2015 Reintroduction & Review
July 4, 2015
As it is, time goes by fast; but when you count your life in 1-, 3- and 5-year IRRs, it FLIES. I started 17 Mile in June 2014, and it feels like yesterday that I was in a Chicago hotel room handwriting the series of essays that introduced my background and why I started the Site. 17 Mile has been a success on multiple fronts, but how that success was achieved has been far and away more satisfying than the success itself. (And that is not false modesty – if anyone has ever competed in athletics at a high level, they know exactly what I am talking about…the path to success is far more rewarding than standing on the podium knowing the journey is over.) Before reviewing the last twelve months, allow me to briefly reintroduce myself.
I am an event-driven, value-oriented private investor looking to build a publicly-documented track record that beats the market – as represented by the Dow Jones U.S. Total Stock Market Total Return index (DWCFT) – by 5% per annum, net of hypothetical fees, over all trailing time periods one year and longer. 17 Mile is the public investment diary that documents my process and performance.
Goal. There are many goals – most of which are too far-fetched to actually make public – but the #1 stated goal is to start a hedge fund. I am fortunate to be in a fantastic position to one day start a fund (platform, resources, contacts, etc.); I *just* need the track record.
Style. I am an event-driven, value-oriented investor focused on generally undervalued, event-driven and special situation equity & credit investments. Primarily long-only, the only ‘shorting’ done is via index hedging in select market environments. The portfolio is concentrated, with the average position size between 20% and 40%; and at times leveraged, depending on my assessment of broad market risk.
Portfolio. The portfolio is broken down along category lines – Generals, Events and Special Situations – with allocations largely incidental. Though while difficult to predict, it would make sense for the portfolio to be more heavily allocated to Events in a fully valued market environment (such as it is now), Special Situations in a ‘risky’ market environment, and Generals in an undervalued market environment. Time will tell.
Portfolio exposure is governed by a “weight of the evidence” approach to market risk management; a system I refer to as the Market Mosaic, which focuses on economic conditions, monetary conditions, market technicals, and market valuation. In non-recessionary environments, portfolio exposure ranges from 0% ‘net’ to 200% ‘gross’; while in recessionary environments the range is -100% to 100% (explained in detail in the “Year in Review” section below). Specific exposure targets are derived from the detailed Market Mosaic (discussed in 17 Mile investment letters).
Risk. At the risk of sounding corny, I view my approach as Soros/Druckenmiller-style aggressiveness + Loeb-style ‘events’. I know it is aggressive, but it is the only way I know how to invest – it ‘fits my eye’, in other words. As such, the portfolio is managed as if I was managing 2.5% of a large endowment; not the family nest egg. So any perceived ‘riskiness’ of my approach should be viewed thru this prism.
17 Mile. The Site is treated as the investment diary that it is. The only reason it is public is to exert as much performance and reporting pressure on myself as possible. There is no system, consistency or neatness; so please follow/read at your own discretion.
Key working pages to follow include Scratch Notes, Idea Incubator, Trading and Performance Reporting. However, primarily due to ease of use, I have found that Twitter (@HFM17Mile) has somewhat replaced the Scratch Notes page, and that I now use the Scratch Notes page as a center for longer-form write-ups not quite worthy of a full post.
YEAR IN REVIEW
Snowball. As you grow older, wiser and more mature (yes, I have far to go) you develop the ability to almost step outside yourself and watch. Sounds (and likely is) odd, but the best way I can describe it is the feeling of being “in the zone” in sports: in golf, you can ‘feel’ every aspect the swing; in baseball, a 95 mph fastball looks underhanded. 17 Mile came together last June as the result of me finding the “zone”; but it took the last twelve months to A) realize that I had in fact entered the “zone”, and B) define the object of the “zone” – or, what the baseball is, if you will.
It turns out that it is next to impossible to avoid Warren Buffett in almost all aspects of life. Buffett’s lifelong obsession has been/is the miracle of compound interest – most notably with regard to investment returns. But as the “Snowball” title of Alice Schroeder’s biography of Buffett implies, Buffett likes to say life is one giant snowball, with every single aspect building on itself.
For me, the baseball is the building process.
Building. I love the building process. Outcomes are difficult to predict – both form and timing – but putting building blocks into place is under one’s full control. For the 5.5 years leading up to last June, I was actively putting the building blocks for 17 Mile into place, but did not realize what I was doing while I was doing it. I was primarily focused on the end goal of becoming a hedge fund manager.
While goals are hugely important – and absolutely vital for driving the underlying passion that in turn drives the (almost disturbing) daily obsession with obtaining them – if they become the daily focus, it is easy to lose appreciation for the day-to-day building process. My mother-in-law says it best (quoting Hal Goddard): “Wherever you are, be there.” I have developed an enormous appreciation for the daily building process by learning to “be there”, and I am humbled by how lucky I am to have developed it relatively early on in my life.
Performance. Though performance was strong over the last twelve months, over time periods shorter than three years, performance is notoriously difficult to predict; so A) short-term returns must be taken with a grain of salt, and B) it is paramount to manage the portfolio where it lies…meaning, let opportunities come to you (i.e. monetize fully valued positions; add to undervalued positions; and let new ideas hit you over the head). If the process is consistent, good performance will follow. While of course there were numerous mistakes – which I am looking forward to outlining in the upcoming investment letter – I believe a good portion of the performance was the result of a relatively sound investment process (I say relatively because the process is always evolving, with ever-present room for improvement).
While I by no means expect 50%+ gross returns every year, I will not say that it is unlikely to happen again. As much as I idolize Buffett and Munger, I do not subscribe to the “forever” holding period they espouse. There are so many idiosyncratic opportunities that materialize over any given 12-month period that it would be next to impossible for me to watch them go by while I sit on “a big block of Wal-Mart and a big block of Coca-Cola” (Munger, USC Business School speech). While I need to improve my monitoring of this idiosyncratic universe, I believe I do a reasonable job of giving myself an opportunity to generate outsized returns, and that the past year has helped prove that out. In the 5.5 years leading up to last June, my underlying stock-picking performance was quite good (though undocumented) – unfortunately it was stifled by horrendous macro trading, which is why I needed 17 Mile to not only prove it to myself, but also a public forum.
I know full well that I need to prove myself not only over more than a 12-month period, but thru a difficult market environment; an environment I look forward to navigating (who knows when it will arrive) with great anticipation. There will be losses, mistakes, and extreme frustration at times; but not only will it be a tremendous learning experience, it will present a wonderful opportunity for alpha generation.
Mosaic. The key to unlocking my stock-picking ability was developing a framework for dealing with market risk. I am a value-oriented, risk-averse investor at heart, so the record high valuations – as demonstrated by the Schiller PE ratio – witnessed in the U.S. stock market since late 2009/early 2010 led me to hold lots of cash and take aggressive index short positions at times. As I learned rather painfully in the 5.5 years leading up to last June, there is far more to market risk analysis than simply valuation. In response, I developed what I call the Market Mosaic, a “weight of the evidence” approach to market risk management. While operationally quite technical, in summary it looks at economic conditions, monetary conditions, market technicals, and market valuation. It is predicated on the historical tendency for the most severe bear market environments to occur inside of recessionary economic conditions, and that non-recessionary bears are typically short-lived and rarely more than -20%. While the overarching goal is to get in harmony with the primary market trend, and not to avoid every 10% market wiggle, I do have several tools in place – two embedded within the Mosaic, one ancillary – that should allow me to side-step most 20% declines; not for the sake of avoiding volatility, but to free up capital to take advantage of the inevitable extreme dislocations that accompany 20%+ declines.
Over the last twelve months there were several 3% to 5% dips and one near-10% correction. The near-10% correction in October elicited relatively high volatility and much talk of a 1987-like crash, but the Mosaic remained firmly bullish for all twelve months, allowing me to keep portfolio exposure largely at full throttle. And while after a year of strong performance – and persistent talk of an overvalued/tired/mature/high-risk market environment – it would be easy to justify reigning in exposure in anticipation of lower market levels, my goal is to play every market environment as it lies. As such – despite a slight deterioration in the Mosaic’s bullish level, the market outlook and associated recommended portfolio exposure are largely identical to where they stood at June 2014 inception.
My uneducated guess would be that 2014 likely represented relatively ‘normal’ volatility for a 12-month period with no recessionary economic conditions. Though a case could be made that Zero Interest Rate Policy (ZIRP) has artificially dampened volatility, and thus a ‘normal’ year would consist of 5% to 7% dips (versus 3-5%) with one or two 8% to 12% corrections (versus one 10% correction). Point is – 20% corrections are rare; full-blown bear markets are even more rare; and the overarching goal is to stay as fully invested for as long as possible, as equity markets have a long-term bullish bent.
Portfolio. In the original outline and construction of the 17 Mile strategy, I came up with a set of portfolio exposure rules that would prevent me from becoming overly negative in a broadly positive market environment, and overly positive in a broadly negative market environment. The rules were as follows:
- Non-Recessionary Environment
- Gross Exposure: 100% minimum, 200% maximum
- Net Exposure: 50% minimum, 200% maximum
- Recessionary Environment
- Gross Exposure: 50% minimum, 100% maximum
- Net Exposure: 0% minimum, 100% maximum
With, my market timing habit now officially kicked, and what I believe to be an attractive market risk analytics tool box in place, I have since revised these rules in order to give myself greater flexibility for going on the offensive in weak market environments. In summary, I have given myself the ability to go fully hedged even in the absence of a recessionary environment; while in a recessionary environment, I can now go -100% net short. The revised rules are as follows:
- Non-Recessionary Environment
- Gross Exposure: 50% minimum, 200% maximum
- Net Exposure: 0% minimum, 200% maximum
- Recessionary Environment
- Gross Exposure: 0% minimum, 100% maximum
- Net Exposure: -100% minimum, 100% maximum
Network. Sometime in early- to mid-2014, prominent Finance Twitter member @LongShortTrader made an interesting comment regarding the latent value in social media properties available to those looking to develop a business/network/reputation (I am paraphrasing). After a year of operating 17 Mile, I believe his comment was prescient. For minimal monetary outlay, I have built a pretty solid network over the last twelve months – for sure relative to personal expectations (honestly though, I had next to none), but just OK in absolute terms, as the quality of content I produce is not yet up to par with top Finance Twitter members. As I discuss in the next section, by far the biggest area for improvement in my entire process is conducting deeper due diligence. I believe that if I can ramp it up on the diligence side, better define my ‘edge’ with each investment, and be a touch more professional on Twitter, I can not only grow the size of my network, but the quality of it as well. I get a lot out of discussing ideas with other investors willing to share their thought process, so I have a strong incentive to grow my following in a quality-adjusted manner.
Interview. THE highlight of the last twelve months was an interview process that I was extremely fortunate to be part of as a result of 17 Mile. Though the opportunity did not work out, it was one of the most rewarding experiences of my career. This individual is by far the smartest investor I have ever met, and more than likely one of the smartest investors in the business; I learned more in eight weeks from this person than I have collectively from all prior mentors, and was able to see not only how it is done at an extremely high level, but what it takes to get there. I exited the process not only not discouraged, but with a high level of confidence, ready to step it up to the next level.
The #1 lesson from the interview process is that I need to step up my level of due diligence; though I am still working thru both what to improve and the mechanics of how to improve, so I do not yet have detailed thoughts here. There are several key headwinds to a greater level of diligence; fortunately they are not structural, and 17 Mile will, over time, go a long way toward addressing them. In the meantime, at minimum the analytical work in my investment write-ups will be improved.
My overarching *problem* is that I utilize a “mosaic” approach to my investments in order to create operating leverage for myself. VRX is a good example. I could have spent twelve months poring over company filings, presentations and transcripts, “Street” reports, competitor filings and industry documents…yet all that work would have not even remotely touched the level of work Pershing Square conducted in less than three months working with the VRX BOD under confidentiality agreement. In my opinion, Pershing’s stamp of approval of VRX’s financials created an enormous margin of safety that I could have never replicated myself. Same with DISH – Charlie Ergen creates a huge margin of safety; one that no level of due diligence on my part could replace.
Work in progress…
This is an extremely long and rambling post, primarily meant to document my own thoughts. So if you read this far, thank you so much for taking the time to read. Frankly, I am honored.
Please feel free to contact me any time at email@example.com and @HFM17Mile.
Thank you very much.