My Portfolio Plan Following A Horrible Year

Let me start off by saying that 2011 has been a horrible year. Under-performance is an understatement, but I am learning many lessons which is vital to each investment year that goes by. It would be easy to brush this year off as a bad year and look forward to a new start, but that’s what mutual funds do.

By the end of Q3, my portfolio was -30.5% compared to the benchmark of -8.3%.

Click images to enlarge

Since inception, my portfolio is up 122% on a cumulative basis, which also comes out to a compounded basis of 22%. I started off the year at a compound rate of 47.7% which has since declined dramatically, but to think that I could have sustained such high levels would have been a dream.

Here is another view of the graphical performance. The volatility in my portfolio is extremely high as I tend to focus on illiquid and small caps. I’ve also invested in bankrupt stocks which tends to shoot up or down by huge amounts in a single day.

-19% in 1 Month?!

At the beginning of the year, I made a bet that the economy would continue to struggle, and despite the fact that the US is a fiat currency system, I was willing to make a bet on gold. Had I invested in the physical metal, my portfolio would look vastly different. Instead, I went with junior gold miners. With gold hitting record levels I anticipated that the miners were extraordinarily undervalued. The ones I were looking for were the ones that had cash flowing production, assets to back up and support the business if things got difficult, and a low chance of dilution.

However, what was cheap got cheaper. Junior miners are synonymous with volatility and as gold and silver margin calls came into play, juniors were hit hard.

My investment in Yukon Nevada Gold (OTCPK:YNGFF), Treveria (TREVF.PK) and Orvana Minerals (OTCPK:ORVMF) were among those victims.

Then there is Dacha Strategic Metals (OTCPK:DCHAF). At the moment, I’m extremely heavy in Dacha as I find it to be a no brainer investment. More on that later but the 3rq quarter in any year is the quietest for Rare Element Resources (REE). Prices of light REE also came down, and although DCHAF has no exposure to light REE, it came crashing down at 3-4x the speed of the market.

Add The Howard Hughes (HHC) to the mix and you’ll see that having a very concentrated portfolio leads to extreme volatility. Definitely not for everyone.

I have 50% of my portfolio in my top 3 positions. None of the losses has been realized and I’m content to wait it out.

A Word on Performance

Here is what Buffett has said about judging performance

While I much prefer a five year test, I feel three years is an absolute minimum for judging performance. It is a certainty that we will have years when the partnership performance is poorer, perhaps substantially so, than the Dow. If any three year or longer period produces poor results, we all should start looking around for other places to have our money. An exception to the latter statement would be three years covering a speculative explosion in a bull market.

a. Our investment will be chosen on the basis of value, not popularity.

b. That we will attempt to bring risk of permanent capital loss (not short term quotational loss) to an absolute minimum by obtaining a wide margin of safety in each commitment and a diversity of commitments; and

c. my wife and I will have virtually our entire network invested in the partnership

I believe that I’ve met each of the above objectives and although this year is a bad one, over my 4 year period, results are satisfactory.

Trust me when I say that watching your portfolio drown 30% is not fun, nor is it easy. It makes you want to do something about it, luckily I knew that I was getting upset and resorted to reading a book on behavioral finance to remind myself of what not to do. Definitely helped.

Biggest Position Update - #1 Dacha Strategic Metals

Investment thesis is still intact. A company selling for less than cash and inventory of rare earth metals. Strategically purchases select rare earth metals with positive trends and high demand. If you read up on rare earth metals, you will come to understand that a lot of the metals are traded illegally. The low supply and high demand has created the situation where Chinese miners will illegally mine over their quota and export it discreetly. Now that the Chinese government is cracking down on such activity and enforcing an adherence to the quota, this will only increase the demand. Dacha is set to take full advantage of this with its inventory held in South Korea and capable of liquidating inventory very easily.

In fact, with such a large discrepancy between the stock price and NAV of $1.40 on a fully diluted basis, management is buying on the open market, shares are being repurchased and management has stated that it plans to liquidate some of their inventory which help should the stock price to catch up to the business.

Biggest Position Update - #2 Howard Hughes

Now at levels from when it was spun off from General Growth Properties (GGP). Investment thesis is still straightforwad. The value of the properties on its books are undervalued to the market price. It has taken markdowns and insiders own a large percentage. Bill Ackman is eating his own cooking along with other insiders.

GGP too has taken a big hit in the recent market decline but I feel the quality of HHC properties is what the market will eventually catch onto.

Biggest Position Update - #3 Retail Holdings (OTCPK:RHDGF)

Based on the $2.50 special dividend at $17.75, I received a hefty 14% dividend. Company operations are fantastic. They continue to make money and management has a large stake and acts for shareholders. I’m expecting another special dividend next year and until the intrinsic value of approx $26 ~ $29 is realized, I’ll continue to hold and collect the juicy dividends.

Biggest Position Update - #4 Gravity Co (GRVY)

One thing I really dislike about ADRs is how you have to pay for their listing fee. Although it may only come out to 1c per share, when you hold several thousand shares, the fees add up.

Flagship game RO2 has been delayed to 2012 but the company is profitable, selling for less than net cash and a small unknown “no prospect” Korean company which the market does not appreciate.

Looking Forward

As you can see, 3 out of my top 4 holdings are listed on the pink sheets or ADR. Looking forward, my plan is to further reduce expenses, reduce turnover and let time work out the intrinsic value.

I firmly believe that a portfolio of stocks trading below expected value will outperform the market over time.

Disclosure: Long DCHAF, HHC, RHDGF, GRVY