Agile investments

Our global perspective is that opportunities are always present, but only unearthed by the discerning eye. Markets tend to react violently to bad news, and exuberantly in response to good news. This is true of liquid markets and illiquid markets, and there are myriad ways that a value investor can capitalize on this peculiarity. Chiefly a symptom of irrational exuberance or panic, markets build putative wealth and momentum precipitously and just as quickly recede in a flurry of panic. So long as these cycles perpetuate, the only reasonable strategy is to investigate fundamentals and buy only when you have sufficient conviction that the asset is undervalued. John Templeton echoed this sentiment when he expounded- “To buy when others are despondently selling and to sell when others are euphorically buying takes the greatest courage, but provides the greatest profit."

Stemming from a value-oriented methodology, our views are necessarily contrarian in nature, but not without sufficient support. As opposed to abstracting from the macro to find opportunities, we are much more focused on individual companies or assets and their general earning power over prolonged periods of time. In our lending operations, this same methodology is applied and we seek to find situations where significant equity is committed behind us, while accruing unusually high yields. This possibility has been afforded to us by virtue of institutional unease in non-traditional lending deals. If there is a mispricing for an unwarranted reason, over time we will perform well if we acquired the asset at a discount to value, whether we are lending or buying equities. Ultimately we are not reinventing the wheel, nor are we trying to capitalize on big winners. By providing for a significant margin of safety, we are underwriting to be potentially wrong, and in turn are exposed to less risk of capital loss. In the long run, we will probably miss a lot of phenomenal opportunities due to our value oriented method, but we will also probably not lose as much as more speculative investors.

Value investing is easier said than done, and we find several reasons why we are more capable than most. Firstly, we aim to distance ourselves from “the herd” by removing ourselves from the culture of finance. It is difficult to remain contrarian when firmly entrenched in an atmosphere that mirrors the hysteria of the market. We spend very little time analyzing the macro economy, and instead focus our attention on areas that are either overlooked or out of favor. This is not to say we are pouring over balance sheets of penny stocks, but good companies or assets that are in an unusual state of disrepair. Reversion to the mean is a certain law that governs almost everything, and businesses are not exempt. I’d rather bet that Kobe Bryant will shoot 30 points after a couple of disappointing games as opposed to betting he will shoot 70 points after a string of above average performances. The same analogy can be made to investing in good companies that have performed unusually poorly.

By the same token, knowing what we don’t know has been a staple of our past success, and we remain acutely aware of our limitations and competitive advantages and disadvantages. In terms of investing in technology, we typically avoid glamorous companies whose earnings or future earnings don’t justify their current price. We don’t have enough conviction in picking winners out of countless losers. In general, there is an overabundance of capital spanning the vast majority of equities due in part to quantitative easing. In consequence, asset prices have been propped up to unprecedented heights. We are happy to patiently wait while investor enthusiasm continues to inflate prices to unreasonable levels. In the meantime, there are still an abundance of lending opportunities and mispriced assets, notwithstanding the inordinate amount of capital chasing deals.

As value investors, perhaps the most indispensable attribute is an ability to know what you don’t know. Rectifying our mistakes and re-evaluating past decisions is an exercise that we take very seriously. Business is cyclical, and we aim to adjust our strategy depending on what is appropriate in the current environment. More recently, we have concentrated our portfolio more heavily in debt positions, given the current frothiness of equities, especially in regards to San Francisco real estate. While yields have plummeted to unthinkable lows, we have been sourcing and investing in debt that offer considerable yield with a favorable risk-reward ratio. Presumably, if prices soften from these historic highs, we will have plenty of protection, while in the meantime accruing yields in the double digits. In general, it is this margin of safety that provides us comfort in the case of a downturn.

In terms of our appraisal of risk, we find risk most closely related with an inability to accurately assess value. Given our long-term horizon, intermittent volatility is much less concerning that overpaying for an asset. Oftentimes investors equate risk with volatility, and while volatility might delay returns when mispricings occur, ultimately value will prevail as the market sobers from either unwarranted pessimism or exuberance. If we take a long-term perspective, volatility is entirely superfluous. Our risk lies in assessing the intrinsic value of an asset, which is an inherently imprecise equation. The future is uncertain, and future cash flows can’t be predicted with certainty. An investor underpays for current value, while a speculator might very well overpay for some future contingent cash flow. To combat risk, we seek to find a substantial margin of safety so that even if our appraisal of value is incorrect, we have already accounted for potential downside possibilities. As Warren Buffett says rather flatly, “we define risk, using dictionary terms, ‘as the possibility of loss or injury’”. It is genuine downside protection - and not an attempt to predict investor behavior - that is the true risk averse variety of investing.

This is not an original concept, but one that often alluded to, and rarely acted upon. We believe that our deep value oriented philosophy gives us conviction in pulling the trigger when the world is in a state of panic, and our analysis indicates that prices are cheap relative to value. Our methods and strategies are contingent upon the particular deal and the general financial environment at the time, but our principles are well preserved through diligence and a long-term outlook.

Size and strategy. At this point in the real estate cycle we find it more prudent and lucrative to act as a lender as opposed to an equity investor. We have financed the entitlement process for land development in the form of bridge loans in San Francisco. We find this strategy suitable because of the substantial interest we are accruing, and a satisfactory level of comfort with the underlying asset. In the case of default, we would be comfortable owning the asset at a substantial discount to value. Considering the heated real estate environment in the bay area, it seems reasonable to lend on the asset, and maintain a substantial margin of safety.

Larger institutions, including REITS, aren’t in the business of land entitlement which often carries immeasurable risk. We have partnered with local developers who have had significant past success with land entitlement to mitigate these risks. Although land entitlement deals do not come without enhanced risk, we give ourselves room by requiring significant equity commitments and loan far below unentitled value. While we have been biased towards lending for the past year or so, we have also committed substantial equity in entitlement deals where the general zoning is in place, but capital is required for entitlement infrastructure. In regards to our lending activities, with a suitable loan to value ratio, there is some room for error while still producing above average returns. As a private moneylender, we are able to take advantage of these niche opportunities that are simply too small or too esoteric for institutional lenders. We aren’t the smartest guys in the room, but our advantage lies in our ability to execute deals that aren’t constrained by rigid institutional criteria. This strategy has been extremely lucrative for the past couple of years and has remains a suitable strategy at this point in the cycle.

Experience. Stuart has been investing family money for over 25 years and has over $500m of transactional experience behind him. When it comes to maneuvering and closing deals, he has been able to move with exceptional speed and adeptness. Through a variety of different investment vehicles, including- commercial aircraft equity and debt, hedge funds, private equity funds, venture capital funds, and real estate- Stuart has been able to achieve exceptional returns. In addition, his breadth of knowledge and experience with different asset classes has provided him with invaluable insight and flexibility as an investor.

Speed and agility. As opposed to the bureaucratic, often self-imposed, limitations inherent in most funds and private groups, we have the unique ability to move quickly and take advantage of fleeting situations. While an institutional lender will require many months to close on a deal, we are capable of making decisions quickly, while still preserving our methodological approach. In particular, when a deal needs to close quickly, we can bypass many of the bureaucratic requirements and get paid a premium for expediency. In the case where a deal does not meet the typical structure required by a group, we will strategically take advantage of non-traditional situations where there is value to be created or captured.

Micro lending became popularized by the famed experiment that later was rewarded with the nobel prize in economics. Mohammad Yunus experimented with microcredit in rural Bangladesh where capital was extremely scarce and there was no precedent for lending to this demographic. However, Yunus’ thesis was that these people were indeed skilled, and simply needed the opportunity to apply these skills to a business.

His lending program became extraordinarily successful and has evolved into a worldwide industry known as micro lending. While these smaller loans have become very popular among financial institutions, small business loans that average a higher dollar amount than micro loans have largely been neglected in many emerging markets. Although the underwriting process for evaluating borrowers of this kind is much more difficult than underwriting a traditional business, there are creative ways that have proven to be quite successful. Yunus recognized that financing skilled people worked tremendously well, even in the absence of traditional data that banks require.

We are inclined to believe that a sizable percentage of the currently "unbanked" businesses are plenty capable of repaying borrowed capital. In the coming months, we will have a much richer set of data to work with in terms of our model for sourcing and funding these loans. Currently, we have experienced no defaults, and our portfolio has been paid according to schedule since its inception.