The Partners III Opportunity Fund’s Institutional Class returned -16.17% in the first quarter of 2020 compared to -19.60% for the S&P 500 (the Fund’s primary benchmark) and -20.90% for the Russell 3000. For the year ending March 31, 2020, the Fund returned -5.83% compared to -6.98% for the S&P 500 and -9.13% for the Russell 3000.
There was extreme volatility in the stock and bond markets during the first quarter of 2020. The COVID-19 crisis has unfolded at an alarming pace, putting the country and much of the world in a kind of economic “time out.” Investors are encouraged to read our latest Value Matters for a deeper analysis of the current investing climate. As detailed below, Fund performance was helped by some very large, mature companies that generally outperformed smaller companies, while the Fund’s index short positions provided some additional ballast. Nevertheless, we were not immune from the swoon. We always prefer to report relative outperformance but acknowledge that does not fully dull the sting of negative absolute results.
Despite the overall gloom, there were a few bright spots in the quarterly numbers. Acquisition vehicle EverArc Holdings (LSE:EVRA, Financial) raised capital in late 2019 and continues to evaluate opportunities to purchase one or more operating businesses. Market-wide asset price declines suggest improving potential returns when EverArc ultimately deploys its war chest of cash. Amazon (AMZN, Financial) managed a small positive return likely due to a shift in retail market share as consumers adjusted to shelter-in-place orders. We also generated positive returns from our sales of Expedia Group (EXPE, Financial) and Colfax (CFX, Financial), which were valuation-driven and completed before the market impact of the outbreak was truly underway. Not surprisingly, our index short positions collectively delivered the greatest positive contributions, providing a partial hedge for the portfolio’s decline.
Our remaining holdings participated to varying degrees in the overall sell-off. Berkshire Hathaway’s (BRK.A)(BRK.B, Financial) position size magnified its market-like return, while others like Liberty Global (LBTYA, Financial) and Liberty SiriusXM (LSXMA) suffered more meaningful markdowns as investors struggled to project the duration and depth of the coming recession, and investors grew even more negative on DXC Technology (DXC, Financial), despite progress on their divestiture plan (and planned debt reduction). We empathize with investors’ near-term uncertainty, but we remain focused on the businesses’ long-term opportunities which we believe are sound.
Long-time holding Redwood Trust (RWT, Financial) faces a less clear path. The non- agency mortgage market is under tremendous duress, and we believe the initial shock was more about liquidity than solvency. Extreme volatility in loan portfolio pricing stemming from the COVID-19 pandemic has pressured the sector’s funding model, with no relief from government intervention in sight. Redwood’s management has equal measures of integrity, resolve and experience; if anyone can safely navigate these waters, we like their chances. The team has taken several difficult, decisive steps to shore up liquidity, and we think they have invested (and marked) with appropriate conservatism. The upside case is clear, yet we also cannot be sure that this unprecedented disruption will not further impair their business. More to follow next quarter.
We were active on both the buy and sell sides of the ledger during the first quarter. In addition to Colfax and Expedia, we also completed a sale of Perspecta (PRSP), while we began two new company investments and one new long ETF position. Among our new investments is CoStar Group (CSGP), the leading provider of data, analytics and marketing services to commercial real estate brokers and tenants as well as the operator of the rental marketplace, Apartments.com. Research Analyst Jon Baker, CFA, provides a more detailed description and summary of our investment thesis in this quarter’s Analyst Corner feature. We also began buying Vulcan Materials (VMC, Financial) (a high-quality provider of aggregates and other building materials to both private and public-sector customers) late in the quarter after its shares were swept up in the overall market decline. We also added a significant new holding of the Financial Select Sector SPDR ETF. Financial stocks (banks, in particular) have disproportionately slumped as rock-bottom interest rates pressure banks’ ability to earn an attractive margin on their loans while an economic slowdown creates concern around consumer and commercial credit. It’s true that banks played a central role in the Great Financial Crisis of 2008-2009, but today banks are much better capitalized and not the epicenter of our current troubles. We believe the magnitude of these declines has been overdone. In the past, we have constructed “baskets” of individual securities to express an “industry thesis.” Today, we can simply and efficiently do the same by purchasing the sector ETF instead.
Within the short book, we closed our SiriusXM short (a hedge that had protected prior gains in Liberty SiriusXM) at a gain and covered the remaining shares of our Dollar General (DG) short at a loss. On balance, we reduced our index short position during the quarter, covering layers of our S&P 500 Index ETF short at various levels during the market decline. Though our Index shorts were positive to the portfolio during the market’s quarter decline, the shares covered resulted in a loss. These moves resulted in a gross short exposure equal to 11% of net assets at quarter end (down from 19% on December 31). Our gross long exposure also declined to 90% (from 97%) during the quarter, resulting in an effective net long position of 79% of net assets.
Despite an uncertain near term, we are confident that the world will recover from the current health crisis. As we continue to navigate through this difficult period, our goal remains unchanged: to identify attractive investment opportunities that can deliver strong returns for years to come.
The views and opinions expressed here are those of the portfolio managers as of 04/20/2020, are subject to change with market conditions, and are not meant as investment advice.
For informational purposes only. Not an investment recommendation.
