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Last investment letter by Mr. Vito Maida


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http://www.patientcapital.com/news

The Winter 2017 edition is out.

Mr. Maida shares his usual concerns and wonders about notable investors going all in.

He also takes a shot at the "Cult of Buffett". Price is what you pay and value is what you get sort of analysis. Interesting take on trade-offs in investment decisions.

He reports a 7.0% return since inception (early 2000), before fees and expenses.

From the letter, we can infer that he has maintained a high cash and cash equivalent balance overall.

His conservative approach is heavily weighted towards downside protection. Since inception, this has "cost" some return.

But, you know what they say, past returns are not indicative of future results.

I would submit (opinion) that, going forward, that cost may have more embedded value.

I have respect for him and would advise my estate to consider him given his long term patient and prudent perspective.

For now, going all in, be more selective than ever or somewhere in between, that is the question.

 

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From the letter, we can infer that he has maintained a high cash and cash equivalent balance overall.

His conservative approach is heavily weighted towards downside protection. Since inception, this has "cost" some return.

 

I realize I have an issue with holding cash as "downside protection". This probably jives with racemize's white paper on holding cash.

 

First, from an outcome-oriented analysis: I think only Baupost has been able to actually post "great" return while holding a sizeable chunk of cash relative to the portfolio size. And what Klarman invests in, I have no idea what his thinking is so I can't comment on that. Maybe he's just that damn brilliant. The dude is holding 20% cash and beating the market in weird pharma stocks. But otherwise, I can't think of an investor holding 20+% cash and outperforming.

 

Second, from a process-oriented perspective: First let me refer back to Buffett's partnership letters (maybe too cultish, bear with me). My recollection may be poor, but I think I recall this (correct me if I am wrong, please): Even back in his day, his downside protection was conservative BUSINESSES. Not conservative position sizing. His idea was, "let me be fully invested, but I will invest in "generals" (i.e. my non-arbitrage/control positions) that I think will fall LESS during a downturn". Equal upside compared to the market in general, less downside.

 

I think this gives you options. Over the long-term, the market will rise. Cash sucks in the long-term. So in theory, your portfolio will rise with the market. When a crash hits, your portfolio does not tank as much. On a relative basis, you can then deploy more capital vs. your peers.

 

This was always my understanding of his approach. Look for stable cash flows first (which protect your downside) and let the general rise of the market do the rest.

 

So that is what I understand as a conservative investment approach. Holding onto 20+% cash (or whatever percentage) seems like a really poor decision.

 

The critic could say: I am looking at the past 5-10 year bull market and saying "well of course you want to be fully invested". That may be true. Look forward to the board's thoughts.

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From the letter, we can infer that he has maintained a high cash and cash equivalent balance overall.

His conservative approach is heavily weighted towards downside protection. Since inception, this has "cost" some return.

 

First, from an outcome-oriented analysis: I think only Baupost has been able to actually post "great" return while holding a sizeable chunk of cash relative to the portfolio size. And what Klarman invests in, I have no idea what his thinking is so I can't comment on that. Maybe he's just that damn brilliant. The dude is holding 20% cash and beating the market in weird pharma stocks. But otherwise, I can't think of an investor holding 20+% cash and outperforming.

 

 

We're no Baupost or Klarman, and we manage a fraction of what they manage, but we've averaged at least 20% cash historically and beat the market from May 2005 when we launched.  Bull market, bear market, bull market, sideways market, bull market...we just keep chugging along.

 

And you can check it for yourself in our Annual Reports by simply adding cash at brokers to any T-bill securities we held!  Yet, like so many managers, we struggle to find partners and keep the ones we have.  Go figure!  Cheers!

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From the letter, we can infer that he has maintained a high cash and cash equivalent balance overall.

His conservative approach is heavily weighted towards downside protection. Since inception, this has "cost" some return.

 

First, from an outcome-oriented analysis: I think only Baupost has been able to actually post "great" return while holding a sizeable chunk of cash relative to the portfolio size. And what Klarman invests in, I have no idea what his thinking is so I can't comment on that. Maybe he's just that damn brilliant. The dude is holding 20% cash and beating the market in weird pharma stocks. But otherwise, I can't think of an investor holding 20+% cash and outperforming.

 

 

We're no Baupost or Klarman, and we manage a fraction of what they manage, but we've averaged at least 20% cash historically and beat the market from May 2005 when we launched.  Bull market, bear market, bull market, sideways market, bull market...we just keep chugging along.

 

And you can check it for yourself in our Annual Reports by simply adding cash at brokers to any T-bill securities we held!  Yet, like so many managers, we struggle to find partners and keep the ones we have.  Go figure!  Cheers!

 

When is your annual report out?

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Starting to see the bigger picture here. I realize that the administrator is the soul of this forum.

Apologies for the Fairfax punches. I accept the fact that my working hypothesis is taken as wrong.

We all face our potential Waterloos. (Maybe polite dissenting voices should be heard)

 

Yes, downside protection, patience and prudence are not fashionable these days. I like though the idea of chugging along ahead of the markets over long periods AND sleeping well at night.

 

LC, thank you for your post. I aim to dissect specific ideas but this is a major question for me right now and I assume that it is also relevant for some.

You see, when I read your post I agree completely. I reviewed the work done by racemize (thank you) and I nod yes reading the analysis and the conclusions.

However, the difficulty I have (trying here) now is that I don't see opportunities. The obvious answer is to consider trade-offs like Mr. Maida suggests and to expand the opportunity set.

Reference to Mr. Buffett in the early days is very relevant. His actions have been studied but he is not the kind of guy to show all his cards. My understanding though (early 70's period) is that he was pretty much fully invested and possibly sold positions that suffered less in order to buy deep bargains (eg Washington Post). That makes sense. Giverny Capital, an investment firm I follow from the outside and who I respect have shown long term decent returns using this approach.

But, right now, even if I kept everything in cash, my inner circle has enough to last expected life remaining and more. The idea (fun) is to get closer to the returns that Mr. Buffett was having during his early periods by adapting the model. When you change something, the aim is to improve, but this is a Bell curve in the aggregate.

Perhaps I need to get rid of biases and misconceptions but I just looked at my portfolios in 2008. Outside of cash and equivalents, the only holdings mostly left were FFH, ORH(OdysseyRe) and Gold. Looking back, I have difficulty believing that I held gold bars in some vault at some point. This was primarily the result of limited opportunities which I realize in my case tends to be correlated with overall poor returns going forward for the markets in general. A similar situation occurred during the dot-com bubble.

I want to adapt, but for the better. I want to be convinced that I need to be more fully invested. The easy answer is to expand the opportunity set and accept trade-offs. Somehow though, I submit that this may not be the best time to switch hats. We'll see.

 

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The real question you have to ask those funds who hold large amounts of cash, is the manager an asset allocator or a security selector.  For most folks, the decision is two decisions.  The first is asset allocation between a risky asset (like stocks) and a less risky asset (like bonds).  The growth objective & volatility tolerance will determine the allocation between the risky & less risky asset.  The second is the specific funds used for each asset type (risky & less risky).  It is a challenge to have funds that straddle the two asset types.  Also, there is the issue of fees & paying fees on cash.  As LC stated above the opportunity cost of holding cash is high especially if the fund is in the risky bucket & is expected to obtain a return to meet a growth objective.  Racemize's study is also insightful in that in all cases of trying to time the mixing of cash & funds do not provide higher returns.  Damodaran has tried to find a system based upon valuation metrics to time the market & has found none.  The best strategy appears to be exposed to risky assets unless there are extreme valuations as the opportunity cost of cash is high.  Two of the smartest guys I know (Buffett & Bogle) have provided rare signals of overvaluation that should be heeded.  They both gave signals that the markets were too high in 2000 & they have not given these types of signals to date. 

 

Packer 

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From the letter, we can infer that he has maintained a high cash and cash equivalent balance overall.

His conservative approach is heavily weighted towards downside protection. Since inception, this has "cost" some return.

 

First, from an outcome-oriented analysis: I think only Baupost has been able to actually post "great" return while holding a sizeable chunk of cash relative to the portfolio size. And what Klarman invests in, I have no idea what his thinking is so I can't comment on that. Maybe he's just that damn brilliant. The dude is holding 20% cash and beating the market in weird pharma stocks. But otherwise, I can't think of an investor holding 20+% cash and outperforming.

 

 

We're no Baupost or Klarman, and we manage a fraction of what they manage, but we've averaged at least 20% cash historically and beat the market from May 2005 when we launched.  Bull market, bear market, bull market, sideways market, bull market...we just keep chugging along.

 

And you can check it for yourself in our Annual Reports by simply adding cash at brokers to any T-bill securities we held!  Yet, like so many managers, we struggle to find partners and keep the ones we have.  Go figure!  Cheers!

 

I hereby amend my statement: only Baupost and Corner Market Capital :)

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I can't speak for anyone else, but I can speak for myself: I remember posting maybe...1-2 years ago about how I was 25% cash. Cue the regular reasons: market highs, potential overvaluation, lack of opportunities, dry powder, etc. Looking back, I think I only held cash out of fear. Maybe that is easy to say with 20/20 hindsight. I don't know.

 

But all 4 of those reasons are bullshit:

 

The first 2 are flat out guesses on the overall level of the economy. Essentially a macro call. So even calling yourself a value investor, ignoring the "macro" etc., I still fall into making a macro call and disguising it to myself. Fear.

 

The second 2 are not real reasons either. Let's say I need cash. Sell something. Let's say I find an incredible opportunity. Sell something.

 

Well, I paid for my decision (in opportunity cost), and am only realizing it a year+ later. Stupido :D 

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Two of the smartest guys I know (Buffett & Bogle) have provided rare signals of overvaluation that should be heeded.  They both gave signals that the markets were too high in 2000 & they have not given these types of signals to date. 

 

 

Not explicitly, but Buffett is sitting on a lot of cash.

 

I think cash has a lot to do with your personal psychology.  If you hate watching the market go up while you're in cash, you'll be fully invested.  If you hate the feeling of having no dry powder, or you prefer only to invest in a limited number of highly undervalued things and cash is the residual of your position sizing, you carry quite a lot.  I'm in the latter camp and although I can't claim a 20% CAGR, I've outperformed. 

 

My point, really, is you're likely to make good decisions when you're psychologically comfortable, and so the best strategy for one person might differ from another's.

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He is holding cash but for reasons that are N/A to me.  He owns an insurance company & has claims to pay & owns businesses that generate tons of distributions.  He also has been explicit that he does not think stocks are expensive if interest rates stay where they are today.

 

I agree that comfort is important in selecting asset allocation but do you want to do this or do you want your fund ymanager to do this.  The Buffett compensation scheme of incentive fee above a certain floor incentivizes the manager to invest versus hold cash.

 

Packer

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He is holding cash but for reasons that are N/A to me.  He owns an insurance company & has claims to pay & owns businesses that generate tons of distributions.  He also has been explicit that he does not think stocks are expensive if interest rates stay where they are today.

 

I agree that comfort is important in selecting asset allocation but do you want to do this or do you want your fund ymanager to do this.  The Buffett compensation scheme of incentive fee above a certain floor incentivizes the manager to invest versus hold cash.

 

Packer

 

Didn't mean to suggest his reasons were applicable to everyone.  And re: my fund managers, I want them to invest in whatever way works for them.  If they have 90% in cash and invest 10% each year in one idea that doubles, they'll compound faster than the market averages over time even after a 1% fee.  If it works for them it works for me!  I invest in managers that are fully invested and some that are not.

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I think we are sitting mid way through 2007.  Aside from the charts Maida has shown I have seen another that shows S&P GAAP EPS, unadjusted.  GAAP earnings have not grown since 2011.  Will post the chart when I find it.  Adjusted, or phony accounting earnings have grown, but not GAAP. 

 

Interest rates are going up.  A quarter point on a 20 T, Federal Debt is 50 B per year. 

A few such increases will make Trumps tax cuts look rather lame.  Before you all rush to correct me I realize that it is not that dramatic, due to curve variations, and so forth, but it is a headwind.  If the fed. does two more raises this year then borrowing costs will have doubled at the short end in one year.  Government and companies fat with debt will at some point have to roll it over at higher rates.  Or issue shares to pay it down which tends to dilute earnings. 

 

As to Buffett, we all know he thinks long term, into and past the next crash.  Berk. is not exactly blowing the budget buying stock.  The cash is piling, and allowing Brk. to be the saviour of last resort on an even bigger scale than before.  May Warren live to see the day. 

 

I am I full delevering mode.  I haven't been this worried since 2007.  There are simply no GOOD values to be found right now.  The dividends flow through the door.  I see no compelling reason to go down the quality curve (been there, done that).  I have cleared all the garbage out of my portfolio, and am now starting to whittle away the really great stuff.  And yes, I am still > 100% invested, about 115% at the moment.  Hoping to get to 100 % over the next few months.  This is way below where I was at when I went into the 2008 crash. 

 

I want resources available when the crash comes.  Since world governments have no ammo to prop anything up this time, any downturn will be long and painful. 

 

 

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Mr Maida, in his letter, comes to the conclusion that the recent election does not essentially change the global investment picture. I would tend to agree.

LC, feedback appreciated. You clearly spell out a position and openly recognize what you consider to be a mistake. I really respect that. I will try to do the same if and when needed.

At the end of the day, I agree that your "exposure" to "risky" assets is a personal decision especially if you don't manage funds for others.

Here, I will keep looking for opportunities and, whatever the context, remain ready to deploy funds in a big way.

I tend to hesitate about the "trade-offs" that Mr. Maida describes especially now. I would tend to side with Uccmal but "delevering" has gone down much further for me. Delever in order to deliver.

I think Mr. Munger has mentioned that Benjamin Graham's results would have been better during his later investment career if he had not been shaken by the 1930's period. Despite the bumps that we went through in the last few decades, can we not say that times have been good? I wonder if some famous investor in the future will reflect on today's time as unusually complacent? Carpe diem?

 

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I keep thinking about Munger's rule of inverting.  Rather than to prove that markets are over valued. 

 

What is in the works that could make them go higher?

 

1) Dropping interest rates (no)

2) Central Bank intervention (there out of ammo).

3) Increase in corporate and or government debt (maybe for a short while)

4) Border tariffs and protectionism (not likely)

5) Sudden innovation or continued innovation in IT sector (May be a short pop but firing people has a way of dampening economic growth)

6) US tax cuts (might help but will raise government debt)

7) China & India (maybe/maybe not)

8) Demographics (not exactly working in the markets favour)

9) Increase in buying by consumers (Looks to be peaking to me - especially big ticket items)

10) Europe - see demographics

11) Dumb money entering market (ETF inflows have been huge).

 

Dumb money entering the market via ETFs seems to be the biggest driver at the moment for overall markets rising in the past couple of years.  I think the dumb money is going to panic at some point.  ETFs, while a good idea, have now become a juggernaut that can work the opposite way, very quickly.

 

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I can't speak for anyone else, but I can speak for myself: I remember posting maybe...1-2 years ago about how I was 25% cash. Cue the regular reasons: market highs, potential overvaluation, lack of opportunities, dry powder, etc. Looking back, I think I only held cash out of fear. Maybe that is easy to say with 20/20 hindsight. I don't know.

 

But all 4 of those reasons are bullshit:

 

The first 2 are flat out guesses on the overall level of the economy. Essentially a macro call. So even calling yourself a value investor, ignoring the "macro" etc., I still fall into making a macro call and disguising it to myself. Fear.

 

The second 2 are not real reasons either. Let's say I need cash. Sell something. Let's say I find an incredible opportunity. Sell something.

 

Well, I paid for my decision (in opportunity cost), and am only realizing it a year+ later. Stupido :D

 

As we prefer to sell, hold cash, then repurchase .... to many we would be considered 'high cash'; when in fact it's anything but - as the cash is committed. Point is that 'cash' really means 'uncommitted cash' + remaining margin capacity + (option strike price - premium) x # of shares.

 

The option position is more subtle, but obvious if you consider Taleb's Antifragile.

 

Imagine you bought 1000 shares at 10, the price today is 15, & you can get a 1 yr call option with a strike at 15 for 2.50. You are concerned there may be be a blow-up, have no idea as to timing, & suspect that things will get more extreme between today & blow-up date. You could;

1) Sell today, sit on a T-Bill, & wait. Cash of 15,000, gain of 5,000, zero risk

2) Do nothing today & buy additional shares on margin, on the dip. No cash, uncertain gain, high risk

3) Sell today & replicate with options. Cash of 12,500, gain of 2,500, zero risk, uncertainty working for you

 

If you're retail you might go with 1), if you're institutional you might go with 3). Point is that 3) is also a source of cash.

 

Obviously not for everyone.

 

SD

 

 

   

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I can't speak for anyone else, but I can speak for myself: I remember posting maybe...1-2 years ago about how I was 25% cash. Cue the regular reasons: market highs, potential overvaluation, lack of opportunities, dry powder, etc. Looking back, I think I only held cash out of fear. Maybe that is easy to say with 20/20 hindsight. I don't know.

 

But all 4 of those reasons are bullshit:

 

The first 2 are flat out guesses on the overall level of the economy. Essentially a macro call. So even calling yourself a value investor, ignoring the "macro" etc., I still fall into making a macro call and disguising it to myself. Fear.

 

The second 2 are not real reasons either. Let's say I need cash. Sell something. Let's say I find an incredible opportunity. Sell something.

 

Well, I paid for my decision (in opportunity cost), and am only realizing it a year+ later. Stupido :D

 

I think your are unnessarily hard on yourself.  Fear is not a bad thing.  If things had gone down, then you would have felt pretty smart getting 50% off some decent stocks, and having that cash available.

 

And paying attention to the Macro is not a bad thing either, for a value investor.  In fact its sensible.  There is no tangible reason why markets have gone up this much in the last few months.  Earnings have not risen.  GDP has not accelerated anywhere.  Inflows into ETFs have skyrocketed. 

 

This notion of animal spirits being unleashed in the US is turning out to be the biggest pile of nonsense in years.  There isnt going to be very much deregulation, fiscal stimulus, or anything else useful until a massive market crash and nasty recession gets their attention. 

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Uccmal,

One of the great things of this forum is to read stuff that resonates with our own thought processes.

I find that what you write is useful and hope to eventually contribute too in a material way.

I will keep a safe distance though and will not hesitate to challenge you (politely).

This is a period of relative hibernation but I'm sharpening my pencil.

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