The Fund generated an attractive absolute return in the fourth quarter with performance led by the Fund’s two largest holdings, PICO Holdings (PICO) and Gulf Island Fabrication (GIFI). The Fund ended the year with 15 companies in the portfolio. The largest position was 15% of the portfolio and the top five positions represented 54% of the portfolio. The Fund added two new companies during the quarter and exited one. Divided by sector, 24% of the portfolio is in real estate (primarily land), 20% in water, 13% in energy, 9% in industrials, 9% in consumer products, 6% in retail, 2% in gaming, 1% in timberland, and 15% in cash. The portfolio has a weighted-average market capitalization of $128 million and an average enterprise value of $121 million.
One of our key investment tenets is to purchase companies and not stocks. Although we do not plan on purchasing the entire company, we consider the purchase of a share of stock as an investment in a share of the assets and future cash flows of the company. In our view, this methodology is the key differentiating factor between speculating and investing. While speculators purchase a share of a company with the hope that the share price goes up (for any number of reasons), investors purchase a share of stock to own a portion of a company – preferably at a discount to the company’s intrinsic value. Thus, we consider it imperative for all investors to understand the value of the assets, liabilities, and cash flows they are purchasing before making any investment.
In much the same way, when either individual or institutional investors consider which investment fund might be right for them, they should understand the pool of assets and liabilities they will be acquiring. This necessitates a very similar process to the one highlighted above, but instead of purchasing an ownership share of one company, the fund investor is purchasing an ownership share in a portfolio of companies. Evaluating a portfolio of companies is more time-consuming than analyzing a single company and the additional required diligence can result in investors allocating capital to an investment fund without a solid understanding of the companies they are purchasing. We find this to be especially prevalent when investors look to allocate capital to index funds, where exposure to certain asset classes is desired (often based on pre-established asset allocation targets) with little or no knowledge of the underlying constituents of the index and their underlying assets and liabilities.
Our focus on micro-cap value companies is centered on the view that this sub-segment of the U.S. equity market provides the best investment opportunities. We look for companies with clean balance sheets, owned real assets, and strong free cash flow. Building a concentrated portfolio of companies that meet these investment criteria should provide our investors with the potential for long-term capital appreciation along with a considerable margin of safety should economic conditions deteriorate. To test this, we compiled the assets and liabilities of each investment in our fund. We then took the fund’s ownership stake in each company and divided this down further to represent the portfolio of assets an investor would purchase with a $100,000 investment in the fund. As of year-end, a $100,000 investment in the fund would acquire over 6 acres of land (including over 1 acre of timberland), 27 acres of mineral rights, 4 acre feet of water rights, and over 170 square feet of building space. The investor would also receive over $32,000 in cash and assume $7,000 in debt, resulting in a net cash position in excess of $25,000. The book value of the portfolio exceeds $110,000 and the portfolio generated over $95,000 in trailing revenue.
While the process highlighted above comes with no assurances that the portfolio companies or the assets they hold will not decline in value, it should provide our investors with comfort in knowing their investment purchased a tangible, unlevered pool of assets. For us, this approach also provides us with additional conviction in the value of each of our underlying holdings should the stock price later depreciate in value.