Ben Franklin Financial – BFFI

We got the initial idea here from Clark Street Value

http://www.clarkstreetvalue.blogspot.com

Its a merger and liquidation of a nano cap bank stock with a favorable risk/reward.

On April 30th, the acquirer, a credit union called America Family, announced they have completed the deal to acquire BFFI and proceed with the liquidation, expected to take about 120 days. Shareholders can expect to receive somewhere between $10.21 and $10.41 in cash versus a current price of BFFI of $9.95.

Assuming a midpoint of $10.31, and 150 days until payout (9/30), it works out to a 3.62% Holding Period Return. (10.31/9.95 = 3.62%). This annualizes to 8.80%. I think that’s really compelling, especially given the high degree of certainty, an uncertain stock market and the paltry returns available in cash alternatives.

I think the true odds here are closer to Treasuries +/- some consideration for illiquidity and risk that liquidation proceeds come in different than the buyer projected. If T-bills are .15 basis points over a comparable 150 days, I think I should earn maybe .15 + .50 for illiquidity + another .50 for liquidation uncertainty or 1.15% (2.80% annualized).

Another way to look at it is as a money line wager. The deal is virtually certain (the transaction has closed), so the only real risks are around timing and the magnitude of the payout. I’m going to assume that the timing and the $10.21 to $10.41 range given by American Family is fairly accurate. Under those assumptions, I think true odds here of receiving something in the range and within the guided timeframe are more like 98 or 99%, which would deserve a 1-2% return. That makes a fair price for BFFI more like $10.10.

Summing it up, I think I’m getting a high return, low risk but illiquid short-term cash substitute, not unlike a CD. I particularly like the high degree of certainty, reasonable time until resolution and projected returns of 6.60% – 11.39% annualized, especially relative to the current stock market. I should get a nice payout for for holding for a few months.

Getting Started

My goal with this investment account is to increase my purchasing power in real terms over time. I believe one way to accomplish this is via a strategy that emphasizes absolute performance and asymmetric positive returns. The easier and cheaper option, of course, is to buy the S&P 500 via an index fund. Doing this, I think its reasonable to expect something on the order of a 6% cumulative return over time, +/- 18% a year, with an average results of 7.50% and max up and downs of 32% and -37%, respectively. At least, that’s what the last twenty years ended 2019 has brought us.

I am aiming for absolute results on the order of 12% a year, on average, over time, with fewer and smaller drawdowns than the S&P. I believe this can be accomplished by using a conservative, multi-strategy approach that emphasizes a minimum hurdle rate and places heavy emphasis on forecasting embedded returns and the probability they will be received – a sort of ultimate “there are no bad assets, just bad prices” method.

I love the idea that true risk is not volatility or risk-adjusted relative performance, but rather the reasoned probability of incurring a permanent loss in purchasing power.

Four investors who align philosophically with what I am attempting though their individual strategies differ are Warren Buffett, Mark Spitznagel, George Soros and Paul Singer. I believe all with the exception of Mr. Spitznagel are under-appreciated for how they focus on absolute returns and asymmetric performance. In my view, they have one thing in common that is vastly under appreciated and under utilized by most investors and that is a preference for building asymmetry into their strategies. In my reading and studying of their methods, all of them demonstrate a willingness to forego gains at the expense of avoiding large drawdowns.

The best investment book on this topic (that based on the $2.65 I paid to acquire from a Goodwill very few have heard of, let alone read) is “Asymmetric Returns: The Future of Active Asset Management”, by Alexander Ineichen.

Aside from using Buffett as an occasional example of an absolute investor, Ineichen suggests that what is considered “active” is really closer to “relative-passive” (alpha, tracking error and Sharp are relative concepts), with true active concerned with absolute risk and absolute profit and loss. He goes on to note how large drawdowns kill the rate at which capital compounds and can be mitigated under more absolute approaches, among many other interesting observations.

When I come away from listening to and scrutinizing my four identified thought leaders, l hear much of what Ineichen has cataloged, including philosophies and processes that emphasize absolute methods and an appreciation for asymmetry – in both seeking to win by not losing and through use of exposures that are highly convex. Consider the following examples from each:

Buffett and his rules number one and two (perhaps the living embodiement of an asymmetric commandment). A comfort with holding large cash balances. A multi-strategy approach (especially in his early years) that included value, special situations and risk arbitrage.

Soros said during an interview with Charlie Rose in 1995 that “managing money the way we do is Spitznagel chronicles his approach in his book the “Dao of Capital”. In particular needing to lose, lose, lose in order to win big and looking like a schmuck (ie earning windfall profits on occasion when nearly all others are in ruins.) painful” and “the reason we have such a good record is we never lose our principal.”

Finally, in a number of interviews readily available online, Paul Singer talks about his start in convertible arbitrage and hedging after “finding every conceivable way to lose money.” The firm’s Part 2 brochure states “the Funds’ principal objective is to generate a return which is as high as is consistent with a goal of minimizing losses during adverse financial market periods. A basic goal is to avoid significant losses under all market conditions.”

The other thing from Buffett and Munger that I think does not get nearly the attention it deserves is their appreciation for inefficient markets. They flat out tell people that they themselves wouldn’t invest they way they do if they weren’t running such a large estate (and perhaps responsible for so many others net worths).

So, in summing it all up, my intent is to think of this portfolio as sort of a grub stake much like one might bring to a casino. Rather than worry about it burning a hole in my pocket and feeling compelled to place wagers, I will wait for opportunities that I believe clearly satisfy my hurdle rate. I expect this will include a range of investments that typically fall under the definition of deep value and special situations and everything in between including options and even binary situations (if the risk/reward is right). I hope to be counter cyclical and return-driven and as Buffett described in his partnership letters, conservative, though not conventional, in pursuit of fun and profit. I will look to find asymmetric payoffs and inefficiencies from a huge variety of sources.