Partners in WMK Group’s Strategic Opportunities portfolio earned a reasonable return in the first half of 2023. In keeping with our stated objectives, we have maintained our long-term ownership of a concentrated group of high-quality businesses. During the first half of the year, we trimmed one position (Arch Capital Group), whose market price performed exceptionally well, and purchased one new business (Topgolf Callaway Brands, detailed below).
We remain comfortable with the management of the companies owned in our conglomerate and are vigilant in searching for opportunities to further improve our positioning—either through prospective returns due to valuation changes or enhanced business quality.
Market Commentary
The divergence between mega cap companies (such as Google and Microsoft) and the rest of the market has accelerated in 2023. This divergence is reflected in the performance gap between market cap weighted and equal weighted indices. Most commonly cited indices (like the S&P 500 or the ACWI) are market cap weighted, meaning larger companies represent a disproportionately large share of the index, while equal weighted indices treat each company equally.
Historically, both index types moved in relative tandem. However, in recent years, and especially in 2023, the performance of market cap weighted indices has meaningfully outpaced that of equal weighted indices. This has left the equal weighted index trading at a noticeable discount relative to the market cap weighted version on a forward-looking valuation basis.
The primary drivers of performance in market cap weighted indices are well-known mega cap companies such as Apple, Microsoft, Nvidia, and Tesla. Within our portfolio, Amazon and Google have also performed well so far this year.
A key question is: what is fueling the market dominance of these massive enterprises? Several factors may help explain the phenomenon:
Business Quality: Companies like Microsoft and Google are fundamentally different than businesses we’ve seen in the past. Despite their enormous scale, they continue to deliver exceptional returns on invested capital, underscoring their unique business quality.
Index Flows: The rise of passive investing has made low-cost index funds dominant buyers of equities. While passive investing is generally positive, one side effect is that these large companies attract a disproportionate share of incremental investment dollars. This can create distortions, favoring overvalued businesses, in contrast to traditional stock picking, which seeks undervaluation.
Outsized Attention: Idiosyncratic excitement—such as enthusiasm around artificial intelligence or company-specific fanbases—has driven extreme price moves in a handful of companies. These moves have been exacerbated by the increased use of options, adding to short-term volatility.
At WMK, we remain focused on evaluating businesses and management teams based on fundamental quality, not near-term market movements. Still, we acknowledge that the market environment presents both opportunities and risks. We aim to be mindful of both as we work to preserve and grow wealth for our Partners—and ourselves.
The increasing concentration within market cap weighted indices brings with it two key risks: 1) a higher likelihood of exaggerated drawdowns during corrections, and 2) diminishing ability of these indices to reflect broader market health. Combined with the accelerating speed of information flow (as discussed in a prior letter), this can lead to persistent mispricing—both on the upside and downside.
Equity Portfolio Update
We added one business to our portfolio during the second quarter: Topgolf Callaway Brands (MODG). This company was formed through the merger of Topgolf and Callaway Golf. MODG operates in three main segments:
- Golf Equipment: The legacy business that includes golf clubs, balls, and accessories.
- Topgolf: A global sports entertainment platform that operates high-tech driving ranges blending golf with food, drink, and entertainment.
- Active Lifestyle: Focused on apparel and accessories marketed to golf and outdoor-focused individuals, including through the TravisMathew brand.
We purchased MODG at what we consider an attractive valuation relative to its projected revenue growth and margin expansion. However, the market appears to be pricing in significant uncertainty around the durability of pandemic-era growth in golf participation.
Golf saw a surge in demand due to the pandemic’s emphasis on outdoor, socially distant activities. As such, there is now investor skepticism around whether this growth is sustainable. A decline in demand could affect the legacy manufacturing business, as lower volumes would put pressure on margins.
Despite this uncertainty, we believe the market is underestimating the strength of the broader business transformation. Topgolf has already surpassed equipment manufacturing as the company’s primary revenue driver, and its contribution is expected to increase further, enhancing the company’s diversification and long-term stability.
Topgolf’s economics are compelling. The company has opened a substantial number of locations, with strong cash-on-cash returns. Management intends to continue growing through new site openings, leveraging smaller formats, and expanding internationally. Even if new locations generate slightly lower returns, the incremental capital deployed is still expected to generate attractive returns—especially for a non-software, capital-intensive business with a tech-enhanced customer experience.
Beyond Topgolf, MODG holds additional growth levers:
- Toptracer, a proprietary ball-tracking technology used at ranges worldwide;
- Growth in athleisure and golf apparel brands supported by lifestyle trends; and
- A more resilient legacy equipment business, driven by improved supply chain execution, a healthier competitive landscape, and broader golf participation.
The company is led by Chip Brewer, who has served as CEO since 2012. With prior experience in the industry and recognition for his leadership, Chip has been instrumental in transforming the business. His acquisition of Topgolf was particularly well-timed and accretive, reflecting disciplined capital allocation.
We look forward to watching MODG execute on what we believe is a compelling long-term opportunity. The current valuation offers downside protection, while the long-term cash-generating potential offers meaningful upside for patient investors.
CFC Required Reserves Portfolio Update
Several of our investors—including myself—are required to own a conservative portfolio composed primarily of investment-grade fixed income, held within reinsurance entities. Our portfolio remains shorter in duration and higher yielding than the benchmark, without taking on additional credit risk.
While inflation has moderated, we do not anticipate a rapid return to the ultra-low interest rate environment of the past. We are comfortable holding a fixed income portfolio that provides a healthy yield and minimal duration risk.
The downside of this positioning is that, in a scenario where interest rates decline sharply, our portfolio would underperform. However, our focus remains on capital preservation and stable income generation. This conservative strategy allows us to avoid undue risk in pursuit of yield, resulting in a portfolio we consider low-risk and well-suited to current conditions.
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.