Partners in WMK’s Strategic Opportunities portfolio enjoyed a strong absolute return in the past year. I believe our conglomerate of businesses will continue to perform at a high level for years to come. However, the returns generated recently are not indicative of future expectations.
The market began to recognize the many overstretched valuations in the latter part of last year, a trend which has accelerated more recently. Luckily, our businesses are rather “boring” and tend to trade at reasonable prices. This makes them less susceptible—though not immune—to market sentiment. When investors decide to sell, even high-quality businesses at reasonable prices can get “caught in the crossfire.”
I continue to believe that valuation matters in investing. But a “cheap” asset may not be a good one. Most important for long-term investors is owning businesses that can invest in high-return projects for years to come and can be purchased for a reasonable price tag. Our conglomerate seems to fit that bill.
As a reminder, returns should be judged on a minimum multi-year time horizon, though an even longer period is a more reasonable measurement for long-term investors.
Portfolio Updates
While we own a sizable number of businesses, I have consistently stated that over time you should expect us to grow more concentrated. Concentration will come when exceedingly attractive opportunities present themselves and as some of our holdings grow as a piece of the overall portfolio due to strong performance.
Risk management in a concentrated portfolio is vitally important, and I believe our returns were generated without assuming significant long-term risk. As a reminder, near-term market price volatility does not accurately reflect risk in the underlying businesses. The operating results of our companies (and most companies!) are much smoother than their stock price performance.
Our businesses are balanced across industries, geographies, and market “factors” such as value/growth and momentum (note: I would rather ignore such “factors” and do not make decisions based on them…but I remain aware). While fundamentally bottoms-up as an investor, I still want to construct a resilient portfolio across market cycles by having balance. It helps me sleep better at night.
A portfolio should be like a well-constructed sports team (my preferred analogies all revolve around baseball). A player who can hit home runs is very important, but so is someone who will be on base when those home runs are hit! Similarly, you wouldn’t build a World Series-winning team without quality starting pitchers.
I believe the market performance over the last several years has lulled many investors into thinking their portfolios are more diversified than they truly are. Diversification is often defined as the number of underlying investments in entry-level finance. The reality of diversification and risk management is much more nuanced. Owning many unprofitable (but high growth) tech businesses would be much less diversified than owning fewer reasonably valued, highly profitable, and deep moat businesses in different sectors and geographies. Sadly, many investors do not share this approach.
The balance in our portfolio worked to our collective benefit recently. In aggregate, our conglomerate improved its total operating profit substantially assuming estimates are relatively close to accurate (before you are impressed…don’t forget how bad the prior comparable period was!). At the same time, total shares outstanding of our businesses increased very little and should decline year-over-year soon. Why does this matter? Almost all the operational improvement accrues to our long-term ownership AND our portfolio got cheaper on a per share basis during the year (operating profit per share increased more than market values). For comparison, the broader market typically experiences less operational improvement and more dilution.
Portfolio Contributors
Key contributors to annual performance included Converge Technology Solutions, Google, and our (re)insurance and financial businesses such as Arch Capital Group, Fairfax Financial, Fidelity National Financial, and Charles Schwab, which collectively contributed significantly to our total return.
Of course, there were detractors and mistakes. These included my investment in Interactive Corporation (IAC), which detracted from the portfolio return. Additionally, IAC spun off Vimeo to shareholders during the year. Vimeo lost significant value quickly prior to our exiting the position. I am focused on the long-term capital allocation of IAC’s management and view the current group of assets as undervalued.
Additionally, Charter Communications was a drag on our performance and remains a top portfolio position. While the loss was not fatal, there was a real opportunity cost of having a significant holding provide minimal return. Despite the tepid market price performance, Charter’s consensus growth outlook is positive, with a share count reduction in place. With an aggressive buyback policy firmly in place and a path to improved margins evident in the business, long-term owners (like us) should be happy about the weak share price. It enables the company to repurchase undervalued shares aggressively, enhancing our ownership position without any incremental capital.
As is always the case, the market rewards certain companies too handsomely and ignores others for too long. In this way, the market can be a bit like the individual who enjoys playing “hard to get.” They eventually find their match (the right price), but sometimes it just takes a little longer! However, we enter the new year with a strong group of companies where the hurdle for future investments into our group is high. Calmness and consistency will be key to success in what I suspect will be a volatile period.
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 for operating assets and are required to hold a very conservative portfolio composed primarily of investment grade fixed income and a limited exposure to U.S. common equities.
As discussed in prior updates, I have proactively reduced our interest rate exposure versus the broad bond market. The combination of preferred equities and interest rate hedged ETFs supported a slight outperformance versus the custom benchmark and a significant outperformance versus the Fed Funds alternative.
To combat a continued rise in interest rates, I have moved our duration (exposure to interest rate moves) lower by shifting a portion of our broad investment grade ETF into a short duration bond ETF that holds investment grade corporate bonds with shorter maturities. The potential downside to this move is a widening in the spread between corporates and treasuries. Over time, I expect the shorter duration to be a positive in the current environment.
Unfortunately, the current interest rate environment makes the pursuit of significant returns in the investment grade U.S. bond market a difficult task. Despite the challenging environment, I will continue to search for opportunities and manage risk appropriately.
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.