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No. of Recommendations: 11
"in a bear market, won't the small cap names get hit harder?"

redrackam, we all know the drill, we aren't buying pieces of paper but real businesses. This is company specific and I'd welcome buying my holdings cheaper. I do maintain some cash, but in a real meltdown like 2008, it's more like 'pigs at the trough', where one is removed to make way for another that is cheaper.




"considering where we are in this cycle, does this make sense now? What I mean is that, if there is a bear market, then I would need to first trade out of illiquid small caps in order to buy something cheaper (in the absence of cash).


Portfolio construction and sizing are almost as important as stock selection (this would require its own thread). As mentioned, I run some family accounts and there is not a one size fits all. For the younger members of the family with far less assets, it's more special situation oriented than my portfolio which comprises a lot of very illiquid securities. But even in my case, I can't put 100% of my portfolio in 'trade-by-appointment' securities because I would lose the flexibility necessary to take advantage of more short term opportunities. I think the best way to answer some of these questions is with real life examples.


In the investment game we all play, knowledge is cumulative and it helps to have a good memory. Long ago in the year 2000, a poster mentioned a stock (VULC), which I thought was interesting, but at the time I also thought it a value trap. Fast forward to 2012, when my largest holding by far was PNC warrants and I couldn't help but think what he had mentioned years ago about Vulcan's largest bank holdings (PNC and USB).


Since VULC's stock price had flat-lined in the intervening 12 years (but their holdings had not), it became increasingly interesting to me, so I decided to buy a few hundred shares in 2012 and dig into the story more deeply. You had to be a shareholder and sign an NDA to get their financials. I saw enough to know I wanted a lot more shares, but very few shares traded. So I bided my time and waited until some shares would eventually shake loose.


As luck would have it, lots of VULC shares were offered at year end 2014, but at exactly the same time I was doing the biggest and best tax arb of my life (CSWC).


These particular tax arbs are exceedingly rare because the stars have to perfectly align. This BDC was doing a spin off and planned on selling their long held appreciated portfolio, retaining the gains, and paying the 35% corporate tax rate. Almost all BDC's distribute these gains, but if retained, shareholders who own the BDC in retirement accounts get 100% tax credit from the IRS. So it was a situation of being a shareholder of record at year end and very likely making 9% safely on all monies invested. Well, you want to play something like that in large size.


On Christmas week in 2014, I was vacationing in Costa Rica with my family. I was familiar with BDC's, but I never saw one retain such large realized gains and pay the 35% tax rate. The opportunity here was buying in my Roth accounts and being credited the tax CSWC paid.


And the more I read about the company, the more I realized a 9% profit was the minimum I would make. But then something happened that created a real dilemma. I wanted to get very large in CSWC, but I also saw big blocks of VULC available that week. I believe it was Piper Jaffray finally throwing in the towel after holding their shares for close to a decade with nothing to show for it.


I'm generally close to fully invested and like everything I own, but now I needed big bucks for CSWC and VULC.


I'd put in an order for 2500 shares of VULC at $40 (what was offered) and scoff them up, then another 2500 was immediately offered, it happened over and over again and it's the day I bought most of my shares. I had no intention of buying that much at that point in time because of the CSWC tax arb, but you have to buy when stock is available with companies like this, so something else was sold to make room (ergo, you have to own some liquid securities.)


I ended up buying everything that was offered (25K VULC shares), which I still own, and 50K shares of CSWC at coincidentally the same $40/share VULC price. Jury is still out whether all the capital should have been invested in CSWC, but it's tough to buy these cheap 'trade-by-appointment' stocks in size, so you have to move when the supply is available. I would have waited if I knew I could buy the same amount in early 2015, but there were no guaranties.


To me, Vulcan at that price was the equivalent of Graham's Northern Pipe and Buffett's Sanborn Map. I had 'treasure in my hand', so I was willing to forgo making ~10% in a week on the funds used to buy Vulcan. So there are trade-offs and opportunity costs associated with illiquidity because I would have bought even more CSWC in my Roth if I could have sold big portfolio positions in some of these very thinly-traded stocks.
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