S&C Messina Capital annual letter for the year ended December 31, 2016. See their full 2016 letter to investors below. But first check out our exclusive interview with their PM on some of the hedge fund’s favorite small caps.
2016 Hedge Fund Letters
S&C Capital Investments 2016 Semi-Annual Letter
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To My Partners,
Gates Capital Management's ECF Value Funds have a fantastic track record. The funds (full-name Excess Cash Flow Value Funds), which invest in an event-driven equity and credit strategy Read More
As of December 31, 2016, the partnership was up 23.16% YTD versus 11.96% YTD for the S&P 500. This represents an outperformance of +11.20% YTD. As we outperformed the S&P 500 by more than 11%, we had a good year in 2016. However, we put little weight into our performance over such short time periods. Our goal remains the same: we wish to outperform the S&P 500 by at least 2% each year on an annualized basis over many, many years.
Our performance in 2016 was driven by the steady appreciation of underlying book values of the P&C insurance carriers in our portfolio. Furthermore, market volatility in 2016 provided attractive entry points, allowing us to add to our positions at cheaper valuations. Lastly, with interest rates starting to rise from historic lows, multiple expansion in the P&C insurance sector contributed positively to our performance. One thing to note is that, all drivers of performance aside, such performance was achieved using minimal leverage, reflecting the highly attractive risk/reward proposition of our strategy.
When Interest Rates Rise, Where Do You Want to Be?
Interest rates have started to rise from historical lows. As shown in the chart below, one can see that the recent rise of rates marks a major inflection point. Rates have been on the decline for the past several decades since the early 80s. The reversal of this trend is of enormous significance. Where do you want to be as rates continue to rise from their historic lows?
For us, we want to own the right P&C insurance carriers because of their levered exposure to short- to medium duration bonds. P&C insurance carriers take in investment premiums and invest those premiums with a significant allocation to short- to medium-duration bonds. In other words, P&C insurance carriers make more money when rates rise; they earn more investment income. As long as their underwriting does not suffer while interest rates rise, every incremental basis point that P&C insurance carriers earn in investment income will fall to the bottom line, resulting in higher ROEs. While we look to invest in companies that achieve 10-15% ROEs, it would not be surprising to see these ROEs jump to the 15-20% range in a normalized interest rate environment. The key, however, is to own these companies before rates return to normalized levels based on historical norms. If one waits, then it will be too late because the market will by then have already priced in such higher earnings power.
S&C Messina – Administrative Update
As you are aware, we have moved our operations to the East Coast. Mark will continue to handle the day-to-day operations whereas I will continue to expand my industry knowledge to scout for companies that we may add to our portfolio.
We are happy with our current group of investors. As we are a private fund that can only accept up to 99 investors, we are careful in inviting the right investors. For 2017, we have decided to open up 10 investor slots for newcomers. We look forward to reaching out to you again in our 2017 mid-year letter. In the meantime, feel free to reach us at anytime.
S&C Messina Capital Management, LLC
See the full PDF below.