As you all know, I absolutely hate to underperform - even in the short term. The last 90 days has been extremely difficult with nearly every holding in our portfolios underperforming against the general markets. Reversion to the mean - to the downside - is not nearly as fun as the ride up. Whenever we have a stretch of underperformance here at Nintai, we do several things. First is get outdoors and get some exercise. This gets me away from the computer and reduces the risk of making a hasty decision that will likely only enhance the problem. The second is I think of a story about Lyndon Johnson and John F Kennedy. On election night of the 196o Presidential race there was a great deal of tension at the Kennedy headquarters as returns coming in showed the results were going to be very close (it was - Kennedy won the total popular vote of 64,329,141 by only 112,827 or 49.72% to 49.55%). In the middle of this chaotic night, many people remember Lyndon Johnson - the Democratic Vice Presidential candidate - calling John F. Kennedy - the Democratic Presidential Candidate - and saying to him “I heard you’re losing in Ohio but we’re winning in Pennsylvania.”
As an investment advisor (and investor), I’ve never been impressed with money managers who take the LBJ way when it comes to reporting results. Many of them seem to live by the ancient Chinese proverb that says “victory has a thousand fathers but defeat is an orphan”. There will be no lonely orphans running around the Nintai Investment’s offices. The last three months have been tough on our portfolios. Though still up over the long term, these poor returns have eaten up half of our total outperformance. No one is responsible for that except me. I apologize for that.
Being a value investor - particularly with other peoples’ money - is not easy. You are sometimes faced with very difficult choices. Occasionally share prices will dance right around purchase or sell prices but never send a clear signal. Sometimes company’s may take on debt yet remain an outstanding investment opportunity. These types of situations can challenge your investment strategy, your investment criteria, or both. Yet we get paid to make decisions (and that may mean doing nothing) in each of those scenarios.
The most difficult situation is when market currents flow in conflicting directions. During these times it seems like any investment decision is a “damned-if-you-do” or “damned-if-you-don’t” proposition. We are currently stuck in an unfortunate market situation where four underlying forces are at work.
- the general markets are overvalued;
- many individual positions in our portfolios are overvalued;
- all the companies in our portfolios - in our estimation - are tremendous long term holdings;
- We find it impossible to time when - or if - prices will become more rational
These four currents have put us in somewhat of an investing bind. I thought I’d share some thoughts on each of these so my readers can better understand Nintai’s decision making process.
General Markets are Overvalued
Just recently (September 8, 2020), Stanley Druckenmiller (who I admire a great deal) stated the markets are in an “absolute raging mania”. Morningstar would disagree with their “Market Fair Value” calculator showing a price to fair value of 1.01 (or 1% above fair value). Who’s right? Darned if I know, but I certainly lean more towards Druckenmiller’s view than Morningstar. It would seem to me a move from a market average PE of 14.8 in 2010 to 28.7 in 2020 is - in general - excessive.
Individual Portfolio Positions are Overvalued
In November 2016 when we first started building out the Nintai Investment model portfolio, the average PE was 16.7. By September 2020 this has jumped to 25.9 with 7 out of 21 portfolio holdings having a PE of 40 or greater. In addition, the portfolio price-to-fair value has jumped from 0.91 (or 9% below fair value) to 1.07 (or 7% above fair value). We are in the very difficult position of holding a selection of outstanding companies with a many significantly overvalued. Do you hold on to these no matter what? Do you sell a portion? Do you sell the entire position with the hope to reinvest again after the price drops? There’s no easy answer to these questions. We’ve unfortunately chosen to sit tight and have lost some of the gains by not taking profits when we could. As Warren Buffett would say, we’ve been guilty of thumb sucking.
All Our Portfolio Companies are Long-Term Holdings
As I mentioned earlier, all our portfolio holdings are led by outstanding capital allocators, have significant competitive moats, and maintain outstanding financials. We look to hold companies like this for decades and let management do the heavy lifting. As most of our investment partners have seen, Nintai’s typical turnover (unless receiving new assets on a regular basis) is less than 5-10% annually. We hate to take profits for several reasons. First, we have to be cognizant of taxes for most of our partners’ portfolios. Second, we hate to dilute or lose any part of a holding in such an outstanding company. Last, we have no idea what the short term price moves will be. For every price drop that takes place after taking some profits, there is an instance where the stock jumps by 30% the day after our sale.
We are Terrible Market Timers
Which brings us to market timing. Even though many of our portfolio holdings are overvalued, we recognize that we have absolutely zero skill in timing the markets. We don’t believe many of our fellow investors have that skill either. We generally purchase shares of a company regardless of what the markets are doing. An example of this is a large pharmaceutical company. We are currently conducting in-depth research on the company and may purchase it into partner portfolios even though markets are flirting with new highs on a near daily basis. Our investment decisions are based on individual corporate valuations alone.
The last year has shown the benefits and costs of a long-term investment horizon combined with high quality investment holdings. The first nine months were dream-like with the average Nintai portfolio returning 30 - 35% versus the S&P 500’s 15.8%. The next three months saw a horrible reversion to the mean with the average Nintai portfolio returning 5 - 7% versus the S&P 500’s 11.7%. Rather than taking the LBJ route (“we in Ohio versus you in Pennsylvania”), we recognize I am responsible for both the first 9 months as well as the latter 3 months of the past year. I have assured our investors we will take a look at these returns to see what learnings can be found to prevent such underperformance in the future. I’ve learned over my career sometimes you can find ways to improve and sometimes you are simply the victim of reversion to the mean. Either way, we will work hard to better understand the nature of our returns and report back to our investors any steps taken to improve our process.
I hope everyone is staying safe, wearing your mask, and practicing social distancing. If you have any questions or comments, please feel to reach out.