By Rupert Hargreaves. Originally published at ValueWalk.
In the world of small value funds, Old Kings Capital stands out for its steady returns and lack of volatility. Managed by two Colombia Business School alumni Randall Heck & Brad Purcell, the hedge fund employs a long-short strategy with net market exposure generally between 30% and 70%. The managers attempt to achieve their investment objectives by emphasizing: 1) independent research, 2) fundamental due diligence focused on cash flow performance, and 3) valuation discipline.
Over the years, Old Kings returns have not been market-beating, but the fund has achieved near market returns after fees with less volatility. Since inception (July 1, 2002) old Kings has produced an annualized return of 7.4% after fees with a standard deviation of 10.3% compared to an annualized return of 8% for the S&P 500 with a standard deviation of 14.3%. The Russell 3000, which is a more accurate representation of the firms Old Kings generally buys, has returned 8.3% per annum with a standard deviation of 14.7%.
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On the other hand, the Old Kings Capital Long Only Fund, which is fully invested in the long positions of the Old Kings Long/Short fund detailed above, has achieved a total back tested return of 379.3% or 11.4% annualized for investors net of fees since July 2002.
Year-to-date the fund returned 8.8% net compared to a return of 12% for the S&P 500, 12.7% for the Russell 3000 and 6.1% for the HFRI Equity Hedge Index.
Old Kings Capital: Betting On Trump Reforms
It is fair to say that Old Kings was positioned against the market during the fourth quarter of 2016. The fund’s net long market exposure averaged less than 60% during the quarter, but the general small rally helped lift returns to 6.9% net, compared to 3.8% for the S&P 500.
Old Kings is generally well-positioned for a Trump presidency. In the firm’s fourth-quarter letter, a copy of which has been reviewed by ValueWalk, Randall Heck & Brad Purcell write:
“The majority of outperformance came from the market beginning to appreciate the intrinsic value of many of our long-term positions. While we endured a fair amount of pain with some of these positions over the last few years, our patience is now paying off. We also benefited from being well positioned relative to many of the investment themes servicing post-election. Beneficiaries of regulatory relief include Credit Acceptance, World Acceptance, Strayer Education, and to a lesser extent Sinclair Broadcast. Beneficiaries of potential infrastructure stimulus include United Rentals, Genesee & Wyoming, and to a lesser extent, CommScope.”
All in all, these key longs added 8.9% to gross performance for the quarter while shorts detracted 1.7%. The largest positive contribution for the quarter came from Strayer Education (+73%). Old Kings’ managers believe that while the for-profit education space still suffers from sluggish demand, Strayer has made all the right decisions by shutting extra capacity and reducing tuition prices. What’s more, the for-profit education sector is likely to see regulatory relief from the new administration. Even though Old Kings has been invested in Strayer since May 2013 (for a compound annual return of 21%) the fund still likes the firm’s outlook as it only trades at less than 14 times this coming year’s free cash flow.
Zebra Technologies was the second-largest contributor with a gain of 23%. Initially, Old Kings became interested in the company as investors fled fearing the worst from on overleveraged balance sheet. However, with six dollars per share in free cash flow, the business looked primed to reduce leveraged rapidly. Today the company is trading at just 12 times forward earnings and is well on its way to recovery.
As well as these legacy positions, Old Kings Capital added to its existing positions including CommScope, Paypal and Mobileye during the fourth quarter and added Etsy. Here, the fund’s analysis concludes that the stock has the potential to double in 2 to 3 years as the firm currently trade at less than eight times next year’s estimated EBITDA and has $2.50 net cash on the balance sheet.
On the short side, Old Kings reduced its short exposure in “economically sensitive stocks as investors not only dismiss 2016 poor earnings but increasingly look past mediocre 2017 results with the hope that 2018 will bring a positive infraction.” While paring back some shorts the fund also added shorts against “a REIT with assets concentrated in retail malls, an office property REIT heavily concentrated in New York City, a casual dining chain, and an auto parts manufacturer.
At the end of the quarter, Old Kings Capital ended with a net long exposure of 70%, consisting of 84% gross long and 14% short exposure. Net long exposure is up from 54% at the beginning of the fourth quarter, principally due to short covering of positions that no longer hold the same promise under a new economic policy.
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Disclosure: The author may own one or more shares mentioned within this article. For a full list of the author’s holdings click here.
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