1H21 Investor Letter
Dear Partners and Friends,
It is with great pleasure and excitement I write to you for the first of what I hope will be many investor letters over the coming years. First and foremost, I’d like to thank you all for your support, encouragement, and most importantly, for investing your hard-earned savings alongside my own. Without you, there is no Shadowridge Value.
Starting a new investment management firm presents an interesting chicken or the egg problem; without an established track record from the manager, there are limited interested investors at the onset. Without investors to help fund operations of an investment firm, you cannot easily build a long-term track record (at least one potential outside investors care about). In response to this conundrum, I simply plan to invest the capital as if it were my own and aim to earn satisfactory returns over multi-year periods without assuming egregious risks. If successful, I think it stands a good chance new investors will be drawn in over time. If you build it, they will come. This under-the-radar, low marketing approach to outside investors certainly won’t appeal to everyone, but more importantly, it will mean building the firm and investing our capital in a way I think is best. To put my money where my mouth is, most of my available liquid net worth is invested alongside you.
During the first half of 2021 (since April when the first accounts were transferred over), returns for the various accounts managed by Shadowridge Value ranged from 1.40 - 45.0%. The median return was 1.8%. On a consolidated basis weighted by average assets under management (AUM), returns across all separately managed accounts (SMAs) were 6.9%. The wide range comes largely from a single personal account of mine which is older and was nearly fully invested vs. new accounts that are 100% cash when they are brought into the fold. As a reminder, separately managed accounts (SMAs) are self-descriptive in that account funds are not commingled and portfolios holdings (and returns) of clients will vary due to the timing of client onboarding as well as my decision-making around the various existing market opportunities and valuations at any given time.
In our search for quality investments at reasonable valuations, I have sought out international markets and found several businesses I like and taken stakes in. As of June 30th, 2021, our portfolio reflected a varied geographic exposure as depicted below. Meanwhile, cash balances as a whole remain elevated at 57.9% as I work to deploy our capital base into compelling ideas as quickly as responsibly possible.
USA - 63%
Australia - 9%
Japan - 9%
Israel - 5.5%
As you know, my goal is to invest with an absolute-returns orientation for double-digit returns over the long-term. In short, an absolute returns orientation means seeking to make investments in businesses that I believe have good odds of providing satisfactory returns, without taking on excessive amounts of risk. Avoiding the latter is important and will hopefully help protect our capital; aka avoid losses that turn out to be permanent (not of the stock price gyration variety). Along these lines, I’ve brainstormed a list of ways to deliberately position oneself to lose money in the stock markets:
· Leverage, particularly when combining operating and financial leverage
· Short-selling or buying securities on margin
· Not understanding the business and/or the risks inherent to the business
· Investing in a business with poor economics and/or long-term prospects
· Overpaying, especially for weak or disrupted business models
· Mis-management and/or major capital allocation errors
· Investing in businesses with complex accounting, manipulated earnings, and/or outright fictitious financial statements (fraud)
· Not doing the due diligence/research to have conviction in your positions
· Forgetting about cyclicality
· Having your equity stake severely diluted
· Holding an investment when the thesis breaks, management repeatedly blunders, or the business simply fails to execute
· Not controlling your emotions
· Buying/averaging down on a company in structural decline
· Selling winners too early
· Over-concentrating
· Over-diversifying
· Dragging your feet on what looks like a good opportunity even if you’re not done with research
· Allowing macro concerns/predictions to scare you out of positions
· Foreign currencies in which you hold investments depreciating vs. the U.S. Dollar (USD)
· Sensitivity to inflation
While not a comprehensive list, I do think this covers a good majority of the ways to go severely wrong when buying stock in a business. Many of these mistakes I have made myself, while others I have learned of vicariously by studying others. Most would be classified as errors of inclusion while a few are more errors of omission (they don’t hurt you with actual realized losses but can be costly all the same).
Rest assured that I will do everything in my power to avoid these hard learned lessons over the years. However, time will prove me wrong in my assessments and I can promise there will plenty of mistakes made in the future by yours truly. Nobody bats 1.000 in investing.
Instead, the main goals from mistakes made will be three-part; 1) to not lose too much when mistakes are made, 2) to recognize and correct the error, and 3) to learn from it going forward. Some of the aforementioned ways to lose money are simply just risks and a cost of doing business that we will accept (FX exchange for example) but do keep them in mind as a client of the firm. They are as a starting point of things I largely shouldn’t be doing, especially if multiple risks are being combined. As an investor, you have a right to bring up concerns along these lines. As the voice over the intercom at the airport says, “If you see something, say something.” I’ll be happy to discuss my perspective at any point in time.
Now let’s get onto priority #1 for the portfolio accounts; deploying the excess cash. Even as someone who values the role of cash in a portfolio, we have too much of it currently. While I won’t yet call it a mistake given the limited duration since the commencement of Shadowridge Value, with the benefit of hindsight, you could make the case that I should have been more fully invested out of the gate. This especially rings true in an environment where stocks repeatedly rise. However, I do believe this cash position will benefit us and I continue to deploy it as time goes on. If at year-end, I am not near 90%+ invested, I think it may be fair to call it a mistake that I did not find compelling enough areas to invest in that timeframe.
The way I see it, there are three possible alternatives to the large cash position we find ourselves with at the onset. The first is to find new investment ideas worthy of our capital. Each day I go to work with this intention and in fact the backlog of names I plan to review and potentially invest in is long and hopefully contains a number of strong candidates. I am optimistic on this front. The larger issue is just the time it can take for one man to get through such a queue and feel confident he did not overlook something important.
The second option is to increase the concentration of open positions we already maintain. This is similarly being weighed and will likely be executed on over the course of the second half of the year. After all, these are companies I already know and like so little incremental work needs to be done before upping allocations in them.
At any given time, I envision us holding anywhere from 12-25 positions in the portfolio. At initial cost, I don’t intend to initiate any position size beyond 15% and realistically, even that will likely take me time to get to. Increasing conviction/concentration is an area I’d like to improve on over time, but for now an initial position is likely to make up no more than 10%. In the interim though, I’d like to get to point where there are perhaps a dozen or so core positions close to that figure with a larger number of smaller holdings comprising the remainder of the portfolio as soon as possible. As time goes on and these businesses hopefully execute, I intend to lean into the winners and “average-up” (increase our allocation at a higher price) provided the forward-looking business prospects and valuation still seems reasonable.
The last option to deploy the cash position quickly is to lower the targeted return threshold for our investments. This alternative I am less enthusiastic about given the long-term goals of the firm, but will consider it all the same. I recognize there is little point in a client paying for an investment manager to hold cash for extended periods of time. Ultimately, I am of the opinion that all three options will play a role in getting us to a point where we are “fully invested.”
Other Operational Notes
Another project currently underway is the development/refinement of a more thorough watchlist. This is essentially a wish list of businesses I’d be interested in our firm owning at the right price and will help organize my research efforts. One challenge in the early innings of Shadowridge Value’s existence has been keeping tabs on all of the businesses and their corresponding market valuations that I review, but don’t initially invest in. In the financial markets, it is not uncommon for a short-lived window of opportunity to exist and potentially pass me by if I cannot get enough confidence in a business from a research perspective. By constantly adding to and revising the watchlist, I am furthering my understanding of various businesses and industries as well as maintaining a watchful eye on valuations in order to be able to capitalize on future opportunities.
Separately, I recently listened to Fred Liu of Hayden Capital interview again with Tilman Versch of Good Investing Talks. In it, Fred spoke of building Hayden Capital as a craftsman pursuing a passion project for himself and finding clients who see value in it, rather than the more typical route of a businessman who creates a product to make money off what customers typically demand. Fred viewed the latter approach as a potential mistake many new managers commonly make when building their investment management firms.
It got me thinking on what and how I would like Shadowridge Value to evolve to over time. While I of course want it to become a viable business capable of sustaining my lifestyle, I don’t want it to come at the expense of materially reduced returns to clients. As a result, I am hereby reducing the performance fee to a 20% take (from 25%) of returns above the 5% threshold. If you are one of our qualified investors, you should see this change come through our custodian, Interactive Brokers by the time you are reading this letter. The fees I currently earn on our limited capital base are not very meaningful in absolute dollar terms, but their potential reduction to partners’ gross returns earned could be. I will contemplate further reductions in the future as I would like the performance fee option to not have any associated management fee, but for now I also want it to cover our extremely low expenses associated with running the firm. As AUM increase whether due to internal compounding or new partners joining us (we’re targeting both), I intend to reduce fees even further.
On that note, if you know any potential investors who have a long-time horizon and the confidence and patience to bet on a new manager, please don’t hesitate to make an introduction. Of course, in line with my beliefs, I will be vetting them from my side just as I expect they will vet me. I will touch on this in later letters, but one huge advantage an investment firm can have is stable investor/partners who provide permanent capital to deploy. As such, appropriate investors for Shadowridge Value will 1) understand business operating performance is more important than short-term stock price movement, 2) want to invest on a multi-year or decade timeline, and 3) can tolerate seeing fluctuations in their holdings.
The next time you will hear from me formally will be after year end to report full year results and more intimately discuss the portfolio and individual positions. If interested, I have attached for your review the short write-up on one of our larger holdings Kelly Partners Group in Australia. Please feel free to reach out with questions or comments anytime. I am at your service.
Thank you for reading.
Sincerely,
Brett Dorendorf
Managing Member
Shadowridge Value LLC
