A snippet from our first investor letter of 2021. Download the full letter here.
Dear friends and valued investors,
CTG Fluxion, LP advanced +9.04 percent during the first four months of the year while the 70/30 benchmark increased +5.66 percent, the S&P 500 (^SPXTR) by +11.85 percent, and the MSCI All-World Index (ACWI) by +9.34 percent. Our equity portfolio in isolation (ex-cash and hedging) returned more than +15 percent. Hedging for the period detracted roughly -1.7 percent and we held cash as a percentage of the portfolio of ~20 percent on average. The largest portfolio contributors were Loral Space & Communications, Facebook, Dropbox, Vera Bradley, Texas Pacific Land Trust, Icahn Enterprises, CVS Health, and Biglari Holdings. CyberArk was our only meaningful equity detractor at with a -0.6 percent impact.
As you may have noticed by now, we’ve persisted in holding a good proportion in cash in anticipation of, and to be duly prepared for, better buying opportunities. I wrote in our second 2019 letter that cash was “a free option to the long-term investor, providing the ability to purchase better companies at more attractive valuations.” Free was the wrong word. It’s either a valuable option when prices fall (e.g., March 2020) or a costly option when prices rise (e.g., April – December 2020). The cash option’s value is only knowable in hindsight. We got a bit more aggressive last spring, but not aggressive enough. (I’m sounding like a broken record here and perhaps stuck in one of Hofstadter’s Strange Loops.) Ideally, I would prefer our investment holdings make up 90-95% of the portfolio. However, I refuse to be hasty. Unlike most investment vehicles, this one is structured to achieve superior long-range risk-adjusted returns in absolute terms, rather than relative to any particular index’s quarterly results.
We could’ve “juiced” returns in the past through various methods. We have not used leverage and have no plans to, though it could happen given the right confluence of events. We do not sell naked puts and work to avoid asymmetric downside profiles. Indiscriminate leverage and put selling are like deals where you invest $100 and receive $10 most years, then every so often lose $150. Whenever you’re pitched a “stable, 10% p.a.” investment, you can bet your bottom dollar it’s one of these asymmetric downside situations.
During the first four months of the year, we reduced CyberArk and Loral. Otherwise, our core holdings remain unchanged, the five largest being Facebook, GoDaddy, Dropbox, CVS, and Amazon. Both Dropbox and GoDaddy have proven to be robust businesses with excellent underlying performance, though the market hasn’t yet recognized this in the same manner it has with Amazon and Facebook. (Incidentally, each reported excellent first quarter results earlier this month.)
An Ownership Mentality
...my baseline expectation is for a company’s executives to destroy value, particularly when they have little ownership. Seven or eight years ago my wife and I were invited out to a meeting in California put on by a large, well-respected mid-western financial services company. They flew us out, put us up in a nice resort near Santa Barbara, and fed us five-star meals. The firm’s key people were the picture-perfect executive-class—highly diplomatic and respectful, avoiding anything controversial—who I learned had flown in on the company’s private planes. They weren’t shy about how frequently they traveled in style (on the company’s dime). Meanwhile, it wasn’t clear during the conference exactly what was to be accomplished for the benefit of either customers or shareholders. A couple years later a few of these same executives flew down to Nashville on one of the company’s private jets. The purpose was to persuade me to do more business with them. I wondered at the time about the price tag of five executives from a moderately profitable financial services company flying private for an hour-long meeting that could’ve been held by phone.
The firm’s profits were derived mostly from fixed income investments and a loan book. Lower rates persisted for longer than anyone expected, which began to eat away at their bottom line. They bought an emerging market insurance company in an attempt to reinvigorate growth. When that plan faltered, they divested a capital markets division to raise cash when competitors retained or expanded separate business lines. After that they tried a management shake-up. Execs were ousted to no avail. Financial results kept deteriorating even as competitors’ results improved.
I recently received notice that this company was being acquired, no doubt out of necessity. That those luxurious trips and unnecessarily lavish expenses were isolated money-wasting decisions is implausible. The cumulative impact over a decade and a half goes without saying. And to think, all of this for the temporarily comfort of a few executives while destroying value for customers and owners. This is just one of many examples of how a lack of ownership mentality leads to such poor capital allocation and decision making. To be clear, owner-insider’s do not guarantee satisfactory decision making. But it’s terribly difficult to find in their absence.