Rhizome Partners Q1 2016 Letter – this is a good letter see the full thing below
During Q1 2016, Class B investors of Rhizome Partners experienced a 5.5% gain net of expenses versus a gain of 1.3% for the S&P 500. For the quarter, Columbia Pipeline Group/Partners, Macy’s, FRPH, and a basket of merger?arbitrages generated estimated gains of 1.5%, 1%, 1%, and 0.5% respectively. No individual names contributed to a loss greater than 0.5% during the quarter.
During Q1, the S&P 500 was down roughly 11% at one point. Due to our large cash holding, we were down roughly half of the S&P 500’s move at the bottom. We expect, but cannot guarantee, this type of outperformance to the S&P 500 in a sharp market selloff. However, Rhizome Partners will always hold a large sum of cash and/or engage in market neutral investments in order to take advantage of future “one hundred year market storms that often come around every 5?10 years.”
Earlier this year, we allocated our dry powder to both general undervalued securities and highly asymmetrical merger?arbitrage opportunities. In addition to securities yielding double digit dividends, we also found merger?arbitrage opportunities with 8?10% spreads that normally would have traded between 1?3%. Our decision to allocate both to generally undervalued and into merger?arbitrages is due to the fact that we cannot predict if the S&P 500 will be at 1,600 or 2,100 at any given moment. If the market were to selloff further, we would have taken the proceeds from the merger?arbitrages and re?invested in more generally undervalued securities.
During our year?end 2015 letter, we speculated that the Q1 market dislocation may last longer this time. To our surprise, the S&P 500 rallied from the February trough. Many of our new positions experienced double digit percentage returns and the spreads in the merger?arbitrage opportunities narrowed substantially. While we are happy to have experienced the investment gains, the market did not provide ample time for us to conduct in depth research which would have allowed us to build larger position size over time. The sizable return on newly invested capital does support our belief that cash deployed during times of distress often lead to outsized returns.
Reflection on Recent Investment Trends
In the last couple of years we have noticed value investors increasingly gravitate to some form of “asset light businesses with innovative CEOs that are disrupting their industry.” The investment landscape is littered with the carnage of once high?flying ventures such as Valeant Pharmaceuticals, SunEdison, Altisource Asset Management Corp, RCS Capital Corp, etc. What is disturbing is how many of the most sophisticated value investors in the world can be found lying in the wake. The results are catastrophic. Valeant has lost 85% of its value from its peak and is being investigated by the government. SunEdison recently filed for bankruptcy following a similar growth trajectory as an overly optimistic real estate developer on a debt fueled development spree. RCS Capital is now bankrupt and Altisource Asset Management experienced a 99% peak to trough decline. Shareholders in both businesses experienced the painful lesson that “high ROIC and asset light” can also mean “assets can walk out the door.”
The failures are good reminders that finding long term compounders is not as easy as Warren Buffett makes it seem. One needs to be humble enough to realize that Buffett’s ability to identify compounders is analogous to Michael Jordan’s ability to dunk. Sure it is elegant and looks easy for them, but it does not mean that most investment managers can consistently pick compounders without a few mistakes. The failures of 2015 are also a reminder that true compounders are few and far between. Not every fast growing high ROIC company is a franchise business like Moody’s or Kraft. During times like this, we are comforted to know that a core portion of our investments is in hard assets such as buildings, rock pits, and land parcels.
In the last three years, we have stayed true to our roots by investing in deeply undervalued securities that we understand. Our best virtue is the fact that we have been honest with what we know and what we do not know. We have been efficient with our research allocation preferring to drive from New York to Florida to visit buildings and rock pits instead of trying to understand whether price gouging of pharmaceutical products will result in long?term economic value creation. While many investors flock to heavily scrutinized large cap names, it seems intuitive for us to labor in obscurity for months while conducting due diligence on our belowthe? radar targets.
Full letter below
Rhizome Partners Q1 2016 Letter