Partners in WMK’s Strategic Opportunities portfolio experienced a challenging year. While the underlying businesses produced relatively stable – and in many cases strong – operating results, the market valued several of our holdings lower.
Because our intention is to own our companies for many years, we try to pay minimal attention to short-term market fluctuations – although they are painful nonetheless! Instead, the focus remains on ensuring our businesses execute at a high level and identifying potentially attractive opportunities to deploy capital into high-quality, undervalued enterprises.
A reminder: returns should be judged through an economic cycle – even one as difficult and unusual as the current environment.
Market Environment
Both equity and fixed income markets posted disappointing performance. It’s rare to see a period where traditional balanced portfolios – composed of stocks and bonds – experience simultaneous, significant declines.
A range of factors contributed to this environment. The most notable was persistently high inflation, which triggered the Federal Reserve to aggressively raise interest rates. Higher rates act as a gravitational force on asset prices – reducing the prices investors are willing to pay for future cash flows.
Beyond the expected macroeconomic forces, additional global challenges included war, ongoing supply chain issues, and political tensions that are increasingly impacting business (such as China’s challenges to dominant enterprises and growing antitrust scrutiny in the U.S.).
Interestingly, despite market weakness, broader U.S. economic data has not reflected a meaningful slowdown. Indicators such as corporate earnings, employment levels, and corporate bankruptcies have shown resilience.
However, even with this strength, it is difficult to assume that rising interest rates – from near-zero to significantly higher levels – won’t eventually weigh on economic activity.
The consumer, in particular, appears increasingly stretched. The absence of pandemic-era stimulus, combined with rising costs, has led to faster growth in consumer borrowing and a sharp decline in savings rates.
While I am not forecasting a recession (I generally avoid making predictions), I remain cautious in expectations for our collective business holdings. Many market participants seem more optimistic, with consensus estimates for corporate earnings showing continued growth. Yet at the same time, a majority of economists expect a recession.
My takeaway from these conflicting signals is simple: we should prepare for any environment by owning conservatively financed, economically resilient businesses.
As Procter & Gamble’s CEO recently put it: “The world seems to want everything to be better… but that’s really not reality. There’s an incredible amount of uncertainty that remains.”
Portfolio Update
As expected in a volatile year, our portfolio of businesses saw wide-ranging outcomes in market prices. In the fourth quarter, our portfolio underperformed the global benchmark. The primary driver was a lack of exposure to China. While Chinese equities struggled for much of the year, they rebounded strongly near year-end – and we currently have no direct exposure to that market.
Our top holding at year-end was a specialty (re)insurance company based in Bermuda. It was a strong contributor to portfolio performance. The company has successfully capitalized on favorable insurance market conditions, allowing it to raise rates and earn attractive investment returns on its float.
Another key contributor was a Canadian oil and gas company. A conservatively run, low-cost producer, it continues to generate meaningful free cash flow. We remain confident in its positioning relative to higher-cost competitors.
On the other hand, our largest detractor was a Canadian technology solutions provider. The company experienced a sharp drop in valuation despite strong expected growth in operating earnings. The stock’s valuation multiple declined significantly year-over-year. As a small-cap name, volatility is expected, and the company continues to expand its higher-margin services business as anticipated when we first invested.
Another underperformer was a holding company focused on internet-based businesses. It owns several growing platforms, stakes in public companies, and maintains a strong cash position. The market repriced many of its venture-backed assets in 2022, but this overlooks substantial underlying value.
We continue to own this company not only because of its current discount to intrinsic value, but also because it possesses numerous levers for long-term success and a track record of significant value creation. The market is currently assigning little or no value to several of its growth drivers, including:
- Optionality in sports betting through its stake in a major gaming company;
- Strong expected earnings from a digital publishing business;
- Continued momentum in a peer-to-peer car rental platform;
- Value potential from other investments, such as an online caregiving platform;
- Future opportunities to acquire assets at attractive prices.
There are many potential paths to success for this business, with limited downside at current valuations. Despite the recent underperformance, we remain optimistic.
In total, we believe our portfolio of businesses is executing well and creating long-term, sustainable value. Over time, this should translate into strong performance for us as owners.
CFC Required Reserves
Note: This section is intended for those who own a Controlled Foreign Corporation (CFC), as many of my investors – and I – do. These entities act as captive reinsurance vehicles for operating businesses and are required to hold very conservative investment portfolios, largely consisting of investment-grade fixed income.
The bond market’s performance made last year particularly challenging for the CFC reserves portfolio. However, our decision to maintain a short duration and conservative positioning helped us significantly outperform the broader bond market on a relative basis.
We remain positioned for a continued moderate rate environment, with floating rate and short-duration investment grade exposure, alongside select preferred equity and common stock holdings. While we made few changes since incorporating floating rate Treasury instruments, we anticipate greater opportunity in the coming year to allocate toward undervalued asset classes as interest rate volatility subsides.
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.