Portfolio Managment

What are your attitudes toward portfolio diversification?

We share the belief that diversification is but an excuse for ignorance and a plea for mediocrity.  Instead, we favor concentration as tempered by sound scaling principles and sound maintenance of cash liquidity.  With knowledge, there’s no reason not to concentrate in the few ideas that aim to maximize our partnership wealth.  To quote Warren Buffett: “"we would rather earn a lumpy 15% over time than a smooth 12%.”  And indeed, the oft cited benefit of diversification – lower volatility – is an acceptable risk in our humble opinion. However, that being said, there will undoubtedly be some diversification across our holdings.  Diversification will come as a result of pursuing the best risk reward opportunities and not as the result of adding more positions just for the sake of adding more positions.  Since we can’t proclaim ourselves to be experts at everything, we won’t attempt to hold more positions than we can possibly feel comfortable with.

 

 

Do you set any position limits?

In practice, we are highly cognizant of the sizing of our positions.  However, conceptually, there may be instances where we take oversized positions in great companies that may represent in excess of 25% of our capital.  Great companies are few and far between, and only on rare occasion does a great company sell at market prices that warrant the outright purchase of the entire company.  Thus, while it’s possible for our partnership to take such oversized positions in a select name, it would be a rare occurrence for such an event to happen.  Realistically, most positions will start off as nominal interest around 2% of capital with average holdings at 5% of capital.  Should the markets give us an opportunity to scale higher at attractive prices, we will have the capacity to do so with our available cash on hand.  In total, we feel most comfortable managing ten to fifteen positions at any given time. 

 

 

What are your criteria for a “buy-and-hold” type core holding?

Our in-house criteria parallels much of what has already been published in many Warren Buffett related investment books and the best reference here is perhaps, Buffettology, by Mary Buffett and David Clark.  Our basic buy-and-hold criteria includes such items as: (1) consistent high returns on equity, (2) durable competitive advantage(s), (3) increasing book value over time, (4) low debt leverage, and (4) the ability to reinvest capital at high rates of return.  Although good management is also an important consideration, we do not explicitly go about personally evaluating them.  Instead, we prefer to look at performance records across longer time periods (15 years) where management changes become less of a factor in a company’s performance.  Unique point(s) of leverage, or lever points, as we like to call them, are also important to us. 

 

 

What do you exactly mean by “lever” points?

The term “leverage” is often used in the context of employing debt to magnify a company’s after-tax returns.  Our notion of “lever points” extends beyond this definition to encompass anything that can amplify a company’s performance which, in turn, allows the company to earn an exceptional return on capital.  Some simple examples of lever points include (1) a network which exploits the multiplicative power of Metcalf’s Law, (2) positive float through exceptional working capital management, and (3) public/private market value arbitrage.  Shareholders benefit from these respective lever points via scale economies, interest income, and earnings bootstrapping.

 

 

How long is your typical holding period?

It depends.  Although we prefer to hold our investments with an eye on the long-term, which can be anywhere from one to ten years, we are more concerned about acting rationally when it comes to how best to deploy our partnership capital.  While tax-efficiency gives us an incentive to hold an investment for longer than one year, we find a greater incentive to hold an investment for several years when such an investment can compound our partnership capital internally at consistently high above-average rates of return.  Unfortunately, few companies can consistently deploy capital at high rates of return.  Thus, we are mindful that not all investments may qualify as long-term “buy and hold” type names.

 

 

Do you invest in technology stocks?

Although we can invest in technology, we rarely do because most tech companies do not represent franchises with durable competitive advantages.  We are inclined to believe that the end game for most technology industries is, in fact, commoditization, whereby innovation becomes synonymous with obsolescence.  The unrelenting ambition to populate our world with lower-cost, higher value goods is as great a boon for consumers as it is a bane for shareholders.  Profits are very difficult to achieve in fast changing industries, and for this reason, most technology companies often fail to create and capture incremental value for their shareholders.   The lack of sound economics makes technology a very difficult place to invest for the long-run.    Moreover, many technology companies are known for their liberal issuance of options grants.  Although such grants may be a necessary incentive for employees in competitive industries, the problem of doling out excessive ownership stakes appears endemic to many technology sectors.  For these reasons, we tend to shy from most technology companies.

 

 

Do you ever use technical analysis?

The short answer is “no,” but the long answer is that technical analysis is pertinent insofar as analyzing the then-current holders of the stock.  The fact of the matter is that a lot of people, wittingly or unwittingly, use technical analysis.  Even folks who proclaim themselves as fundamental analysts secretly use technical analysis.  We call such folks: “closet chartists.”  Therefore, although we don’t fancy ourselves to be technical analysts, we appreciate that school of thought enough to take it into consideration when assessing the probable behavior of the holders, and consequently, the probability return distribution of the stock.