"Adapt or Die" - Billy Beane, Moneyball
Clarendon Capital Management (NYSE:CCM) is outlining a shift in its investment strategy and focus. This change in focus will not change our perspective of value investors - but will broaden the opportunities we pursue, those included in the portfolio, and portfolio construction.
We expect the range of three types of investment opportunities to be within the corridors below.
Long investments: 0-100%. Ideal weighting: 60%
Short investments: = 0-25%. Ideal weighting: 10%
Activist investments or strategic changes: 0-50% Ideal weighting: 30%
CCM is not under an obligation to strictly adhere to these weightings while maintaining a long-term horizon.
The biggest changes are the addition of short-selling and greater emphasis on activist led and strategic change investments. We see four main areas of this last category: involvement or campaign by an activist investor (typically a hedge fund), a shift in business strategy, a change in capital allocation, or a transformational transaction such as a merger/acquisition or spin-out/off. Related to the greater focus on companies undergoing strategic changes, I also envision more attention on small and micro-capitalization companies. CCM had previously maintained a soft floor of $200 million at the time of investment. Lastly, short selling and activist/strategic change investments will typically have a shorter time horizon and therefore higher portfolio turnover.
Since CCM's launch in 2012, with a couple of exceptions, CCM's separately managed account strategy has been 100% long and had a handful of investments in companies that experienced a strategic change such as a spin-off/out or where activists pushed for change. Selectively, these investments included Apple (Carl Icahn), CF Industries (Dan Loeb), Freeport-McMoran, (Carl Icahn), Hyster-Yale (Spin-out), NCR (Blackstone Group), and PSX (Spin-out).
A similar portfolio management strategy is followed by other investors including Michael Price, though we believe CCM's target weightings are different and play to our strengths. While we acknowledge following activists, spin-offs, and similar tactics is short-term focused, we want to do so with a long-term perspective. Investing on the coattails of more influential investors is a way to participate in the improvement of company operations, focus, and governance - while allowing us to follow our values when we may not be able to exert significant influence given our small capital base. However, our small capital base will not prevent CCM from sharing its opinions with other investors and company leaders. Unlike some other activist investors engaging in hostile tactics, we would very much like be constructive. As Larry Fink penned to CEOs, we hope to see an emphasis on the long-term and investing in their own business growth. There has been some recent opinion and evidence that the returns of investing in spin-offs have diminished. However, I believe some of the evidence is over time periods that are too short and strategically timed ending recently to pull down results after going through a period that has been more challenging. To which, this "evidence" will force us to be more selective and can be complemented with the short selling capability to make investments where we disagree with the strategy and management decisions. Companies, broadly speaking, make a couple of errors in this area such as overpaying for acquisitions and buybacks when valuations are high. This concern over higher valuation and transaction timing then limits the upside potential of spin-offs.
CCM's edge comes from a few areas, those that are available and practiced by value investors including a long-term horizon, taking advantage of volatility, and paying greater attention to opportunities with low expectations and underfollowed companies. We see our principle advantage in understanding and assessing business models and strategies.
It may appear contradictory to be following activist investors and wanting to be constructive while also having short positions. However, on the short side, there will be two main focuses of short positions. First, companies we believe follow a poor business strategy, pursue changes that will destroy shareholder value, and irrational (high) valuations.
I am hoping that adding that the activist focus will accomplish a few things. First, I hope it will allow me to focus on an attractive set of opportunities. Second, I want it to help produce superior returns. Thirdly, it should allow me to exploit what I see as one of my primary advantages as an investor - understanding of superior business strategies.
Personally, I hope it will improve me as an investor making more well rounded. I also want personal gratification from supporting long-term constructive changes, offering a contribution to capitalism and society.
Best wishes in 2017.
Carlos Sava, CFA, CPA
Founder and Portfolio Manager
Disclosure: I am/we are long AAPL, CF, HY, NCR, PSX.