Barac Capital Management 4Q17 Letter To Investors: Gains On RokuVW Staff
Barac Capital Management letter to investors for the fourth quarter ended December 31, 2047.
This is the Fund’s twentieth regular quarterly report to provide updates on the Partnership’s performance. The Partnership’s Fund administrator, Fund Associates, LLC, is also generating monthly investment reports for each Partner, by directly and independently accessing the Fund’s electronic brokerage data.
For the three-months ending December 31, 2017, the Barac Value Fund L.P. (the “Fund” or “Partnership”) delivered net returns of 6.9% (after the deduction of management fees) versus a return of 4.1% for the benchmark1.
Since the Partnership’s inception (on July 14, 2011), the Fund has returned 86.2% (after deducting management fees) versus a return of 80.7% for the benchmark, resulting in relative outperformance of 556 basis points.
Gross and net annualized returns for the Fund since inception amounted to 11.3% and 10.1%, respectively, versus a return of 9.6% for the benchmark.
Fourth Quarter Performance
For the fourth quarter ending December 31, 2017, returns for the Fund amounted to 7.3% on a gross basis and 6.9% on a net basis (after management fees), compared to 4.2% for the benchmark. The Funds quarterly performance also outperformed both the benchmark’s equity2 (up 6.6% quarter-to-date) and fixed-income3 (up 0.4%) subcomponents.
As always, it is important to re-state that the Fund’s returns were generated without leverage (either direct or effective leverage through options), without taking highly concentrated positions, and while conservatively holding substantial cash and/or Treasury bond positions. I also continue to “put my money where my mouth is” and most of my liquid net worth also remains invested in the Fund along with the other Partners.
It should also be noted that going forward (as of January 1, 2018) the Partnership’s management fee was reduced from 1.50% to 0.95%/annum4. This brings the Fund’s fees in-line with Barac Capital’s new separately-managed-account offering (launched in April of 2017), which is important in the interest of fairness and consistency. I believe that high fee levels continue to be one of the most value destructive components of the investment management industry (particularly for hedge funds) and I intend to keep ours below industry norms.
The Fund’s outperformance for the quarter was driven by individual security selections. Top individual contributors for the period included Roku (+88.0% from entry price to quarter-end), Under Armour (+25.0% from entry price to quarter end), Home Depot (+16.5%), and Target (+11.7%). The only two negative return performers for the quarter were Adidas (-11.8%) and AMC Networks (-7.5%).
The contribution of Roku was particularly strong. The Fund purchased shares of Roku October, following an earnings report which gave me more optimism in the company’s growth prospects. More specifically, it gave me more confidence in Roku’s ability to monetize their leading operating system for “over-the-top“ television (viewing which doesn’t require a cable/satellite subscription: e.g. Netflix, Hulu, etc.). Subsequent to this purchase, investor sentiment for the company improved substantially and the share price increased by about 88% (as measured at the end of the quarter).
While I remained optimistic on Roku’s prospects and believed the company’s shares continued to offer good value, I also believed that the recent price runup had somewhat reduced the attractiveness of the share’s risk/reward dynamics (as more speculative growth was priced into the stock). For this reason, and in order to re-adjust position sizing, the number of shares held by the Fund was subsequently reduced by about 50% (at price levels 65% above the Fund’s entry price).
While Roku was the largest contributor to quarterly performance, the Fund’s other positions also performed well during the quarter and the Fund would have comfortably outperformed its benchmark without any contribution from Roku. As of the end of the quarter, Roku accounted for approximately 2.2% of the Partnership’s Assets-Under-Management (“A.U.M”).
Outlook and Positioning
of the end of December, the Partnership remained underweight equities (at 58% of A.U.M. versus 60% for the benchmark) and fixed-income (at 36% of A.U.M. versus 40% for the benchmark) and held a cash balance of 6% of A.U.M. In order to mitigate against credit and interest rate risks, all of the Fund’s fixed-income positions remain in U.S. Treasuries with a maturity of less than 5 years.
I do remain generally cautious with regard to “risk assets” (stocks and corporate bonds). This is more a result of market risk factors rather than concerns with respect to current equity valuation multiples. At the end of the quarter, I believe that the equity risk premium remains reasonable -- with a forward earnings’ yield on the S&P 500 index of 5.0% versus a 2.4% yield for 10-year Treasuries.
What does concern me, however, is the earnings part of the price/earnings equation and the increasing risk that some of the contributors to current (high) profit margins could come under pressure. Earnings’ levels now reflect low interest rates (and low credit spreads), low wage growth, and the positive wealth effect of 8 years of rising stock prices and home values.
As we approach full employment and some of the government’s pro-growth policies come into effect, there is a heightened risk of wage pressure and increased interest rates with increased inflation. Furthermore, current valuations appear to incorporate little with respect to geo-political risks at a time when there is much political change and uncertainty. It also warrants bearing in mind that if/when the business cycle does turn (and assets prices fall), a resulting “reverse wealth effect” could exacerbate the impact of a cyclical downturn.
or all of these reasons, the Partnership remains more defensively positioned than its benchmark (which, itself, reflects a conservative asset allocation). This is reflected in the fact that 42% of the Fund’s A.U.M. are either in cash or U.S. Treasuries with maturities of less than 5 years5. While a defensive positioning has somewhat constrained performance returns over the past year, I am willing to sacrifice some upside potential as capital preservation remains paramount to the Fund’s investment strategy.
To be clear, the Partnership’s defensive positioning is in place in order to mitigate against market risks and not based on the expectation for an imminent fall in equity prices. In fact, I believe that the current uptrend in the equity market could continue for a while. Furthermore, I believe that the Fund’s equity holdings include idiosyncratic value opportunities (for specific stocks) that are superior to those of the equity markets as a whole.
Thank you to everyone for your interest and support and please let me know if there are any questions you may have that I haven’t answered. The next quarterly report will be for the quarter-ending March 31st, 2018 and the next subscription period for the Fund will be on January 31st.
Managing Member of Barac Capital Management, LLC
See the full PDF below.