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Arquitos Capital Up 30% CAGR On 5 Year Fund Anniversary

We profiled Steve Kiel in our latest edition and he is killing it yet again. See his Q1 letter below and find the full issue here.

Also see

Arquitos Capital Up 55% In 2016 (28% CAGR) Amid Big

Hedge Fund Interview: Steven Kiel: Arquitos Capital … –


Arquitos Capital Partners returned 17.6% net of fees in the first quarter of 2017. Please see page four for more detailed performance information.

We celebrated the fund’s five year anniversary on April 10. During that time period, we returned 30.9% annually net of fees, beating the S&P 500 by 17.2% per year and the HFRI Index, an index that broadly measures the performance of all hedge funds, by 26.9% per year. Before fees, the fund returned 38.8% annually.

Arquitos provided positive returns in four out of five years and beat the market four out of five years. $100,000 invested at the outset is now worth $384,750. At that pace, your money has doubled every two years and seven months.

Do not expect these astronomical gains to continue. We had a variety of things working in our favor. First, the market was up each year during this time period. The S&P 500 itself performed very well, netting 13.7% per year with dividends reinvested. While I have tried to invest in companies outside of the mainstream, we have still ridden a strong wave.

Second, we are small. Assets under management today are $11 million. They were far smaller when we started and along the way. In the investment world, we are a speck. A brightly burning one, for sure, but still not much more than a piece of dust. Right now and since the launch of the fund, we have had the ability to make an investment in nearly any public company no matter the size. As assets grow, some of those companies will be too small for us to make a meaningful investment. My philosophy and approach will stay the same, but at some point the universe of opportunities will begin to shrink. We are not yet to that point, and may not get there for some time, but it will happen and it will have an effect on returns.

In my first letter to you in 2012 I wrote about the partnership that Warren Buffett ran from 1957 to 1968. He beat the markets by about 16% per year and returned 25.3% per year to investors, with no down years, I might add. We simply will not beat that performance over the lifetime of our fund.

The great thing is that because of the power of compound interest, we only have to do a fraction of our past performance in order to do well in the future. Compounding at 10% per year makes an initial $100,000 investment worth about $673,000 in 20 years and $1.75 million in 30 years. That is a tremendous gain. The keys for compounding are getting started and patience.

When I started the fund I knew we would do well. A fundamental value strategy focused on long term results promised that. It turns out that trying to not lose money gives you a big advantage over the competition. I did not strive for this performance by taking risks. It came from investing in companies that I understood, companies that generally had strong balance sheets and low risk of permanent capital loss, and situations where the markets did not fully recognize attractive aspects of the business. We will continue to do well by taking this approach.

Arquitos Capital Partners 3Q16 Investor Letter; Up 14.6 ..

While I write these letters and provide performance returns each quarter, and you get investor statements monthly, this is far too short of a time period to make any determination of investment skill. Investors get excited or depressed about specific companies at various times. The emotional state of the market is not a reflection of the actual value of a company. That actual value will generally be reflected over time periods much longer than a month, a quarter, or a year. Ignore short term performance and focus on longer time periods. A three to five year time period is a better gauge. A track record over several market cycles is best.
What has led to our success over the first five years?
Read More

Stanphyl Capital March Letter To Investors

February letter from Stanphyl Capital. The hedge fund was profiled in our second edition and returned 31% in 2016. Check out the post and especially the end of the PDF for more on their small cap stocks.

For March 2017 the fund was down approximately 4.9% net of all fees and expenses. By way of comparison, the S&P 500 was up approximately 0.1% and the Russell 2000 was also up approximately 0.1%. Year to date the fund is down approximately 5.1% net while the S&P 500 is up approximately 6.1% and the Russell 2000 is up approximately 2.5%. Since inception on June 1, 2011 the fund is up approximately 116.5% net while the S&P 500 is up approximately 99.0% and the Russell 2000 is up approximately 77.4%. (The S&P and Russell performances are based on their “Total Returns” indices which include reinvested dividends.) As always, investors will receive the fund’s exact performance figures from its outside administrator within a week or two.

Our shorts really hurt us this month while our longs (collectively) had little impact. Despite this month’s awful performance, for the reasons outlined below I think there’s now much more money to be made on the short side of these markets than on the long side, and thus we remain net short. Here are the specifics…

In March I added substantially to our short position in the Vanguard Total International Bond ETF (ticker: BNDX), comprised of dollar-hedged non-US investment grade debt (over 80% government) with a ridiculously low “SEC yield” of 0.78% at an average duration of 7.7 years. As I’ve written since putting on this position in July 2016, I believe this ETF is a great way to short what may be the biggest asset bubble in history, considering that Europe and Japan (which comprise most of its holdings) are printing approximately $124 billion a month (¥6.7 trillion + €60 billion [tapered beginning in April from €80 billion]), yet are long-term insolvent due to their massive liabilities. What will force the bond buying to stop (beyond the April taper)? For Europe I suspect it will be intense pressure from Germany in the face of U.S. tariff threats due to the weak euro or perhaps pressure from German savers, or it could simply be inflation. And when European printing stops (or even tapers), I think asset prices of all types worldwide (including, or perhaps especially, stocks) will correct heavily. (See our Russell 2000 short, below.)

Japan I think can never stop printing (its ratio of debt to GDP is too huge and growing too quickly) but will eventually crash the yen into oblivion (we’ve been short yen since 2012) and with that its bonds will crash too. (I discuss Japan more extensively in the last paragraph of this letter.) The borrow cost for BNDX is less than 2% a year (plus the yield) and as I see around 5% potential downside to this position (vs. our basis,n plus the cost of carry) vs. at least 30% (unlevered) upside, I think it’s a terrific place to sit and wait for the inevitable denouement.

In March I also added substantially to our short position in the Russell 2000 (via the IWM ETF). I think this is a good hedge for our microcap long positions as well as an outright bet against what I perceive to be a dangerously expensive market, especially in the face of soaring auto loan defaults and a plunge in used vehicle prices that may be both a warning and a cause of a recession. Meanwhile, valuation is far above historical norms, measured by both a current PE of 138 and an EV-to-EBITDA ratio near 18x:

Stanphyl Capital
Stanphyl Capital

Again, I strongly believe that as Europe tapers its printing the liquidity that’s been keeping the equity bubble inflated will dry up and the bubble will burst. I can think of few better ways to profit from that than to be short this obscenely overpriced index.

Stanphyl Capital Letter continues below – skip to end to see small cap discussion

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March Issue Of Hidden Value Stocks

NOTE: Existing members can skip to the bottom to find the full 40 page issue.

We asked a ton of ValueWalk readers what their #1 goal was for improving their value investing.

Can you guess what they said?

No, it wasn’t more coverage of Apple or Tesla, those are already well covered by the likes of CNBC, sell side firms and blogs.

Nor was it more coverage of risky leveraged trades, ETNs.

They wanted good small-cap investment ideas that are vetted and have liquidity, but not well covered by Wall Street, Bloomberg, CNBC, sell-side analysts, blogs or even closed sites like SumZero or Value Investing Club.

This answer makes sense: we all want to collect more winners in our portfolio.

But after following investments of ultra-famous investors (Buffett, Dalio, Icahn), reading diligently through 10-Qs at night, and even combing through article after article on obscure forums and blogs, it can be hard to find qualified “special situation” ideas that aren’t already widely known.

So, to meet this key need of our readers, ValueWalk launched the Hidden Value Stock newsletter.

The Hidden Value Stock newsletter is a 30+ page deep dive report that gives you detailed analysis behind specific small and mid cap stocks that two under-the-radar value investing hedge funds like, as well as interviews with the fund managers about their investing process.

The latest issue of Hidden Value Stocks is out this week and if you want to sign up to receive an issue.

Below is an excerpt from our interview with Steven Kiel of Arquitos Capital Partners. At the bottom of this page, there’s a teaser copy of the new issue.

Interview With Steven Kiel Of Arquitos Capital Partners

Arquitos was founded with a goal of emulating the success of Warren Buffett’s early partnerships. Even your mission statement is lifted directly from the Buffett Partnerships. A lot of people have tried to replicate Buffett’s success in the past and failed. What made you think you could succeed?

Buffett has been an inspiration to a generation of investors, myself included. Investors should learn from him, but ultimately you have to apply your own personality to the way you approach research and the construction of the portfolio. You should try to emulate the process, but in a way that fits you.

The goal for any investor should be to compound funds at a better than average rate with less exposure to long term loss of capital. How do you improve on that statement? It’s kind of like the Declaration of Independence. The ideals stand the test of time. If you were starting a new country, just copy the first 273 words of the Declaration of Independence as the foundation of your country. That’s how I felt about the mission statement.

As far as what made me think I could succeed, it’s a constant process of proving it. Just like a baseball player, you’re only as good as your last year.

Do you have three special investment buckets similar to those of Buffett?

I break the portfolio into several segments but in a different way from the Buffett Partnership approach. We have core holdings that I would like to own as long as the company has internal reinvestment opportunities and as long as they effectively allocate capital. I also have a portion of the portfolio focused on arbitrage or special situations such as mergers, spin-offs, or other short term opportunities. I also keep on a more general market hedge.

Arquitos returned 54.9% for its investors during 2016, a tremendous result. What would you attribute this return to?

Well, we definitely had a great year. I would not expect that our run over the first five years of the fund is sustainable, but I’ll certainly keep trying. It’s important to remember that you can only control the inputs, not the outputs. Because our portfolio is fairly concentrated (12-20 stocks) good results will come when the largest holdings do well. The results haven’t historically been connected to the general markets. The timing is just luck and can’t be controlled, but the goal is to be consistent on the process. This may sound trite, but our biggest holdings went up the most, Intrawest Resorts, MMA Capital, Berkshire LEAPs, and Bank of America warrants. There is still value in all of them, though I exited the Berkshire LEAPs.

Your best-performing stock last year was Intrawest Resorts Holdings. Can you give a brief description of what happened here and how you stumbled across to opportunity?

That one is a good example of the importance of being flexible. Intrawest was cheap on the merits, but what caused me to make it our largest holding in the beginning of 2016 was their tender offer. They had sold their time share business and bought back about 12% of their outstanding shares. Fortress owns 60% of the company and did not sell any shares despite having a need to exit the investment. Clearly, Fortress thought that shares were trading too cheaply and it seemed to me that they had a plan to realize the value. Their plan seems to have come to fruition and recently Intrawest announced that they were putting themselves up for sale. Shares have passed $20, up from the $9.00 tender offer price a year ago.

On that note, what do you look for when you’re assessing a potential investment, what makes you say, “yes we want that” or “no we don’t”?

There are patterns. The Intrawest example is a good one because the situation was similar to previous investments I’ve made and witnessed where there was a large tender offer and the controlling shareholder does not participate. Seeing that definitely makes my ears perk up. On the negative side, there are a lot of things that make me want to stay away. The biggest ones are ethics issues. There are too many opportunities out there to get hung up with a company that has a poor culture.

So a company’s management plays a significant role in your decisions?

It plays a big role, especially with regards to incentives. My favorite investments are ones where the management is effectively allocating capital. The best companies are the ones that have high returns on equity and continue to find internal reinvestment opportunities. Those are the ones you can own for a long time. Sometimes the managers are inherently good capital allocators. Other times they are responding to incentives that cause them to focus on returns on invested capital and cash generation.  

Do you get involved with managements at all in an activist way?

I’d prefer not to. The frustration of dealing with negative things just kills too many brain cells. As a passive investor if management is doing something I don’t like, it’s just better to move on. Chances are they’ll continue to frustrate you. The one time I didn’t follow that path led to me taking over Sitestar (OTCQB:SYTE) with two other partners, Jeff Moore and Jeremy Gold, and led to a lot of work to clean the company up. I wouldn’t want to go through that experience again though we have a lot of interesting opportunities within Sitestar. Once was enough for me. I have supported other activists on occasion and am happy to ride their coattails.

Let’s move on to another of your winning positions last year, which was Berkshire Hathaway. You own the stock through long dated options. Can you explain the logic behind this trade?

Berkshire traded below 1.3 times book value at the beginning of 2016 and even lower if you considered what they were likely to report the next quarter. Of course, Buffett has said that he will buy back shares under 1.2 times book value. Given that situation, the easiest thing to do is either buy shares directly or buy long dated call options at the 1.2 times book strike price. I bought the call options. I don’t typically buy options, but you had to believe that at some point in the next two years either the multiple would be higher than what I bought the options at or book value would have grown or both. It turns out both happened and we made a really nice return. The risk/reward profile was better for the long dated options than the stock. It was a pretty simple thesis. It really required willpower more than anything else.

Do you do any shorting and if so do you have any short positions on at the moment?

I don’t have any short position though I keep a small hedge on. I just haven’t had luck with specific company shorts. It doesn’t seem suited to my approach.

Sure. Moving back to your investment strategy, reading through your letters to investors, you seem to focus on a company’s Net Operating Losses (NOLs) more than any other metric when analyzing its future potential. Why do you prefer to use NOLs to evaluate a company, rather than more traditional valuation methods?

That may be a trade that goes away if corporate tax rates are lowered. Tax reform would bring other opportunities such as partnerships converting to C corps, so I’m keeping an eye on any changes that occur….

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March 2017 teaser

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Stanphyl Capital February Letter To Investors

February letter from Stanphyl Capital. The hedge fund was profiled in our second edition and returned 31% in 2016. Check out the post and especially the end of the PDF for more on their small cap stocks.

For February 2017 the fund was up approximately 3.9% net of all fees and expenses. By way of comparison, the S&P 500 was up approximately 4.0% while the Russell 2000 was up approximately 1.9%. Year to date the fund is down approximately 0.1% net while the S&P 500 is up approximately 5.9% and the Russell 2000 is up approximately 2.3%. Since inception on June 1, 2011 the fund is up approximately 127.8% net while the S&P 500 is up approximately 98.8% and the Russell 2000 is up approximately 77.2%. (The S&P and Russell performances are based on their “Total Returns” indices which include reinvested dividends.) As always, investors will receive the fund’s exact performance figures from its outside administrator within a week or two.
We continue to hold a large short position in the Russell 2000 (via the IWM ETF). I think this is a good hedge for our microcap long positions in what I perceive to be a dangerously expensive market, and as the companies in the index collectively have no earnings a potential Trump corporate tax cut can’t help them, while valuation (as measured by EV to EBITDA) is far above historical norms:

stanphyl capital
stanphyl capital

(Keep in mind that the last spike in that chart comes from Bloomberg [the source] using only partial numbers from Q4 2016, and thus the correct multiple is probably “only” around 22x… which is still almost double the long-term historical mean!)
We continue to hold a large short position in the Vanguard Total International Bond ETF (ticker: BNDX), comprised of dollar-hedged non-US investment grade debt (over 80% government) with a ridiculously low “SEC yield” of 0.75% at an average duration of 7.7 years. As I’ve written since putting on this position in July 2016, I believe this ETF is a great way to short what may be the biggest asset bubble in history, considering that Europe and Japan (which comprise most of its holdings) are printing approximately $144 billion a month (¥67 trillion + €80 billion, “tapering” to €60 billion in April), yet are long-term insolvent due to their retiree liabilities. What will force the bond buying to stop? For Europe I suspect it will either be intense political pressure from the north or inflation; either way, the end appears increasingly near. Japan I think can never stop printing (its ratio of debt to GDP is too huge and growing too quickly) but will eventually crash the yen into oblivion (we’ve been short yen since 2012) and with that its bonds will crash too. (I discuss Japan more extensively in the last paragraph of this letter.) The borrow cost for BNDX is just 2% a year (plus the yield) and as I see around 5% potential downside to this position (vs. our basis, plus the cost of carry) vs. at least 30% (unlevered) upside, I think it’s a terrific place to sit and wait for the inevitable denouement.

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S&C Messina Capital 2016 Letter: Value In Insurance

S&C Messina Capital 2016 Letter: Value In Insurance

To My Partners,

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.

S&C Messina

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?

S&C Messina

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.

Administrative Update

As you are aware, we have moved our operations to the East Coast. Mark will continue to handle the dayto-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.

Best regards,

Noh-Joon Choo Managing Partner S&C Messina Capital Management, LLC www.scmessinacapital.com

Appendix Ground Rules

1. Our goal is to outperform the S&P 500 on the basis of annualized total returns, including dividends reinvested, over a period of 5 years. Year-over-year performance is guaranteed to be lumpy and volatile, but over 5 years we aim to compound invested capital at a higher rate than what would have been achieved had such capital been invested in the S&P 500.

2. As an intermediate assessment, every calendar year we will measure the annual total return for an investment in the partnership against the annual total return in the S&P 500. We will call it a “bad” year when we underperform the S&P 500. Conversely, we will call it a “good” year when we outperform the S&P 500. It is an absolute certainty we will have bad years.

3. A minimum of 5 years is the length of time one should use when judging our annualized performance or compound annual growth rate versus that of the S&P 500. If the partnership does not outperform the S&P 500 over a period of more than 5 years, everyone, including myself, should start thinking about other places to put their capital. However, if there is a raging 5-year bull market, outperformance should not be expected.

4. We would much rather outperform in any given year when the S&P 500 has declined, meaning we prefer being down -10% when the market is down -30% rather than being up 30% when the market is up 10%. We look down before looking up, prioritizing downside protection and preservation of capital over the long term.

5. If the S&P 500 is up for the year to a degree approximating its historical averages, we are happy if the partnership achieves a positive return close to this figure. If the S&P 500 has an exceptional year, especially during a frothy, bullish period, we will most likely underperform for the year. The S&P 500 for the previous ten years has achieved an annualized total return of approximately 7% per annum. Historically, this figure has been approximately 10%.

6. We cannot predict whether the stock market is going to go up or down. We cannot predict economic cycles nor changes in the general or global economy. We cannot predict when trading multiples will expand or contract. If you think the ability to predict the aforementioned is critical to a successful investment strategy, you should not join the partnership.

7. We cannot guarantee results for members of the partnership. However, I can promise the following:

  • a. Each P&C insurance company owned in the partnership’s portfolio will be selected based on its ability to compound shareholder value (represented by its book value per share and market price per share) over the long term;
  • b. The partnership will only pay prices that are fair or discounted with a margin of safety relative to the intrinsic values of its portfolio companies;
  • c. The risk of permanent loss of capital (not short-term mark-to-market declines in value) will be minimized by limiting the partnership’s ownership of P&C insurance companies to those:
    • i. That have downside protection in the form of underlying book values backed by real, tangible assets (i.e. marketable securities, bonds, stocks and cash) that can be liquidated today at close to 100% of their marked values on the balance sheet;
    • ii. That have downside protection in the form of wide, competitive moats defending their ability to compound book value per share over long periods at above-market rates of return;
    • iii. That can be purchased at fair intrinsic values or below with a margin of safety, with such intrinsic values being estimated to the best of our ability by conservatively discounting long-term growth in book values per share;
    • iv. That we would be comfortable buying in their entirety (i.e. 100% of outstanding stock).
  • d. I aim to have almost 100% of my entire net worth invested in the partnership alongside fellow members of the partnership. To further align incentives, “qualified clients,” as defined by our confidential private offering memorandum, may opt to pay a 0% annual management fee coupled with a high water mark and a 25% annual performance fee applied to returns above a 5% hurdle. In other words, we don’t get paid unless the value of your investment is above its high water mark and your investment has increased at least 5% annually.

S&C Messina Capital 2016 Letter: Value In Insurance

S&C Messina Capital 2016 Letter: Value In Insurance

To My Partners,

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.

S&C Messina

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?

S&C Messina

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.

Administrative Update

As you are aware, we have moved our operations to the East Coast. Mark will continue to handle the dayto-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.

Best regards,

Noh-Joon Choo Managing Partner S&C Messina Capital Management, LLC www.scmessinacapital.com

Appendix Ground Rules

1. Our goal is to outperform the S&P 500 on the basis of annualized total returns, including dividends reinvested, over a period of 5 years. Year-over-year performance is guaranteed to be lumpy and volatile, but over 5 years we aim to compound invested capital at a higher rate than what would have been achieved had such capital been invested in the S&P 500.

2. As an intermediate assessment, every calendar year we will measure the annual total return for an investment in the partnership against the annual total return in the S&P 500. We will call it a “bad” year when we underperform the S&P 500. Conversely, we will call it a “good” year when we outperform the S&P 500. It is an absolute certainty we will have bad years.

3. A minimum of 5 years is the length of time one should use when judging our annualized performance or compound annual growth rate versus that of the S&P 500. If the partnership does not outperform the S&P 500 over a period of more than 5 years, everyone, including myself, should start thinking about other places to put their capital. However, if there is a raging 5-year bull market, outperformance should not be expected.

4. We would much rather outperform in any given year when the S&P 500 has declined, meaning we prefer being down -10% when the market is down -30% rather than being up 30% when the market is up 10%. We look down before looking up, prioritizing downside protection and preservation of capital over the long term.

5. If the S&P 500 is up for the year to a degree approximating its historical averages, we are happy if the partnership achieves a positive return close to this figure. If the S&P 500 has an exceptional year, especially during a frothy, bullish period, we will most likely underperform for the year. The S&P 500 for the previous ten years has achieved an annualized total return of approximately 7% per annum. Historically, this figure has been approximately 10%.

6. We cannot predict whether the stock market is going to go up or down. We cannot predict economic cycles nor changes in the general or global economy. We cannot predict when trading multiples will expand or contract. If you think the ability to predict the aforementioned is critical to a successful investment strategy, you should not join the partnership.

7. We cannot guarantee results for members of the partnership. However, I can promise the following:

  • a. Each P&C insurance company owned in the partnership’s portfolio will be selected based on its ability to compound shareholder value (represented by its book value per share and market price per share) over the long term;
  • b. The partnership will only pay prices that are fair or discounted with a margin of safety relative to the intrinsic values of its portfolio companies;
  • c. The risk of permanent loss of capital (not short-term mark-to-market declines in value) will be minimized by limiting the partnership’s ownership of P&C insurance companies to those:
    • i. That have downside protection in the form of underlying book values backed by real, tangible assets (i.e. marketable securities, bonds, stocks and cash) that can be liquidated today at close to 100% of their marked values on the balance sheet;
    • ii. That have downside protection in the form of wide, competitive moats defending their ability to compound book value per share over long periods at above-market rates of return;
    • iii. That can be purchased at fair intrinsic values or below with a margin of safety, with such intrinsic values being estimated to the best of our ability by conservatively discounting long-term growth in book values per share;
    • iv. That we would be comfortable buying in their entirety (i.e. 100% of outstanding stock).
  • d. I aim to have almost 100% of my entire net worth invested in the partnership alongside fellow members of the partnership. To further align incentives, “qualified clients,” as defined by our confidential private offering memorandum, may opt to pay a 0% annual management fee coupled with a high water mark and a 25% annual performance fee applied to returns above a 5% hurdle. In other words, we don’t get paid unless the value of your investment is above its high water mark and your investment has increased at least 5% annually.

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