Download Q1 2017 Quarterly Letter - Carmel Capital Partners

12250 El Camino Real, Suite 320
San Diego, CA 92130
Q1 2017 Quarterly Letter
Anthony Josephson and Russell Silberstein 4/18/17
We are pleased to report continued positive performance across our strategies during the first quarter of the
year. Before we dive into the details, we thought it would be worthwhile to review the competitive
advantages of our investment strategy. While we have addressed this topic in previous quarterly letters, it
seems particularly timely in-light-of the growing trend towards passive index investing. Lost in the love affair
with low-cost, diversified index strategies are the benefits of a more selective and nuanced investment
approach. After eight years of a bull market and increasingly high valuations, these benefits are more
important than ever.
Competitive Advantages
Nothing is more essential to a successful investment process than creating a sustainable competitive
advantage. We have summarized below the attributes that differentiate our strategy – not just from passive
index investing but from most other investors as well. This applies not only to equities but also fixed income,
real estate and private equity.
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Value Discipline: Our ability and willingness to maintain a value-oriented investment philosophy
provides us with a margin-of-safety that lowers the overall risk of any one investment. Internally, we
refer to this as “buying 50-cent dollars”. This is in stark contrast to passively investing in a large basket
of securities that inherently include many overvalued investments. Selectively investing in
undervalued securities creates a natural advantage that should produce superior results with lower
risk.
Size: By industry standards we are relatively small-in-size – and in this business, size matters! There
is ample evidence that large amounts of capital act as an anchor to performance. Conversely, our
smaller size allows us to invest in many situations where a larger asset base would preclude us from
investing. Case in point, the average market capitalization of our existing portfolio is approximately
$17 billion compared to $42 billion for the S&P 500. With a larger pond to fish in we can be highly
selective in the investments we make – this is a big advantage that applies to both public and private
investments (i.e. real estate and private equity).
Investing in Your Best Ideas: By definition, passive index investing results in the ownership of a broad
selection of investments which inherently include a sub-segment of lousy businesses and overvalued
securities. This is not a strategy for intelligent investing. Instead, we take advantage of a wellresearched, carefully selected portfolio of 20-25 investments where our capital is concentrated in our
best ideas. Over the long-term this portfolio should produce better results with lower risk.
Long-term Time Horizon: We are afforded a major advantage by utilizing a truly long-term time
horizon. Most of our investments are made with at least a five-year time frame in mind and some of
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them have been held for greater than 10 years. This allows us to capitalize on short-term dislocations
to purchase investments at very attractive valuations and sets us apart from most other investors.
Patient Capital: None of the above would be possible without a capital base that is patient and longterm oriented. Most investors, even those that wish to invest with a long-term viewpoint, often times
are forced to react to short-term noise. This is dictated by the wants and needs of their capital base.
We are incredibly lucky to have a client base that consists mostly of long-term relationships with highnet-worth families and individuals (average tenure of 9.5 years). Whether you realize it or not, your
confidence and long-term trust in us serves as an enormous competitive advantage.
Equity Update
Our equity portfolio returned 1.9% during the first quarter. Excluding cash, the performance of the underlying
investments increased 3.3%. Gains were dispersed broadly throughout the portfolio with particularly strong
results from our investments in Apollo Group (+28%) and Richemont (+20%). This was partially offset by
weakness in our energy investments and Wesco Aircraft (-24%).
We sold our position in New Senior Investments Group (SNR) during the quarter as the stock reached our
appraisal of fair value. This position was held for just over one year – an unusually short time frame for us –
but the result were very favorable with a total return of 33%.
At the end of the quarter we added an investment in Seritage Growth Properties (SRG) to the portfolio.
Seritage was spun out of Sears Holdings in July 2015 as a publicly traded REIT with ownership of 266 Sears
properties. The company has a large opportunity to “unlock” value because its master lease with Sears allows
it to recapture up to 50% of existing square footage for re-tenanting and redevelopment. Based on results
to date, Seritage is able to achieve a 4-5x increase in annual rent for third party tenants compared to legacy
Sears leases. Assuming this ratio holds, the company will be able to more than double Net Operating Income
(NOI) over the next five years which will result in very attractive shareholder returns.
Fixed Income Update
Our taxable fixed income investments, which consists almost entirely of corporate bonds, returned 2.5%
during the quarter. Declining interest rates certainly helped results but we also benefited from strong gains
in positions like Calpine and Titan. We added two new bond positions in Hertz and Windstream, both of which
yield more than 7% and mature in less than five years. At quarter end the current portfolio of 18 positions
has an average Yield-to-Maturity (YTM) of 5.6% with an average duration of three years.
The returns for our tax-free municipal bond investments also performed well during the quarter with a gain
of 1.1%. The current portfolio has an average yield (YTM) of 4.4% with an average duration of approximately
eight years.
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We continue to be mindful of a potentially rising rate environment and as a result average durations remain
relatively short. As you can see by the yields mentioned above, this stance hasn’t necessarily prevented us
from finding attractive fixed income investments. By utilizing some of the advantages mentioned earlier we
are able to deploy capital in a nimble and opportunistic manner to uncover some of the few remaining
bargains left in the fixed income universe.
Real Estate Update
We are pleased to report the closing of our first private real estate transaction which took place in January.
In coordination with our partner, F&F Investments, we purchased a 15-unit apartment complex located in
Rolando Village (near SDSU) for approximately $4 million. We believe the property is in a highly desirable
location and was purchased at a discount to current market rates. The business plan calls for an additional
$500,000 in capital improvements for both interior and exterior renovations. Once completed, rental rates
should increase materially and we are modeling for a total net return to investors of approximately 12.5%.
We currently have additional transactions in the pipeline with other partners at various stages of due
diligence. We are a hopeful that at least a couple of these will close by year-end.
Private Equity Update
We continue to actively pursue private equity transactions, although, admittedly the pace has been slower
than we anticipated. This is partly due to the inherent sporadic nature of investing in small private companies,
but it is also a function of current valuations. As we mentioned in prior quarterly letters, we have been outbid
on several transactions even though we believed our offers were fairly priced. You can be confident that we
will maintain the same rigor and valuation discipline in evaluating private equity transaction that we have
historically utilized in our other strategies.
As always, we thank you for your continued support and trust and welcome any questions or comments.
Anthony Josephson
Principal
Russell Silberstein
Principal
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