Dear Investors,
Through the end of August, Tarpon in its sixth year was up 9.4% net of fees, though it did begin to lag its S&P 500 benchmark this summer. We're sitting on a little cash in Tarpon that I have been slowly putting to work in spots, but that alone doesn't explain our standing still while the broader market has inched ahead.
Contrary to headlines about the market continuing to reach new highs all summer, you may find it surprising that nearly half of the stocks on the NASDAQ are actually down by 20% or more in 2014.
You might chalk that disparity up to any number of things, from naughty algorithms to a more hawkish Fed to, more recently, "the strong-dollar trade", but from my perspective, it doesn't particularly matter. That all goes into the "things we cannot control" pile. I try to keep things simple by staying focused on things we can control, like material risks, monitoring the performance of our companies and the constant search for new ideas. So despite the headlines, it's actually been a busy summer in terms of finding new companies to look into - and for a number of other exciting things going on at IIM, too, that I hope to be able to share more about soon. You may notice I'm sending out this third quarter report a few weeks early, and that's to clear the decks for some more announcements later this year. Please stay tuned.
There are still good values in the market, though quality companies are unequivocally harder to find - at least in large cap names. Small cap stocks in particular have had a rougher go of things of late compared to larger companies, and that has crimped our recent results a bit. And yes, I find that a bit annoying in the short-term, too, but that's also the price we pay in trying to outperform over the long-term.
The biggest macro risks that I continue to keep an eye on - other than ranting about high frequency trading, I mean - are with regards to interest rates and the economic slowdown in China. To be clear, the latter is of far less concern to me than the former, and though it is probably worthy of a much longer discussion at a later time, until then, just know that very few scenarios involving the Chinese economy would entail me actually making any changes in Tarpon. It's more likely that a bad scenario over there would unearth some good opportunities for us over here.
Alas, along the same lines - no, Alibaba shares trading at 18 times revenue will never show up in Tarpon. And technically, those aren't even "shares" of Alibaba that are now trading. They are actually legal contracts for what is called a Variable Interest Entity registered in the Cayman Islands that purports to provide investors here with a stake in the company's profits - if approved by the Alibaba CEO and board. So the next time someone asks you if your investment guy got you in on the Alibaba IPO, please tell them, "No, my guy is a cranky old fiduciary." But I digress.
The economy continued to slowly improve this summer, in fits and starts and still at a less-than-satisfying pace. While unemployment remains an issue in the eyes of the Fed, core rate inflation is nowhere to be found. Nonetheless, an eventual rise in interest rates should be of modest concern to all of us - though not because of the consequences of that rise on the stock market, which will likely be irritating but brief, but because the Fed is in uncharted territory here in general. A small mistake in interpreting data could in theory quickly escalate into a big mistake in macroeconomic policy. And there are plenty of ways to make small mistakes when interpreting so much data.
Nonetheless, the bond market seems to suggest that we have plenty of time, and that we, too, should let the data determine what if anything we should do about rates that will eventually rise. As per reports this past week, most economists on the Fed's Open Market Committee now see interest rates rising to 1% before the end of 2015, and then hitting 2.5% by the end of 2016. Those absolute percentages aren't nearly as informative as what they imply about monetary policy, however, which is that the Fed is well ahead of the markets in those predictions. In other words, the bond market thinks rates are going to stay low for much longer than the Fed does. And I would submit that we want the Fed to be a little more forward-leaning on rates then everyone else - to be absolutely sure we avoid the scourge of high inflation in particular.
So when it comes to macro portfolio risks, all of that is a long-winded way of saying, "Lot of watching. Not much doing. This is okay, for now." And as this summer winds down, I once again have Macro Pundit Talking Head Fatigue. Let's get back to some good old fundamental analysis, eh?
Below I am including the first page of a longer write-up on one of our newest holdings, SeaChange International. I thought it might better illustrate the kinds of good opportunities that are out there right now - if you're willing to do the digging. This particular investment thesis gets a bit techie, but I think you'll recognize some common themes for us. SeaChange is a significantly undervalued company with obscured earnings power and a modest competitive advantage going through a smart, deliberate transformation of its business.
To download the complete PDF, please click here. And if you would like a copy of my valuation model, just shoot me an email.
Please let me know if you have any questions. And thank you for investing with IIM.
- Cale
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Cale's Notes: 
