk of a material pull-back in equities, I continue to believe that a substantial cash position is prudent. As such, cash held by the Fund amounted to 18% of A.U.M. at quarter-end.
Thank you to everyone for your interest and support and please let me know if there are any questions you may have that I have not answered. The next quarterly report will be for the quarter ending June 30th, 2016 and the next subscription period for the Fund will be April 29th.
Managing Member of Barac Capital Management, LLC