Partners in WMK’s Strategic Opportunities portfolio have not been immune to the volatility of the markets this year. We entered fully invested, aligned with our long-term intentions. Luckily, WMK owns businesses that are defensive both in their cash flow generation and use of leverage.
The intrinsic values of our business holdings are far less volatile than their stock prices. By focusing on business value instead of stock price, there is a stable ballast to protect against suboptimal decisions during volatile times. Our conglomerate continues to trade at market prices below what I view as the long-term intrinsic value of the whole. Importantly, I expect our businesses to grow their intrinsic values at attractive rates over time. The competent and trustworthy managers of our businesses put us in an enviable position to “sit tight” and watch our companies perform.
Despite a modest loss early in the year, the market price of our holdings outperformed the broader global stock basket that is often used as a benchmark. I do not find that benchmark particularly helpful. My internal compass is defined by whether we own a small subset of high-quality, reasonably priced businesses likely to create wealth over the long term. This test is almost certainly passed, and the bar to entry in our portfolio remains high.
As a reminder, returns should be judged over a multi-year time horizon, with longer periods being more reasonable for long-term investors.
Risk vs. Uncertainty
“It is far easier to figure out if something is fragile than to predict the occurrence of an event that may harm it.” — Nassim Taleb
Since launching WMK’s portfolio, the world has experienced a remarkable onslaught of global events, including:
- An ongoing global pandemic.
- Political regime changes in the U.S. government.
- Dramatic swings in oil prices.
- Inflation rising sharply.
- An unimaginable war in Ukraine, causing immense human suffering and disrupting global supply chains and commodities.
We should all hope for a “boring” year ahead.
The volume of geopolitical events reminds us how limited our collective knowledge of the future truly is. For example, a prominent financial publication in early 2020 confidently predicted no recession that year, yet failed to mention the looming pandemic that would dominate 2020.
I hold no criticism for these missed forecasts—many would have said the same if asked back then. The issues discussed were topical, but were they truly important?
If you consume global news regularly, you’ll notice a steady stream of articles on market risks and opportunities. Many contain thoughtful macroeconomic insights. Still, I want to remind my Partners how I view risk.
I do not see risk as stock price volatility. Instead, I define risk as the permanent impairment of the real purchasing power of capital. When analyzing an opportunity, I focus on the business drivers that will allow a company to thrive or struggle in the future. Essentially, my long-term strategy requires owning businesses with strong terminal value — that is, businesses that can endure.
I categorize variables impacting our businesses into three broad buckets:
- Knowable & Impactful: A relatively small number of variables truly matter to a business’s long-term viability. My job is to identify, understand, and monitor these deeply.
- Unknowable & Impactful: There are countless unknowable variables that can affect businesses—like the pandemic-induced shutdowns. These “Black Swan” events are unpredictable. I don’t try to forecast them but instead build resilience by buying companies with a margin of safety. This margin comes from both attractive purchase prices and owning businesses led by thoughtful management that prudently handle cash flow and leverage (it’s hard to go bankrupt without debt!).
- Uncertain & Temporary: Many variables create near-term uncertainty. This is the space where journalists and market participants often focus. But just because something is timely doesn’t make it important. Near-term uncertainties impact quarterly earnings, ours included. Some may evolve into longer-term risks, but if you own a business for the long haul, these uncertainties are mostly irrelevant.
This third bucket requires general monitoring mainly to: 1) identify attractive entry points for investors with longer horizons, and 2) spot uncertainties that might become long-term risks early.
The key to successful investing in my style is focusing on what is both knowable and impactful long-term (bucket 1). Traders may excel on short-term “bucket 3” events—I’m happy to let them play that game. I’ll focus on patience and focus to create lasting value for our portfolio.
There are many geopolitical uncertainties today. Rather than trying to predict them all, I remain focused on identifying what truly matters to the long-term viability of our current and potential business holdings.
Portfolio Contributors
Canadian Natural Resources was our top performer early in the year. Those who have followed the portfolio know I held this company for a long time before selling after strong gains, assuming oil production would ramp up significantly as prices recovered, consistent with historical patterns.
Later, I realized the supply/demand imbalance would persist longer than expected. Recognizing this mistake, I repurchased the company at slightly higher levels before geopolitical tensions further constrained oil production.
While I wish I had never sold, I’m grateful to have corrected my error by buying back a high-quality company at an attractive price. The company continues to generate strong cash flow, though there will eventually come a time when oil is no longer as attractive an asset.
The portfolio’s worst performer in the quarter was Coupang, a South Korean e-commerce leader. Despite purchasing below its IPO level, Coupang’s near-term stock price has been challenged due to three key issues: geopolitical risks affecting inflation, a market rotation away from “high growth” stocks, and selling pressure from their largest investor, a conglomerate facing its own challenges due to leverage and poor performance in key holdings.
I place all these issues in the “uncertain and temporary” bucket.
Coupang is led by a young and ambitious founder who has built a significant physical infrastructure (not an asset-light model). While costly upfront, this infrastructure supports a superior customer experience and can create a sustainable competitive advantage. I look forward to watching Coupang’s growth for many years to come.
CFC Required Reserves
Note: Feel free to ignore this section if you do not own a Controlled Foreign Corporation, as many of my investors—and myself—do. These entities are captive reinsurance businesses and must maintain a conservative portfolio heavily weighted toward investment-grade fixed income and limited U.S. equity exposure.
Bond markets faced significant challenges early in the year, driven by the Federal Reserve’s commitment to raising interest rates to combat inflation. Our bond portfolio was negatively impacted due to our obligation to hold bonds.
Those who have followed these updates know I actively trade interest rate risk for credit risk by reducing duration—meaning less sensitivity to interest rate changes—through holding shorter-term or interest rate hedged corporate bonds. Our portfolio’s duration is substantially lower than the broad bond market benchmark.
These adjustments have resulted in meaningful outperformance versus the benchmark, despite wider spreads on corporate bonds due to geopolitical risks. While performance declined in the short term, these are long-term portfolios. As geopolitical uncertainties subside, I expect gradual recovery. Over time, patiently investing capital almost certainly outperforms holding cash on an inflation-adjusted basis.
Disclosures:
The views expressed above are those of WMK Investment Partners. These views are subject to change at any time based on market and other conditions, and WMK disclaims any responsibility to update such views.
Past performance is not indicative of future performance. Principal value and investment return will fluctuate. There are no implied guarantees or assurances that the target returns will be achieved, or objectives will be met. Future returns may differ significantly from past returns due to many different factors. Investments involve risk and the possibility of loss of principal. The values and performance numbers represented in this report do not reflect management fees.
WMK may discuss and display, charts, graphs, formulas which are not intended to be used by themselves to determine which securities to buy or sell, or when to buy or sell them. Such charts and graphs offer limited information and should not be used on their own to make investment decisions. To the extent that certain of the information contained herein has been obtained from third-party sources, such sources will be cited, and are believed to be reliable, but WMK has not independently verified the accuracy of such information.