The Partners III Opportunity Fund’s Institutional Class returned -2.39% in the fourth calendar quarter compared to +6.64% for the S&P 500 and +6.34% for the Russell 3000 indices. For the 2017 calendar year, the Partners III Opportunity Fund’s Institutional Class returned +5.45% compared to +21.83% for the S&P 500 and +21.13% for the Russell 3000.
A challenging fourth quarter capped a disappointing calendar year on both an absolute and relative basis. The Fund holds short positions in broad market indices, the proceeds from which are generally used to add to our highest-conviction long ideas that we believe have the potential for greater-than-market appreciation. When successful, this strategy can generate additional return without adding to our net investment exposure. A natural consequence, however, is that the stronger the return of the underlying market index or indices, the greater the headwind to performance (absolute and relative).
Markets were strong indeed, as investors continued to purchase stocks against the backdrop of low interest rates, low inflation, and finally in the fourth quarter, signed legislation to lower corporate taxes. As a result, our “basket” of shorts against ETFs that track the Russell 2000 (+2% Q4, +15% 2017), S&P 500 (+7% Q4, +22% 2017) and Nasdaq 100 (+7% Q4, +33% YTD) indices was the largest detractor to Fund performance for both periods. We can’t predict what the market will do, but with tax reform now in the rearview mirror and the Federal Reserve looking to push short-term interest rates higher, we anticipate that individual company fundamentals and valuation may carry more weight in investors’ minds in 2018.
Berkshire Hathaway (+8% Q4, +22% 2017) and Mastercard (+7% Q4, +48% 2017) were top contributors for both the fourth quarter and calendar year. Berkshire, the Fund’s largest holding, continues to execute well across its various insurance, railroad, utility and manufacturing businesses, driving a healthy increase in our estimate of business value in the process. Mastercard and our smaller investment in Visa (+9% Q4, +47% 2017) were clear beneficiaries of investors’ desire to own businesses with long runways of secular growth. Texas Instruments (+17% Q4), another top contributor in the quarter, beat expectations on the back of continued strong growth in their core markets and solid execution that expanded profit margins and issued guidance for the fourth quarter that was modestly ahead of consensus. Rounding out the calendar year “Honor Roll” was Liberty Ventures (+47% 2017), whose shares positively inflected upon their announced acquisition of Alaskan cable and wireless provider GCI Communications and the underlying performance of its investment in Liberty Broadband.
In addition to our short positions, Allergan (AGN, Financial) (-20% Q4, -21% 2017) was a top detractor in both the quarter and calendar year. Shares fell during the quarter as patents for its dry eye treatment Restasis were invalidated in federal court. After incorporating the earlier-than-expected loss of Restasis profits, we made a downward revision to our business value estimate. Nevertheless, we believe Allergan’s share price decline has overshot reality, and it continues to trade at a significant discount. Liberty Broadband (-11% Q4) and Wesco Aircraft (-51% 2017) also were top detractors for the quarter and year, respectively. Liberty Broadband (LBRDA, Financial) saw its investment in Charter Communications (CHTR, Financial) (- 8% Q4) decline when the company surprised investors with larger-than-expected video losses and slower growth in broadband customers. We remain confident in management’s playbook to integrate and realize value from the combinations with Time Warner Cable and Bright House Networks. Wesco (WAIR, Financial) remains in the depths of a difficult turnaround. Results for their recently completed quarter were again disappointing, and despite new management’s guidance for revenue and EBITDA growth in the coming year, investors are reluctant to take them at their word. We underestimated the complexity of the required turnaround, but we are encouraged by signs of incremental progress and believe shares currently trade at an attractive discount to our reset expectations.
Our lone portfolio addition, Amazon.com (AMZN, Financial), requires little introduction. Amazon has built an unassailable global competitive advantage in its core retail business, and we believe it will continue to gain worldwide retail (not just e-commerce) market share for many years to come. In addition, Amazon Web Services has also built a significant share in the large and rapidly growing “infrastructure as a service” market. We foresee Amazon’s unique technical capabilities, global scale and culture of customer obsession will allow the company to grow its business value for many years. In the quarter, we also continued to build our initial position in Danaher. On the sale side, we closed our position in Wells Fargo as shares recovered from recent customer woes and investors forecast a friendlier regulatory environment, sold our remaining shares of CommerceHub, and trimmed our holdings of QVC Group.
During the fourth quarter, our long exposure increased by roughly 2.5 percentage points to 94% of net assets. We closed our short position in the iShares Russell 2000 ETF, resulting in an unchanged short exposure of 32% at year end. The Fund’s effective net long position was 62% of net assets at year end (rounded to the nearest percentage point.)
