Partners in WMK’s Strategic Opportunities portfolio own a piece of a number of high-quality enterprises. While you will see multiple “tickers” on your brokerage statement, some exposures are duplicative. Activity during the quarter was minimal.
Q3 performance did not deliver the wealth-creating result we aspire to achieve. However, short-term results – whether good or bad – are a poor barometer for the performance of our “conglomerate” of businesses. Over a long period, the economics of our business holdings and total portfolio returns will align. As a reminder, returns should be judged on a minimum of a multi-year time horizon, with an even longer period being a more reasonable measurement for long-term investors.
Business Updates
Aon: Our top contributor to Q3 performance was Aon (ticker: AON), a large, global insurance brokerage firm that meaningfully added to the portfolio’s return. Aon is widely trusted by businesses worldwide to provide strategic advice and risk mitigation across a variety of hazards, from natural disasters to cybersecurity.
While our business holdings have significant collective exposure to the (re)insurance space, I try to avoid direct, outsized exposure to catastrophe risk such as hurricanes. This is due to my view that the severity of catastrophe risks continues to accelerate, making many (re)insurance companies underprepared for future claims. Our businesses are more specialized in nature, such as Arch Capital Group (discussed in my previous update) or Fidelity National Financial, which is a title insurance business.
As an insurance broker, Aon occupies an interesting position in the insurance value chain. The brokerage industry exhibits oligopolistic qualities, with increasing returns to scale from negotiating leverage and shared costs. In fact, while (re)insurance companies could suffer from increasing severity of catastrophe losses, Aon should benefit from these secular trends as businesses increasingly seek protection against a growing stream of risks. Aon’s expertise is needed now more than ever.
Aon’s management is intensely focused on Returns on Invested Capital (ROIC) and free-cash-flow (FCF) growth, the two metrics I value most. Businesses create value by generating cash and reinvesting it in high-return projects. The longer this reinvestment continues, the more valuable the enterprise becomes. I purchased Aon early in the portfolio’s life at an attractive valuation, and I expect Aon to remain a core holding for quite some time.
Canadian Pacific: While Canadian Pacific (ticker: CP) weighed on performance during the quarter, the company successfully obtained shareholder approval for a strategic acquisition of Kansas City Southern (ticker: KSU). Regulatory approval by the relevant authority has not yet been granted, though an encouraging interim step has improved the odds of success.
In my view, CP is the best-operated railroad in North America, led by Keith Creel, who learned from his renowned predecessor. Since taking on operational responsibilities, Keith has significantly improved the railroad’s efficiency—a testament to the impact of strong management.
KSU operates extensively in Mexico and connects seamlessly with CP in Kansas City. It has long been a prized asset, with CP’s main Canadian competitor unsuccessfully attempting to acquire it. I see this acquisition as highly strategic for two key reasons:
First, CP’s network will be materially enhanced by KSU’s assets. By offering a seamless shipping experience from Mexico through Canada, CP stands to benefit from any reshoring of production to North America in response to global supply chain challenges.
Second, if there is any doubt about the strategic importance of this merger, a recent industry competitor voiced concerns about potential market power shifts, underscoring the significance of the transaction.
As owners of CP today, we are no longer betting on a turnaround, but rather on continued excellence by Keith and his team. My biggest concern had been the risk of Keith being recruited by a larger competitor. However, with the combined company remaining relatively small and Keith’s reputation tied heavily to the deal’s success, I believe this strengthens his commitment to CP, which should provide comfort to us as long-term investors.
Alibaba: My biggest mistake this quarter was the purchase and swift sale of Alibaba (ticker: BABA). This position detracted meaningfully from performance. I have long respected the Chinese e-commerce giant and believed its valuation did not reflect its true economics. I waited for clarity from a government antitrust investigation before purchasing, and after a relatively minor fine was imposed, I felt it was safe to invest.
However, I did not anticipate the broader regulatory crackdown the Chinese government would impose on many non-Alibaba businesses. While the long-term effects of this regulation on Alibaba remain uncertain, investors are rightly wary of the challenging business environment in China. Recognizing my misjudgment, I exited the position quickly, mitigating further losses.
Although I still believe in Alibaba’s underlying value, I am uncomfortable with the unpredictable government risk that I cannot effectively assess or manage. This experience has been a valuable lesson in the nuances of risk management and the importance of situational analysis alongside business and valuation work.
Goals
“It’s a constant quest to try to be better today than you were yesterday and better tomorrow than you were the day before.”
– Kobe Bryant
While I have been clear about my intention to be a long-term steward of your collective capital, I realized I have not outlined a concrete goal for you, my Partners.
My primary goal is simple: deliver excellent long-term returns with the highest levels of transparency and integrity.
Excellence means at least top quartile performance compared to other investors over extended periods.
You might ask why not target top decile performance consistently. While that would be remarkable, it is exceedingly rare over long horizons. Historical data shows only a small fraction of top-quartile funds maintain that status over subsequent periods.
Academic literature—and media narratives—often dismiss active investment management as futile. I see things differently. I believe investors tend to underperform for two main reasons:
- Situational: Investors lacking sufficient concentration and a long-term focus tend to “closet index,” closely tracking benchmarks without meaningful differentiation, prioritizing asset gathering over returns.
- Inflexible: Investors adhering rigidly to a particular style that only performs well in certain market environments.
These factors are less a reflection of intelligence and more about industry incentives and structure.
Why be a closet indexer? Because collecting fees on average performance is a strong business. Why adopt a style that only sometimes adds value? Because marketing a complex-sounding strategy often sells better than a simple, patient approach.
To achieve strong long-term results, my commitment is to a sustainable process rooted in discipline, continuous learning, and conviction in our businesses.
How will we invest to reach this goal? While I will share process details later, my plan is to maintain a low turnover, concentrated portfolio, which has historically delivered meaningful outperformance. The businesses we own are likely to share these traits:
- Economically defensive moats.
- Management teams with high integrity and strong alignment.
In summary, my focus is on consistent excellence rather than occasional brilliance.
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 essentially set up as captive reinsurance businesses for operating assets and are required to hold a very conservative portfolio, primarily composed of investment grade fixed income with only a small maximum allocation to US common equities.
In my previous portfolio update, I discussed several adjustments made to the required reserves portfolio aimed at reducing both our interest rate exposure and fees on investment products. To summarize the moves:
I shifted a significant portion of our broad investment grade ETF allocation into an interest rate hedged investment grade corporate bond ETF. This change not only reduced duration risk (interest rate risk) but also helped increase incremental yield.
I also moved from a broad preferred equities ETF into two specific preferred securities, which both lowered expenses and materially enhanced yield on the portion allocated to preferred equities.
Early in the quarter, interest rates fell further but then began trending upward toward the end of the period—and have continued this trend since. This upward drift in interest rates—which seems like a long-term inevitability—validates the reduction in interest rate exposure in the portfolio. I remain comfortable with our relative positioning and am pleased to deliver results that are far superior to what we could achieve with cash alternatives (though, certainly, there is room for improvement).
You will notice that I have started including a Fed Funds alternative in the performance reporting. While our custom benchmark illustrates “what is possible” if we could invest directly in the market from our CFCs, achieving these returns is not possible without incurring expenses. The Fed Funds rate provides the true alternative to my investing efforts, as it represents where your CFC required reserves would otherwise be invested.
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.