May 16, 2021
Investing in small/micro cap companies and special situations within a concentrated portfolio
Artko Capital 1Q 2021 Partner Letter
For the first calendar quarter of 2021, an average partnership interest in Artko Capital LP returned 30.9% net of fees. At the same time, investments in the most comparable market indexes—Russell 2000, Russell Microcap, and the S&P 500—were up 12.7%, 23.9%, and 6.2% respectively. Our detailed results and related footnotes are available in the table at the end of this letter. Our results this quarter came from Shyft Group, HireQuest, as well as modest contributions from US Ecology warrants and Northern Technologies.
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P a g e
Peter Rabover
Portfolio Manager
Artko Capital LP
May
15
, 2021
Dear Partner,
For the first
calendar quarter of 20
21
, a
n average
partnership inter
est in Artko Capital LP returned 3
0
.
9
%
net of fees. At the same time, investment
s
in the most comparable market indexes
—
Russell 2000, Russell
Microcap, and the S&P 500
—
were up
12
.
7
%,
23.9
%, and
6.2
% respectively
.
Our
detailed
results
and
related footnotes
are available in the table at the end
of this letter
.
Our results this quarter came from
Shyft Group, HireQuest, as well as modest contributions from US Ecology warrants and Northern
Technologies.
2Q20
3Q20
4Q20
1Q21
1 year
3 year
5 year
Inception
7/1/2015
Inception
Annualized
Artko LP Net
-11.4%
22.0%
17.2%
30.9%
65.7%
9.0%
14.4%
109.4%
13.7%
Russell 2000 Index
25.4%
4.9%
31.4%
12.7%
94.9%
14.8%
16.4%
91.5%
12.0%
Russell MicroCap Index
30.5%
3.7%
31.4%
23.9%
120.3%
16.6%
18.1%
94.3%
12.2%
S&P 500 Index
20.5%
8.9%
12.2%
6.2%
56.4%
16.8%
16.3%
116.0%
14.3%
On Willful Ignorance
In the late 90’s former Federal Reserve Chairman
Alan Greenspan coined a phrase
“irrational exuberance”
to describe the
go
-
go years
and the
investor
behavior
of the dot
-
com
market environment
. The phrase
went on to gain even more prominence as
Nobel
Prize laureate
Robert
J Shiller
published
the
eponymous
ly
titled book
at the peak of the market in March 2000
. In
a
similar
vein
the phrase “Too Big T
o Fail”
became
popular and synonymous with the
housing crash and financial institution crisis in the late 2000s. It seems
at every cycle
there is a
phrase that captures the
market sentiment at its most definitive moment.
Having
been an active market participant for over two decades and a
n active
reader
of financial history
,
your
portfolio manager would like to try his hand at
coining a phrase th
at
describes today’s market
environment
:
willful ignorance
, a
decision in bad faith to avoid becoming informed about something so as
to avoid having to make undesirable decisions that such information might prompt
.
The current market cycle continues to bene
fit from
an
exponential
increas
e
in
willful ignorance by
almost
every corner
and participant
in
the economy
:
from the regulatory apparatuses such as
Securities and
Exchange Commission (SEC)
to monetary and fiscal policy makers such as the Federal Rese
rve and
Executive and Legislative branches of the government, to
institutional allocators of capital
.
The gorging
gene theory
wh
ich states humans are predisposed to gorge on scarce high calorie foods due to our
foraging history
30,000 years ago is alive a
nd well today, except
instead of a fig tree we are gorging on
capital, hereto a scare resource. However,
with costs of
capital, or at least perception of, nearly free and
the
scarcity of capital
nearly non
-
existent,
everyone seems to be gorging
themselves
on assets without
any regard to the consequences
of so called inflationary obesity that is
now
prevalent in our society today.
And
certainly
i
t
’s hard to care about the future when the present
has the easiest fi
nancial conditions on
record:
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That inflation is here is not a question
,
as the 4.2% “surprise”
CPI
reading
showed
this
week
. Listening to
earnings calls of
some of the world’s biggest companies
in the 1
st
quarter of 2021
it is by far the number
one topic and concern among business executives today.
The question is how
policy makers can
continue
to advocate monetary and fiscal policies that
instead of
taming
inflation
and substantial asset bubbles
are
actua
lly pouring gasoline on them
by continuing with the substantial quantitative easing
of
policies and
massive fiscal spending bills.
There are numerous problems with this scenario
,
but
our main concern
essentially boil
s
down to uncertainty.
It has been mor
e than a few generations since our society, both
economic participants and
policy makers have seen real, high single
-
digit/low
double
-
digit
inflation
outside of the massive asset bubbles that continue to build up all around us
(
that
Jerome Powell at the
Fed has explicitly dismissed as outside of his
purview). The real problem with inflation is not the actual
loss in purchasing power (though that is cer
tainly also a BIG problem)
but the uncertainty it creates in
almost every aspect of decision making along the
economic chain, from
everyday
grocery purchases to
multi
-
year and
multibillion
-
dollar
investment decision
s.
It feels surreal
for our
leaders to clamor
and
encourage something that has
in the past brought down presidential administrations, nations
,
and
empires and has destroyed
economic security that is prized
,
above all
,
by most of humanity.
Uncertainty
breeds volatility
and that is in fact the real
risk that we see here. With most of the market regulatory
apparatuses asleep at the wheel over the last decade
,
we have built up significant hidden risks within our
system.
While for some
,
the even
ts so far in 2021, like
the Gamestop episode bringing down a number of
reputable funds or the Archegos family office implosion
while the markets are putting up all time highs
causing tens of billions in losses to major banks,
are seen
as one offs, we see t
hem as
signs of
cracks in an
increasingly unstable market structure
that simply
cannot
handle any increase in volatility or interest
rates
.
We are not prognosticators of markets, but our job as
a
steward of your capital
is to make sure we
keep
a clo
se on eye on them. With the economy
posting
fairly decent
fundamental
numbers in growth
and jobs
and
expected to be
back to above its
pre
-
Covid
economic shut down numbers this quarter
, as
well as aforementioned lax fiscal and monetary policies
,
we
see a
decent probability of
continu
ing
to see
substantial
gains in the markets
and our portfiolio with
our companies continuing to report fantastic
numbers and
sporting modest valuations
,
relative to the market
.
It is fair to sa
y that our portfolio
is
still
in the middle innings of recovering from the
drawdown in the
1
st
half of 2020
and our “reopening bets”
and other individual
name
theses
still have a long runway to continue to play out
.
However, with the
concerns we outlined a
bove we assign
almost an equal probability to seeing chaos in the markets in the
intermediate future
.
Our current strategy is to continue to
aggressively hedge our portfolio (currently via tech index
es
and
ETFs) in the most
cost
-
efficient
way possible and to continue to hold our current portfolio without making
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substantial
moves other than for risk management purposes.
We are in the process of continuing to build
up a Core Portfolio position in an insurance microcap and
we did sell our po
sition in Channel Advisor
(ECOM) both
for
an individual red flag reason and for
de
-
risking the portfolio from a frothy tech sector
after a nice 40% plus return.
However, past those moves, while we have an active watch list, we are
looking to stay put
with our current portfolio.
Core
Portfolio
Additions
•
We are patiently adding to a
microcap insurance company with a potential event driven special
situation in the near future. We look forward to updating you on the
name and thesis
once
we
have
built up a full position.
Core
Portfolio
Sales
•
Channel Advisor
(
ECOM
)
–
We
sold our position in Channel Advisor
in the low $20s dur
ing the quarter.
While we do consider ourselves long
-
term investors with an average holding period of
over
3.5 years
and tend to be tax conscious with respect to capital gains and losses
,
we just felt increasingly
uncomfortable with
the behavior of the tech sector. More importantly a slew of insider sales,
including from the
director whom
we have
followed into the
story
, have always been a red flag signal
for us which more often than not follows some bad news
/decline in the stock and we just were not
comfortable with the position
. We took our 40% gain and ran.
Other Portfolio Updates
•
HireQuest
(
HQI
)
–
Our biggest contributor to our
portfolio’s performance
this past quarter was a 90%
run up in
the small cap franchisor of staffing branches
.
Our original thesis that the reverse merger
with Command Center and the subsequent franchise sales of those branc
hes
would
add to
HireQuest
’
s own franchised brand network would result in a very high margin business
which w
ould
throw off significant cash flow.
The thesis was playing out as expected prior to the Covid
-
19 pandemic,
which certainly curtailed de
mand for
on
-
demand staffing, especially in the event space where HQI
had a large presence. However
, the company, led by their impressive CEO
,
Richard Hermans, and their
solid cash positive balance sheet, navigated the tumultuous waters of the past year
wi
th
$9mm
positive cash flow
and
,
in the 1
st
quarter
,
added two “tuck in acquisitions” in the South, that increased
its system
-
wide sales by 50%.
Between the acquisitions and its own base business
,
the compan
y is still
operating 50% below
its pre
-
pandemic levels while generating impressive cash flow ($4mm in 1Q ex
acquisitions)
. With the United States “open for business” we expect the rest of
year to go gangbusters,
especially with the increasing demand for la
bor
, and expect this $250mm market cap company to
potentially generate over $30mm in Free Cash Flow in the next twelve
months.
While we have
certainly enjoyed the 200%+ return
we have
had in the holding so far, we expect at least another 100
-
200% in
the intermediate future as the market recognizes the operating leverage and the
cash flow
generating potential for this impressive company.
Partnership Updates
We welcomed one new partner to the partnership this quarter, bringing our total to 4
6
at the e
nd of
March
. Despite the current economic challenges,
we
are excited about the continued growth in partners
and
recovery in
assets under management and
,
as always
,
are thankful for your business
.
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Next Fund Opening
Our next partnership openings will
be June 1
, 202
1. Please reach out for updated offering documents and
presentations at
info@artkocapital.com
or 415.531.2699.
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Appendix
A
: Performance Statistics Tabl
e
Artko LP
Gross
Artko LP Net
Russell 2000
Index
Russell
MicroCap
Index
S&P 500
Index
YTD
32.7%
30.9%
12.7%
23.9%
6.2%
1 Year
69.4%
65.8%
94.9%
120.3%
56.4%
3 Year
14.6%
10.8%
14.8%
16.6%
16.8%
5 Year
18.9%
14.4%
16.4%
18.1%
16.3%
Inception 7/1/2015
161.9%
109.4%
91.5%
94.3%
116.0%
Inception Annualized
18.2%
13.7%
12.0%
12.2%
14.3%
Monthly Average
1.7%
1.3%
1.1%
1.2%
1.2%
Monthly St Deviation
7.1%
6.7%
6.0%
6.6%
4.3%
Correlation w Net
-
1.00
0.74
0.71
0.71
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Legal Disclosure
The Partnership’s performance is based on operations during a period of general market growth and
extraordinary market volatility during part of the period, and is not
necessarily indicative of results the
Partnership may achieve in the future. In addition, the results are based on the periods as a whole, but
results for individual months or quarters within each period have been more favorable or less favorable
than the
average, as the case may be. The foregoing data have been prepared by the General Partner and
have not been compiled, reviewed or audited by an independent accountant and non
-
year end results
are subject to adjustment.
The results portrayed are for an inv
estor since inception in the Partnership and the results reflect the
reinvestment of dividends and other earnings and the deduction of costs, the management fees charged
to the Partnership and a pro forma reduction of the General Partner’s special profit a
llocation, if
applicable. The General Partner believes that the comparison of Partnership performance to any single
market index is inappropriate. The Partnership’s portfolio may contain options and other derivative
securities, fixed income investments, ma
y include short sales of securities and margin trading and is not
as diversified as the indices, shown. The Standard & Poor's 500 Index contains 500 industrial,
transportation, utility and financial companies and is generally representative of the large ca
pitalization
US stock market. The Russell 2000 Index is comprised of the smallest 2000 companies in the Russell 3000
Index and is generally representative of the small capitalization U.S. stock market. The Russell Microcap
Index is comprised of the smalles
t 1,000 securities in the Russell 2000 Index plus the next 1,000 securities
(traded on national exchanges). The Russell Microcap is generally representative of the microcap segment
of the U.S. stock market. All of the indices are unmanaged, market weighted
and reflect the reinvestment
of dividends. Due to the differences among the Partnership’s portfolio and the performance of the equity
market indices shown above, however, the General Partner cautions potential investors that no such
index is directly comp
arable to the investment strategy of the Partnership.
While the General Partner believes that to date the Partnership has been managed with an investment
philosophy and methodology similar to that described in the Partnership’s Offering Circular and to th
at
which will be used to manage the Partnership in the future, future investments will be made under
different economic conditions and in different securities. Further, the performance discussed herein does
not reflect the General Partner’s performance in
all different economic cycles. It should not be assumed
that investors will experience returns in the future, if any, comparable to those discussed above. The
information given above is historic and should not be taken as any indication of future performan
ce. It
should not be assumed that recommendations made in the future will be profitable, or will equal, the
performance of the securities discussed in this material. Upon request, the General Partner will provide
to you a list of all the recommendations ma
de by it within the past year.
This document is not intended as and does not constitute an offer to sell any securities to any person or
a solicitation of any person of any offer to purchase any securities. Such an offer or solicitation can only
be made b
y the confidential Offering Circular of the Partnership. This information omits most of the
information material to a decision whether to invest in the Partnership. No person should rely on any
information in this document, but should rely exclusively on t
he Offering Circular in considering whether
to invest in the Partnership.
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