Nintai Investments average portfolio has done quite well against the market indexes over the year-to-date as well as 1 year and 3 years. Our outperformance has a great amount to do with our returns in Q4 2018 (-2.78% for Nintai Investment portfolios versus -14.33% for S&P 500TR) and Q1 2020 (-12.25% for Nintai Investment portfolios versus -21.08% for S&P 500TR). By keeping an eye out for the downside, we have found returns will do fine over the long-term.
 
Use All Tools Available to Us Now
Fifty years ago, very few investors (individual or professional) had ever heard of behavioral finance. There has been an explosion in the last decade in our understanding about how the human mind thinks about investing, making and losing money, decision making during stressful times, etc. Almost none of it leads us to be better investors. In fact, the field of behavioral finance is largely about avoiding emotional responses and biases in our decision making. Spending a small amount of time understanding the topic and building steps into your investment decision making process can pay large dividends over the long term.   
 
Contrarian Thinking is Even Rarer Today
In 2009 index funds made up roughly 25% of all mutual fund assets. That’s now nearly 50% according to Morningstar. This growth of indexing has taken the art form of stock selection out of the hands of personal and professional investors and simply allowing computers and algorithms to make stock selections. At Nintai Investments, this has created an increasingly large gap between stocks that meet the needs of index funds and those that fall through the cracks. We think – over the long term – it’s never been (other than the 30’s and 40s of the last century) a better time to be an active manager in the value investment field. As jumbo cap companies take up an increasing amount of investment dollars (simply because they must be owned in most index funds), we find there are many small cap gems that are passed over and are diamonds in the rough ready to b scooped up. At Nintai, we strongly believe our performance reflects this type of thinking and success.    
 
Conclusions
 
At the time of writing this article (August 2020), the S&P 500 was on the verge of setting a new high on a near weekly basis. At the same time, roughly 175,000 Americans have died of the corona virus, there has been roughly 5.7 million cases nationwide, and roughly 1,000 additional patients die per day. In the race for a cure, citizens seem to be blissfully ignorant of how long it takes to develop a vaccine, how effective that vaccine will be, and whether we will be looking at a second wave of infections combined with the standard influenza later this fall and winter. In July, the unemployment rate declined by 0.9 percentage point to 10.2 percent, and the number of unemployed persons fell by 1.4 million to 16.3 million. Despite declines over the past 3 months, these measures are up by 6.7 percentage points and 10.6 million - respectively - since February. Huge swaths of the US economy - retail, restaurants, airlines, etc. - continue to face ominous reports that many of their brethren are simply not coming back (In New York City, it is estimated nearly one out of every three restaurants will not reopen their doors). 
 
With all of this going on, it’s hard to get your arms around the enormous gains made in the markets. Are investors simply ignorant, dumb or simply wildly optimistic? It’s hard to know because every bubble or pricey market is unique. There are so many variables it’s hard to build a model that takes everything into account. All that said, we try to keep our thinking straightforward and simple as possible. At Nintai, we think risks far outweigh rewards - this includes earnings growth, interest rates, debt levels, and general economic trends such as our politico-economic relations with China and the EU. We will continue to do what we do best by locating the highest quality companies that have been overlooked by the indexing world and trading at cheap prices relative to our estimated intrinsic value. We will also look for companies with rock solid financials with characteristics such as no debt, high free cash flow margins, and outstanding return on capital. Finally, we will continue to hold lots of dry powder until opportunities come along. We will work hard to avoid any unforced errors and not be rattled by bad news. In the final analysis, when markets are seemingly out of touch with the economy, its best to review your current holdings, work hard on your watch list and be patient. Anything else would be doing yourself and your investors a grave disservice.   

[1] “The Power of Dividends: Past, Present, and Future”, Hartford Funds 2020 Insights. The report can be found here.
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“By then I knew one thing for certain: the Detroit-based auto industry was a debt- enfeebled house of cards that had been a Wall Street playpen of deal making and LBOs for years…it needed nothing so much as a cold bath of free market house cleaning, along with a drastic rollback of the preposterous $100,000 per year cost of UAW jobs.”
                                                                            -      David Stockman[1] 

I’ve been involved in some way in the capitalistic system of the United States since I was 9 years old and delivered 112 newspapers on a route which I biked 6 days a week and collected exactly $21.60 in wages and somewhere between $20 - $30 in tips each week. It was a great experience in learning the core concepts of capitalism - seeing the conflict between management and labor (I couldn’t see why we weren’t paid more on Saturdays as the newspapers weighed exactly 1.8 times more than the other 5 days and it took twice as long to deliver that day’s papers), the importance of customer service and quality (delivering on time and in the location requested by customers meant better tips), and the power of a duopoly (there were only two newspapers in our town - the Concord Monitor and the Manchester Union Leader). My parents didn’t earn a lot of money in those days and sometimes borrowed from my tip jar to help pay the bills. They then scrupulously payed back the exact amount borrowed. I also learned that when Polonius said “neither a borrower or lender be” what he really meant was if you need to be one - be a lender. 
 
Over time, my understanding of the capitalistic system became richer, deeper, and more profound as I helped found a small private-equity firm after earning my undergraduate degree and partnering with two friends who had both money and political connections. By the time I started Nintai Partners I had a pretty good understanding of the nature of competition, profit & loss, the power and danger of leverage, and the strength associated with free cash flow. As I transferred this knowledge from being the CEO of a boutique consulting firm to starting Nintai Investments LLC (a small registered investment advisory firm), I felt I had a very broad – and yet focused – knowledge on the type of company that I believe makes a powerful long-term investment prospect. I operated in this capitalistic system making 
enough profits to help live a life filled with adventure, experience, and more than enough benefits to live quite happily.  
 
My trip down memory lane isn’t the first sign of me losing my mind (at least I don’t think so!). Rather, I bring all this up as I’ve been giving a lot of thought of where my industry - which has been so good to me and so many others - is headed and what changes have taken place over the past 20 - 25 years. As I’ve moved full time into a role as a CEO of an investment advisory firm as well as chief investment officer, I’ve given a lot of thought about my experiences and what they taught me for being a quality investment manager. 
 
In my article last week (“Quality in Investing – Part 2”, August 1 2020. It can be found here.), I ended my discussion about finding quality not just in your portfolio holding but also in your financial advisor. Since my first day as an investment manager I’ve held one tenet as the bedrock of my business values - I have a fiduciary responsibility to my investment partners. This simply means that my actions must take into account my clients first, and Nintai Investments’ needs second. Fiduciary responsibility can be a flexible concept. Some see how much (0.75% or 2%) you charge your clients while others see how (% of assets or 2/20) you charge them as the litmus test for fiduciary responsibility. Others see quality management as investing your own money as you do your clients’ (or as Warren Buffett said, “eating your own cooking” as Nintai does). There are many, many ways to achieve what appears to be a fair and equitable model. At Nintai, we think there are a set of core values that make up good fiduciary guidance and policy. I thought I’d share these with you today. 
 
Our Fees 
One of the questions you have to ask from the onset of opening your doors - and going forward until you close those doors - is the amount you will charge your investment partners for your services. The industry’s view on this has changed dramatically since the onset of “Bogles Folly” - Vanguard’s first index fund. Passive indexing means just that - there is no active component to managing client funds. An index fund simply follows its respective index (the S&P 500 TR, the Russell 2000, etc.) and rebalances once a year. The fees to manage such a fund are miniscule - in today’s world sometimes being less than 0.1% of AUM. It’s really only since around 2000 and the great “Tech Bubble” that saw fees began their dramatic descent. For instance, from 1979 - 1999 the average weighted expense ratio (with sales loads) increased from 1.50% to 1.52%[2].  Since 2000, index funds have hammered the active fund management industry. The average annual management fee for actively managed funds from 2000 – 2019 has dropped 1.52% to 0.74%. Actively managed fund fees have been cut in half in the last 20 years. Overall, you’d think this would be a great trend for those invested in actively managed funds. But not so fast! During the period from 2000 - 2019, the total amount of revenues paid by investors (front end, back end, 12b-1, management fees, etc.) to mutual funds skyrocketed from roughly $45B in 2000 to nearly $107B in 2019. So much for cutting costs in half! In his classic book “The Battle for the Soul of Capitalism”, Jack Bogle writes that during 1997 – 2002 alone, the total revenues paid by investors to investment banking and brokerage firms exceeded $1 trillion, and payments to mutual funds exceeded $275 billion[3].    
 
The arithmetic is simple in calculation and staggering in its impact. Let’s assume an investor starts out by investing $1M in a vanilla mutual fund that earns 6% annually. Let’s also assume a very helpful family member pays the small 0.1% management fee as an incentive to save. That $1M – with no fees – over 25 years would earn $330,000. Added to your initial $100,000 investment you’d have $430,000. Let assume life went another direction and no generous relative showed up and you invested your $100,000 in a fund that charged 2% (that’s not unreasonable for an active managed fund when you include all-in costs such as trading, differences in bid-ask, etc.). Paying those fees you’d earn $170,000. Added to your initial $100,000 investment you’d end up with $270,000. That’s quite a difference from $430,000. A 40% difference actually. So a 2% difference in fees can eat up 40% of your returns[4]. That’s a lot of vacations, anniversary gifts, or heavens forbid medical care if you need it. Where are the customers’ yachts indeed? Where does all this money come from and where does it go? It’s pretty simple. Customers pay the fees and mutual fund executives and fund managers see the profits. As many of us know, paying all these fees doesn’t assure quality or outperformance. Amazingly, even after all these costs the vast majority of managers underperform a simple index fund. In investment management, you rarely get what you pay for when it comes to long-term returns. 
 
At Nintai Investments, we charge 0.75% of all assets under management. We have an internal policy that should an individual’s personal investment account underperform its proxy (generally the Russell 2000 or S&P 500TR), for two straight years we reduce our management fee to 0.50%. After three years of underperformance we reduce the fee to 0.25%. If longer, it’s likely the Board will suggest we look for a career outside investment management! 
 
Our Returns
We’ve all seen the disclaimer (usually in a ridiculously small font) that “past results are no guarantee of future returns” or something of the like. It’s probably one of the most accurate statements you’ll read in all your interactions with Wall Street. Because it is true. As an investment manager myself I have no idea what my returns will be in 1 year, 3 years, or 5 years. I certainly hope they will outperform the greater markets. But in reality I have no idea. Being honest about that to both your investors and yourself must be a bedrock intellectual foundation throughout your investment career. Bad things happen to both parties when a manager loses sight of this. Scenarios from simple pig-headed investment strategies to Bernie Madoff debacles are the inevitable by-product of those who are convinced they know more - and that they will always outperform - the markets in general. 
 
Another critical trait in the investment returns of the great investors is the recognition that if you can avoid the truly horrific downturns (particularly those that permanently impair capital) the upside will take care of itself. At Nintai Investments, we spend an extraordinary amount of time looking for companies that meet our quality criteria (see our two-part series “Quality in Investing” published earlier in July/August 2020) that help us avoid significant drawdowns. If we can find companies with fortress-like balance sheets, strong free cash flow, deep competitive moats and trading at reasonable prices, then we are comfortable (but it is not guaranteed!) that the company can generate adequate returns over the next 10 - 20 years.   
 
Nintai’s clients have been fortunate in that we have - on average - had investment partner portfolios beat the S&P 500TR by roughly 16% since inception and the Russell 2000 (a closer proxy) by 24% since inception. As we are required to say (and understand all too clearly), past performance is no guarantee of future returns. 
 
Our Communication
For decades, the practice of many money managers was to issue an annual letter (or God forbid a quarterly letter!) that briefly outlined fund performance (usually skimpy in numbers or so complicated they were impossible to understand, but no happy medium).  The manager would then spend a vast amount of the report pontificating on where the economy was going, what tax laws were going to change, and finishing with some inexecrable use of industry jargon like “synthetic options triple witching”. Overall, it was a report useful mostly for starting a wood fire or when you run short of vital bathroom supplies. 
 
At Nintai we take a different approach. We like to provide our investment partners with content we’d like to receive ourselves if we were in their shoes. This includes investment cases and valuation spreadsheets on each of our portfolio holdings, quarterly reports which explain – in plain terms – how their portfolios performed, what went right, and more importantly, what went wrong. We want our investment partners to feel just that – partners in making investment decisions. If an investment manager can’t describe why they own a holding, how much that holding is worth, or discuss the major characteristics of the holding (products, services, competition, markets, etc.) then they really aren’t managing anything, other than collecting their fees.   
 
Our Ethics
When individuals discuss ethics, they generally are referring to the investment managers personal ethics – do they have any sanctions or settlements in their past, have they stolen from their clients, etc. At Nintai, we believe that’s important. But equally important is the ethics of both the company and management outside the business. We believe strongly ethics means a positive and active engagement by management in their community, supporting people, organizations (even animals) in need, or helping those who simply need a hand up. It also means the company actively supports charitable giving. We live and work in a system - and country - that has provided us with enormous opportunity. Our corporate ethics requires us to help those who don’t have the same advantages or opportunities. So while we pledge to provide ethical management in our investment business, we also pledge to be ethical in our compensation to support staff, to our vendors who do the hundreds of things that make our business run, and to regulators who have provided us with voluntary guidance and assistance. Next time you think of the ethics of an investment manager, remember they don’t operate in a bubble, or only work with you. Make sure they provide a global view of doing the right thing. It makes all of us better workers, citizens, and human beings on an increasingly integrated planet.    
 
Conclusions
 
I’ve given a lot of thought to the David Stockman quote at the beginning of this article. Here was a man who had everything in the world and yet as a senior partner at a private equity company participated in the very process he so aggrievedly writes about. He is right about nearly everything he discusses without understanding the irony that he helped create and engage in this very activity and helped design the system. His work at Blackstone – and later Heartland – is a record of all the characteristics one should avoid in an investment manager. The fee structure of Heartland Industrial Partners assured the winning hands were weighted heavily against the investor. His returns were abysmal leading to Steve Schwarzman (CEO of Blackstone) cutting him off from investment deals . His record was even worse at Heartland leading to a $340M loss in in its Collins & Aikman investment. His ethics certainly took a hit when federal prosecutors indicted Stockman and the SEC brought civil charges. Both were related to “a scheme to defraud Collins & Aikman's investors, banks and creditors by manipulating C&A's reported revenues and earnings.” In fairness, it should be noted the federal prosecutors dropped their charges in 2009. 
 
When one is looking for quality in an investment manager, I feel strongly the individual should have traits more in alignment with Nintai’s than Mr. Stockman’s. Fees and returns should prove the manager has both the skills and emotions to be a successful long-term investor. Communications between the investor and manager should be clear and concise discussing returns and other issues in a manner where the investor comes away satisfied they know everything necessary to explain their portfolio. Finally, the manager and his/her organization should have a deeply ethical framework in their personal and professional actions and decision making. Finding such a manager might be difficult, but certainly possible. There are many outstanding investors and investment teams who meet these criteria. Choosing one will be one of the best investment decisions you will ever make.  
 
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[1] “The Great Deformation: The Corruption of Capitalism in America”, David Stockman, PublicAffairs, Perseus Books Group, 2013

[2] Securities and Exchange Commission, Division of Investment Management, “ Report on Mutual Fund Fees and Expenses”, December 2000

[3] “The Battle for the Soul of Capitalism”, John C. Bogle, Yale University Press, 2006, page 11

[4] A special thanks to Vanguard for the basis of this example.

Low quality investment opportunities are actually quite easy to stumble on. Having a company implode from over indebtedness, corporate fraud, or simple gross incompetence is remarkably common in today’s “go-go” easy money markets. Finding quality - outstanding management, pristine balance sheets, deep competitive moats, and high customer satisfaction - is actually quite difficult.  
 
At Nintai Investments, we utilize roughly 16 measures that help us create a list of quality companies based financial, operational, strategic, market-based, and competitive characteristics. This leaves us with 41 of 3,671 (1.12%) total United States publicly traded companies, 305 of 17,602 (0.23%) total Asian publicly traded companies, and 88 of 8300 (0.49%) total European publicly traded companies. As one can see pretty quickly, the amount of companies that identify as quality is less than 1% world-wide. 
 
Last week I reviewed what we defined as poor quality at Nintai Investments. One might think that high-quality companies simply feature the opposite traits of poor-quality companies, but that’s not entirely accurate. A quality company has characteristics unique to their category - in much the same way as poor-quality have their own. As Tolstoy wrote, “All happy families are alike; each unhappy family is unhappy in its own way”. 
 
The kind of qualities we look for in at Nintai Investments fall into four key buckets. These include:
 
Excellence in Management: We look for management that have a vested interest in how the company performs (by purchasing shares in the open market, not stock option grants), provide a history of outstanding management candidates (similar to GE’s top 3 candidates for CEO - when one was chosen and the other two were considered outstanding managers in their own right and are expected to leave the company as CEO of another firm), deeply understand they work for both shareholders and their respective community, and finally achieve outstanding results in both operational measures (ROE, ROA) and strategic measures (ROIC, FCF margins). Most important than all of these, we look for management with a clear moral compass. This presents itself in forbidding financial transactions that profit management (such as renting a building they own directly or through corporate ownership), not using off-balance sheet gimmicks (such as special investment vehicles - SIVs), forbidding any type of family interactions with the business (such as placing family members on the Board), and the use of stock options as a transfer of wealth from corporate coffers to management’s pocket book. We feel strongly the fish rots from the head and it won’t be long before that rot works its way downwards.    
 
Create Deep External Facing and Inward looking Moats: In both good times and bad, we look for managers who can create exceptional defensive moats that can keep competitors at bay as well as drive significant value for their customers creating a moat that keeps them from seeking out replacement products and services. Sometimes managers can spend blood and capital digging a defensive moat but they spend little time listening to their customers’ needs. This type of one-way thinking can create significant weaknesses in looking for new offensive opportunities in existing customers, markets, or adjacent markets. An inward looking moat means management has developed the means to make their products and services essential to their customers’ strategy and operations. This type of in-depth value - for lack of a better term “the tape worm approach” - demands a nearly constant improvement in quality, scope of offering, and new products/services on a daily basis. It’s hard to find management and corporate structures that have the drive to approach each work day as means to radically improve their value to their clients. A great example of this is Veeva’s constant evolution of products and services in the biotechnology industry. In the past 5 years the company has launched 116 new offerings and made over 1200 changes to existing offerings. That’s a launch or change nearly every 2 days.        
 
Creates a Rock Solid Financial Castle: At Nintai Investments, we look for investment opportunities that can survive the most violent shock to its foundations. This can include a sudden elimination of access to any capital (the type of shock that overcame the financial markets in 2007 - 2009), a rapid increase/decrease in the Federal Reserves’ prime rate, or the LTCM failure demanding government intervention to stave off financial disaster. All of these led to some form of catastrophic market failure.  We look for a company that is reliant upon no one or no institution for survival or financial bailout in a time of market crisis. This requires a balance sheet with little to no debt (or the ability to pay 100% of liabilities with 1 year of free cash flow), high free cash flow yield, and outstanding returns on capital, equity, and assets. This demands we focus on cash rather than earnings because we believe in Alfred Rappaports’s “profits are an opinion, cash is a fact”. We recognize its is very difficult to sniff out financial shenanigans if management is intent on cheating and the consequences be damned. But we think keeping a hawk eye on cash gives us the best chance to avoid partnering with an unethical management team. 
 
A Singular Focus on Market Domination: We look for companies that seek to wholly dominate a market so large that the runway for growth is roughly 15 – 20 years. We want to know with some assurance the company will be in the same markets (or adjacent ones) dominating them with high market share, outstanding returns, and great gross and net margins for an extended period of time. Obviously it is difficult to find a company that operates in a monopoly or duopoly environment at a discount to our estimated intrinsic value, but it is possible in the micro to small-cap markets. Examples of this include iRadimed (IRMD), Computer Modelling Group (CMDXF), and Veeva (VEEV). Finding these hidden gems – which requires an awful lot of research and industry knowledge - can successfully drive investment returns for decades. We’ve often stated that two companies - Factset Research (FDS) and Manhattan Associates (MANH) - drove nearly 80% of the Nintai Partner’s internal investment fund’s outperformance. We still believe a combination of these gems with some larger companies that meet our criteria can provide outperformance with less risk. 
 
A Final Note
 
I would be remiss to say that successful investing isn’t about just quality companies. We firmly believe your financial investment advisors core intellectual (and emotional) models matter equally. These models should include acting on facts rather than emotions (in both bull and bear markets), always being intellectually open to new ideas, new industries, and new companies, being humble about your success and even more humble about failures, and reveling in diagnosing and discussing investment screw-ups. I’ve found over the years the latter is one of the greatest distinctions between Nintai and our competitors. While we have the same animal spirits as others in this field and are driven by our competition, we actually enjoy writing about our mistakes. Perhaps enjoy is too strong a word (after all we hate losing our investment partners’ hard earned capital), but we find discussing these occasional debacles helps ground our egos and forces us to better understand what happened, why it happened, and how to prevent it from happening again. So while quality investments drive returns, an investment manager should have qualities of excellence as well. 
 
We look forward to hearing your thoughts and comments. 
 
DISCLOSURE: Nintai Investments LLC has positions in iRadimed, Computer Modelling Group, Veeva, and Manhattan Associates in either or both business investment accounts or individual investment partner accounts.       
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