Hazelton Capital Partners commentary for the fourth quarter ended December 31, 2020.
The ExodusPoint Partners International Fund returned 0.36% for May, bringing its year-to-date return to 3.31% in a year that's been particularly challenging for most hedge funds, pushing many into the red. Macroeconomic factors continued to weigh on the market, resulting in significant intra-month volatility for May, although risk assets generally ended the month flat. Macro Read More
Hazelton Capital Partners, LLC (the “Fund”) returned 30.9% from October 1, 2020 through December 31, 2020 and appreciated 32.5% year-to-date. By comparison, the S&P 500 returned 12.2% during the same quarter and 18.4% year-to-date.
The Year in Review – Embrace the Uncertainty
Hazelton Capital Partners ended the 4th quarter with a portfolio of 15 equity positions and a cash level equivalent to 15% of assets under management. The top five portfolio holdings, which are equal to roughly 60% of the Fund’s net assets, are: Renewable Energy Group (REGI), Micron Technology (MU), Caesar Entertainment (CZR), Apple Inc (AAPL), and USA Technologies (USAT).
“Remember, the struggles endured along the way are only meant to shape and guide you for your purpose and for your journey…Press on with pride and press on with purpose.” - Chadwick Boseman (“Wakanda Forever!”)
I think I speak for the collective when I say that 2020 was a wretched year. Our global lives have been disrupted, businesses shuttered or destroyed, and our physical and mental health jeopardized. It feels like we have retreated into the darkness and have yet to feel the warmth of the light. The recent distribution of the Covid vaccines is a start, but it will take time for the positive impact to take hold in our communities. As we look back on the year that was, even though the negatives are so glaringly obvious, there are a great number of things to be grateful for and I have chosen to remain optimistic. On a personal level, I have come to appreciate the impact of uncertainty, the continued need for patience and thoughtfulness, distilling down what is important in one’s life, understanding that a text is not the same as speaking with someone, not taking family and friendships for granted, the connection a simple handshake can provide, and the beauty that exists in the sound of laughter. I have also learned first-hand, after having to wear a mask for the past 9 months, that I should make using a breath mint a part of my daily routine.
Twenty-twenty was a very “Dickensesque” year; it was a stark reminder of the contrast that exists in our world between essential and non-essential, wisdom and folly, and hope and despair. Unlike A Tale of Two Cities, 2020 began with the “worst of times” and despite the boon to the equity markets, I am hard-pressed to say that it resembles the “best of times.” I am sober to the fact that our economy remains fragile and bifurcated. For every Chipotle Mexican Grill (CMG), Amazon (AMZN), and Peloton (PTON) that have survived and thrived during the pandemic,thousands of local restaurants, retailers, and fitness centers/personal trainers have been forced to close their doors and layoff their workforce. The market gyrations and recent stock valuations continue to give me pause as I am reminded that we live in a decidedly complex world where little is obvious and even less is clear.
What is clear is that without the swift and dynamic actions of the Federal Reserve (lowering interest rates to essentially zero, providing liquidity through multiple credit facilities, and supporting the bond market by purchasing both mortgage and corporate bonds), a tsunami of financial destruction, far greater than what was witnessed, would have devastated the US economy with banks and financial institutions getting caught in the undertow. Unfortunately, the Federal Reserve’s support did not flow down to small and individual businesses. Making matters worse was Congress’ inability to act decisively to provide both additional stimulus and unemployment aid, leaving many small business owners financially paralyzed – not knowing how to plan for their future or even if they are going to have one. And yet the bull market goes on.
“Bull markets are born in pessimism, grow on skepticism, mature on optimism, and die in euphoria” – Sir John Templeton
It is difficult to determine if we are in the “optimism” or “euphoria” phase of Templeton’s bull market timeline. Recent market momentum and elevated valuations evoke memories of 1999 and the unbridled days of speculation right before the implosion of the “Dot Com” bubble. Of course, one person’s “euphoria” is another person’s “optimism.” Which begs the question, “What can an investor expect going forward?” To which I can answer with complete certainty, “I do not know.”
Markets do not adhere to a set schedule and given the ongoing accommodative actions of the Federal Reserve and the current high level of savings with additional cash on the “sidelines,” the “optimism” and “euphoria” stage of this bull market can last much longer than it has in the past. However, not all market sectors have benefited from the market’s overall enthusiasm, as many have been left behind in the wake of the recent recovery. In the meantime, an investor can expect there to be a continued rotation in sector leadership going forward as the market sorts itself out.
Hazelton Capital Partners finished the quarter and the year on a strong note. Throughout 2020, the Fund actively repositioned a number of its portfolio holdings by eliminating companies whose recovery and ongoing business model remained unreliable, adding to established positions at attractive prices, and putting cash to work in new opportunities. In the 4th quarter, aside from Micron (MU), which contributed the lion’s share of the quarter’s performance, the Fund saw strong contribution from its investments in financials, consumer cyclicals, technology, energy, and industrials.
Hazelton Capital Partners has always strived to create and maintain a long-term, concentrated portfolio that focuses on quality over quantity. Historically, a top 5 portfolio member achieves its rank through years of ongoing research into the company, its management, business model, potential for continued growth, and active patience. These investing criteria provide both the structure and flexibility to invest in the long-term fundamentals and growth prospects of a company while not being influenced by market volatility. As of the end of the 4th Quarter, the average holding period of the Fund’s top 5 holdings was just under 6 years.
The current market environment is very unpredictable and could remain that way for the foreseeable future. Hazelton Capital Partners will continue to actively embrace the uncertainty while keeping its focus on upgrading the portfolio by uncovering new investments for long-term profitability.
Micron Technology (MU) Current Holding
Micron operates in the cyclical and commoditized business of developing and manufacturing both DRAM digital memory (~70% of revenue) and NAND digital storage (~30% of revenue). For a commodity business that requires a constant investment of capital (CapEx and R&D), an investor would be right to believe that the company would be hard-pressed to see any type of long-term return on its investment. In the past, there were numerous semiconductor companies jockeying for dominance in digital memory and storage, but over time, competition forced many of them to shut down or merged with a stronger partner. Today, there are only three key global producers of DRAM and approximately five main manufacturers of NAND, all of which are now more focused on profitability than market share.
Over the past 5 years, Micron has made great strides in its research and development to reduce the technology gap that existed between itself and its competitors. During that time, the company has been able to advance its technical expertise, shorten its development time, lower its cost structure, and improved its manufacturing capabilities. However, many of those benefits were masked by the headwinds impacting both Micron and the digital memory/storage industry. These headwinds came in the form of conversion to 3D NAND, trade tariffs with China, and a global pandemic that impacts both their supply chains and ongoing production. Micron has faced its own challenges over the past 5 years, a debt-laden balance sheet, restricted sales to one of its top customers (Huawei), and transitioning from its legacy floating gate technology to charge-trap to improve its chip’s scalability and performance.
As the past and current impediments subside, Micron is well-positioned to benefit from its hard work and focus. Even with the recent run up in Micron’s share price over the last few months, the company continues to have a strong tailwind driven by higher demand and pricing for its DRAM memory, significant growth expected from 5G, artificial intelligence (AI), augmented & virtual reality (AR & VR), machine learnings (ML), and a global economy that is destined to recover and grow. These tailwinds along with Micron’s strong balance sheet will benefit the company’s profit margins, management’s stock repurchases, and investors’ willingness to pay a higher multiple than what was paid in the past.
Berkshire Hathaway (BRK.B) Current Holding
At the end of the 3rd Quarter, Berkshire Hathaway was Hazelton Capital Partners 5th largest holding. Since that time, the US conglomerate and holding company with operations in insurance, transportation, energy, and manufacturing was overtaken by other portfolio investments which benefitted from a strong 4th quarter.
Hazelton Capital Partners invested in Berkshire Hathaway in late March and early April of 2020. Given the company’s balance sheet and the success Warren Buffett had acting as a “lender of last resort” during the 2008/2009 financial crisis, the Fund made the investment as both a hedge against a severe market disruption and Buffett’s ability to put large sums of money to work in lucrative deals. In April, the Wall Street Journal reported that Charlie Munger, Berkshire’s vice chairman, said that the company’s phone “...is not ringing off the hook.” In May, during Berkshire’s annual meeting, Buffett went into more detail, explaining that when the Federal Reserve took decisive actions to underpin the markets, they “squeezed” out Berkshire from its previous role of “lender of last resort.”
Hazelton Capital Partners recognize that its initial reason for investing in Berkshire Hathaway happily did not play out and even though the company’s stock is not best suited for the recent market momentum, Berkshire can still do well especially as the economy shows signs of a recovery. Like all of the Fund’s holdings, Berkshire will be continuously monitored as to whether it remains a “good fit” for the portfolio.
JP Morgan Chase & Wells Fargo (JPM & WFC) Current Holding
Hazelton Capital Partners added JP Morgan Chase and Wells Fargo to the portfolio in June-July of 2020 and October-November of 2020, respectively. The financial sector fell in tandem with the market during the pandemic selloff in March. However, the financial industry did not benefit in late March when the Federal Reserve underpinned the markets. Investors became fearful that a recession was imminent as Treasury Bond yields continued to fall, flattening out the yield curve and negatively impacting banks’ profitability. In addition, many began to worry of the inherent risk to banks’ loan portfolios.
JP Morgan’s loan portfolio has meaningful exposure to the energy and real estate sectors along with consumer loans related to its credit card portfolio. With fears that the spreading pandemic would cause a rash of bankruptcies and loan defaults, JPM began adding loan loss reserves to its balance sheet starting in the 1st quarter of 2020. By the end of the third quarter of 2020, JP Morgan had reserved over $19 billion, levels not seen since the 2008/2009 financial crisis. Loan loss reserves represent a charge against a company’s earnings and, in JP Morgan’s case, reducing its already pressured profits. Unlike the financial crisis, the government has provided massive stimulus in the form of expanded unemployment payments and stimulus checks which, raising the nations’ savings rate materially above the 7% average over the past 10 years.
With the recent release of the Covid vaccine, another round of stimulus checks in the mail (with more government aid expected), and states working to try and reopen their economies, expectations are that even the outpaced sectors of the economy will begin to improve. In the 4th Quarter, JP Morgan began to cautiously reduce its loan loss reserves which is expected to continue throughout 2021. Reduced loan loss reserves and an improving economic outlook will eliminate two of JP Morgan’s ongoing headwinds.
Wells Fargo, in addition to having the same industry headwinds as JP Morgan, has its own unique issues impacting the bank. Since 2018, Wells Fargo has been operating under an asset cap of $1.95 trillion imposed by the Federal Reserve. This was the consequence of rampant corruption that existed for over a decade, including a scandal in which bank employees created millions of fraudulent bank accounts to meet internal sales goals.
Although there is no set date to remove the bank’s asset cap, the Federal Reserve is keenly aware that Wells Fargo is a major provider of both lending and services to the small business community. During the Paycheck Protection Program (PPP), Wells Fargo asset cap forced the bank to limit its participation to just $10 billion of the $350 billion program even though it is the largest lender to small businesses in the US.
JP Morgan and Wells Fargo have been negatively impacted by the pandemic and the economic shut down that followed. Both banks were forced to increase their loan loss reserves against a very uncertain economic outlook. Today, as segments of the economy return to life, the yield curve begins to regain its slope, and businesses are willing to invest in the future, JP Morgan and Wells Fargo profitability should continue to improve, building on the momentum started late in the 4th quarter of 2020.
On January 6th of this year, I, along with many around the world, watched in disbelief as the US Capital, the symbol of America’s Democracy, came under attack. The notion of democracy hasbeen around for thousands of years, but only recently (relatively) has the concept of a “government of the people, by the people, for the people” been put into action and adopted by other countries around the world. Democracy is hard. It is both durable and fragile and requires constant maintenance. Every year, I end my year-end letter with a pledge. It is a reminder that trust is fragile, requiring years of hard work to be earned but can be destroyed in a matter of seconds. The reminder is directed at me to stay vigilant, humble, and not take my partners’ trust in me for granted. The same holds true for democracy.
From my years of experience in business and investing, I have come to learn that trust is earned, not bestowed. It takes years of hard work to earn someone’s trust, but only a few seconds to destroy it. I do not take your trust in me lightly and pledge to continue to go beyond what is required to meet your expectations. The goal of Hazelton Capital Partners is to repay your trust with returns that will outperform the market.
Investing in Hazelton Capital Partners
Hazelton Capital Partners was created as an investment vehicle, allowing those interested in long-term exposure to the equity market to invest alongside me. With a substantial portion of my own capital in the fund, I manage Hazelton Capital Partners assets in the same way I manage my own capital. The best source of introduction to potential investors in the Fund has come from those that have invested or followed Hazelton Capital Partners progress over the years. Introductions are both welcome and appreciated.
If you are interested in making or increasing your contribution to Hazelton Capital Partners or just learning more about The Fund, please feel free to contact me.
Please do not hesitate to call me at (312) 970-9202 or email me firstname.lastname@example.org with any questions or concerns.
Hazelton Capital Partners