FRMO - FRMO Corp.

[Fowci]

I very much enjoy reading their letters and conference call transcripts.  The one problem I have is that when I look into the mutual fund performances across all of the Horizon Kinetics funds, they don't show meaningful outperformance against the respective indices.  Many show underperformance.  I don't necessarily think it detracts from the wisdom he shares, just shows you how hard it is to outperform against the "good old S&P", and make you ponder what are the right strategies to follow if one's goal is to generate outsized returns.

 

Not sure what you're talking about. I look at their GIPS compliant performance presentations on their website. I pulled together all of them. Here's what I found:

 

 

I just went to their mutual fund website:

http://kineticsfunds.com/funds/paradigm-fund/

10 yr 8.05%, S&P 8.01%

 

http://kineticsfunds.com/funds/small-cap-opportunities-fund/

10 yr 8.76%, Russell 2k 8.82%

 

..., ...

 

Interesting to see the discrepancy, which I guess is mostly the difference in start date.

 

For what it's worth, I used to work at a place where quite a few people signed on to Horizon to run their separate account before the crisis, largely on a stellar performance.  A bunch of them were distributed in kind during the crisis, and some still have positions like Cemex, Beijing Airport, the exchanges, etc, the favored names from before the crisis.  The conclusion I'm reaching is that from late 90's leading up to the crisis, they performed great.  Since the crisis, they more or less matched the index.  But the thesis in the late 90's is different from the thesis today.  Is there enough leg in the current thesis to carry performance going forward?

 

This is interesting. Thanks for following through with the mutual funds.

 

It does seem like performance has been par/subpar since the crisis. I think their thesis since the crisis is new (the rise and rise of indexing) and it would likely need more time to work through to performance. For one thing, I'd expect their strategy of avoiding the big index names will probably do well in a sharp downturn (that's speculative though).

[Hielko]

I thought the discussion of their shorting of structurally unsound ETFs was interesting. Basically they're saying that the proceeds from the short sales are like "float" which they can invest in money making ventures, while the float actually earns money because the ETFs are going to zero. (Incidentally, it made me think they've probably picked up the same types of issues that Chris DeMuth Jr. has picked up with VIX and XIV. Chris is long XIV to pick up strong roll yield, but FRMO might be short VIX to do the same).

I seriously doubt that value investors without a strong quantitative background in structured finance/derivatives know what they are really doing when they go short/long VIX/XIV. You are basically selling insurance that needs to be paid out at the worst possible time: when markets are in distress and you presumably would want to put cash into good idea's. Instead of that you will be looking at large losses, and possibly even a margin call. It's not really the kind of position you want to have without getting a good expected return.

 

Because these ETF's trade in various futures that are based on the VIX index which in turn is based on the implied volatility of various S&P index options you have a very complex product, and I think most investors don't know how to properly calculate at what price they are selling insurance and what kind of risk they are exactly taking. I bet most of those investors aren't selling put options on the S&P index, yet that is almost exactly what they are doing.

[HJ]

They are certainly not indexers, which is pretty cool.  But there are certainly index names that other managers favor for a variety of reasons that has convincing arguments too, and are not represented in their portfolio.  So for example it forces you to answer the question of whether Howard Hughes Corp will have higher return going forward than say, Wells Fargo.  It's such a difficult question to answer, and you have to repeat it for other names in the index as well for Howard Hughes to be a 10% position in the fund. 

 

Which is why I find the private equity approach to this out performance game more convincing.  You find something that you have a good feel will have low teens return, doesn't have to be higher than these other good companies, but high enough under most economic environment.  You lever that to something like 3:1 debt to equity at something like 6-7% cost of debt today.  You can care less whether some other company will get a higher return than this one, since most of your return is going to come because of leverage, and you feel like your return on investment is good enough in most economic environment.  It's not a game smaller investors can play, but small guys can replicate that through a variety of leverage strategy, calls / warrants / whatever instrument that can be found with reasonable cost. 

 

I agree that indexing could be stupid under certain circumstances.  But how do tell, before hand, how much alpha against an index there is in the approach you have decided on, for example, this owner operator approach?

 

[Jurgis]

I agree that indexing could be stupid under certain circumstances.  But how do tell, before hand, how much alpha against an index there is in the approach you have decided on, for example, this owner operator approach?

 

This is a tough question for any (value) investing approach. You can try to estimate expected return and compare it against expected index return. Both both of these estimates can be out of whack.

 

In general, if you buy owner operators sufficiently cheap and their business is good (enough), their compounding should outperform the index compounding. The issue is that good owner operators being really cheap might correspond to the index being really cheap...

 

At this point in time, I think index is somewhat expensive while some owner operators are still reasonably priced. Does this guarantee outperformance? We'll see.

 

One concern I have about Horizon Kinetics and FRMO is that theories don't pay bills. They may have great theories and writeups that I like. But if execution lacks, the good theories are not enough. There are tons of people in Wall Street with good theories, usually contradicting ones too. ;)

 

Disclosure: I own a position in FRMO. I am not adding or selling at this time.

[Fowci]

I thought the discussion of their shorting of structurally unsound ETFs was interesting. Basically they're saying that the proceeds from the short sales are like "float" which they can invest in money making ventures, while the float actually earns money because the ETFs are going to zero. (Incidentally, it made me think they've probably picked up the same types of issues that Chris DeMuth Jr. has picked up with VIX and XIV. Chris is long XIV to pick up strong roll yield, but FRMO might be short VIX to do the same).

I seriously doubt that value investors without a strong quantitative background in structured finance/derivatives know what they are really doing when they go short/long VIX/XIV. You are basically selling insurance that needs to be paid out at the worst possible time: when markets are in distress and you presumably would want to put cash into good idea's. Instead of that you will be looking at large losses, and possibly even a margin call. It's not really the kind of position you want to have without getting a good expected return.

 

Because these ETF's trade in various futures that are based on the VIX index which in turn is based on the implied volatility of various S&P index options you have a very complex product, and I think most investors don't know how to properly calculate at what price they are selling insurance and what kind of risk they are exactly taking. I bet most of those investors aren't selling put options on the S&P index, yet that is almost exactly what they are doing.

 

I think you raise valid points Hielko. I think value investors are generally overconfident (and underdiversify accordingly), and the particular trade I described could be a manifestation of that. To be clear though; we don't know that's what the FRMO guys are talking about.

[Liberty]

I doubt that what Stahl is doing is just shorting the VIX. He said that there are enough dysfunctional ETFs being created that he could just write about those every day and still not have enough time. My sense is that he's found stuff that is less obvious than the VIX, and he's probably diversified across a number of those dysfunctional ETFs that won't all move in the same direction at the same time, and possibly not at the time when you could use the case elsewhere, unlike the VIX. But that's just my guess...

[jay21]

They are certainly not indexers, which is pretty cool.  But there are certainly index names that other managers favor for a variety of reasons that has convincing arguments too, and are not represented in their portfolio.  So for example it forces you to answer the question of whether Howard Hughes Corp will have higher return going forward than say, Wells Fargo.  It's such a difficult question to answer, and you have to repeat it for other names in the index as well for Howard Hughes to be a 10% position in the fund. 

 

Which is why I find the private equity approach to this out performance game more convincing.  You find something that you have a good feel will have low teens return, doesn't have to be higher than these other good companies, but high enough under most economic environment.  You lever that to something like 3:1 debt to equity at something like 6-7% cost of debt today.  You can care less whether some other company will get a higher return than this one, since most of your return is going to come because of leverage, and you feel like your return on investment is good enough in most economic environment.  It's not a game smaller investors can play, but small guys can replicate that through a variety of leverage strategy, calls / warrants / whatever instrument that can be found with reasonable cost. 

 

I agree that indexing could be stupid under certain circumstances.  But how do tell, before hand, how much alpha against an index there is in the approach you have decided on, for example, this owner operator approach?

 

We both agree that in order to create a massive amount of wealth you need some form of leverage or scale.

 

One thing I think about is levering a 60/40 portfolio/ETF assuming you have very cheap margin available. The one thing that is always scary is that public equities can get cut in half or more and most leverage strategies for retail investors require you to be right on timing as well. Looking at a 60/40 portfolio you rarely have negative performance which should reduce the probability of a margin call.

 

Maybe I will think about this again when the yield curve is steeper.

[Haasje]

He shorts short ETFs and leveraged ETFs, not VIX I think.

[Liberty]

Nate has an interesting post on Winland:

 

http://www.oddballstocks.com/2015/06/winland-electronics-case-of-hidden.html

[Jurgis]

How to run up a nanocap stock in one easy step.  ;)

[oddballstocks]

How to run up a nanocap stock in one easy step.  ;)

 

Not my intention..looks like a market order went through.  I see someone sitting on the Bid with 5,000, 100 at the Ask.

 

Amazing what my post did that Stahl's letter didn't do.

[Jurgis]

How to run up a nanocap stock in one easy step.  ;)

 

Not my intention..looks like a market order went through.  I see someone sitting on the Bid with 5,000, 100 at the Ask.

 

Amazing what my post did that Stahl's letter didn't do.

 

Yes, I was just kidding. Though that's always the risk when posting about nanocaps. :)

 

The first buy of the day was 1 share lol.

[matjone]

If I knew how to do anything with computers I could probably set up some kind of automated trading system to just buy whatever he posts about and make a killing on small amounts of capital.

 

I do get some ideas from his blog but I like to do a little research before buying.  A lot of times after he posts it runs up from having a large MOS to just a mediocre one.  But if you wait many times it will dip back down again a few months later.

[Jurgis]

Nate has an interesting post on Winland:

 

http://www.oddballstocks.com/2015/06/winland-electronics-case-of-hidden.html

 

So here's why I hate investing in nanocaps: http://www.otcmarkets.com/otciq/ajax/showNewsReleaseDocumentById.pdf?id=15892

 

On Friday, July 10, 2015, Winland Electronics, Inc. (the “Company”) completed an investment of $200,000 in Northumberland IX LLC (“Northumberland”), an entity formed with another third party to invest a total of $1.2 million in EDG-PMA, LLC (“EDG-PMA”), itself an entity formed in cooperation with Exhibits Development Group, LLC (“EDG”) to develop, design, construct, market, place, own, and operate a traveling museum exhibition presently known as The Magical History Tour: A Beatles Memorabilia Exhibition.

 

So a nanocap heavily promoted by couple known value investors and capital allocators elects them onto BoD. You'd think that means the company will try to find ways to grow its business that apparently has great products but was lagging because of not enough salesforce activity (see FRMO comments about Winland). Nah, they find something more important to do: spend a bunch of money on a questionable "entity" that will operate a traveling circus exhibition. Cause clearly developing, manufacturing and selling critical condition monitoring solutions is a great fit with a traveling memorabilia. Perhaps they will sell their laughing gas monitors at the booth... And clearly $6M company has more than enough staff to do whatever side projects they want.

[Fowci]

Nate has an interesting post on Winland:

 

http://www.oddballstocks.com/2015/06/winland-electronics-case-of-hidden.html

 

So here's why I hate investing in nanocaps: http://www.otcmarkets.com/otciq/ajax/showNewsReleaseDocumentById.pdf?id=15892

 

On Friday, July 10, 2015, Winland Electronics, Inc. (the “Company”) completed an investment of $200,000 in Northumberland IX LLC (“Northumberland”), an entity formed with another third party to invest a total of $1.2 million in EDG-PMA, LLC (“EDG-PMA”), itself an entity formed in cooperation with Exhibits Development Group, LLC (“EDG”) to develop, design, construct, market, place, own, and operate a traveling museum exhibition presently known as The Magical History Tour: A Beatles Memorabilia Exhibition.

 

So a nanocap heavily promoted by couple known value investors and capital allocators elects them onto BoD. You'd think that means the company will try to find ways to grow its business that apparently has great products but was lagging because of not enough salesforce activity (see FRMO comments about Winland). Nah, they find something more important to do: spend a bunch of money on a questionable "entity" that will operate a traveling circus exhibition. Cause clearly developing, manufacturing and selling critical condition monitoring solutions is a great fit with a traveling memorabilia. Perhaps they will sell their laughing gas monitors at the booth... And clearly $6M company has more than enough staff to do whatever side projects they want.

 

I agree that this is an almost comically bizarre announcement.

[no_thanks]

wtf...

[Sportgamma]

Nate has an interesting post on Winland:

 

http://www.oddballstocks.com/2015/06/winland-electronics-case-of-hidden.html

 

So here's why I hate investing in nanocaps: http://www.otcmarkets.com/otciq/ajax/showNewsReleaseDocumentById.pdf?id=15892

 

On Friday, July 10, 2015, Winland Electronics, Inc. (the “Company”) completed an investment of $200,000 in Northumberland IX LLC (“Northumberland”), an entity formed with another third party to invest a total of $1.2 million in EDG-PMA, LLC (“EDG-PMA”), itself an entity formed in cooperation with Exhibits Development Group, LLC (“EDG”) to develop, design, construct, market, place, own, and operate a traveling museum exhibition presently known as The Magical History Tour: A Beatles Memorabilia Exhibition.

 

So a nanocap heavily promoted by couple known value investors and capital allocators elects them onto BoD. You'd think that means the company will try to find ways to grow its business that apparently has great products but was lagging because of not enough salesforce activity (see FRMO comments about Winland). Nah, they find something more important to do: spend a bunch of money on a questionable "entity" that will operate a traveling circus exhibition. Cause clearly developing, manufacturing and selling critical condition monitoring solutions is a great fit with a traveling memorabilia. Perhaps they will sell their laughing gas monitors at the booth... And clearly $6M company has more than enough staff to do whatever side projects they want.

 

You left out the most interesting bit:

 

"Northumberland’s investment in EDG-PMA is effectively structured as convertible preferred equity. The convertible preferred equity pays an irregular preferred dividend at a rate of 10 percent per annum on any outstanding principal balance and is

immediately convertible into 30 percent of EDG-PMA common equity upon repayment of Northumberland’s $1.2 million principal amount, the timing of such repayment being dependent on the distributable cash flow of EDG-PMA.

 

Until repayment of Northumberland’s $1.2 million principal amount, the convertible preferred equity is entitled to the entirety of EDG-PMA distributable cash flow. Prior to the repayment of principal, the Company’s interest in Northumberland is proportionate to its $200,000 investment. Following the repayment of principal, the Company’s interest in Northumberland shall be 83.33 percent."

 

A very interesting structure to say the least.

 

Anyway, I´m not sure why this should come as a surprise as the company has excess cash and I would presume that the main value in having Stahl on the board would be to influence capital allocation. Is this out of line with their commentary on Winland ("But Winland also has cash on the balance sheet that it doesn’t need at all for operating purposes" or "What does Winland represent for us? It represents optionality")?

 

After this transaction Winland will still have over $1m excess cash and I would not expect them to pay out dividends...

 

And how is this a heavily promoted stock? Because Stahl and Bregman answer questions about it in a FRMO conference call?

[Liberty]

Almost like taking the unecessary cash from a textile mill and buying unrelated businesses with it... Crazy, right?

 

Doesn't Winland have NOLs that make it advantageous to run other operating businesses from inside it rather than at the FRMO level?

[no_thanks]

Almost like taking the unecessary cash from a textile mill and buying unrelated businesses with it... Crazy, right?

 

Doesn't Winland have NOLs that make it advantageous to run other operating businesses from inside it rather than at the FRMO level?

 

Ok, I should have read a bit more before I jumped to a conclusion.  The completely unrelated business that doesn't sound great, or have steady profits with a high tax rate to untilize the NOLs just seemed really out there.  But how much optionality or scale can there be in a traveling exhibit...  I passed on Premier Exhibits the first time...

[WideMoat]

 

So here's why I hate investing in nanocaps:

 

So a nanocap heavily promoted by couple known value investors and capital allocators elects them onto BoD. You'd think that means the company will try to find ways to grow its business that apparently has great products but was lagging because of not enough salesforce activity (see FRMO comments about Winland). Nah, they find something more important to do: spend a bunch of money on a questionable "entity" that will operate a traveling circus exhibition. Cause clearly developing, manufacturing and selling critical condition monitoring solutions is a great fit with a traveling memorabilia. Perhaps they will sell their laughing gas monitors at the booth... And clearly $6M company has more than enough staff to do whatever side projects they want.

 

We can use sarcasm, hasty generalizations, and false dichotomies to depict humorously a set of assumptions that no actual owner of WELX would hold.  I guess there's no harm in a good laugh.

 

The crucial investing insight that I take away from Stahl is the importance of exposing an investment portfolio to multiple paths of optionality.  Particularly if those paths can be obtained for a modest cost.  That insight seems not dissimilar from Ben Graham's postscript in The Intelligent Investor (in reference to his Geico investment):

 

"...one lucky break, or one supremely shrewd decision--can we tell them apart?--may count for more than a lifetime of journeyman efforts."

[Liberty]

Almost like taking the unecessary cash from a textile mill and buying unrelated businesses with it... Crazy, right?

 

Doesn't Winland have NOLs that make it advantageous to run other operating businesses from inside it rather than at the FRMO level?

 

Ok, I should have read a bit more before I jumped to a conclusion.  The completely unrelated business that doesn't sound great, or have steady profits with a high tax rate to untilize the NOLs just seemed really out there.  But how much optionality or scale can there be in a traveling exhibit...  I passed on Premier Exhibits the first time...

 

I don't know, I'm not saying it'll be the next big thing for FRMO, but for the scale of Winland, I'm sure there's a reason and that it was an opportunistic thing that will give better return than having unnecessary cash in the bank earning nothing.

[Jurgis]

The amount of rationalizing of this as "but Buffett did it too" is hilarious.

 

Carry on.

[Liberty]

The amount of rationalizing of this as "but Buffett did it too" is hilarious.

 

Carry on.

 

I'm just saying that when you don't know any details about a situation, it's easy make snide comments about it.

[Jurgis]

The amount of rationalizing of this as "but Buffett did it too" is hilarious.

 

Carry on.

 

I'm just saying that when you don't know any details about a situation, it's easy make snide comments about it.

 

Can you clarify: do you object to my evaluation in general without looking at the company/press release or you have looked at WELX and the press release and you believe that this was a great thing to do?

[Sportgamma]

The amount of rationalizing of this as "but Buffett did it too" is hilarious.

 

Carry on.

 

You implied that:

- that Winland was a heavily promoted stock by Stahl & Bregman (I presume)

- that Winland was taking resources away from its operating business and putting into other ventures

- that a rationale for this investment is because of synergetic effects

- that servicing museums with exhibitional content is a lousy or inferior business.

 

All of what you opine is either wrong or misleading.

 

Also, the press release indicates that they will get the principal amount back in a relatively short amount of time. However, if things work out, they will also own 83.33% of Northumberland after repayment of the principal. To me this looks more like a bond with a very sweet equity kicker and a very asymmetric bet.