To Charlotte Lane Partners: Returns for Period February 1, 2016 – February 29, 2016 YTD Returns for Period January 4, 2016 –
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To Charlotte Lane partners: February was a poor month for the strategy, with the Fund losing 2.27% in a choppy but net flat market. Since inception on January 4, 2016, the Fund has gained 2.35% vs. a 5.06% loss for the S&P 500. The numbers are presented in the tables below, followed by a discussion of portfolio performance, risk management, and the investment process. Returns for Period February 1, 2016 – February 29, 2016 Source: Interactive Brokers (IB)1 Charlotte Lane S&P 500 Russell 1000 Total Return (2.27%) (0.08%) (0.04%) Sharpe Ratio (1.51) 0.03 0.07 Sortino Ratio (2.71) (0.46) (0.39) Carlmar Ratio (4.79) (0.26) (0.11) Standard Deviation 1.27% 1.13% 1.15% Max Drawdown (6.86%) (5.61%) (5.84%) YTD Returns for Period January 4, 2016 – February 29, 2016 Charlotte Lane S&P 500 Russell 1000 Total Return 2.35% (5.06%) (5.42%) Sharpe Ratio 1.02 (1.74) (1.84) Sortino Ratio 1.06 (2.68) (2.80) Carlmar Ratio 3.34 (3.59) (3.58) Standard Deviation 1.18% 1.29% 1.31% Max Drawdown (6.86%) (10.31%) (10.91%) 1 All return information contained herein for information purposes only. All return data unaudited. Return data not presented as GIPS-compliant. Returns are net of management fees and expenses. Charlotte Lane Capital 1 February 2016 Letter [email protected] Downloaded from www.hvst.com by IP address 192.168.160.10 on 09/26/2021 Cumulative Return for Period January 4, 2016 – February 29, 2016 Source: IB, Charlotte Lane Capital (CLC) 15.00% Charlotte Lane SPX 10.00% 5.00% 0.00% (5.00%) (10.00%) (15.00%) Part 1: February Performance, Portfolio Management, and Risk Management February wasn’t a disaster, but the minute I come to you and blame underperformance on a “low- quality rally” or in any way avoid an honest discussion of why performance wasn’t up to our standards, I would advise you to terminate your account. Failures of one sort or another are inevitable in investing, and in all things, and February's drawdown offers an opportunity to discuss more fully my portfolio management and risk management processes. Part 2: On Failure, Shorting, Rebirth, and Value Investing As promised in the January letter, I elaborate on why Buffalo, N.Y., is a perfect place for a short seller (and long investor!) to have spent the first 25 years of his life. In a phrase, nothing succeeds like failure. There was much to learn about shorting growing up amidst the failure of American integrated steel mills, the Love Canal environmental disaster, two of the top U.S. savings & loan (S&L) implosions, failed public policy decisions, and four Super Bowl losses by the Buffalo Bills. There is also much to learn about value investing in such an environment. The seeds of success are often sowed in and nourished by the ashes of decay. Charlotte Lane Capital 2 February 2016 Letter [email protected] Downloaded from www.hvst.com by IP address 192.168.160.10 on 09/26/2021 Companies Mentioned Company Page Company Page Synchrony Financial (SYF) 6 Cloud Peak (CLD) 16 Goldman Sachs (GS) 6 Vivendi (VIV FP) 16 PRA Group (PRAA) 6 Generac (GNRC) 17 General Electric (GE) 6 Seadrill (SDRL) 19 Deutsche Bank (DB) 7 Chesapeake Energy (CHK) 19 M&T Bank (MTB) 8 UnitedContinental (UAL) 20 Key Bank (KEY) 8 Union Pacific (UNP) 20 Australian, Canadian banks 8 Delta (DAL) 20 Transocean (RIG) 7% of 2028 11 Norfolk Southern (NSC) 21 Schlumberger (SLB) 11 Canadian Pacific (CP) 21 EOG (EOG) 11 Amazon (AMZN) 21 Chevron (CVX) 12 Boston Beer (SAM) 22 PACCAR (PCAR) 15 Bethlehem Steel 25 Brown Forman (BF/B) 16 Nucor (NUE) 26 February Performance, Portfolio Management, and Risk Management February came in like a lion and went out like a lamb… on a spit. (I’m a month early with that metaphor, I know.) The second half of February was what is known as a “face ripper.” I have managed the Charlotte Lane strategy with a high gross, net short stance from the start of the incubation period in February 2014 and from inception as a standalone entity on January 4, 2016. This is the result of my read on bottom-up, company-by-company factors as well as top-down macro factors, which worsened in 2015 and have continued to worsen this year. Given further macro deterioration, I started 2016 building short exposures and holding down long investments. Within the first week, Charlotte Lane was 96% invested on the short side and less than 50% in longs. Gross and net exposures to-date are as follows: Charlotte Lane Capital 3 February 2016 Letter [email protected] Downloaded from www.hvst.com by IP address 192.168.160.10 on 09/26/2021 Charlotte Lane Gross Exposures Source: IB, CLC 100% 50% 0% (50%) (100%) (150%) Long Short 240% Gross Invested Assets 220% 200% 180% 160% 140% 120% 100% 80% Charlotte Lane Capital 4 February 2016 Letter [email protected] Downloaded from www.hvst.com by IP address 192.168.160.10 on 09/26/2021 Charlotte Lane Net Exposure Source: IB, CLC 0% (10%) (20%) (30%) (40%) (50%) (60%) On February 8, I concluded that bearish behavior in the market had reached a crescendo and cut short exposure that day by 22 points, to (101%). Had I done nothing else, that would have been the (more) correct move for the rally that followed. However, I replaced that exposure in short order, but I also built long exposure such that the quarter ended with a 91% long position and a 117% short position. Consequently, returns for the month suffered in part due to my stance on length of market, which averaged (38%) in February2. From the end of January through the end of February, the net stance of the portfolio declined by nearly 20 percentage points: 2 Daily average Charlotte Lane Capital 5 February 2016 Letter [email protected] Downloaded from www.hvst.com by IP address 192.168.160.10 on 09/26/2021 Charlotte Lane Exposures at Month-End Source: IB, CLC Gross Exposure Net Exposure 1/29/2016 2/29/2016 1/29/2016 2/29/2016 Consumer Discretionary 42.8% 53.5% Consumer Discretionary (15.9%) (13.9%) Consumer Staples 24.5% 25.6% Consumer Staples 3.3% 6.6% Energy 32.7% 25.3% Energy (8.5%) (5.0%) Financials 17.9% 34.3% Financials (6.2%) (3.3%) Health Care 8.5% 10.7% Health Care 8.5% 10.7% Industrials 55.0% 51.2% Industrials (21.4%) (15.2%) Information Technology 8.8% 6.0% Information Technology (2.4%) (6.0%) Materials 2.9% 0.0% Materials (2.9%) 0.0% Telecommunication Services 0.0% 0.0% Telecommunication Services 0.0% 0.0% Utilities 0.0% 0.0% Utilities 0.0% 0.0% Total 193.1% 206.5% Total (45.6%) (26.1%) Long Short Long Short 1/29/2016 1/29/2016 2/29/2016 2/29/2016 Consumer Discretionary 13.4% (29.3%) Consumer Discretionary 19.8% (33.7%) Consumer Staples 13.9% (10.6%) Consumer Staples 16.1% (9.5%) Energy 12.1% (20.6%) Energy 10.1% (15.1%) Financials 5.9% (12.1%) Financials 15.5% (18.8%) Health Care 8.5% 0.0% Health Care 10.7% 0.0% Industrials 16.8% (38.2%) Industrials 18.0% (33.2%) Information Technology 3.2% (5.6%) Information Technology 0.0% (6.0%) Materials 0.0% (2.9%) Materials 0.0% 0.0% Telecommunication Services 0.0% 0.0% Telecommunication Services 0.0% 0.0% Utilities 0.0% 0.0% Utilities 0.0% 0.0% Total 73.7% (119.3%) Total 90.2% (116.3%) In general, you will find my largest exposures in areas where I have the most experience3, and I will often stake out new or increased positions in sectors that have experienced a big move up or down. Take Financials, for instance. I have about 20 years of experience in the sector and nearly doubled overall exposure to it from the end of January through February after the S&P 500 Financials index turned in by far the worst YTD sector performance in the broad market. This allowed me to nearly triple the Fund's long exposure to Financials by month-end, adding new longs in Synchrony Financial (SYF) and Goldman Sachs (GS) and increasing our small position in debt collection firm PRA Group (PRAA). Synchrony Financial I have long been involved in specialty financials, and Synchrony is a gem of a company spun off from General Electric (GE) late in 2015, straight into a Financials sector maelstrom. Synchrony is the largest provider of private label (PL) credit cards in the U.S. PL cards are growing on a secular basis because they provide a high return on investment to retailers, which use them to attract and retain customers. They allow a retailer deep insight into customer behavior, which provides the opportunity to target customer spending far more precisely than broadcast, direct mail, and even interactive marketing 3 Dollar-weighted and in years of experience Charlotte Lane Capital 6 February 2016 Letter [email protected] Downloaded from www.hvst.com by IP address 192.168.160.10 on 09/26/2021 campaigns. For a sector under siege from online competitors, the value proposition for retailer customers is very clear. Synchrony trades at 10x estimated 2016 EPS and has a well-capitalized balance sheet with 13%+ tangible common equity to assets.