“The years say what the days cannot tell.”—Ancient Chinese proverb
Dear Partners,
The table below summarizes Rowan Street Capital performance since inception in March 2015:
Note: Rowan Street returns were achieved with only 35-40% of portfolio being invested on average; the rest was held in cash.
Our operation has produced a gain of 7% gross of fund expenses and 6% net since we started vs. a 6.6% gain for the S&P 500 and a 5.1% loss for the MSCI All Country World Index x-USA. Since we had a couple of new investors join our fund as of late, we would like to re-iterate what the fund expenses are. Here is what we explained in one of our 2015 letter:
“Let me explain what the fund expenses are. These include our start-up costs, amortized over 5 years for accounting purposes, a fund administration fee, as well as tax and financial statement preparation fees. We should emphasize that our start-up costs and our operational costs are incredibly low by industry standards. By our estimates they are probably at most a third of the general operating costs of a comparable fund. We were able to achieve these low costs thanks to Joe Mass and his other company, Synergy Financial Management (SFM), which is a Registered Investment Advisor (RIA) based in Seattle, WA that is overseeing Rowan Street Capital, LLC for compliance purposes and provides us with various financial subscriptions necessary for our research. Although there are many synergies between our fund and Synergy Financial Management, there are fund expenses that we must still pay for and even though they are relatively small, they do have an effect on our fund performance (net), since our fund is very new and still relatively small in size. As our fund grows, these expenses will be very immaterial and will not have much effect on our investment performance.”
To the point above, we have made significant progress doubling our assets under management (AUM) since the beginning of this year. Our goal is to at least double our AUM again by the time our fund hits a two-year mark (March of 2017) from where we stand today, and we have a number of prospective partners in the process of signing up with Rowan Street.
It’s also important to note that we have produced a 7% gain despite being only 35-40% invested on average. Our decision early on was to maintain a significant cash position and patiently wait for attractive opportunities where we can expect to at least double our capital within 5 years, staying prudent with your money and true to our investment principles. Resisting a temptation to buy stocks in a generally expensive market is no easy task for most managers chasing short term performance numbers in an attempt to impress their investors, keep their jobs and earn their annual bonuses.
At Rowan Street, our focus is on the long term investment horizon of at least 3-5 years. We will only add to our fund investments if we find opportunities that can be expected to produce double digit annual returns over the next 5 years. We will stick to this principle for two reasons (1) we don’t like losing money (2) we think of cash differently than conventional investors. To us, cash is not just an asset class that earns next to nothing. We think of cash as a call option with no expiration date, an option on every asset class, with no strike price. We believe if we look at cash as an option – in essence, the price of being able to scoop up a bargain when it becomes available – than it is less tempting to be bothered by the fact that in the short term, it earns next to nothing. This option has even a higher value to us after an 8 year-old bull market, which has been a very unusual period of government-manipulated securities markets producing valuations that are generally high and balance sheets that are stretched for a lot of companies. The key question becomes: How much can the cash earn if we have it when we need to buy other assets that suddenly become cheap, versus the upfront cost of holding it?
Activity during the quarter
We sold Dick’s Sporting Goods (DKS) : We first established a position in DKS at the end of 2015 after investors have taken the stock down by almost half from the highs due to short term growth concerns and weak sales in the company’s golf division. We have followed this company for the past 10 years and were very familiar with its fundamentals. We were attracted to the company because of its leading position as a sporting goods retailer with attractive store economics, buying power, plenty of room for geographic expansion, and a proven owner-operator at the helm. Moreover, the valuations have become attractive enough to meet our double digit expected annual return requirement. Over the next six months following our purchase the stock had gained 36%, helped by better earnings and the bankruptcy of one of their biggest competitors, Sport Chalet. We decided to lock in our gains as we did not expect the stock to advance so much so fast, and thought that the valuations were no longer favorable given some longer term secular concerns.
We sold Cimpress (CMPR): We first established a position in the company after the stock had taken a 20% hit in one day at the end of July of 2015. The drop was following the earnings announcement that worried short term oriented investors and the analyst community by saying it will no longer provide forward looking guidance and will stop reporting many of the operational metrics they have previously reported because, given the changes they have made, they were no longer relevant to how top management and the supervisory board views and measures their business. Though the fickle market is notoriously averse to change, after a bunch of in-depth research we were convinced that this newer, more-vague guidance is NOT a result of underlying problems with the business. In fact, the company’s appeal became apparent to us - a strong track record, compelling economics, intelligent management with significant ownership, and our favorite, a dominant market position with powerful competitive advantages; plus a very attractive purchase price. After about nine months following after our purchase the stock had gained 39% and hit its all-time high. We decided to lock in our gains as the company became fairly valued and no longer reflected the pessimism of 2015.
We also started buying shares in a small cap company that is a leader in thermal management technologies. The company supplies major automobile manufacturers with personal comfort modules for heating and cooling seats and steering wheels. They do not currently have any major competitors in this space as they bought out their main competitor in 2013. Part of their strategy is to look for other industries in which its thermoelectric technology can have additional benefits to help drive topline growth. They had recently entered into a deal with the Mattress Firm, the largest mattress store in the U.S., to launch its new Climate Controlled Sleep Systems (CCSS) utilizing their technology. Management believes that thermoelectric capabilities have applications in other global markets and industries including aviation, defense, medicine and furniture. Recently, they had signed the first contract for its new battery thermal management system (BTM), a thermoelectric cooling system for batteries used in hybrid and electrified vehicles, which can be a new area of growth for them. We view their current valuation as attractive and estimate that we are likely to make above 15% annualized return over the next 10 years and are likely to double our capital over the next 5 years in this stock.
Thank you to our partners for entrusting us with the investment of your hard-earned dollars. We are grateful and humbled by the confidence you have expressed in us and endeavor to continue doing the best we can to reward your decision.
Sincerely,
Alex and Joe