Letters
October 10, 2009
Dear Investor:
As the table below indicates the third quarter saw assets appreciated greatly. Investors should not annualize such returns because the quarter was somewhat unique. However, we feel strongly that our asset appreciation does signal Saddle Peak’s value added investment process. We are very excited about the future and see continued value added.
| Saddle Peak Asset Management Performance | 3rd Quarter (Net of Fees) | YTD (Net of Fees) | Since Inception (Annualized) |
|---|---|---|---|
| Saddle Peak Hedge | 26.1% | 86.3% | 10.1% |
| S & P 500 | 15.6% | 19.3% | (2.3)% |
Over the last twelve months much has occurred in the investment world, and we believe some analysis of Saddle Peak is helpful. Thus, we have investigated our performance from two different perspectives. First, we look at the trailing four quarter performance and second from an up versus down market phase perspective. Please note when we refer to an up market phase we are referring to a market that goes up and then down to the same point. Whereas a down market phase is a market that goes down and then up returning to the same starting point. This is different then up market and down market capture that some consultants focus on.
Trailing Four Quarter Performance
Saddle Peak’s trailing four quarter performance is very revealing. Trailing four quarter performance is the last 12 months or four quarters that has occurred. The trailing four quarter period ending September 30, 2009 is thus from October 1, 2008. Many observers will instantly know that this period has meaningful significance to investors because it has coincided with a difficult investment period for many investors. Over this period many became fearful in the short term and sold. Unfortunately, many continue to sit on the sidelines during a once in a decade investing opportunity. Likewise, the prior four quarters or twelve month period ending September 30, 2008 was when the market meaningfully depreciated from its high and value managers had a period to show their asset preservation focus by declining less than the market. Unfortunately, many value managers did not preserve capital losing substantial amounts in financial stocks (one of the largest value traps of all time).
Our performance is detailed below and reflects a classic value manager.
| Trailing 12 month Return | Saddle Peak | S&P 500 |
|---|---|---|
| 2009 (10/01/2008 - 9/30/2009) | 36.2% | -6.9% |
| 2008 (10/01/2007 - 9/30/2008) | -12.9% | -22.0% |
| 2007 (10/01/2006 - 9/30/2007) | 16.4% | 16.4% |
| 2006 (1/03/2006 - 9/30/2006) | 4.4% | 8.5% |
| Compounded return from inception | 44% | -8% |
In the first nine months we marginally underperformed in an up market. In the second year, we performed in line with a continued up market. In year three, the market depreciated significantly and we depreciated meaningfully less. In the last twelve months, we significantly appreciated despite a small decline in the markets. The total return from inception of 44% versus a decline of 8% for the S&P 500 represents substantial value added from inception. More importantly, the pattern of returns is that of a value oriented hedge fund.
Up Phase and Down Phase Analysis
Additionally, we can look at the performance from inception from an up market phase and a down market phase to help us determine where our value added is being produced. The S&P 500 is our representative index. We are approximating both the up and down phases. The down phase is not yet complete until it appreciates to its approximate starting point. If we used the Russell index the down phase would have already been completed. However, we feel strongly in comparing Saddle Peak to the most widely used index, the S&P 500.
| Total Return in Up and Down Phases | Saddle Peak | S&P 500 |
|---|---|---|
| Up Phase (1/03/2006 – 9/30/2008) | 5.8% | - 1.5% |
| Down Phase (10/01/2008 – 9/30/2009) | 36.2% | - 6.9% |
The conclusion is Saddle Peak produced value added in both phases of the market. The first phase where the market went up, peaked, and went back down to its starting level produced approximately 7.3% value added. The second phase which is still occurring when the market went down, bottomed, and then appreciated back to almost its starting point produced 43.1% value added. Each phase of the market is always unique as is the value added produced. However, common characteristics of a value oriented approach should be evident. A value manager should be defensive and strive to not lose money and then compound capital when asset are cheap. In Saddle Peak’s case the use of in-the-money long dated options should produce meaningful appreciation when assets are cheap. Thus, the importance of this analysis is the pattern of returns is that of a value oriented hedge fund.
The Market and Saddle Peak
The debate du jour is the shape of the economic recovery a W, a U, robust, lethargic or simply no recovery. We continue to believe that the economy will recover and that companies will make more money in the future. This view is now much more popular than nine months ago. However, we do not believe the recovery will be robust for all. Many sectors of the economy could take years to recover (i.e. getting back to 2007 levels). Likewise, it is important to keep in mind this is a worldwide economic recovery not just a U. S. one. For example, worldwide PC demand is much more important than U.S. demand for the semiconductor, PC, and software providers. Across the board, the matter is a worldwide issue not a U.S. one. Even in thought to be domestic industries like real estate, many similarities exist across the world.
For Saddle Peak, the third quarter saw much drama with increasing prices and performance but less drama in changes to the portfolio. Marginally, cash was raised over the course of the quarter as price reached or approached intrinsic value for some companies. During the period, our in-the-money option strategy worked as designed producing increased returns. Performance stars included American Express and Starbucks. However, solid performance was across the board. The only exception was Speedway Motorsports and Wal-Mart. In both cases, we increased our weightings by quarter end. For Wal-Mart, the increase was significant, and it now represents a major holding. Over the next two years, we firmly believe Wal-Mart will turn out to be a good if not great investment. Every quarter the company gets bigger and makes more money. Its international business, a quarter of the company, grows at double digit rates while the U.S. continues to grow. The company repurchases its own shares. Yet the stock is down for the year, and investors don’t like to watch its boring steady growth. Saddle Peak will take the opportunity. The in-the-money options purchased should provide excellent returns without exposing us to capital risk.
Please visit our website at www.saddlepeakam.com for updated information, presentations, etc.
Thank you for your confidence and time,
Douglas W. Grey
