Iolite Partners 2014 Letter To Investors

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Iolite Partners fourth quarter 2014 review.


Iolite Partners: Market Review

Global equities delivered positive returns in a volatile quarter. The US dollar continued to strengthen against most other currencies as the US Federal Reserve ended its quantitative easing program while most other central banks in developed nations continued to ease monetary policy. Emerging markets posted negative returns as commodity prices declined on a broad basis, especially oil and iron ore. The Russian stock market was particularly weak amid deteriorating economic data, a sharply falling oil price and pressure on the ruble.

Iolite Partners: Portfolio Review

Key positive drivers of the portfolio’s performance for the quarter included good share price performance of most Asian holdings and a 53% realized gain (25% IRR) following news that financial investor Siris Capital offered to take Digital River (a 10% holding) private at USD 26/share. However, the strengthening of the US dollar hurt performance measured in dollars, while two large holdings saw severe price declines — I used the price weakness to add to these positions (I consider the moves temporary as my investment thesis hasn’t changed). Adding to the positions at lower prices means they now feature a much more favorable risk-return-profile on a weighted basis.

Iolite Partners: Quarterly Review

For the quarter ended December 31, 2014, the portfolio returned +3.7% in EUR (0.3% in USD), net of all fees. Since inception on October 1, 2008, the core portfolio has generated net cumulative returns of +154.6% in EUR (+127.0% in USD) and annualized net returns of 16.1% in EUR (+14.0% in USD). In other words, a euro invested at inception has turned into €2.55 (a dollar invested at inception has turned into $2.27).

In 2014, the US dollar strengthened against most other currencies (EUR 13%, JPY 14%, AUD 9%, GBP 6%). Since the portfolio’s underlying assets generate most of their earnings in other currencies, performance was hurt if measured in USD.

While I consider the 2014 annual net performance of 13.6% (in euros) satisfactory, slightly better timing of trades could have easily added 5% to overall performance. Two positions I exited (Telenav and Microsoft) subsequently rallied 30%, and two large new holdings fell 10% and 20% until year-end. While this is mildly frustrating, I am not in the business of timing the market and my decisions were based on the difference between my intrinsic value estimates and market prices.

The quarter also saw the largest absolute one-day gain when Digital River (NASDAQ:DRIV), a 10% holding, increased by 50% following an offer from Siris Capital to take the company private at USD 26/share. I had bought the stock when it was trading at USD 14/share in February 2012 and estimated intrinsic value to be in the mid-20s. My investment thesis was published in the Manual of Ideas3. It feels good if an idea worked out so well. Certain events in December also turned Digital River into a great case study in merger arbitrage, as explained further below.

Iolite Partners: Thoughts on Dividend Strategies

I was recently asked what I think of dividend strategies, i.e. choosing an investment opportunity based on the dividend yield of a company or buying so-called blue-chip companies with high dividends. My answer: “Not much.”

Dividend strategies are commonly promoted as safe, non-speculative investment approaches offering a steady stream of inflation-protected cash income. They are targeted at (and appeal to) safety-oriented savers. It is suggested companies that have paid out a steady stream of dividends over the last few years are of high-quality and therefore safe investments. A common promotional slogan would be: “Don’t worry about volatile markets and focus on the steady stream of cash dividends you’ll be receiving.”

In my mind, the thought that dividend strategies offer a higher degree of safety is a dangerous misconception. Yes, dividends can be a sign of well-managed, stable companies with high earnings power. However, on a standalone basis, they provide little indication of a company’s operating performance, the true quality of its asset base, or the gap between its intrinsic value and market price – and therefore the risk/return-profile of an investment. Any investor constructing a portfolio based on past dividends alone is making decisions based on a quick and narrowly focused look into the rear-view mirror, even if he is buying what are commonly known as “high-quality businesses”.

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