TIMING IS OVERRATED
“Only liars manage to always be out during bad times and in during good times.”
Bernard Baruch
I have a gift for launching new strategies at either the exactly right or the exactly wrong time (depending upon who you ask). I began my first strategy on Covid’s doorstep in February of 2020. In less than a month, the Russell 2000 would fall more than 40%. Five years later, I launched Epigram Capital Partners Fund I. The Russell quickly entered a bear market, declining 23% from late February to early April. The index began in 1984, and both periods are among the more rapid declines in its history. Fortunately, I was in business school in 2009, otherwise I could have had the perfect trifecta.
The rub about falling prices is that they decrease investor appetite while simultaneously increasing mine. Most managers tend to gather assets when the outlook is rosy and shed them when it’s not. Raising capital in a bear market is notoriously difficult, even though prospective returns are often better.
To date, I’ve been circumspect about deploying capital, ending April 54% invested which deserves comment. Most managers don’t have the luxury of holding cash. If an investor has decided they want equity-like returns, it’s industry practice to give it to them, regardless of price. These funds are primarily judged relative to a benchmark and are forgiven for declining in a down market.
As an alternative fund, Epigram Capital has different objectives. Its goal is to provide absolute returns (don’t lose money), relative returns (beat the benchmark) and risk-adjusted returns (a smoother ride). While some managers try to achieve this using leverage, derivatives or shorting, Epigram Capital does not. This means cash and security selection are the only levers at its disposal.
Historically, I’ve accomplished all three. Since 2020, the Russell 2000 has declined in 28 months. The fund and its predecessor outperformed in 27 of them. Drawdowns have been roughly half of the benchmark and volatility only two-thirds. In other words, cash can be a useful tool. It’s unlikely to remain 46% in perpetuity, but when starting a fund, or any investment for that matter, it’s often wise to buy over time.
Those of you familiar with the strategy know that I relish volatility. As March and April had plenty, you might be surprised I’m not fully invested. After falling 23% in seven weeks, the Russell 2000 has since stabilized, recovering 15%. The S&P 500 was recently up nine days in a row, its longest winning streak since 2004.
This makes little sense to me. I have no desire to inflict my political views on you, only my economic ones. Addressing persistent trade deficits is a worthy task. As capital providers, we should want US products and services to be as competitive on the global stage as possible. The S&P 500 generates 41% of its revenue outside the US which has made our country wealthier than it would have otherwise been.
So while I commend the objective, I suspect current policy is too disruptive and likely to result in slower growth, higher inflation and unforeseen retaliation. Trade policy has historically been a dial, not an off switch. While Q1 earnings were fairly robust, most executives have scant visibility into future demand, costs or their supply chain. Uncertainty is high and earnings growth less likely.
What’s more, we’ve seen a rapid deceleration in demand-sensitive sectors of the economy like travel, trucking and staffing. Even if all tariffs were shelved, the impact on confidence has been significant, increasing the odds of a recession meaningfully. When I believe prices reflect this, I will be more aggressive, but I’m in no rush.
Some of you have asked why give capital to a manger who’s hiding in cash? My answer would be that things can change rapidly, and hopefully you trust me to deploy your capital wisely, even if my timeline differs slightly from yours.
Given the volatility in the market, many of you have asked how I’m positioned or if I’m finding compelling ideas. I’ve bought 30 securities year-to-date, sold 10 to harvest tax losses, 13 have positive returns, and 19 are ahead of the benchmark. Their average return has been -5.7%. Many have cash-rich balance sheets, healthy dividend yields and have been active repurchasers of their own shares. I’ve avoided economically sensitive sectors like consumer discretionary (I own two, they provide oil changes and funeral services). I own five insurance companies on the premise that insurance is one of the sole beneficiaries of rising costs (if cars and construction become more expensive, insurers raise their premiums). I continue to look for special situations, including four real estate plays that have substantial hidden assets.
You should expect me to continue to be measured regarding deployment and prioritize capital preservation and capital returns. I believe there will be substantial opportunity in the near future and thank you for your interest in Epigram Capital.
Sincerely,
Dan Walker
General Manager