Market Commentary

2nd Quarter Commentary

July 2016

2016 WhiteTree Investment Management, LLC

Market Commentary
July 2016

2nd Quarter 2016

People with no plan wait and see, people

with a plan see and wait for the right time.
- Josey Wales

Marlon James,
A Brief History of Seven Killings

2016 WhiteTree Investment Management, LLC

Market Commentary
July 2016

2nd Quarter 2016

To:

WhiteTree Investment Management Clients and Interested Parties

From: Peter Cook, CFA, CFP- Chief Investment Officer, and Founder
Date: July 12, 2016
Re: Second Quarter 2016

Performance Table
Q2 2016

H1 2016

Since
Inception

WhiteTree Micro-Cap Value

0.54%

2.27%

(2.89%)

Russell 2000 Index (IWM)

3.81%

2.26%

(2.17%)

Russell Micro-Cap Index

3.97%

(1.69%)

(6.76%)

Q2 2016

H1 2016

Since
Inception

WhiteTree All Seasons (Custom)

3.82%

9.23%

6.28%

Global X Permanent ETF (PERM)

4.59%

10.98%

5.50%

Strategy

Q2 2016

June, 2016

Since
Inception

WhiteTree All Seasons (Unleveraged)

3.74%

3.84%

3.74%

WhiteTree All Seasons ( 1.5x Leverage)

5.92%

5.71%

5.92%

WhiteTree All Seasons (2x Leverage)

7.28%

7.59%

7.28%

Q2 2016

June, 2016

Since
Inception

0.28%

(1.78%)

0.28%

Strategy

Strategy

Strategy
WhiteTree Absolute Return

The first table provides the returns for all accounts utilizing our Micro-Cap Value Strategy
and the applicable benchmark. These are reported before fees, and net of trading expenses.
Individual account returns for the quarter will vary based on the timing of funding, legacy
positions held, and any special investment restrictions. IWM and PERM benchmark returns are
reported net of fees. For the Micro-Cap Value strategy, since inception refers to January, 1 2014.
This performance disclosure section is continued on page 14 of this commentary. Please
see page 14 of this document for additional important disclosures related to performance
calculations.

2016 WhiteTree Investment Management, LLC

Market Commentary
2nd Quarter 2016

July 2016

Introduction
I am pleased to present WhiteTrees second quarter, 2016 investment commentary. In the interest
of making this letter easy to read (or skip through) it is split into the following sections:
1. Administrative Announcements
2. All Seasons Commentary
3. Hidden Risks - Whats in a 60/40 Portfolio?
3. Micro-Cap Value Commentary
5. Size Matters or Its Hard To Be Large
6. Other Items of Interest
7. Concluding Thoughts

Administrative Announcements
Clients and readers of previous commentaries will notice that the reporting table for WhiteTrees
strategies has expanded. This is the result of changes on two fronts.
The first change relates to the WhiteTree All Seasons strategy. Previously the All Seasons strategy
was reported by creating a composite of all accounts using the strategy, often with accounts
using different amounts of leverage. That situation made it extremely difficult for non-financial
professionals to discern the true return profile of the strategy. Therefore in the interest of
transparency and clarity, the All Seasons strategy will now be broken down by the degree of
leverage incurred.
In addition, the All Seasons will be further differentiated between accounts utilizing the micro-cap
value strategy and other custom features, and the long-only All Seasons strategies broken down
by the degree of leverage in use.
The second change is the addition of a strategy labeled WhiteTree Absolute Return. In the
simplest terms, the Absolute Return is a hedge-fund strategy. That means its objective is to earn
positive absolute returns throughout all market environments. And more distinctively it has the
ability to undertake the following actions to achieve those ends:
1. The strategy may assume highly concentrated positions in single name stocks, bonds or
currency pairs.
2. The strategy may employ short-selling. This includes short sales of individual securities,
currencies, and futures.
3. The strategy may employ a high degree of leverage in the form of margin, options, futures and
other derivative instruments.

2016 WhiteTree Investment Management, LLC

Market Commentary
July 2016

2nd Quarter 2016

With the addition of the Absolute Return, WhiteTree now offers strategies that cover the full
spectrum of Beta to Alpha. With advanced apologies to those unfamiliar with the meaning of the
academic terms Alpha and Beta, here is how the strategies breakdown:

Strategy

Description

WhiteTree All Seasons

WhiteTree Micro-Cap Value
WhiteTree Absolute Return

Intelligently Diversified Beta (Asset Allocation)

Idiosyncratic Beta (Micro-Caps) + Constrained Alpha
Unconstrained Alpha

All Seasons Commentary

For the three months ended June 30, 2016 the WhiteTree All Seasons (Custom) strategy delivered
a return of 3.82%. The benchmark, the Global X Permanent Portfolio ETF returned, 4.59%. Since
inception the All Seasons (Custom) strategy has returned 6.28% vs. 5.50% for the benchmark, an
out-performance of 0.78%.
Being a student of the markets teaches you to expect the unexpected. Nevertheless, if you had
told me that the U.S. stock market would rebound to erase all losses within one week of Great
Britains historic vote to brexit the EU, I would have been incredulous. Luckily I dont invest
WhiteTree clients money on the basis of my intuitions about what the market will do over the
next week, month or even year.
The All Seasons is case in point. As a strategy designed to maximize the benefits of economic
diversification, it has the potential to earn returns when traditional asset allocation strategies
suffer. And indeed, as world reeled from the result of the brexit decision and global stock markets
fell, clients invested in the All Seasons strategy saw their account values rise.
As such, events such as the brexit serve to demonstrate an additional feature of the All
Seasons strategy: a psychological benefit. It is a consolation to watch your account rise when
the world is in turmoil. Which is not to say that the All Seasons will always make money in all
adverse economic scenarios, it wont. Rather that the All Seasons is much more likely to perform
irrespective of the economic circumstances, in contrast with stock heavy traditional allocation
approaches which wilt in situations of slowing economic growth.

2016 WhiteTree Investment Management, LLC

Market Commentary
July 2016

2nd Quarter 2016

This property of the All Seasons was borne out during the turmoil over the brexit but it is equally
evident in the statistics of historical performance. It can be observed most clearly in the difference
between the worst years returns for a 60% stock / 40% Portfolio and a Risk Parity portfolio
similar to the All Seasons:

1972 - 2015
Portfolio Type

Worst Year

60% Stock / 40% Bond

Risk Parity Unleveraged

(20.20%)
(4.25%)

The table shows that the 60%/40% portfolio had a worst year performance of ~(20%), while the
Risk Parity portfolio was down only (4.25%) in its worst year.

Hidden Risks - Whats in a 60/40 Portfolio?

In my professional opinion, portfolio balance is perhaps the most important concept in investing.
This is unfortunate because it requires a nuanced and multidimensional understanding of
asset classes to parse whether a portfolio is in or out of balance. In short, balance is hard to
see. Because of this it is easier to approach the subject by first observing its counterpoint, an
unbalanced portfolio, and more specifically in this case, the classic 60/40 portfolio.
The 60% stock, 40% bond portfolio is a very popular asset allocation strategy. So popular in
fact that it has become know as the traditional choice for pension and endowment funds.
Many investment companies offer a version of it. For instance, the Fidelity Balanced fund which
manages approximately 28 billion or the Vanguard Balanced fund which coincidentally also
manages 28 billion of investor capital. Suffice to say, a significant number of institutions and
individuals have invested their wealth into a 60% stock / 40% bond investment allocation. Which
begs the question, why is this particular asset allocation so popular?
My conjecture is that the popularity of the 60/40 portfolio is the result of its ability to satisfy
investors desires in two respects. First, investors are aware consciously or semi-consciously that
American stocks have been the highest yielding asset class over the past century, and being 60%
invested in stocks gives them the assurance that they wont be missing out on that great bull
market. Second, the 40% allocation to bonds provides an aura of conservatism. The investor can
say to themselves, 60% of the assets are in stocks sure, because after-all they need some return
but 40% of the assets are in bonds because hey, they are not reckless, they are responsible
investors. Thus the portfolio deftly and simply satisfies the aesthetic appetites of both the greed
and fear that drive investor behavior.
Unfortunately for investors, trying to understand the implications of their portfolio allocation from
a simple assessment of the dollar weighting in each asset class is a fundamentally incomplete, if
not a downright misleading exercise. Assessing the economic profile of an investment allocation

2016 WhiteTree Investment Management, LLC

Market Commentary
2nd Quarter 2016

July 2016

requires evaluating a portfolio in additional dimensions. Just as a doctor uses an X-ray or MRI to
create a better informed diagnosis, intelligent investors have to probe deeper to understand what
they own. The most straightforward way to examine a portfolio is to adjust the components of the
allocation (in this case the stocks and bonds) for risk.
What risk means is a complex question, and there are many ways to approach it. But in finance
the most commonly used form of risk measurement is called standard deviation. To define it as
simply as possible, standard deviation is a measure of how volatile a given investments price has
been historically. So in order to look at the 60/40 portfolio in terms of its risk, we will adjust the
dollar weightings of each asset class by their respective standard deviations.
Over the past 43 years the U.S. Stock market has had a standard deviation of 17.93% the U.S. Total
Bond Market, a standard deviation of 6.73%. Therefore by this measure of risk, every 1 dollar
allocated to U.S. stocks carries 2.66 times more risk than a dollar allocated to bonds.
This adjustment means that while the dollar weighted allocation of the 60/40 portfolio will look
like this:

2016 WhiteTree Investment Management, LLC

Market Commentary
2nd Quarter 2016

July 2016

The risk weighted allocation of the portfolio will look like this:

The above risk weighted graph is telling us that the stock portion of the portfolio accounts for 80%
of the total risk in this portfolio. What that means is that in any given year, 80% of this portfolios
return is likely to come from the performance of the stock market. More simply, this portfolio
is making a much larger bet on the performance of the stock market than the dollar weighted
allocation would suggest. What appeared balanced in terms of dollars is actually very skewed in
terms of risk.
Another way to assess the 60/40 portfolio is to examine its correlation with another market. More
specifically, we can draw inference about the amount of diversification the portfolio provides by
examining its correlation with the U.S. stock market itself. If it has a low correlation with the stock
market, it is likely that the portfolio is taking on different risks and providing diversification. If the
correlation is high, we can assume that the portfolio as a whole is taking similar risks to those of
the U.S. stock market.
Correlations can take any value between 0 and 1. The 60/40 portfolio has a correlation with the
U.S. stock market of .98, a very high correlation. Thus this additional measure confirms what
we saw when we adjusted the portfolio for risk. The investor who thinks their portfolio is well
diversified because of their 40% allocation to bonds is not seeing the whole picture, and if your
money is important to you, we can assume you want to see the whole picture.
The take-away from this is that examining an investment portfolio requires more than looking
at the dollar weighted allocation of its components. Diversification works to reduce risk without
reducing return because financial assets have different types of economic biases and sensitivities.
However, without the proper understanding of magnitude of these sensitivities investors can end
up with a portfolio that is carrying much more risk than meets the eye.

2016 WhiteTree Investment Management, LLC

Market Commentary
2nd Quarter 2016

July 2016

Micro-Cap Value Commentary

For the three months ended June 30, 2016, the WhiteTree Micro-Cap Value strategy delivered
a return of 0.54%. The benchmarks, the Russell 2000 index, 3.81% and the Russell Micro-Cap
index 3.97%. Since inception, the Micro-Cap Value strategy has returned -2.89% vs -2.17% for the
Russell 200 benchmark and -6.76% for the Russell Micro-Cap benchmark, under-performance of
0.72% and an out-performance of 3.87% respectively.
Despite the under-performance during the quarter, I am very happy with the progress the
strategies portfolio companies made during the quarter. The remainder of this section will review
a few of the strategies holdings:
QC Holdings Inc. (QCCO) - Last quarter I discussed our position in QC holdings, a very small and
illiquid stock whose price was severely punished for voluntarily delisitng itself from the NASDAQ
exchange. During the second quarter the stock again found its footing and nearly doubled in
price. Even with this recent appreciation the company still trades at a very large discount to its
conservative liquidation value and is therefore an attractive holding for the strategy.
Awilco Drilling (AWDR) - During the quarter the strategy divested its position in Awilco drilling.
Regular readers may recall that I reasoned Awilco drilling was a very attractive investment on
the basis of its long-term contract at above market rates with Apache Corporation. A contract
whose expected profit effectively paid for the investment in the stock. Unfortunately after a
routine maintenance trip, Apache refused to accept the companys rig and stopped payment on
the contract. Although management assured investors the contract was iron-clad, the companys
weak negotiating position and the prospect of drawn-out legal battle simply made the situation
too risky. I therefore divested the position and continue to monitor the situation closely.
Pardee Resources (PDER) - Pardee continues to be a core holding for the strategy. Since our
first investment in the company the stock has suffered in two ways. First, management made
unfortunate decisions with respect to purchasing gas and oil properties in 2013 that in the current
energy pricing environment were clearly value destructive. Second, the companies primary
revenue source is from coal leases on its large property holdings in Pennsylvania. Finding a willing
and able coal lessees in this market has proven challenging and revenue has declined substantially.
Despite these challenges, we continue to invest in Pardee because the shares are attractively
priced. The companys timber holdings alone are worth approximately $216 per share and
therefore, with prices currently around $170 we are effectively purchasing the timber at a
discount and receiving a free option on a recovery in oil, gas and coal prices, not to mention
the potential long-term real estate value of the companys massive land holdings. This value
proposition is further enhanced by the presence of a management team that owns a significant
portion of the outstanding shares. I expect Pardee will produce very satisfactory long-term results
for WhiteTree clients.

2016 WhiteTree Investment Management, LLC

Market Commentary
2nd Quarter 2016

July 2016

Zedge, Inc. (ZDGE) - Zedge does not fit the typical description of value stock. It trades at a
high multiple of current earnings and it is a technology company. More specifically, it is mobile
application company or an app. Zedges app allows its users to create customized wallpapers,
ringtones and icons. What makes Zedge so interesting is not that its product is unique but that its
product is so popular. The company has had its app installed over 200 million times, 90 million
active installs, and 35 million monthly active users (MAU). It consistently ranks among the top
apps for both the iTunes and Android app stores. To put that in perspective, Instagram had a
similar number of monthly active users when it was acquired for 1 billion by Facebook. Zedge by
contrast trades at a market capitalization of 30-40 million.
The companys low valuation is partially explained by its minimal efforts to monetize its users,
up until the present. In its first earnings call since being spun-off from IDT, the company stated
its intention to place an increased emphasis on monetization, and evidence of this focus on
profitability has already surfaced in the form of a content distribution deal with IDW media
holdings. IDW is the largest publisher of licensed comics in the U.S.. Thus in addition to traditional
banner advertising revenue, the company is leveraging its active user base to become both a
promoter and distributor of third parties premium content.
While there are risks with any technology based business model, Zedge extremely strong user
base and untapped monetization potential provide the potential for extremely large upside given
its current pricing. As such it represents an asymmetric risk / reward proposition that I am happy
to have as a small position within the strategy.
Macmahon Holdings (MAH) - Macmahon is one of the strategies largest positions. As a mining
services firm the company felt the pressure of the cyclical downtrend in the industry at large.
In fact I initiated the investment when there were doubts about the companys ability to make
debt payments. Since that time they have resolved their debt issues, replaced their CEO and
undertaken cost-cutting initiatives in order to bring there expenses in line with lower revenues.
In addition, the board recognizes that with 0.18 per share of tangible book value, and a current
trading price of ~ 0.10 per share, there is an opportunity to repurchase shares and has begun
doing so. Taken together, cost cutting and intelligent capital allocation are the beginnings of a
great investment for a company caught in a cyclical downturn because when the cycle inevitably
turns up the repurchased shares and improved operating margins will appear all the more
attractive. As the great investor Stanley Druckenmiller put it, you have invest with an eye to the
future:
But before he left, he taught me two things. A, never ever invest in the present. It doesnt
matter what a companys earning, what they have earned. He taught me that you have to
visualize the situation 18 months from now, and whatever that is, thats where the price will
be, not where it is today. And too many people tend to look at the present, oh this is a great
company, theyve done this or this central bank is doing all the right things. But you have to
look to the future. If you invest in the present, youre going to get run over.
Stanley Druckenmiller

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Market Commentary
July 2016

2nd Quarter 2016

Size Matters or Its Hard To Be Large

If I was running $1 million today, or $10 million for that matter, Id be fully invested. Anyone
who says that size does not hurt investment performance is selling. The highest rates of return
Ive ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was
investing peanuts then. Its a huge structural advantage not to have a lot of money. I think I
could make you 50% a year on $1 million. No, I know I could. I guarantee that.
- Warren Buffett
Often people tell me that if they had more money investing would be easier. They imagine that
with more wealth they could somehow find better deals. Now, living with more money might be
easier, I wont argue with that. But investing is funny in that it actually becomes more difficult the
more you have to invest.
Consider the extreme but nonetheless illustrative example of Saudi Arabia. The Kingdom has fallen
on hard times with the drop in oil prices. In an effort to modernize its economy the country is
considering selling its nationalized oil company Aramco. Aramco is theoretically valued at as much
as 2 trillion dollars. Thats $2,000,000,000,000 - a lot of zeros.
If Saudi Arabia wanted to invest 5% of this 2 trillion portfolio in U.S. real estate, that would be
$100 billion of investments to make. Lets assume further that Saudi Arabia wanted to do this
using publicly traded U.S. Real Estate Investment Trusts (REITS). What kind of deal could it get
there? Here are the five largest 5 U.S. REITS:

REIT Name

Market Capitalization

Simon Property
Public Storage
Equity Residential
Health care REIT Inc.
Ventas Inc.

$60 billion
$34 billion
$28 billion
$25 billion
$25 billion

To invest that $100 billion, Saudi Arabia would have to buy all of the top two U.S. REITS by market
capitalization, and 20% of the third or 50% of all the top 5. A feat which is practically impossible
without paying a significant premium to their current prices. In other words, Saudi Arabias
massive wealth actually means it will have access to less and worse opportunities than smaller
market participants like you and me. Counter intuitively, when it comes to investing, it pays to be
small.

2016 WhiteTree Investment Management, LLC

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Market Commentary
2nd Quarter 2016

July 2016

Other Items of Interest

Monday Morning Quarterback
One aspect of financial markets that I have always found appealing, as opposed to say politics, is
that you dont have to convince other people that you are right. That doesnt mean that you cant
argue about what you think is cheap or expensive, or how the world should be because people
sure do. But rather at the end of the day you have the option to buy what you believe in or sell
what you dont and let money be your reward if you are right. So it was both disconcerting and
fascinating to read that a Delaware judge had overruled the markets verdict about the fair value of
Silver Lakes acquisition of Dell, and come up with his own. Caveat Emptor I suppose...
Michael Dell Bought His Company Too Cheaply:
http://www.bloomberg.com/view/articles/2016-06-01/michael-dell-bought-his-company-toocheaply
Pension Problems
It seems not a month goes by without a new article about Americas growing pension problems.
Personally I find it very interesting that we live in a society where some people are expected to
save and invest intelligently for their own retirement and others are promised that they will be
taken care of by their employers.
Puerto Ricos Fiscal Fiasco is a Harbinger of Mainland Woes:
http://www.nytimes.com/2016/05/11/business/dealbook/puerto-ricos-fiscal-fiasco-is-harbingerof-mainland-woes.html?_r=0
Chicagos Pension-Fund Woes just became 11.5 Billion Bigger:
http://www.bloomberg.com/news/articles/2016-05-19/chicago-s-pension-fund-troubles-justbecame-11-5-billion-bigger
The Inside Track
Sometimes I speak to people who think that the ultra-wealthy, big banks and politicians have
the inside track when it comes to investing. My experience working at global banks has led me
to think otherwise. So I was amused to read about the implosion of a hedge fund run by Bill and
Hillary Clintons son-in-law that counted Lloyd Blankfein, CEO of Goldman Sachs among its notable
investors.

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Market Commentary
2nd Quarter 2016

July 2016

From The New York Times:

Some of the firms earliest investors were Goldman partners, including Lloyd C. Blankfein,
Goldmans chief executive officer, who let Eaglevale use his name in marketing the flagship fund
The one silver lining for the funds investors from all of this is that they will have a somewhat
larger tax loss on investments to claim next year.

Concluding Thoughts
I would like to conclude by thanking all the firms clients for the trust and responsibility you have
placed in WhiteTree and myself. It is not a responsibility that I take lightly. If you are aware of
others who might benefit from WhiteTrees services, I would be grateful for the introduction. If
you have any questions or comments, please do not hesitate to contact me.
Regards,

Peter Cook, CFA, CFP

2016 WhiteTree Investment Management, LLC

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Market Commentary
July 2016

2nd Quarter 2016

Q2 2016

H1 2016

Since
Inception

WhiteTree Micro-Cap Value

0.54%

2.27%

(2.89%)

Russell 2000 Index (IWM)

3.81%

2.26%

(2.17%)

Russell Micro-Cap Index

3.97%

(1.69%)

(6.76%)

Q2 2016

H1 2016

Since
Inception

WhiteTree All Seasons (Custom)

3.82%

9.23%

6.28%

Global X Permanent ETF (PERM)

4.59%

10.98%

0.89%

Q2 2016

June, 2016

Since
Inception

WhiteTree All Seasons (Unleveraged)

3.74%

3.84%

3.74%

WhiteTree All Seasons ( 1.5x Leverage)*

5.92%

5.71%

5.92%

WhiteTree All Seasons (2x Leverage)*

7.28%

7.59%

7.28%

Q2 2016

June, 2016

Since
Inception

0.28%

(1.78%)

0.28%

Strategy

Strategy

Strategy

Strategy
WhiteTree Absolute Return

Continued from page 3...

The second table of figures includes the asset-weighted returns for all accounts following the
WhiteTree All Seasons Strategy (custom), net of all fees and trading expenses. It should be
further noted that due to differing use of leverage among accounts, the timing of funding, legacy
positions and other special circumstances, the performance of your All Seasons account and that
of the asset-weighted returns reported above may differ significantly. Readers should note that
the performance of the All Seasons (custom) strategy includes accounts utilizing leverage, the
degree to which varies and is not materially at the discretion of the advisor. As a consequence,
simple return comparisons may be inappropriate.
The WhiteTree All Seasons (Unleveraged) figures are reported gross of fees, and net of trading
expenses.
*The WhiteTree All Seasons (1.5x Leverage) and WhiteTree All Seasons (2x Leverage)
performance figures are based on a hypothetical leveraging of the composite used to report
the WhiteTree All Seasons (Unleveraged). Returns are reported gross of fees and reduced by
a hypothetical margin expense of 1%, prorated monthly. The actual margin cost, and trading
expenses of an actual account could differ materially and investors should take this into account
when considering performance figures.

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Market Commentary
July 2016

2nd Quarter 2016

Disclosures / Disclaimer
All WhiteTree Investment Management Strategies are subject to market risk, including the risk of
permanent losses. Before investing, clients should carefully evaluate their financial situation and
their ability to tolerate volatility.
Be advised, all performance figures are un-audited, and unverified by any third party. WhiteTree
Investment Management, LLC believes the statistics included in this letter to be correct but
provides no warranty against errors in calculation or transcription. Historical performance fees are
no guarantee of future performance.
WhiteTree Investment Management, LLC is a New York - registered RIA practice, and is able to
serve clients in all US states and many other nations.This communication does not constitute
a recommendation to buy, sell, or hold any investment securities. A list of securities recently
recommended by our firm will be made available upon request.
This information should not be used as a general guide to investing or as a source of any
specific investment recommendations, and makes no implied or expressed recommendations
concerning the manner in which an account should or would be handled, as appropriate
investment strategies depend upon specific investment guidelines and objectives. This is not an
offer to sell or a solicitation to invest.
This information is intended solely to report on investment strategies implemented by WhiteTree
Investment Management, LLC and its investment managers. Opinions and estimates offered
constitute our judgment and are subject to change without notice, as are statements of financial
market trends, which are based on current market conditions. Under no circumstances
does the information contained within represent a recommendation to buy, hold or sell
any security, and it should not be assumed that the securities transactions or holdings
discussed were or will prove to be profitable. There are risks associated with purchasing
and selling securities and options thereon, including the risk that you could lose money.

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