ADW Capital Partners commentary for the first quarter ended March 31, 2017.
First see a brief excerpt from their email to investors
Partners and Friends of ADW Capital:
Baupost's investment process involves "never-ending" gleaning of facts to help support investment ideas Seth Klarman writes in his end-of-year letter to investors. In the letter, a copy of which ValueWalk has been able to review, the value investor describes the Baupost Group's process to identify ideas and answer the most critical questions about its potential Read More
As you will see from the numbers below, we are having a very strong start to 2017. More importantly, the performance is in line or AHEAD of our NET ANNUALIZED return since inception of +28.16% or to put it another way, each dollar invested at the launch of the fund is now worth close to $4.81.
In running a concentrated portfolio, quarter-to-quarter volatility can and should be expected. That being said, we continue to find extremely attractive investments. In fact, in the fourth quarter of 2016 we added a new core holding that I am very excited about and was recently profiled in the most recent edition of Value Investor Insight – a prestigious subscription newsletter. If I am close to right about its prospects, it can return multiples of our capital over the coming decade.
If you are interested in adding to your account or opening a new account the next deadline is June 1st.
And, please take the time to read our 1st Quarter Letter (attached). There is a good deal of analysis on our strategy, ethos, and philosophy toward the Fund.
Thank you again for your continued support.
Below please find the un-audited APRIL and 2017 YTD performance update for ADW Capital Partners, LP*:
|Since Inception (Jan 2011)|
|*Assumes a 2%/20% fee structure. Individual investor returns may vary based on the timing of subscriptions.|
ADW letter below
It is our pleasure to report results for the 1st quarter of 2017 and our 25th quarter since inception.
At the risk of sounding like a broken record, we want to reiterate a critical point discussed in all quarterly letters. ADW Capital Partners, L.P. (the “Fund”) operates a concentrated, tax-sensitive and long-term strategy designed to minimize correlation to the broader indices with a focus on avoiding permanent capital loss. Inevitably, this approach will result in periods of underperformance. By the same token, our efforts to maintain a lower correlation strategy driven by company-specific outcomes may produce significant outperformance in periods of market weakness, as we saw in 2011. We are not traders, return chasers or month-to-month stock jockeys. We are investors who look for opportunities to return multiples on the Fund’s capital in a tax-efficient manner over an extended period of time. While this strategy may yield lumpy results, we believe it limits idea dilution and protects the Fund’s returns from Uncle Sam and Wall Street.
ADW Capital Partners – Quarterly Update:
The celebration of the Passover holiday last month reminds us of the importance of asking questions. The tradition of asking the four questions around the seder table is rooted in ancient times, however the purpose of Passover in our personal lives today is about freeing oneself from internal constraints by asking fundamental questions. It is in that spirit that we at ADW Capital find ourselves asking our own set of questions.
“Why is this quarter different from all other quarters?”:
In our fourth quarter letter, we discussed the quality of our capital base which through proper education and conditioning has allowed us to weather some “difficult times” on a “mark-tomarket” basis. In fact, some of you even took the opportunity to add to your accounts and take advantage of what I would call “stock market deviation from business
You may ask yourself what does that mean…..?
To answer that question, you must first answer two other questions: You must first ask yourself what makes stocks of companies go up and down and what is a stock? Let’s start with the latter.
A “stock” – generally – is a share of a company which represents some fractional ownership of a business. This fraction of a company – generally – entitles you to certain intangible rights like voting and certain economic rights — “the earnings per your share” which can either be reinvested in its own shares, back into the underlying business, or distributed through dividends.
Generally, with the exception of tech titans like Amazon and Tesla, companies that over time grow their earnings per share become more valuable as they have more money to either grow through re-investment or distribute to shareholders. This mechanism of becoming more valuable is incremental buyers or existing owners of the Company buying more and driving up the price on expectation of future growth in earnings and future potential capital return – dividends / share repurchases. This maxim/fundamental reason for what drives stock prices is basically the only maxim we subscribe to.
So, we have defined what a stock is and what – generally – influences stock prices to go up. But what makes them go down? Well, sometimes investors get overly ebullient and drive prices to a level where the expected earnings growth/shareholder return is already “priced in”. Sometimes, a company’s growth misses “expectations” and can force a stock to trade down. If the quality of the business/management team is good and the business model has great long term characteristics / runway these are usually great buying opportunities. Other reasons stocks of companies would go down is if the company’s business model is getting disintermediated or losing market share to competition. If a company quits growing or its earnings start declining then the business becomes less valuable and would cause shareholders to sell. These two reasons would be fundamentally why we would either sell a long holding or short shares of a company. There are many other nuances – capital structure, refinancing issues, cyclicality, etc. but they are all generally captured above.
But why else do stocks go down?
One reason stocks go down (and up for that matter) is indexation and more broadly “factor”/sector capital flows. Certain companies are grouped into indices for certain investors who want to get long or short a certain sector but don’t want to take single company risk. If investors want to own more or less of a certain index then the index creator has to buy more or sell more of the individual constituents of that index.
For example, in early 2016, a lot of foreign capital was “short Italy” based on a perceived imminent banking crisis and political uncertainty over its upcoming referendum/elections. So, to be “short Italy” someone needed to sell more of the underlying components of the index – driving down the prices of individual companies. Companies like Fiat (FCAU) and Ferrari (RACE) for reasons that had nothing to do with their own business performance were sold off because they were included in an index. We knew that the underlying fundamentals of these businesses were intact. In fact, it was our belief that not only was the growth of these businesses accelerating but that consumer confidence in Italy was strong and the economy there was poised for acceleration. While the short term “mark-to-market” was painful, we knew the fundamentals were there to support and grow prices over the longer term.
Another reason stocks go down (which we really like for buying opportunities) is non-economic selling. This is expressed in a few different ways. For example, when a big company spins off a much smaller company, a portfolio manager may not be able to hang on to the shares of the smaller capitalization company based on their own individual mandate – i.e. can’t own certain companies under $5 billion per their fund’s rules. Another reason may be that a fund is closing down or changing their mandate. In that circumstance, someone would be selling shares of a company to return cash to their investors or to raise cash to buy different types of companies broadly. Again, these reasons have little to do with the underlying performance of an individual asset or stock.
Lastly, we must ask ourselves…
“What makes our “fund” different from all other hedge funds?”:
The first point is that we typically own about six to ten companies at a given time. We are also incredibly low turnover – at points we have gone years without selling a single position. From a risk perspective, we also do not fall into the trap of many funds who use excess leverage and/or short indices to try and increase gross exposure and magnify mediocre assets/returns. We are by definition disciplined long term holders who demand superb returns on unlevered capital. Probably our most distinguishing characteristic is that we look more like a private equity fund than anything else.
Private Equity in the Public Markets:
I recently had a conversation with a prospective investor and the investor said, “Well Adam, you are basically doing private equity in the public markets.” And I responded, “Yes, that’s correct the only difference is that we have to mark our portfolios to market by prices that are quoted by the second.”
Another potential investor came to me and said, “Why should I invest with you?”… “I am getting 20+ percent in the private equity funds I am invested with. My response back to him was, “If I had a twenty-year lock-up and could lever the S&P 500 5x with zero chance of margin call than I could do it too.” I was being a bit glib but directionally I think the point holds true. What are mega cap private equity funds doing? Private equity funds are paying buyout premiums for low growth defensible businesses that should grow on average at the same rate as the S&P and levering them up 3, 4, 5, 6, 7x –oh, and also taking generous fees from the portfolio companies as well. Here is another thought provoking exercise. If one were to look at 2005, 2006, and 2007 vintage private equity funds and the assets that they purchased at the multiples they purchased them at with the level of leverage they had on these assets, most of the “equity” in the deals would have been wiped out if not substantially negative. The same “analogy” applies to real estate. Given the leverage on most assets in real estate, the expansion of cap-rates in the crisis rendered equity tranches substantially impaired or underwater on a “mark-to-market” basis.
Perhaps these exercises are to condition our investors for the inevitable downturn/drawdown and to help them properly compare our “performance” to other asset classes. But, another reason might be to show that what we are doing truly is differentiated and does create economic value that goes beyond just financial engineering and opaque private equity reporting. Shorting, trading, sector hedging, are all constructs for people who mark their portfolio daily. It is our belief that “owners” do not calculate their net worth daily. Agents, gatekeepers, and the folks who are more interested in keeping a steady job over longer term wealth creation have created a “shorttermism” in public market investing that has created wonderful opportunities for us as investors.
The truly talented may not get to scale and close removing competition for good ideas and/or their investing style changes to fit the capital provider’s goals creating un-economic selling and a whole host of opportunities for us as investors.
The comfort in owning illiquid assets, levered capital constructs, and not “marking your portfolio” to market is fundamentally misleading. Our hope is that the institutional capital providers will think more about the long-term benefits of their benefactors and will direct capital more efficiently in the future… I only half hope though because it does create opportunity for us in the form of less competition for good assets!
Until then, this experience has made me appreciate my existing limited partners even more. You all are different, you are independent thinking, and you get the difference between short term volatility and permanent impairment of capital. Most importantly, we all know from our own business careers and personal endeavors that in order to grow we must keep challenging ourselves by asking questions – but more importantly the right questions. It will be my commitment to constantly asking the hard questions that will make me a stronger investor and manager in the future for all of you.
As our track record builds, perhaps investors will judge us with the same time horizon they give the private equity folks…. we won’t even ask for the leverage!
In connection with the growth of the firm and based on reverse inquiry, we decided to host our first annual meeting / breakfast in February at Jefferies in NYC. We had a tremendous turnout with many folks travelling from great distances. The group asked thoughtful questions and it was enjoyable to catch up with all of you. I truly am proud to be the leader of such a resolute, kind, and trustworthy group.
We want to thank all of you again for the opportunity to steward your capital and look forward to many more years with you as partners.
As always, we are available to answer any and all of your questions regarding the operations of the Fund or about the exciting opportunity set we are currently deploying capital into.
Adam D. Wyden