Hazelton Capital Partners ended the 4th quarter with a portfolio of 19 equity positions and a cash level equivalent to 7% of assets under management. The Fund’s top five portfolio holdings, which are equal to 39% of the Fund’s net assets, are: Western Digital (WDC), DreamWorks Animation (DWA), Apple Inc (AAPL), Abercrombie and Fitch (ANF) and CUI Global (CUI).
Beginning in mid-August, investors have been treated to a market roller coaster ride, complete with stomach turning plunges, heart pounding recoveries, and a series of quick directional turns that have left many market participants not only nauseated but unnerved. Many investors have questioned why the market has turned so turbulent so quickly. The truth is that investors have unknowingly been on this ride for much longer than they are aware. Every roller coaster journey begins in much the same way: An upward and steady climb to the apex, and then as the riders slowly crest over the top, they pick up speed on the way down leading to the simultaneous feelings of exhilaration, unease, and apprehension. The main difference between a roller coaster ride and the current equity market is that a roller coaster ride lasts, on average, for 2-3 minutes, whereas the recent market swoon appears to be unending. Investors have once again been reminded of a fundamental fact about assets: Prices can go down as well as up. While emotionally taxing, market sell-offs are a necessary ingredient to maintain a healthy and robust capital market.
Capitalism is an economic system that is based on the principles of competition, private property, profit motivation, private enterprise and consumer sovereignty. These principles allow for supply and demand to set a market-clearing price for goods and service, assets, and wages. But the foundation on which the pillars of capitalism are built is failure. The main precepts of capitalism are that assets flow from weak to strong hands. Businesses may go bankrupt, their assets sold and employees let go, but from these ashes come new opportunities to re-deploy capital and utilize those assets in a profit generating venture. Of course, it does not happen overnight, and it is not without discomfort. But as we have learned so often throughout history, trying to arrest the inherent movement of nature will often lead to larger and more disruptive events in the future.
Until recently, the United States National Park Service (NPS) aggressively fought to extinguish all forest fires. The actions of the NPS, even though well intended, over time lead to an overgrowth of trees, grasslands, and brush, that when ignited, accelerated the scale, scope, and damage of future forest fires. Fire is one of the tools that nature uses to return its habitat into balance and promote future and sustainable growth. Similarly, the arbitrary actions of the global Central banks to stave off a recession and artificially promote growth through quantitative easing, may have been well intended, but produced a global economy which remains bottlenecked, its growth anemic and its asset prices distorted. Adding to this market instability, OPEC (Saudi Arabia), which behaves like a central bank for oil producing countries, has purposely been driving down the price of oil by oversupplying the global market by an estimated 2.5 million barrels/day. Representing over 15% of the world’s oil production, Saudi Arabia’s primary motivation to keep production elevated is to eliminate growing competition from countries like Russia and US whose production costs are significantly higher. Given the unpredictable actions of governments and governing bodies, it is no wonder why many people have come to question whether capitalism is dead or at the very least sleeping.
By all measures, markets have become more volatile over the past few months, but are they more risky? There two types of risk an investor incurs after making an investment: Business risk and market risk. Business risk is specifically associated with a particular company, its business model, management, or the industry in which it operates. These risks can negatively impact the value of a company. Market risk is systemic risk. It is the risk that the overall downturn in the market will drag down the share price of a company’s stock. There are a number of ways an investor can reduce the business risk within a portfolio, but the ideal way is to avoid these traps altogether. There is no substitute for having an in-depth understanding of a company’s fundamentals, its management and the industry in which it operates. The best way to achieve this knowledge is through extensive and ongoing research. But even armed with insight into a company’s internal workings, there is very little an investor can do, in the short-run, to shelter their investments when market pessimism reaches a gale force intensity.
How Hazelton Capital Partners Has Been Reacting to the Recent Volatility
As the current market turmoil is casting a long shadow upon the future outlook for the economy, it becomes increasingly difficult to foresee a time when markets will calm themselves, let alone improve from its current levels. It is commonplace for investing strategies to call for an increase in cash when market fundamentals become unhinged. Hazelton Capital Partners is a big proponent of having cash on hand to invest, especially during extreme downturns in the market. However, moving into cash during uncertainty may reduce the emotional torture investors have had to endure for the past few months, but it is only the first part of an investing process. The second part is having the mental strength to re-deploy that cash. The current market environment has given investors plenty to worry about, but long-term investing opportunities are born from extreme negativity and grow from uncertainty. In recent months, Hazelton Capital Partners has transitioned out of a handful of legacy positions and reinvested that capital and more into an equal number of new positions with greater upside potential. The Fund’s cash is at its lowest level since the fund started back in 2009, and if we had more cash on hand, we would continue to deploy it. It is important to remember that Hazelton Capital Partners’ cash levels are a by-product of investing opportunities and not a macro outlook.
Hazelton Capital Partners remains concerned with the recent market volatility, but as we have also learned from past experience, measure twice and cut once. To avoid investing paralysis, The Fund’s current portfolio positions and potential new additions are continuously reviewed with a singular focus of validating our investment thesis, as we search for acts of omissions, overconfidence and a margin of safety level that is commensurate with market volatility. We have made mistakes over the past year, but no more or less than we have in the past. However, in the past, our portfolio of hand selected companies helped compensate for our oversight. Today, having an equity portfolio, regardless of its makeup, has become a liability. Given today’s current market environment, there are easily one hundred and one reasons why not to make an investment, but Hazelton Capital Partners is focused on the primary reason for making an investment: An opportunity to purchase shares of a cash generating company with a robust balance sheet and earnings power that is trading meaningfully below its future intrinsic value. This has always been and will remain our chief motivation for allocating capital, whether we are on a steady glide path higher or have crested over the apex.
This article has been excerpted from a letter to partners of Hazelton Capital Partners.