17 Mile Investment Letter January 2017

17 Mile 

Investment Letter 

January 2017


Dear Reader,

As my communication has been sparse of late, an overview/history/update of 17 Mile is in order before a portfolio discussion.

* * * * * * * * * * * *

After 5.5 years of what I viewed to be an investment ‘residency’ of sorts, I launched the 17 Mile blog/project in June 2014 to document the process and performance of my event-driven, value-oriented investment strategy in order to develop a well-documented public – albeit crude and unaudited – performance track record.

From the beginning I have described my investment approach as “Loeb-style ‘events’ + Druckenmiller-style aggressiveness” – one designed for no more than 5% of a total portfolio, not 100% of grannie’s net worth.

From June 2014 thru October 2015 the 17 Mile ‘project’ and strategy went very well. Due to investment performance, yes, but also how that performance was achieved and what I learned about myself along the way. That is…

My core competency is not in deep, on the ground due diligence – that, for better or worse, remains in development – but rather the curation and management of ideas from a wide variety of sources. In other words, portfolio management. (I am fully aware how ‘nails-on-a-chalk-board’ this paragraph will sound to most.)

It turns out that I have a pretty darn good gut feel for the ‘tape’ (and no, when I say ‘tape’ that does not mean staring at price charts). And when I lose the ability to manage according to that ‘feel’, things go very badly.

From November 2015 thru February 8, 2016 the performance of my 17 Mile strategy collapsed. In ascending order of importance:

  1. I misread the broad market environment
  2. Given #1 I was far too aggressively positioned
  3. I broke my portfolio management rules
  4. I allowed market volatility to impair my cognition
  5. Due to a workplace conflict, I boxed myself in from a portfolio/risk management standpoint

At quite literally the worst possible time I simultaneously received a margin call + had a ‘come to Jesus’ investment life moment. Given that I was running the 17 Mile strategy as if it was an actual fund, I decided to shut things down…akin to investors pulling $$$ after a large – even if temporary – drawdown.

That did not last long, and I was quickly back at it, believing I could fight my way back. But given my cognitive impairment from the drawdown, I could not mentally get back into the security that caused the pain in the size needed to recover performance. So in early March I moved on from the forbidden security and on to what I believed to be the next big trade: another leg down for the broad market.

To bring things full circle, the 17 Mile ‘strategy’ evolved as follows:

  • June 14-October 15: Aggressive, yet diversified, event/value
  • November 15-February 16: Aggressive, highly concentrated Energy beta/event/value
  • March-June 16: Aggressive, concentrated macro/market timing
  • July 16 to present: Square 1

As painful and horrifically embarrassing it was to have my original event-driven, value-oriented strategy collapse in public, it was the best thing that could have happened. Truly. With not a shred of false modesty or rationalization.

I have, God willing, 4-5 decades of investing ahead of me. I now have one of the worst investment periods for active managers in the last 2-3 decades under my experience belt + documented in excruciating detail to guide me thru those 4-5 decades. How can I not be anything but ecstatic?

From June 2014 thru today I have learned the following (in no particular order):

  1. Become your own investor
  2. Listen to yourself while listening to others
  3. Do not mess with dangerous market environments
  4. Develop a robust market outlook framework
  5. Live to fight another day
  6. Don’t sacrifice the significant gains to be had on the other side of the abyss for the sake of catching the bottom
  7. Bottoms are pretty darn obvious – WAIT FOR THEM TO HAPPEN
  8. You have to buy ‘distress’ – pick a definition
  9. Get to know everyone’s strengths and weaknesses…particularly the experts
  10. Diversify your concentrations – pick a definition

With these ten lessons in mind I have:

  1. Streamlined the original 17 Mile strategy (17M)
  2. Launched an unlevered event/value strategy called “17 Mile Global” (17MG)
  3. Continue to nurture a fledgling ‘short’ strategy
  4. Developed a third strategy called “17 Mile Distressed” (17MD)
  5. Enhanced my market outlook framework
  6. Cleaned up the blog and Twitter
  7. Developed and launched US equity total return and global asset allocation strategies outside of 17 Mile
  8. Streamlined the management of my total personal investment portfolio

17M. As originally launched, 17M combined long-term oriented value investing with 1-3 year ‘events’, overlaid with portfolio management rules and aggressive trading. Sort of in that loose order of priority.

As demonstrated by the ‘evolution’ outlined earlier, at its core it is really just a highly aggressive trading vehicle with a 6-18 month time horizon and limited portfolio management structure.

With the longer duration investments and strict portfolio management rules now funneled thru 17MG, I can now do whatever I please in 17M. So for example…

As I will get into in later sections, I currently anticipate a fantastic opportunity to “short in May and go away” this year, and I want to be able to take full advantage of that. So rather than not go net short for the sake of strategic purity, I can now confine that bet to 17M where I now allow myself to go aggressively net short.

Lastly – despite the fact that I did a fair amount of opportunistic trading in 17M from June 14 thru October 15, I still kept myself rather constrained. Now, I let it rip. If a ST trade begins to ‘behave’ poorly, it’s gone.

17MG. The 17MG strategy is designed how 17M should have been originally. It is a medium- to long-duration event-driven, value-oriented strategy, with modest amounts of opportunistic trading, and limited market timing. I launched this strategy in May 2016 as a pure-play stock picking vehicle with strict portfolio management rules. It is unlevered; must hold at least 10 securities; has a max initial position size of 10%; and can hold no more than 50% cash.

Within a globally-oriented equity portfolio, I would be comfortable with 17MG comprising upwards of 50% of the US Mid & Large equity allocation (for reference, at present US M&L equities comprise roughly 50% of the global equity benchmark).

Shorting. I really should not even be writing about an extremely rough attempt at developing a short strategy. But FWIW, I am testing it out via a paper model (barred from shorting IRL for compliance purposes). Unfortunately I just do not have the time to devote 110% of my attention to it, so it is really managed from the sidelines with very limited turnover. I do not have position sizing rules, but the short side cannot be more than 100% gross, and I can hedge the market on the long side up to 100% gross. So max total gross is 200%. As I develop my due diligence and universe coverage expertise, I anticipate this ‘model’ ramping significantly over time…

17MD. The “17 Mile Distressed” strategy (anticipated launch sometime in 1Q17) was born out of a personal need + the general streamlining of my total personal investment portfolio. The long-duration portion of my total portfolio is comprised of a 17MG-like buy & hold portfolio (but more concentrated, as money added continually over time acts as a natural hedge/diversifier), index funds and 17M. But I need a portfolio/strategy for savings with a 1-10 year duration – kids’ college, cars, house, vacation, etc, etc. It needs to be a portfolio where I can have my cake and eat it too – above fixed income/cash returns with fixed income/cash-like volatility…i.e. NO drawdowns. This portfolio/strategy construction requires the following:

  1. Zero leverage
  2. Strict position sizing + industry concentration rules
  3. Extraordinarily strict, mechanical portfolio exposure ‘schedule’ tied to broad market conditions + market sentiment

And when I use the term ‘distressed’ I do not necessarily mean the traditional use of the term. A high quality company/stock such as JNJ for example can experience temporary bouts of ‘distress’. I am ecstatic about this strategy, as it takes the best parts of 17M and 17MG and overlays strict portfolio management rules with mechanical market timing. I’m pumped.

Market Outlook. My original ‘Market Mosaic’ framework was: Economic Conditions + Monetary Conditions + Market Technicals + a proprietary Market Model. The Economic Conditions component is by far the most critical, as all sustained 30%+ market declines have historically occurred inside of recessionary economic conditions as defined by the YOY rate of change of Weekly Jobless Claims (4-week moving average) above 20%. And the fact that the May 2015 to early February 2016 cyclical bear market was limited to less than 20% helped confirm this indicator in real time…

…(Unfortunately I failed to heed this indicator by becoming far too bearish from March-June 2016 based on what I believed to be a highly negative set of market ‘technical’ indicators.)

I have since tweaked the Mosaic by removing the ‘Market Model’, revamping the indicator set within the Market Technical component, tweaking how I interpret the Market Technical component, and adding placing greater emphasis on sentiment indicators as a supplement to the Mosaic itself. I am not going to go into great detail, but by far the most important change was the addition of supply & demand indicators.

Clean-Up. If you are in the business of ‘documentation’, then you understand the fact that accumulation of knowledge over time naturally invites a cluttering effect. As such, enormous mental relief is obtained by a semi-regular revamp of the documentation process. For example, I had begun to use the 17 Mile Twitter feed as a market analysis journal of sorts, posting updated thoughts on a weekly basis. But this generated far too much clutter for my Twitter feed, so I created a “Market Analysis” page on the blog in order to simplify and streamline the storage of those thoughts. (That page is now private, as I regularly post content for myself that I am unable to publicly distribute.) Also – I created an alternative Twitter account in order to house more regular intra-day market and stock-specific thoughts, as those too can clutter up the feed (I’m sure someone will happen upon a correct guess over time…).

Two more blog revamps were the de-emphasis of the “Scratch Notes” page and the removal of the “Business & Politics” section. Consistent use of the Scratch Notes page was sucking up far too much precious time that could otherwise be devoted to greater amounts of reading. I love taking notes, as it greatly assists in retaining information; but the pay-off did not exceed the time spent documenting, as I never really used the page to go back and review the notes. I will occasionally post a significant article or two, but activity will be very limited going forward.

The Business & Politics section was born out of my life-long obsession with politics + a riveting campaign season. As I am sure anyone with even a shred of political curiosity found this election cycle, my pre-conceived political notions were questioned – both to the good and bad – on almost every level on virtually a daily basis; and I wanted my thoughts documented in real time. Further, I thought that once the election concluded that my curiosity would naturally subside. But I was wrong – it has only accelerated. As such, I removed the B&P section from the blog and moved my thoughts to the land of political anonymity, far removed from world of “Finance Twitter”.

* * * * * * * * * * * *

While all of the above could perhaps be viewed as highly disparate, that view is wrong. The above is the development of long-term building blocks. The investment business is one of the most scalable operations on earth…once the ‘building blocks’ of process – in all of its forms – are put into place. And at this point in my career, I remain in the building block stage, for better or worse.

Of course MANY are much further ahead than I am from both a process and net worth standpoint. But I do not care. I cannot manage my own investment ‘personality’ according to outside investment personalities. I learn every single day by observing others, learning their strengths and weaknesses. But long-term multi-decade success requires the patient, methodical development of key investment building blocks built upon one’s own investment personality.

Largely by accident I built the 17 Mile project around a single strategy, one that was highly aggressive and not representative of me as an investor in my entirety. As I told a now good investment friend over coffee in Omaha last year, at heart I am actually a very boring, long-term oriented investor that would prefer to buy whole businesses and reinvest excess earnings as I see fit. That is how I manage the bulk of the long-duration portion of my total investment portfolio. As such, the vast majority of my development as an investor/trader over the last 8 or so years has been on the ‘hedge fund’ side of the equation, for lack of a better descriptor. If I spend the next 4-5 decades in a continual state of reinvention, then I will have failed mightily as an investor. But I find this possibility to have a near-ZERO probability of occurrence 🙂

On to the portfolio discussion…

PERFORMANCE

17M. For 2016 the 17M strategy was down -46.9% (gross), versus the DWCFT index return of +12.6%, ending the year with an NAV of $7.18. Since 6/15/14 inception, the 17M strategy is down -28.2%, versus the DWCFT benchmark return of +20.8%.

Clearly horrific, as the commentary above eluded to. However – since the strategy came full circle back to its strategic roots, the process & performance has gained significant momentum. I anticipate that NAV will climb to north of $20 within the next 12-15 months or so.

17MG. From 5/1/16 inception thru 2016 YE, 17MG is up 7.2% (gross) versus the DWCFT index return of +10.9%.

This result is to be expected from an unlevered, relatively low-turnover strategy only eight months into existence. For the first two months the strategy held upwards of 40% cash, as I was bearish on the broad market; and a large long-term weighting in Drug stocks has weighed on ST performance, with ‘ripening’ of those investments not expected until the 2017-2018 time period.

PORTFOLIO CONSTRUCTION

17 Mile

Positions in order of size: DISH, NXST, FOXA, PFE, ADS, DISCK, QVCA, JCI, GDX and ADNT.

Current exposure is largely maxed out, as I believe the short- to medium-term market set-up is highly bullish. But GDX acts as an uncorrelated hedge with gold sentiment bombed out on a short-term sentiment due to a smoking hot USD + the PFE and FOXA positions were initiated as short-term trades into temporary ‘distress’ with the potential to turn into medium- to long-term positions + the out-sized DISH and NXST positions contain large ‘special situation’ components. In other words, exposure can be quickly managed down if needed.

In the event a new opportunity pops up, GDX and PFE would be the first sources of funds. I am currently eyeing SHLD and VRX as potential special situation trades –> medium-duration investments (?), but neither is cooperating at the moment, as I wanted both much lower than current levels.

DISH, ADS, DISCK, QVCA, JCI/ADNT are core medium- to long-term positions, with all but DISH currently sized as such. NXST is not a great long-term business, but the valuation + near-term catalysts are a highly compelling combination for a near- to medium-term trade/investment. FOXA is likely to turn into a core position; PFE is likely to be recycled into a more compelling idea; and GDX is a near-term trade/hedge.

Heading into 2017, DISH possesses the highly compelling troika of: long-term undervaluation + event-potential + high probability near-term special situation. The bear case is that technology will reduce the $3.50 to $4.50 per ‘MHz-POP’ fair value of DISH’s spectrum portfolio to somewhere below $1.50. Perhaps. But I refuse to believe so without a free & clear 6-18 months of industry M&A discussion going by without DISH involved in a transaction of some kind. With the Broadcast Auction coming to a close, the M&A runway is finally clear for DISH to engage with key ‘connectivity’ industry players. As with any position at any time, I am open to the possibility that I am dead friggin wrong. But putting the ‘mosaic’ together, I do not believe now is the time to be bearish on DISH.

We’ll see how the year plays out. If we get a rip-roaring 1H17, I anticipate a serious reduction in portfolio exposure into the May/June time frame, and a likely (large?) net short position. But I will play it where it lies; and if we simply get maybe two or three 5-10% corrections, portfolio exposure may not vary much.

17 Mile Global

17MG is fully invested, and will likely remain so unless we get a hot 1H17 –> “short in May” set-up.

The portfolio is dominated by Media names (>50%) – DISH, FOXA, DISCK, LBTYK, MSGN, NXST – and Drug stocks (20%) – TEVA, MYL, AGN. Other positions include: ADS, WFC, QCOM, HTZ and HRI (in order of size).

INVESTMENTS

Media. Each Media investment has its own catalyst(s) – DISH spectrum, FOXA international investments/SOTP realization/industry consolidation, MSGN Dolan, NXST Media General, LBTYK long-term Comcast take-out (?), DISCK industry consolidation – but the key investment theme is: long-term “OTT” competition is not only further out than market participants believe, but will also not be as negative to long-term earnings power as market participants believe. The worst case scenario is the ‘bundle’ breaks up and the Content Cos are forced to distribute on a standalone basis. But this is irrational, as the cost to reconstruct the bundle ala carte would far exceed the cost of the current ‘bundle’. The market knows this – since if this was a realistic scenario, DISCK would trade for 7x earnings ($14), not 13.5x. IMO, it is likely that as the underemployed ‘Millennials’ cohort comes of age – and assuming they do not descend into socialist hell – the demand for high quality content at scale, distributed in a highly tech-friendly manner will rise. In short, the current ‘bundle’ does not have a demand problem, but rather a structure/tech/usability problem. At minimum this thesis warrants a re-rating to at least 15x earnings for diversified, high quality content. Again, IMO.

A highly catalytic ‘space’ led by top-notch management teams, on top of the fundamental thesis outlined above, is what leads me to an out-sized aggregate position.

Drugs. After Pershing Square kicked off a hedge fund bonanza in the Drug space from April 2014 thru July 2015, the sector has been in a choppy-yet-steady decline. Headlines are ugly – politics, pricing, competition, etc, etc – but valuations are extraordinarily cheap. Unfortunately I am not smart enough to envision much in the way of catalysts; but I do believe we are very close if not at THE bottom, based on classic end-of-year technical selling pressure. As Energy continued to sell off into early 2016 before making its penultimate bottom, Drug stocks could continue to sell off here into the new year. I believe that is unlikely; but if they do, I believe that is the final capitulation moment.

MARKET OUTLOOK 

Macro. The US economy continues to chug along, the global economy ex. US has begun to heal from the 2015 cyclical downturn, and global credit markets remain WIDE open. Without runaway investor sentiment, equity market downside is likely limited to 5-10%.

Technicals. Since Brexit, the amount of demand that has come into the US equity market has been nothing short of explosive. And while there is always room for multi-week/month consolidation, such as what we saw going into the US election, measures of demand continue to point toward further equity market upside.

I will play the market as it lies – so I do not really care about making a ‘big call’ on where the market will go this year…but according to the market demand measures I follow, this market looks eerily similar to the early stages of the 2013 bull market. Reading the ‘tea leaves’ – the market likes to stall in the June-September time frame, and given the extremely elevated absolute valuation of the market, it would not even remotely surprise me to see runaway market sentiment into the May time frame, setting up a wonderful “short in May and go away” opportunity.

* * * * * * * * * * * *

I have already exceeded how much I wanted to write, as one of my New Year resolutions is to write in a more concise, digestible fashion. So I will leave it here for now. I will follow up with a more lighthearted post of various 2017 prognostications I have been accumulating over the past month or so; as well as a more in-depth market outlook for the 17 Mile Seeking Alpha account.

Happy New Year to all.

17M


DISCLAIMER: The views and information I provide are for informational purposes only; are not meant as investment advice; are subject to change without notice of any kind; do not constitute an offer of products or services with regard to any fund, investment scheme, or pooled investment; nor do they in any way, shape or form represent the views of my employer.

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