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GrizzlyRock 2017 Second Quarter Investor Letter

July 21st, 2017

Fellow Partners,

GrizzlyRock Institutional Value Partners, LP and GrizzlyRock Value Partners, LP (together “GrizzlyRock” or the “Fund”) decreased 2.03% net of expenses during the second quarter of 2017 and has returned -7.06% year to date through 6/30/17. Since inception, the Fund has compounded at 9.0% net of expenses per year.(1) The culprit of poor year-to-date performance has been the short portfolio (Fund long portfolio has a positive attribution yearto-date).

Short losses year-to-date have resulted from stock price increases of businesses with reasonable and/or cyclical revenue growth, yet a considerable lack of profitability. These businesses are not simply high quality companies at stretched valuations; rather, these companies have little hope of reaching and/or sustaining profitability given weak competitive positions, lack of technological innovation, capital market dependence, continually high reinvestment rates, and below average management teams. One could synthesize this year’s short portfolio this way: while we asserted “the emperor has no clothes and clothes are unlikely to materialize for quite some time”, for a number of businesses market claims have been “when the emperor dons clothes they will be the most magnificent clothes the world has ever seen!” Substituting the concept of enduring profitability for “clothes” explains Fund performance year-to-date.

In fundamental long/short investing, two imperative concepts are (1) being “early” is the same as being “wrong” and (2) managers must be pragmatic rather than dogmatic. This year we have made the error of being early on many short positions, yet thankfully we have been pragmatic with position sizing.

For a stock to increase markedly in price without showing commensurate profit, the narrative must appear compelling. However, business valuation over time will ultimately be grounded in economic reality. With a 9 year bull market continuing and the “fear index” VIX at all-time lows, market participants continue to pay ever higher prices for the prospect of future cash flows. Speculators are reaching far out on the risk spectrum in story stocks heralded by management teams and investment bankers with a story to tell about the “emperor’s clothes”. The current environment has not been conducive for many of our short positions, and thus our positioning has been both early and wrong.

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Arquitos Capital Partners – Q2 2017 Investor Letter

The coziest spot is under the warm blanket of ideology. It offers easy answers to difficult problems. But, man, is it dangerous, especially in an adapting world. Great stuff happens at the intersection of “Confident enough to take a stand” and “Humble enough to admit when something I don’t want to be true is true.” Morgan Housel

Dear Partner:

Arquitos Capital Partners returned 5.5% net of fees and expenses in the second quarter of 2017, bringing the year to date return to 24.1%. Our annualized net return since the April 10, 2012 launch is 30.6%. Please see page five for more detailed performance information.

The quote above is from a great blog post, “What I Believe Most,” by Morgan Housel. The entire post is great. The most successful investors have a unique ability to combine confidence and humility. They have to have the confidence to make the decision to buy and sell a stock when their opinion differs from the collective wisdom of the crowd (i.e., the current share price), and they have to have the humility to realize that most of the time the crowd is right.

Getting that proper balance is very difficult, especially in times of market stress. It is even harder to consistently maintain the proper mental equilibrium for effective decision-making. This is why being self-aware and intellectually honest are the two most important traits to reduce risk. If your initial reaction to stress is to deflect rather than internalize, it is going to be tough to be objective with yourself.

I’d like to address the subject of risk in this letter. This is a topic that is a lot easier to talk about when you’ve racked up a few good quarters in a row! This also is probably the most important time to do so. Lessons tend to take hold better when you are receiving negative feedback from your poor decisions. Real risks grow when all seems well.

Let’s get this foundational question out of the way: What is risk? The answer is that risk is the probability of permanent capital loss.

The chance of the price of a stock going down and the chance of the performance of the portfolio going down is not risk. Rather, risk in this context is not being able to psychologically handle a short term decline. By short term I mean less than a few years. Ignore your monthly, quarterly, and even annual returns. Look at them over a three to five year period. Your life will improve.

See the rest of the letter below:

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June Issue Of Hidden Value Stocks

NOTE: Existing members can skip to the bottom to find the full 20-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 20+ 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 a teaser copy of the new issue. If you would like to get the full issue and access to the entire site subscribe with one of the options below.

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June 2017 teaser

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Stanphyl May 2017 Letter

For May 2017 the fund was down approximately 4.7% net of all fees and expenses. By way of comparison,
the S&P 500 was up approximately 1.4% while the Russell 2000 was down approximately 2.0%. Year to
date the fund is down approximately 13.4% net while the S&P 500 is up approximately 8.7% and the
Russell 2000 is up approximately 1.5%. Since inception on June 1, 2011 the fund is up approximately 96.8%
net while the S&P 500 is up approximately 103.9% and the Russell 2000 is up approximately 75.7%. Since
inception the fund has compounded at approximately 12.0% annually vs 12.6% for the S&P 500 and 9.9%
for the Russell 2000. (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; meanwhile, I continue to waive the annual management
fee until we regain our high-water mark.

Needless to say this year’s performance has been extremely disappointing, yet the fund has been down
more than this before (between 2014 and 2015) and subsequently went on to recover that downdraft and
set a new all-time high NAV, and I have every intention that it will do so again. Since inception we’re just
a hair below the performance of the S&P 500 (and have outperformed the Russell 2000) despite holding
numerous large short positions during one of the biggest bull markets in history. In hindsight these shorts
cost us a lot of performance, but the multi-year money-printing environment in which we’re investing has
created a de facto bubble in asset prices (and the debt-fueled economic conditions that drive those
prices), and I don’t want to be “too net long” when that bubble bursts.

By many metrics the U.S. stock market’s current valuation was topped only in 1929 and 1999-2000,
making this the most difficult part of a market cycle for a long-short value fund such as ours, with few
stocks cheap enough to buy while seemingly solid short candidates continue to climb higher. Although
the S&P 500’s current Shiller PE is an absurdly high 29, one must acknowledge that it hit almost 33 just
before the 1929 crash and 44 just before the 2000 crash, and in neither of those instances were central
banks (ECB/BOJ/BOE/SNB) printing well over $100 billion a month as they are now, nor (as they are now)
were major worldwide real interest rates almost universally negative. On the other hand, during neither
of those eras was total U.S. debt (household, commercial and government) anywhere near as high relative
to GDP as it is now, which—if you think of the U.S. on an “enterprise value” basis– may make today’s
equity market at least as overvalued as it was at either of those peaks:

The rest of the letter is below:

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6 Jun

The Small-Cap Investing Handbook Part Six: Peter’s Principles

This is part six of a ten-part series on our Small-Cap Investing Guide.

Throughout this series, I’m looking at both the benefits, and drawbacks of investing in small caps, considering all of the evidence available to us today for both sides of the debate.

When completed we are planning to turn the series into an e-book, which we hope will be a comprehensive guide to investing in small caps.

 

For the other parts of this Small-Cap Investing Guide series please follow the links below:

So far in this series, I’ve looked at the academic research on small-cap investing but while academic research is always interesting, it’s no substitute for real-world experience. With that being the case, in parts five and six of this series are devoted to Peter Lynch.

Small-Cap Investing Guide Part Six: Peter’s Principles

Why spend so much time on Lynch and his principles? Well, when it comes to real world experience you just can’t beat the experience and record of Lynch.

There have been plenty of other successful small-cap investors throughout history but Lynch is the only investor to be able to have successfully replicated his stock picking success with thousands of equities.

So, here are Peter Lynch’s 21 “Peter’s Principles”, which are intended to sum up the points made in his book, Beating the Street.

Peter Lynch Small-Cap Investing Handbook

Small-Cap Investing Handbook – Peter Lynch’s Principles

Principle #1
When the operas outnumber the football games three to zero, you know there is something wrong with your life.
This point relates specifically to Lynch’s desire to spend more time with his family rather than trying to keep up with all his equities, but the idea behind the principle is simply to remember to make time for what you love in life.

Principle #2
Gentlemen who prefer bonds don’t know what they are missing.

Bonds are inferior to stocks.

Principle #3
Never invest in any idea you can’t illustrate with a crayon.

Buffett has a similar process whereby he avoids what he does not understand. This is the same principle.

Principle #4
You can’t see the future through a rearview mirror.

Past returns are not a guide to future success.

Principle #5
There’s no point paying Yo-Yo Ma to play a radio.

There’s no point paying a bond manager when you can just go and buy the bonds yourself for no annual management fee. The same principle can be used with high costs active funds that closet index.

Principle #6
As long as you’re picking a fund, you might as well pick a good one.

It pays to do your research.

Principle #7
The extravagance of any corporate office is directly proportional to management’s reluctance to reward shareholders.

Excellent companies are thrifty.
Principle #8
When yields on long-term government bonds exceed the dividend yield of the S&P 500 by 6 percent or more, sell your stocks and buy bonds.

This goes against principle two, but it’s offered as a sort of defensive strategy.

Principle #9
Not all common stocks are equally common.

Some companies are very special. Others are junk.

Principle #10
Never look back when you’re driving on the autobahn.

Principle #11
The best stock to buy may be the one you already own.

Principle #12
A sure cure for taking a stock for granted is a big drop in the price.

Nothing brings you back down to earth after a string of winning positions more than a sudden loss.

Principle #13
Never bet on a comeback while they’re playing “Taps”.

(“Taps” is the name of that bugle tune they play at military funerals. In stock terms, it never pays to buy a stock just because its share price has fallen.)

Principle #14
If you like the store, chances are you’ll love the stock.

Successful companies can be spotted before their stock market darlings by watching how many people use the store. Footfall will reveal more about future sales growth than backward looking financials.

Principle #15
When insiders are buying, it’s a good sign – unless they happen to be New England bankers.

(Refers to the management of a number of Texas and New England banks who violated principle #13, continuing to add to their holdings right up until the very end.)

Principle #16
In business, competition is never as healthy as total domination.

A dominating monopoly company will generate much better returns for investors than several smaller companies fighting for market share.

Principle #17
All else being equal, invest in the company with the fewest color photographs in the annual report.

To understand this principle, all you need to do it look at the annual report of Berkshire Hathaway.

Principle #18
When even the analysts are bored, it’s time to start buying.

When analysts get bored by the company’s lack of progress, the company may be boring enough to buy.

Principle #19
Unless you’re a short seller or a poet looking for a wealthy spouse, it never pays to be pessimistic.

Cyclicals can be a great way to make a buck if you buy them at the bottom, so it helps to look for opportunity in depressed stocks, rather than think of all the reasons why a cyclical is going to take losses. Optimism is required.

Principle #20
Corporations, like people, change their names for one of two reasons: either they’ve gotten married, or they’ve been involved in some fiasco that they hope the public will forget.

If it’s the latter, it’s best to stay away.

Principle #21
Whatever the Queen is selling, buy it.

If countries privatize formal state-owned companies, they usually do so on such attractive terms that shareholders are almost guaranteed to make great profits.

Stay tuned for our Small-Cap Investing Guide part VII!

6 Jun

The Small-Cap Investing Handbook Part Six: Peter’s Principles

This is part six of a ten-part series on our Small-Cap Investing Guide.

Throughout this series, I’m looking at both the benefits, and drawbacks of investing in small caps, considering all of the evidence available to us today for both sides of the debate.

When completed we are planning to turn the series into an e-book, which we hope will be a comprehensive guide to investing in small caps.

 

For the other parts of this Small-Cap Investing Guide series please follow the links below:

So far in this series, I’ve looked at the academic research on small-cap investing but while academic research is always interesting, it’s no substitute for real-world experience. With that being the case, in parts five and six of this series are devoted to Peter Lynch.

Small-Cap Investing Guide Part Six: Peter’s Principles

Why spend so much time on Lynch and his principles? Well, when it comes to real world experience you just can’t beat the experience and record of Lynch.

There have been plenty of other successful small-cap investors throughout history but Lynch is the only investor to be able to have successfully replicated his stock picking success with thousands of equities.

So, here are Peter Lynch’s 21 “Peter’s Principles”, which are intended to sum up the points made in his book, Beating the Street.

Peter Lynch Small-Cap Investing Handbook

Small-Cap Investing Handbook – Peter Lynch’s Principles

Principle #1
When the operas outnumber the football games three to zero, you know there is something wrong with your life.
This point relates specifically to Lynch’s desire to spend more time with his family rather than trying to keep up with all his equities, but the idea behind the principle is simply to remember to make time for what you love in life.

Principle #2
Gentlemen who prefer bonds don’t know what they are missing.

Bonds are inferior to stocks.

Principle #3
Never invest in any idea you can’t illustrate with a crayon.

Buffett has a similar process whereby he avoids what he does not understand. This is the same principle.

Principle #4
You can’t see the future through a rearview mirror.

Past returns are not a guide to future success.

Principle #5
There’s no point paying Yo-Yo Ma to play a radio.

There’s no point paying a bond manager when you can just go and buy the bonds yourself for no annual management fee. The same principle can be used with high costs active funds that closet index.

Principle #6
As long as you’re picking a fund, you might as well pick a good one.

It pays to do your research.

Principle #7
The extravagance of any corporate office is directly proportional to management’s reluctance to reward shareholders.

Excellent companies are thrifty.
Principle #8
When yields on long-term government bonds exceed the dividend yield of the S&P 500 by 6 percent or more, sell your stocks and buy bonds.

This goes against principle two, but it’s offered as a sort of defensive strategy.

Principle #9
Not all common stocks are equally common.

Some companies are very special. Others are junk.

Principle #10
Never look back when you’re driving on the autobahn.

Principle #11
The best stock to buy may be the one you already own.

Principle #12
A sure cure for taking a stock for granted is a big drop in the price.

Nothing brings you back down to earth after a string of winning positions more than a sudden loss.

Principle #13
Never bet on a comeback while they’re playing “Taps”.

(“Taps” is the name of that bugle tune they play at military funerals. In stock terms, it never pays to buy a stock just because its share price has fallen.)

Principle #14
If you like the store, chances are you’ll love the stock.

Successful companies can be spotted before their stock market darlings by watching how many people use the store. Footfall will reveal more about future sales growth than backward looking financials.

Principle #15
When insiders are buying, it’s a good sign – unless they happen to be New England bankers.

(Refers to the management of a number of Texas and New England banks who violated principle #13, continuing to add to their holdings right up until the very end.)

Principle #16
In business, competition is never as healthy as total domination.

A dominating monopoly company will generate much better returns for investors than several smaller companies fighting for market share.

Principle #17
All else being equal, invest in the company with the fewest color photographs in the annual report.

To understand this principle, all you need to do it look at the annual report of Berkshire Hathaway.

Principle #18
When even the analysts are bored, it’s time to start buying.

When analysts get bored by the company’s lack of progress, the company may be boring enough to buy.

Principle #19
Unless you’re a short seller or a poet looking for a wealthy spouse, it never pays to be pessimistic.

Cyclicals can be a great way to make a buck if you buy them at the bottom, so it helps to look for opportunity in depressed stocks, rather than think of all the reasons why a cyclical is going to take losses. Optimism is required.

Principle #20
Corporations, like people, change their names for one of two reasons: either they’ve gotten married, or they’ve been involved in some fiasco that they hope the public will forget.

If it’s the latter, it’s best to stay away.

Principle #21
Whatever the Queen is selling, buy it.

If countries privatize formal state-owned companies, they usually do so on such attractive terms that shareholders are almost guaranteed to make great profits.

Stay tuned for our Small-Cap Investing Guide part VII!

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