The Fund ended the quarter with 13 positions. The largest position was 15% of the portfolio and the top five positions represented 59% of the portfolio. The Fund added one new position and also exited one position during the quarter. The portfolio consists entirely of deep-value microcap companies providing a considerable margin of safety and the potential for capital appreciation. The deep value focus is evident as the average portfolio company has a Price/Book ratio of 0.8x and an Enterprise Value/EBITDA ratio of 6.0x. These valuation metrics compare favorably to the S&P 500 which has a Price/Book ratio of 2.8x and an Enterprise Value/EBITDA ratio of 12.8x. The companies in our portfolio also have conservatively managed capital structures, with 10 of our 13 portfolio companies having more cash than debt on the balance sheet. The average portfolio company has a market capitalization of $86 million and an enterprise value of $74 million. Divided by sector, 28% of the portfolio is in real estate (primarily land), 15% in industrials, 13% in energy, 13% in housing, 10% in consumer products, 7% in retail, 5% in gaming, 2% in distribution, and 7% in cash.

Given the concerns raised earlier in this letter regarding a potential government bond bubble and overextended equity valuations, we have remained particularly diligent in our investment approach and very patient when looking to allocate capital. While attractive opportunities are rare, our investment process continues to uncover companies with long-term competitive advantages trading at a discount to intrinsic value and also providing a margin of safety. There are also several procedures we adhere to that help protect the portfolio from concerns raised earlier in this letter regarding falling discount rates, a mass rotation into index investing, and strong investor demand for current yield. As readers may recall, we derive our target valuation for each of our portfolio companies from a discounted cash flow analysis. Unlike many other investors, we do not reduce our discount rate just because government bond yields have declined. We have maintained a required rate of return for our portfolio companies between 12.5% and 15.0% as we feel this rate of return fairly compensates our investors for taking equity market risk in microcap companies. While we may refer to valuation metrics such as Price/Earnings or Enterprise Value/EBITDA ratios for comparison purposes, our intrinsic value calculations are not based on relative value measures that can be subject to manipulation both through sizeable adjustments and the stretching of forward ratios several years into the future to justify current valuations. Similarly, our absolute return focus allows us to own companies regardless of whether they might be included in an equity index, with only 5 of our 13 portfolio companies currently included in the Russell Microcap Index. Of these 5 companies, we estimate that index funds own less than 0.5% of the total shares outstanding. This is very small percentage relative to most other investment funds and could help limit our potential losses in the event investors retreat from passively-managed strategies. Finally, while we appreciate companies that can provide their owners with steady profits and stable cash flows, in the current low interest rate environment we feel that companies that deliver bond-like cash flows are often overvalued. We have recently found value in companies that own long-term assets that do not provide a steady income but rather generate lumpy cash flows when one of their properties or assets is monetized. One of our newest portfolio companies owns a significant amount of water rights and water-related assets in the southwestern United States. As a popular quote widely attributed to Mark Twain states, “Whiskey is for drinking, water is for fighting over.” While the timetable for monetizing these water assets is uncertain, we are confident these water assets will be worth fighting over in the coming years.

[us_separator] The above post has been excerpted from a recent letter of Gate City Capital Management.

Performance for the period from September 2011 through August 2014 has undergone an Examination by Spicer Jeffries LLP. Performance for the period from September 2014 through December 2015 has undergone an Audit by Spicer Jeffries LLP. Performance for 2016 is unaudited. The performance results presented above reflect the reinvestment of interest, dividends and capital gains. The Fund did not charge any fees prior to September 2014. The results shown prior to September 2014 do not reflect the deduction of costs, including management fees, that would have been payable to manage the portfolio and that would have reduced the portfolio’s returns. Actual performance results will be reduced by fees including, but not limited to, investment management fees and other costs such as custodial, reporting, evaluation and advisory services. The net compounded impact of the deduction of such fees over time will be affected by the amount of the fees, the time period and investment performance. Specific calculations of net of fees performance can be provided upon request.