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Jean-Marie Eveillard on China vs. India

September 15, 2017 in Asia, Asian Investing Summit, Commentary, Macro

In Jean-Marie Eveillard’s Q&A session at Asian Investing Summit 2017, a member wrote in a question about the very long-term prospects of China vs. India, i.e., over the next two decades or more. The questioner paraphrased Charlie Munger who has reportedly said that India has taken the worst aspects of democracy and tied its economy in knots because of that. As a result, Munger has been much more bullish on China.

Meanwhile, Rahul Saraogi, Managing Director of Atyant Capital Advisors and instructor at Asian Investing Summit, has in the past forcefully argued that India is building its future on a much more solid foundation than is China. Rahul essentially argues that China’s command-and-control economy suffers from major mis-allocations of capital stemming from massive government intervention. Meanwhile, India has let the competitive dynamics of free market capitalism take hold, with much less government intervention than is the case in China.

So what is Jean-Marie Eveillard’s take?

While acknowledging his respect for Charlie Munger, Jean-Marie left no doubt which country he sees ahead over the very long term.

Consider his remarks:

I hate to disagree with Charlie Munger because I admire him considerably. Warren Buffett concedes that he was pushed to some extent by Charlie Munger to develop his own approach of looking at businesses with sustainable competitive advantage. I hate to disagree with Charlie Munger but I think Mr. Modi has already taken steps and may make a difference.

A day after Jean-Marie Q&A session, we had an opportunity to pose the question of India vs. China again to Rahul Saraogi. His answer was nuanced and enlightening:

India versus China is a bad comparison. China has ~1.3 billion people, India has ~1.3 billion people, but that is where the comparison ends. China is a $9 trillion economy, India is a $2 trillion economy. India is not even in the same league. China has done a terrific job of pulling a lot of people out of poverty. It is easy to belittle a capital-intensive growth model and infrastructure build-out growth model [but] they are the envy of the world. The U.S. would like to do it today, but it is very hard when you have to get things through Congress and the court system. China is able to rally its local and state governments to build the things that it has built. In one generation, they have pulled a lot of people out of poverty.

India has too much due process. It has a lot of democracy, and it has those issues. Having said that, as investors we are not here to pass value judgments on which model is right. The only thing that matters is margin of safety and upside; I call that asymmetry. From my perspective—I’m making a figurative statement—India is at a “5”, and China is at “90”. I don’t see China going from 90 to 100. China might come down from 90 to 70, and India might go from 5 to 10. At 10, India is still going to be a minion compared to China at 70. China is not going to go away as an economy, it’s not going to become smaller as an economy. But as an investor, a move from 90 to 70 is very different from 90 to 100 or 110 or 120, which is what China was doing for the last twenty years. From India’s perspective, if it can double from an economic perspective, it will probably not get to where China is given the baggage of democracy, but it still makes a pretty good hunting ground for investors.

When we invest, the only thing that matters is, where are we coming from and where are we going? I need to give that context. India’s act looks pretty cleaned up. It is probably headed from “5” to “10” over the next several years, which is a great environment in which to pick stocks.

replay the keynote Q&A session with Jean-Marie Eveillard

replay the session with Rahul Saraogi

Value Investing in Asia — Navigating Threats and Opportunities

September 15, 2017 in Asia, Audio, Equities, Featured, Interviews, Latticework, Latticework New York, Transcripts

Adam Schwartz, senior managing director of First Manhattan Co., and Sean Huang, managing director and portfolio manager of First Beijing, joined the MOI Global community at the Latticework 2017 summit, held at the Yale Club of New York City in September.

We are pleased to share a transcript of the session with members.

The following transcript has been edited for space and clarity.

Shai Dardashti, MOI Global: We have Adam Schwartz and Sean Huang joining us from First Manhattan and First Beijing. Sean flew in from China to be here. Adam Schwartz is the Chief Disruption Officer at First Manhattan Co., which is quite applicable for this context.

I’m hoping we will explore a few nuances: First Manhattan is transferring knowledge across geographies, applying institutional knowledge from North America into the Asian context — so understanding how First Manhattan is transferring knowledge. We also have the nuance of figuring out Asia, from a standing start — how do you unpack Asia? We are going to learn from great first-hand experience, we are very honored to have you here with us, in person.

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GlobalSCAPE: High-Quality Micro-Cap Software Business

September 15, 2017 in Equities, Ideas, Information Technology, Micro Cap, North America

GlobalSCAPE is a ~$90 million market cap company (assuming all outstanding options are exercised) operating in the managed file transfer (MFT) software space. The company has a number of exceptional qualities, including a high margin, recurring revenue maintenance and support stream, a strong balance sheet, a history of exceptional growth, and sustainably high margins. Despite all this, there are some uncertainties relative to the longer term competitive positioning of the company. This, combined with recent accounting issues that are still unfolding, provide some uncertainty to the situation. Nevertheless, I believe that an adequate margin of safety is currently provided given the current FCF yield on EV of ~11%.

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Fear of Crashes and Bubbles is Bad for Health

September 15, 2017 in Commentary, Equities, Europe, European Investing Summit, Macro

This post is authored by Christian Kahler, chief equity strategist of DZ BANK and instructor at European Investing Summit. Christian is among a small group of sell-side practitioners who embrace value investing. He publishes VALUE IDEAS research.

If you ask experienced investors what occurs to them spontaneously regarding the equity market in the eighties they would presumably say “the October crash of 1987.” Bond investors harking back to the nineties often mention the bond market crash of 1994. Is it worth investing in the emerging markets? – A currency crisis like that in 1997 could be looming. Tech stocks around the millennium? Wild dreams about the possibilities of the internet that were followed by a crash. The financial crisis and the Lehman bankruptcy in 2008? Bankers carrying cardboard boxes out of a skyscraper, including a stock market crash, German state-owned banks were also involved.

Even those investors who were not directly involved in these events (e.g. the millennials) are constantly reminded of them. Television images and newspaper reports of anniversaries or interviews with the “crash prophets” have burnt these memories permanently into the brain-synapses of many an investor and non- investor. Who is interested if the crash experts proverbially predicted “15 of the past two” collapses correctly? After all, they need to be mentioned to justify their existence. Such observations are all-pervasive. It is often a case of the newspaper publisher’s motto “a successful aircraft-landing doesn’t sell.” Only crashes make the headlines. Gold is then played as the trump card as an investment vehicle – as though the much-cited baker during the war could with impunity pile up gold ingots in the cellar for the bread rolls he sells. This argument goes down particularly well with German investors, after all the experience of hyperinflation in the twenties has been passed down by word of mouth and in writing from one (investor) generation to the next.

In fact, the DAX and S&P 500 rose three and fourfold in the “awful” eighties. In the nineties things went even better before a few disappointing years came after the millennium. Since the beginning of the seventies German shares have increased by a factor of 26, in the case of the S&P – including dividends – they have even risen 125 times on initial prices. This corresponds to annual returns of 7.2% (DAX) and 10.8% (S&P 500). In the long term, no other asset class can boast such a good performance. The bond markets and the emerging markets, which stumbled at times during the nineties, have since then also generated high returns and in some cases have even outperformed shares. With hindsight, the aforementioned crashes during the past thirty years of the capital market’s history were often no more than mere anecdotes which, with the exception of the 2008/09 crash, had no dramatic consequences for the medium-term performance of the real economy in the highly industrialized countries.

In the global equity markets – similar to the global property markets – there are always temporary exaggerations. At the moment, these are possibly to be found in the USA among the “FANG” stocks. These days such “super firms” play a major role in the equity market. But they differ from those involved in the “dot.com” bubble of a good 17 years ago such as “Pets.com” and similar firms which at that time lived from exorbitant promises but did not earn any money at the operating level or in the worst cases did not even generate any sales revenues. Today, the top-5 companies occupy globally dominant positions which already generate high levels of profitability (e.g. Apple) or which may do so in the future (Amazon).

Looked at from today’s point of view these companies operate in markets in which broad-based growth can still be achieved in the coming years. Today these companies are already sitting on huge cash cushions. To put things in perspective: at around USD 500 bn the net cash positions of the six-biggest US companies (including Berkshire Hathaway) would be enough to buy at a single stroke the six- biggest German companies in the DAX (SAP, Siemens, Bayer, BASF, Daimler, Allianz) at today’s market prices.

Today it is already foreseeable that the next few years will bring many technological breakthroughs in technologies such as blockchain, artificial intelligence, autonomous cars or virtual reality. Combined with more powerful resources (batteries, computing power, data storage, sensors, cameras etc.) and “end consumers” that can be reached by smartphone or in their cars, these technologies are set to create yet more giant sales markets.

At any rate, there is no sign of a broad-based bubble or “naivety-driven bull market” or similar in the equity market. Signs of a bubble include:

  • The product is “hip” and it will bring about a “sea change”/ a change of paradigm.
  • Stock prices have already risen exponentially within a short period of
  • Valuation is not possible using traditional methods (change of paradigm: “this time is different”).
  • Demand exceeds supply many

At the moment these arguments may possibly hold in the bitcoins market, but certainly not for the broad equity market. On the contrary: German investors still appear to find it hard to shift capital into shares with a current DAX PER of 12.5 points. Widespread market euphoria is something else.

“Shares are the work of the devil?”

If a share is bought “at the wrong place and at the wrong time,” i.e. in the form of a bad company at too high a price and with a short investment horizon then the chances of significant price losses are indeed not insignificant. This was the case across a broad front during the dot.com bubble at the end of the nineties. But if shares had been bought from a large number of good companies from different sectors (key word: diversification) at a fair price (it need not always have been an extremely low price) and if they had been held for a long time, then on average such shares would often have become assets with a high return. Share-price fluctuations, which have nothing to do with a company’s true performance over the short term, need to be disregarded. Economies grow as long as there is progress and competition without serious military conflicts. The longer the time horizon of an investment in equities, the nearer the returns on equities come to the earnings of the underlying “business.” The purchase price is then of secondary importance. More important is that the “compound interest effect” is not interrupted.

Naturally errors also occur with this type of strategy. Many US value investors call these “errors of omission” (e.g. not having had Facebook, Apple and Amazon shares in the portfolio) or “errors of commission” (e.g. holding Nokia or Arcandor shares for too long). This has a negative effect mentally (who likes to miss a “100-bagger”) or in terms of hard cash. Scientific studies show that the negative emotional impact of suffering share price losses or missing “homerun” investments activates the same areas of the brain that deal with mortal danger.

But investors that bet on many shares (=an index) at the same time will on average always win in the long term. True to the Dalai Lama’s principle “there are many ways to nirvana” no investors should have only Apple or Amazon in their portfolio if they want to increase their wealth – there are enough other good companies. The lower the purchasing price the higher prospects of price gains are. The purchase price is in turn dependent on the degree of uncertainty in the equity market. Good sentiment and good purchase prices usually rule each other out. Investors who invest rationally do not like (market) optimism as this is tantamount to high prices and thus the prospect of below-average returns. A significant correction is ideal for stock purchases.

Compared to professional investors, private investors have the advantage that they do not need to score investment successes within a twelve-month horizon, but only over the long term, including taxes and inflation. As a rule, they are net savers over several decades and do not need the assets until pensionable age. It is, therefore, a good strategy – especially for private investors – to buy into the equity market patiently and regularly.

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Howard Marks on the Business of Investing

September 14, 2017 in Build a Great Firm Podcast, Building a Great Investment Firm, Featured, Full Video, Interviews, Member Podcasts, Transcripts

Howard Marks is the co-chairman of Oaktree Capital Management, essayist, and the author of the 2011 book, The Most Important Thing. He’s a tremendous contributor to the value investing community. We’ve been lucky over the years to host Howard for multiple in-depth conversations on topics such as his widely acclaimed Buffett-endorsed book, personal investing philosophy, and thoughts on what it means to be an excellent investor.

Howard Marks began his investment career as an analyst researching conglomerates at the end of the ’60s. He then led a group working on distressed assets and served as the chief investment officer for domestic fixed income at TCW. In 1995, Marks formed his current company, Oaktree Capital Management (OAK), giving him over twenty years running his own firm, and nearly fifty years working in the investment industry.

On the Importance of Self-Assessment

It’s no surprise then, that one of the qualities Marks cites as a contributor to gaining superior insight, is experience. Marks believes in the idea that in the short run, the market is a voting machine, and in the long run, it’s a weighing machine–an idea you could also apply when evaluating an investor’s track record. It’s true that luck plays a small component, but in time, it’s your skill that does the talking. This is precisely the concept that Warren Buffett argues and writes about in his article, The Superinvestors of Graham and Doddsville.

It probably takes at least ten years for somebody reliably to be able to say, “I have superior insight or I don’t.” I think it’s very important that people be honest with themselves and really mark your portfolio of the market at the end of the year and say, “Which of the things that I thought would happen happened? Which of the things I thought would happen didn’t happen? Where was my mistake? Do I really have a superior ability to figure out which companies will succeed, which stocks are inexpensive, which risks are worth taking?”

Once you’re aware of your mistakes, it’s on you to make the necessary corrections. To Marks, self-assessment isn’t just about saving you money, but also your time.

It’s not like getting a blood test, but it’s very, very important because you could waste your time and you could waste your life as an investor making average decisions. If you make average decisions, you might as well throw darts or invest in an index fund and get a job that you are better at. I’ve got to believe that if anybody with introspection spends ten or twenty years in the investment business that hasn’t figured out they know better than the market, then I don’t think their life can be very satisfying, so I think it’s very important to do that as a self-assessment and probably if you don’t do it for yourself, somebody else will do it for you.

This is a profound idea. In one of his memos to clients, Marks writes, “In my view, the investment IQ of the market isn’t any higher than the average IQ of the participants.” Thus, if your goal is to achieve superior returns, you must also have superior insight compared to that of the average investor. Another name for this is second-level thinking, a topic Marks writes extensively about in his book, The Most Important Thing.

On Developing and Sticking to Your Investment Philosophy

Howard Marks is known for being a risk averse value investor. You could say that deconstructing risk is one of his specialties, one which has served him particularly well over the years. Admittedly though, Howard says he doesn’t offer a magic formula for successful investing, and that there is more than one way to achieve favorable returns.

There are lots of ways to be successful. I always talk about the importance of risk-controlled investing. There are high risk investors who’ve been successful. I think the key is 1) to have an approach, well thought out, built out hopefully over some years or decades. Hold it strongly.

Ultimately, it would seem that regardless of your personal investing style, Marks believes that in order to be a long-term successful investor, you must use your experience to enhance your circle of competence, and continue to stay within those principles. Only time can tell if your ideas are working, so it’s best to perform some honest, self-assessment on your thinking in the event of going ten years without outperforming the indexes.

On the Most Dangerous Thing

Although his book is titled, The Most Important Thing, Marks also talks about, in his opinion, is the most dangerous thing for investors — risk. The sign of a great investor isn’t the ability to make a lot of money, you could do that in Vegas. The sign of a great investor is to make a lot of money while simultaneously minimizing exposure to risk.

Whether it’s a good year or a bad year for the market, the great investor has to be able to avoid compounding losses. Once again, this brings back the idea that investing is a long-term game, and that short-term performance is not an indicator of future success. Thinking about investing in this way reminds me of the following quote by Seth Godin:

In finite games (short and long) there are players, there are rules and there are winners. The game is designed to end, and it’s based on scarcity. In the infinite game, though, something completely different is going on. In the infinite game, the point is to keep playing, not to win. In the infinite game, the journey is all there is. And so, players in an infinite game never stop giving so they can take.

Building a reputation in investing is definitely a long game. You can’t just win one year and quit. So by mitigating your risk, you increase your chances of staying in the game. That’s what Seth is talking about, thinking long term changes the way you play.

Howard shares many additional insights into investing and the business of investing in the full 35-minute exclusive conversation with MOI Global. We are pleased to include below a video of the wide-ranging interview as well as an edited transcript.

The following transcript of the full conversation has been edited for space and clarity.

The Manual of Ideas: In your memo, Dare to be Great, you say that the bottom line for investors is not whether you dare to be different or to be wrong, but whether you dare to look wrong. How is the daring affected by where an investor is in their career?

Howard Marks: That’s an interesting question — nobody’s asked me that before. I don’t know if there is an answer. The first blush reaction is that when you’re younger and you’re just trying to get started, you can’t afford to be wrong because maybe you’ll never get any further if you lose your job. On the other hand, you could take the position that when you’re starting you don’t have much to lose, so you might as well take a shot. I think the conventional answer is that a person trying to get started will not have the mental resolve to take substantial risk of looking wrong and will tend to do more conventional things.

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This article is based on a post by MOI Global contributor Brian Hertzog. For more by Howard Marks, visit the Oaktree website to read his brilliant memos to shareholders.

Indian Infrastructure: A Decade in the Making

September 14, 2017 in Asia, Asian Investing Summit, Capital Goods, Commentary, Macro, Materials

This article is authored by Rahul Saraogi, MOI Global instructor, managing director of Atyant Capital Advisors, and author of Investing in India.

The global investment landscape today looks quite unexciting. Consumers in developed countries have been maxed out for the better part of a decade. Notwithstanding the recent optimism in the US, it is highly unlikely that consumption growth will re-accelerate. The best scenario one can hope for is that consumption growth settles at a 1% to 2% rate and that fears of contraction subside.

China has been the engine of growth in emerging markets for the last two decades but the Chinese engine is now sputtering.

Emerging markets face a completely different problem – that of China. China has been the engine of growth in emerging markets for the last two decades but the Chinese engine is now sputtering. China made a miraculous transformation of its economy by building infrastructure that is the envy of even the developed world. It fueled this growth with massive amounts of debt (most of it domestic, thankfully) and by borrowing growth from the future by conspicuous overbuilding. The problem with a capital or fixed hyper-investment model is that one cannot stop. If one stops then the entire economy stalls and crashes.

China has been adding capacity in roads, railways, ports, power, steel, aluminum etc. Each of these sectors depends on the other sector’s “growth” to keep itself going. If one sector stops adding to capacity, the feedback loop stalls capacity addition in all other sectors. China has reached the point where the discourse has shifted from growth of capacities to utilization and shut down of capacities. For example, Chinese steel capacity exceeds 1 billion tonnes or about 50% of global installed steel capacity. China produces 825 million tonnes of steel. Chinese aluminum capacity exceeds 45 million tonnes which is once again more than 50% of global installed aluminum capacity. China produces about 30 million tonnes of aluminum a year. While steel capacity growth has completely stopped, China added 7 million tonnes of primary aluminum capacity last year. This year the discourse in aluminum has also shifted to capacity utilization and shut downs. Chinese consumer spending is a sideshow compared to its fixed investment juggernaut. Discussing Chinese consumer spending as a driver of China’s economy is like discussing the restaurant industry in the Bay area as a driver of Silicon Valley.

I am not necessarily calling a bubble or a crash in China. The only point I am making is that the Chinese economy of the next decade is going to be very different from the Chinese economy of the previous two and that it will have major consequences for the world economy, especially for emerging markets. China will import a lot less of the primary commodities it had been importing during the previous decade. The buoyancy in commodity prices since the China scare of February 2016 appears to have been driven more by speculative activity in China than by a meaningful resumption in fixed investment or capacity growth. A resumption of the global commodity meltdown experienced in early 2016 will be devastating for emerging markets. China will also dump a lot more of its manufactured goods on the world market despite protectionist safeguards and duties. This will keep a lid on global capital investment and capacity expansion.

India will remain a bright spot (albeit a small one) in the global investment landscape…

This brings me to my main topic – India. I have always maintained that India is a bottom up economy and unlike China, it does not have the ability to execute state diktat while ignoring popular opinion. Therefore, it behaves a lot less like a focused corporation and a lot more like a feuding extended family. India is an emerging market and will get materially affected by the goings on in China. However, India is also emerging from a gut wrenching five-year slowdown and a clean-up of its banking system and its political system. India will remain a bright spot (albeit a small one) in the global investment landscape during the next few years. What then is likely to do well in India and what is likely to not do well?

The financial services and financial inclusion story in India is a little long in the tooth. It has been so difficult to deploy money in the Indian real economy in the recent past that all investment dollars have gone to the easy business of leveraged lending. Anytime financials start trading at more than three times price to book value, the risk reward asymmetry becomes inverted. When the entire financial system starts to trade at valuations of more than three times price to book value, investors should be prepared for a very long period of underperformance. It is possible that the economy keeps growing but financials underperform as their economic realities catch up with expectations built into their stock prices.

The non-cyclical consumption story in India also looks a little over extended. The problem with consumption in India is that it is a hundred small countries inside a large sub-continent. Purchasing power and consumer behavior and preferences are so heterogeneous that the addressable organized opportunity for individual players is relatively small. This has been anecdotally experienced by investors in Indian listed consumer stocks. Companies experience high double digit and even triple digit growth from small bases and their growth tends to taper off as they reach $250-$300 million in revenues. Unfortunately for investors, valuations continue to climb and it is not uncommon to find non-cyclical consumer names trading at between five and ten times multiple of revenues. Often managements find themselves under tremendous pressure to grow to sustain market valuations and expectations. This often results in sub-par decisions and diworsefications to capture unrelated and dissimilar lateral markets.

Large core industrials like steel, power, mining, chemicals and textiles are in unenviable positions. They are suffering from large domestic as well as global overcapacities in their respective sectors and the resulting absence of pricing power. This is unlikely to change even if the India economy grows dramatically. Global (Chinese) overcapacity is going to ensure that investors in these companies make sub-par returns on investment even in a growing economy. Manufacturing is therefore going to lag the economy and will not be a driver of economic activity in the first few years of the Indian growth rebound.

What will do very well in India is anything that is cyclical but domestic and not influenced by global overcapacity.

What will do very well in India then is anything that is cyclical but domestic and not influenced by global overcapacity. I believe that the Modi government’s thrust on infrastructure building and housing for all by 2022 is going to become the engine of the Indian economy. This will liquefy the market for land in India and will create a real estate boom. A boom in land and real estate both in transaction volumes and prices is essential to create a wealth effect in the economy and to rekindle animal spirits. The wealth effect will result in explosive cyclical consumption growth in durable goods. This imminent boom in infrastructure and real estate has been a decade in the making. These sectors are however prone to excessive leverage and systemic corruption. They will eventually succumb to excesses like at the end of every economic expansion. Hopefully these sectors will be able to put in a few years of high quality growth before they succumb to excesses.

Indian markets will therefore remain volatile and large sections of the market will suffer with contagion from other emerging markets. The markets will be a paradise for stock pickers who can stomach volatility and who can find idiosyncratic names that benefit from the growth in the Indian economy while remaining fundamentally insulated from global overcapacity.

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Good Different and Bad Different

September 14, 2017 in Letters, Reading Recommendations

This article by Scott Miller is excerpted from a letter of Greenhaven Road Capital. The article is inspired by the book Different: Escaping the Competitive Herd, by Youngme Moon. The book was a featured selection at The Zurich Project 2017.

I will try not to spoil the book for you, but it does a great job of highlighting businesses that are intentionally different than their competitors and very successful. One business profiled is Ikea. When Ikea came along, they broke several rules of furniture retailing. Ikea doesn’t promise the furniture will last forever. They position it as a durable good with a life of a few years, greatly lowering the anxiety of the purchaser. According to the book, the average American will have as many wives as dining room tables (1.5) and has historically approached the table purchase with great apprehension.

Ikea is different from traditional furniture retailers in multiple other ways, including the lack of hovering sales people. Ikea puts the burden on the consumer to transport the furniture home and assemble it. The company launched with only four styles of furniture, greatly reducing selection. Ikea was different in that it subtracted service, delivery, choice, and durability. Ikea added daycare, Swedish meatballs, and created a euro flavored “retailtainment” environment. According to the author, “Ikea has discovered the cool unapologetic contradiction. It is stingy, it is indulgent. It says yes; it says no. It strips things down; it sweetens them up.” Clearly Ikea understood that most retailers don’t have 50,000-square-foot stores without salespeople when they launched their stores. These differences are intentional choices.

In many other areas, Ikea chose to be the same, adopting many of the best practices of the day used by their competitors. For example, Ikea uses a point-of-sale system and accepts credit cards. In dozens of areas, Ikea chose not to be different from their competitors in ways that have contributed to their success.

This highlights that there is a good kind of different and a bad kind. For instance, a car that does not turn right or does not have windows would be different, but most people would agree that would be “bad” different. The challenge in designing a business is to figure out where and how to be different. Where to be the same? Understand why you are different and what you are achieving by being different.

As Greenhaven Road has celebrated its fifth birthday, it has been a period of reflection and planning. The goal is to keep and grow “good different” and get rid of bad different. My core belief is that the world does not need another asset-gathering, crowd-following, index-hugging fund, with fancy marketing and a false sense of risk management. The world doesn’t need more investment committees. I want to spend my limited time on this earth building something good different. I believe that a smaller fund is better because it increases the opportunity set. I believe that an investment team of one is the perfect size. I believe that when investing fundamentals matter, balance sheets matter, cash flow matters, management matters, and management incentives matter. I also believe that investing requires patience, because even though fundamentals matter, there can be long periods where there are disconnects – thus the capital to invest should be aligned with the strategy.

The design of Greenhaven Road reflects dozens of choices. I aligned incentives by being the largest investor. For me personally it is by far my largest liquid investment, and that is how I believe it should be. The alignment of incentives is deepened with a hurdle rate and a high watermark. You have to make money for me to make money. The choice to have a very broad mandate is intentional as well. I can invest in the smallest and the largest companies across geographies. We are not a U.S. small cap fund, which would be easier to describe. The flexibility on the investment front is important because I want a vehicle that can last decades, and I don’t want my savings only in U.S. companies with market capitalizations below $5 billion or some other artificial constraint. Our vast opportunity set combined with the small size allows us to go off the beaten path of the S&P 500 while remaining concentrated. To quote a great value investor, Howard Marks, “This just in, you cannot take the same actions as everyone else and expect to outperform.” Being different in the investment management business clearly has value. There are a lot of positives and I am proud of everything accomplished in the last five years. We are off to a good start.

Yet, there are a few areas that haven’t historically been “good different,” and I want to address them in the coming year. I firmly believe that the best investment decisions are made by an individual and not a committee. The best performing venture capital fund ever was headed by a team of one (Chris Sacca). The Buffett partnerships had a team of — you guessed it — one. This is not to say that other models cannot work – but for me it is the right size, and there are enough data points of success that I believe my running a one-man boutique is “good different.”

However, in this case, my version of good different comes with bad different. As a one-person boutique, in the unlikely event that I were to die, the closing of the fund would be a challenge. While that would not be my greatest concern as I would be dead, the fund has friends, family, and people’s savings invested who deserve a better solution. As a one-person operation, it is difficult to require two signatures on money transfers and large checks. There cannot be a second set of eyes ensuring compliance with the partnership agreement. One person simply cannot be two sets of eyes. Checks and balances are impossible to achieve as a one-person boutique. Lastly, while the fund has an auditor and a third-party administrator, I am currently the back office, which can take time away from my main function: adding value through investing. I add no value in the administrative sphere, but in the current arrangement, the investment team (me) is also the back office liaison. So these “bad” differences have been nagging at me for a while, and I have considered a number of solutions. Some funds hire an outsourced CFO, some funds hire an administrative team, some funds muddle along indefinitely and hope nothing happens. Each of these solutions is suboptimal, but so is the status quo. Fortunately, I think waiting to put a solution in place has paid off in spades. I have found “good different” in my email in-box.

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Disclaimer: This document, which is being provided on a confidential basis, shall not constitute an offer to sell or the solicitation of any offer to buy which may only be made at the time a qualified offeree receives a confidential private offering memorandum (“CPOM”) / confidential explanatory memorandum (“CEM”), which contains important information (including investment objective, policies, risk factors, fees, tax implications and relevant qualifications), and only in those jurisdictions where permitted by law. In the case of any inconsistency between the descriptions or terms in this document and the CPOM/CEM, the CPOM/CEM shall control. These securities shall not be offered or sold in any jurisdiction in which such offer, solicitation or sale would be unlawful until the requirements of the laws of such jurisdiction have been satisfied. This document is not intended for public use or distribution. While all the information prepared in this document is believed to be accurate, Greenhaven Road Capital Fund 1 LP and MVM Funds makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors, appearing in the document. An investment in the fund/partnership is speculative and involves a high degree of risk. Opportunities for withdrawal/redemption and transferability of interests are restricted, so investors may not have access to capital when it is needed. There is no secondary market for the interests and none is expected to develop. The portfolio is under the sole trading authority of the general partner/investment manager. A portion of the trades executed may take place on non-U.S. exchanges. Leverage may be employed in the portfolio, which can make investment performance volatile. An investor should not make an investment, unless it is prepared to lose all or a substantial portion of its investment. The fees and expenses charged in connection with this investment may be higher than the fees and expenses of other investment alternatives and may offset profits. There is no guarantee that the investment objective will be achieved. Moreover, the past performance of the investment team should not be construed as an indicator of future performance. Any projections, market outlooks or estimates in this document are forward-looking statements and are based upon certain assumptions. Other events which were not taken into account may occur and may significantly affect the returns or performance of the fund/partnership. Any projections, outlooks or assumptions should not be construed to be indicative of the actual events which will occur. The enclosed material is confidential and not to be reproduced or redistributed in whole or in part without the prior written consent of Greenhaven Road Capital Fund 1 LP and MVM Funds. The information in this material is only current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Any statements of opinion constitute only current opinions of Greenhaven Road Capital Fund 1 LP and MVM Funds, which are subject to change and which Greenhaven Road Capital Fund 1 LP and MVM Funds do not undertake to update. Due to, among other things, the volatile nature of the markets, an investment in the fund/partnership may only be suitable for certain investors. Parties should independently investigate any investment strategy or manager, and should consult with qualified investment, legal and tax professionals before making any investment. The fund/partnership is not registered under the investment company act of 1940, as amended, in reliance on an exemption thereunder. Interests in the fund/partnership have not been registered under the securities act of 1933, as amended, or the securities laws of any state and are being offered and sold in reliance on exemptions from the registration requirements of said act and laws. The S&P 500 and Russell 2000 are indices of US equities. They are included for informational purposes only and may not be representative of the type of investments made by the fund.

Grit Is Overrated

September 13, 2017 in Commentary

This post is authored by Samir Patel, founder of Askeladden Capital. For more of Samir’s thoughts on grit, listen to this episode of The Zurich Project Podcast.

One of the things I’ve been thinking a lot about lately is the context-dependency of advice. Over the course of my life, I’ve received a lot of (well-meaning) advice that has been somewhere between wholly unhelpful and totally wrong, and it’s not so much that the givers of advice were unqualified (often quite the opposite) or that their advice didn’t make sense (within a certain paradigm). But when you have a different starting point (or ending goal) than the person who is giving you advice, there may be a few things lost in translation.

I tend to be a natural contrarian insofar as seeing everyone going in one direction usually primes me to think about what they could be missing, and the concept of “grit” is one such issue. It’s not a new thing, really just a distillation of a larger trend that has been ongoing for some time – the semi-Puritanical glorification of hard work, perseverance, commitment, whatever you wanna call it. And it’s one that, on some level, I think is wholly misguided.

This is a conclusion I’ve come to after about 15 years of pursuing a “Batman-has-no-limits” approach to life – I competed in the National Spelling Bee five times in elementary and middle school, I graduated concurrently from community college and high school, I started working full-time in a white collar job at eighteen while also being a full-time student and maintaining a >3.9 GPA and finishing an MBA before I turned 21. Clearly, by any objective standard, my life has not been characterized by a lack of grit – yet grit was wholly insufficient for the challenges I faced next. What I’ve come to believe is that advancing the cult of “better faster harder stronger” as the always-and-everywhere solution to problems is not only suboptimal, but in many cases dangerous.

Maximum Effort… in what direction?

Deadpool recommends: MAXIMUM EFFORT! (And now you know where I get my email handle from.)

Let me explain: I think “put some effort in a productive direction” is great advice to give to a fourteen year old who spends the entirety of his life playing Call of Duty and paging through Playboy. But as I thought David Denby explained pretty well in “The Limits of Grit,” that’s a rather unhelpful directive to a vast swath of the target audience of Grit (the book). As I told my wildly ambitious and accomplished intern Matt when he emailed me with a crazy plan to improve his mental and physical stamina (that reminded me of something I might have done myself a few years ago), “the telos [of what you’re talking about doing] is misery, divorce, and a mid-life crisis fueled by utter self-hatred.”

Since this a blog post rather than a whitepaper, I’m not gonna bother finding/citing sources, but we all know the drill: Americans are workaholics who worship at the shrine of busyness, putting in way too many hours at (and away from) the office and not taking enough vacation. And so on. So if you’re a reasonably successful white-collar professional, chances are that your problem (or your kids’ problem, if you’ve had any involvement in their lives) is not a lack of effort or persistence. The solution to your problems, by corollary, is not “try harder!” In fact, I think oftentimes, quitting is the harder rather than easier option – opting out of a culture of workaholism and optics-over-results, or choosing fewer resume-padding extracurriculars in lieu of the chance to do some real learning.

Let’s take one of the most-cited examples of grit – the Navy SEALs. Popular culture (assisted by a few war stories) plays up Hell Week and the raw toughness of SEALs. They are the real-life version of Rambo, of Jack Bauer, of Captain America and Iron Man – they beat you by being bigger, badder, and just generally imposing their force of will. They punch you until you stop punching back.

Or so the story goes – reality is, I think, a little different. I am not saying that SEALs aren’t tough (of course they are; they’re ridiculously tough). But SEALs don’t win (most of the time) by being grittier than you. One of the coolest experiences I’ve had since launching my fund was getting to sit down with Mike Zapata, who was actually a Navy SEAL (eventually joining “SEAL Team Six,” no less), and is now a value investor. What I took away from chatting with Mike was completely different than the pop-culture view of the SEALs. In fact, here’s what Mike had to say in an interview with the Manual of Ideas a while back:

“From a military side, from the special operations side: My first commander, Tim Szymanski of Seal Team 2, the first team that I was at, discussed ‘stacking the odds in our favor.’ He looked at it from a combat perspective which is (i) operationally, (ii) tactically, from our preparation, and (iii) technically, whether that is night-vision or air-assets. People think that special forces operations are dangerous and high risk — we didn’t see it that way. We saw it as incredibly low risk because we stacked the odds in our favor. We used all these advantages to our benefit and I would much rather have been in our position — conducting our operations — because we de-risked a lot of it.”

On Systems, Sand, and Senses

When I was in high school, I was pretty fond of this thought experiment I came up with about sand: you can work really hard moving a giant pile of sand on a beach from point A to point B with your bare hands. This is what the really gritty person would do – you’re hot and dehydrated and your hands are bleeding? Nobody cares, TOUGH IT OUT MAN.

The person who is a little less pain-tolerant (more on that in a second) would look at the problem and say, well, I could spend my life doing this, orrrrrrrrrr I could go rent a Cat dozer and bam, I have the afternoon to play in the surf. (The really smart person might ask, hey, why are we moving this sand to begin with?)

If you invert the issue a little bit, it’s important, I think, to think about why pain exists in the first place (assuming that “grit” can be dimensionalized, in one way, as the ability/willingness to push through pain and discomfort.) We’ve all had those moments where we wish we couldn’t feel pain – but being able to feel pain obviously has more benefits than drawbacks (otherwise we’d end up in all sorts of horrible situations without realizing it.) Pain is a signal saying “hey, something is no bueno, check it out.” The ability to stretch yourself and expand your limits is good – but again, the sort of people who tend to be value investors (or executives or successful whatevers) tend not to be the sort of people who encounter a challenge and promptly give up. If anything, they’re the sort of people who don’t give up easily enough on things that aren’t working because they think if we just tried a little harder…

“Be gritty” or, in other words, “try harder” is thus patently unhelpful advice, empirically, for a number of thorny problems on a personal or societal level: nutrition and fitness, productivity, making good decisions, etc. On the other hand, to go back to the SEAL example, success appears to be about systems or structuring problems in a way that they are solvable with less effort (rather than trying to brute-force them with maximum effort). Indeed, the pop psychology / self-help books I’ve gotten the most mileage out of tend to be those with action-oriented systems with tangible rationale for their effectiveness- Charles Duhigg’s The Power of Habit or Shawn Achor’s The Happiness Advantage, Stephen Covey’s The 7 Habits of Highly Effective People (disclosure, long FC), or Cal Newport’s Deep Work.

Three quick personal anecdotes here. The first, on the productivity front – for much of 2016, I was spending 12+ hours five days a week (and often half or more of a sixth) sitting at my computer trying to “work” (i.e. do research). So, 60-80 hours of attempted work, on average. I would estimate that my actual honest to god productivity was probably, I dunno, 20 hours? I can’t account for the rest of the hours but I can tell you that other than working out and the occasional lunch/dinner with a friend, I spent a lot of the year not attending to my personal hobbies. My vegetable garden withered and died [ ? ], my guitar was gathering dust, my bookcase piled up with unread Amazon orders, etcetcetc. And yet the more I tried to willpower my way into productivity, the less and less I got done, until I was at the point where there were whole days (even weeks) where I would sit in front of my computer trying my very hardest to no avail.

Over the past ~six weeks or so, I’d say my productivity (measured by the tangible, documented research produced that is available for my future reference) has doubled or tripled (with the exception of a week off between dealing with audit/compliance stuff and getting over a minor cold). Over that time period, I’ve read as many books as I read in the second half of 2016, I’ve made more progress on learning to actually play guitar than I have at any point in the past decade, and I’m spending far less time “working” but getting nothing done.

What changed? It wasn’t trying harder – it was actively deciding to try less hard (constrain working hours, prioritize other things) and let various process improvements (standardizing research format, etc) do some of the heavy lifting. Abandoning the mentality of “I can just push through this” has made me way more productive. More effort did not = more productivity.

The second, on sleep – as I’ve mentioned elsewhere, half the reason I launched Askeladden is an intractable circadian rhythm issue which makes mornings challenging. The (well-meaning) advice I got from family and friends was along the lines of “go to sleep earlier! drink less caffeine! learn to love mornings!” and of course, you can’t just effort your way through the way your brain processes artificial light exposure. I tried for the better part of a year to do that and it plain didn’t work. Setting my own schedule, I accomplish 10x what I ever could have accomplished working on a normal schedule.

The third, on capital raising – a while back I had a lunch with a (really nice) guy here in Dallas who runs just south of $1B in AUM. He more or less suggested that I abandon the content marketing approach to capital raising and instead do the whole networking-with-local-potential-fund-investors thing. Setting aside the fact that I don’t know any local potential fund investors (I didn’t see that category in the phonebook), I am absolutely terrible at introducing myself to people. It’s not that I’m uncomfortable speaking to people – I was an ace high school debater and would be totally fine speaking to a stadium; I’m also typically a pretty good conversationalist if I have a warm intro and a few points of mutual interest – I can talk your ear off! But for some reason, I really struggle with establishing credibility / a platform / whatever in interpersonal interactions with strangers. I have worked on this! I read Dale Carnegie and everything! I have gone from being the awkward kid in the corner at cocktail mixers, never introducing himself to anyone, to being the kid who spends 20 minutes working up the courage to introduce himself to one poor unsuspecting soul, and then promptly clinging to them for the rest of the event with such leech-like tenacity that one hotel checkout and two Uber rides later, bemused TSA agents have to separate us using the jaws of life.

I’m being a bit self-effacing, of course, but the point is that no matter how much I work on this, I’m never gonna be my friend who can walk into a roomful of strangers and 30 minutes later have 100 new BFFs. It’s just not me – and rather than bash my head against the wall (be gritty, don’t give up) I’ve found an alternative way to build my business that leverages my strengths (writing) instead of forcing me to overcome the obstacles of my weaknesses.

Implications For Growth and Self-Improvement

That third point is a nice segue to my conclusion. I recently read an interesting book – “Different” by Youngme Moon – about consumer brands that break the mold. Without rehashing the entire book (it’s short and you can/should read it yourself), one of the key takeaways is that brands all attempting to improve on their weaknesses eventually leads to a homogenized, undifferentiated product. i.e. if you have a sporty car and try to make it more comfortable and safe, and if you have a safe car and try to make it more comfortable and sporty, and if you have a comfortable car and try to make it more safe and sporty, eventually you end up with three cars that look pretty much the same and now nobody’s happy. (I immediately thought of parallels to Malcolm Gladwell’s “perfect spaghetti sauce” story – there is no perfect spaghetti sauce, the average focus group result is despised by all. there are only multiple perfect spaghetti sauces…)

Anyway, the read-across to growth and self-improvement (the holy grail of the people and things that interest me) is that maybe improving on your weaknesses isn’t all that it’s cut out to be. Again, you have to remember that what I’m saying here is context-dependent – in the absolute it is totally a good idea to try and get better at things you are not good at, but with the starting point of being someone focused on self-improvement perhaps there is a point at which there is diminishing returns.

Indeed, one of the things that is somewhat impolite to say but totally true is that skill/talent/natural ability are real things; nobody sensible or reasonable would recommend that Cole Beasley become a value investor or that I become a slot receiver. (I don’t know, I’ve never met Beasley, maybe he’d make a great investor. But just for the point of my argument.)

The point is that every action has an opportunity cost – time spent improving XYZ weakness is also time that could have been spent improving ABC strength – and you have to ask yourself if the payoff from delta(XYZ) is really bigger than the foregone payoff from delta(ABC). In the case of consumer brands, Moon pretty compellingly makes the case in Different that the answer is often “no.”

In the case of self-improvement, I think the answer is sometimes (but not always) the same. If there is a specific weakness that is explicitly hindering your ability to get where you want to go, then working on it is probably a good thing. But inverting the problem, a much easier and more profitable way of approaching things (whether as a businessperson or investor or whatever) is to solve problems that you are naturally good at solving, rather than to try to make yourself good at solving problems that you are naturally bad at solving…

Perhaps this is a bit of an unsatisfying conclusion, or a bit rambly. That’s why this is a blog post and not a whitepaper – the action items and synthesis of key concepts are very clear in my head (insofar as my tactical rather than brute-force approach to life). But I think, again with the caveat of the starting point being the sort of value-investor-people who read think-y books and blogs, that grit and effort and the cult of “more better faster stronger harder” are way overrated. They are prerequisites to success but everyone reading Grit (and similar books) has enough of them anyway. The path to different/better results isn’t “try harder.” It’s “do something different and shape the problem to your strengths.”

In fact, “weaknesses and strengths” is a bit of a bad paradigm anyway – again with the context-dependency – it’s much better to think of yourself v. the world in terms of traits that are adaptive or not under certain circumstances. The analogy is a bit hokey, but there’s that classic saying about not judging an elephant by its ability to climb a tree. That doesn’t make it a bad elephant. It just makes it an elephant.

Traits that are highly adaptive in certain contexts (empathy/depth of feeling, in the context of interpersonal relationships and being an ethical person) are highly un-adaptive in other contexts (dealing with market volatility, for example). The solution isn’t to feel less… but rather to set up systems or approaches where you are less exposed to that (configuring your trading interface to not show daily PNL, not tracking or checking relative or absolute performance on a frequent basis, etc).

That’s my best (maximum?) effort on this topic for now. I’ll come back to it later. Summary: if you’re having really hard time moving sand by hand, find a bulldozer.

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SeaLink Travel: An Example of a “Perennial” Compounder

September 13, 2017 in Asia, Equities, Ideas, The Moat Report Asia, Wide Moat

This article by Koon Boon Kee is excerpted from a publication of the Singapore-based Hidden Champions Fund.

If Singapore’s Changi Airport Group (CAG) is ever listed, it will be one of our top positions in the Hidden Champions Fund. CAG is the archetypal Hidden Champion with the winning characteristic of a “perennial compounder”, in similar ways to our top position ASX-listed SeaLink Travel which we will elaborate later about its transformation in business model in its latest corporate development in developing a new Townsville Strand ferry terminal hub with potential new recurring retail concession and rental income opportunity.

As our international gateway where more than 100 airlines connect Singapore to more than 300 cities across the world, Changi Airport gives all visitors an excellent introduction to the way Singapore works and Singapore’s reputation for excellence. But the non-linear success and growth was not an easy nor obvious path to undertake.

In 1975, then-Prime Minister Lee Kuan Yew had the Long View and made the critical decision to move from Paya Lebar to Changi, a site that was five times larger. This was despite the Cabinet’s decision for the go-ahead in 1972 to expand Paya Lebar Airport based on a British expert’s report that it would cost less and that there was not enough time to get Changi built up to meet increasing traffic needs. It was the single biggest public project at that time and the tough call meant writing off some S$800 million that had already been invested in Paya Lebar airport, a commitment of S$1.5 billion, six intense years, incredible foresight and the commitment of the entire nation to make it happen. But Mr. Lee himself described it as “one of the best S$1.5 billion investments we ever made”. Mr. Lee, Howe Yoon Chong, Sim Kee Boon, Teh Cheang Wan and Woon Wah Siang had the grand vision that the tangible infrastructure must have the intangible quality to engender the network effect and multiply in value. From airport management software to the texture of trolley handles, Sim insisted every aspect of customer experience must keep up with its impressive infrastructure. The quality of toilets – at night – was even under his radar. He was quoted saying that the first and last point of exposure to an airport is the toilet. It gives you an impression of the country.

As a result of the vision and attention to details, CAG was able to reap multi-fold gains from the infrastructural asset with multiple recurring income streams in airport concession and rental income, airport services and security services, generating over S$2 billion in sales and S$900 million in EBIT from S$8.5 billion in total assets (10.5% ROA) and S$6.6 million in total equity (13.6% ROE). Today, airport concession and rental income contributed over half on the back of strong retail sales which grew to reach a record high of more than S$2.3 billion as passengers are spoilt for choices by the 360 retail and services outlets and 140 dining outlets spread over 76,000 square metres of retail space. This placed Changi Airport as one of the top three airports in the world for concession sales. Because of CAG, Singapore serves over 100 world-class aerospace companies and commands over 6% of the global maintenance, repair and overhaul (MRO) industry market and about one quarter of the Asian market. The success of Changi Airport, SIA, the MRO and air cargo sectors and their spin-offs have all contributed significantly to Singapore’s economic growth.

Similar to Changi Airport Group, SeaLink Travel, Australia’s largest tourism travel and transport group which captures over 1.2 million international visitors, or 15% of Australia’s annual international tourist arrivals, is quietly transforming into a perennial business model with various strategic multi-year growth initiatives as part of its Long View. One of which is the new Townsville Strand ferry terminal hub to be completed by mid-2020 together with a consortium of developers to replace the aging Breakwater terminal facilities in a announcement by the Queensland government on 17 August.

The new Strand terminal will boost connections between Townsville, the Great Barrier Reef Marine Park, Magnetic and Palm Islands with city-link ferry service which could connect key CBD site, the new stadium, and transform the area into a thriving tourism precinct with potential Terminal retail opportunities for SeaLink (link one, link two). Sealink looks to explore the option of (1) Becoming an anchor tenant in the building, thereby giving others the confidence to invest in the development; (2) Acquiring/ purchase the Terminal (retail) component of the development to secure its long term position in that building; (3) Acquiring the full retail area, thereby allowing SeaLink the ability to attract the correct tenants to the retail space. The retail space of the development if acquired by SeaLink is estimated to under $10m and SeaLink would not be looking to raise capital to fund the project which will be financed internally. Traffic on the current Breakwater Terminal site includes an estimated 1 million passenger movements per annum, 120,000 car movements and 10,000 bus movements annually. As a comparison, Kangaroo Island, which SeaLink made famous as one of South Australia’s most popular tourist attractions and has quasi-monopoly ferry operations, attracts 200,000 tourists annually. SeaLink is negotiating to secure a multi-year contract with the Queensland Government to operate the Strand terminal exclusively and not shared with any other marine operators.

Perennial Compounder = Long View x Innovation x Multiplicity,

where The Long View = Ecosystem Approach x Focus x Sacrifice

Perennial. Evergreen. Enduring.

In every industry – from aviation to books to movies and software – certain creations like the Changi Airport can be described as “perennial”. Works that seem to last forever. These products, services or solutions become timeless, dependable resources that have found continued success and more customers over time. In his thought-provoking book “Perennial Sellers: The Art of Making and Marketing Work That Lasts”, Ryan Holiday illuminates the brilliance of perennials in that they grow stronger with each passing day.

Perennials like Star Wars isn’t suddenly going to stop making money – in fact, the profits from the franchise are actually now accelerating, some forty years after conception. Despite getting little radio airplay, heavy metal group Iron Maiden has defied every stereotype, every trend, every bit of conventional wisdom about not just their genre of heavy metal but the music business, selling more than 85 million albums, 24 world tours and 2,000 concerts in 59 countries over the course of a four-decade-long career. They sell their own beer, they are one of the highest earning acts in the world, and they travel from sold-out stadium to sold-out stadium in a Boeing 757 piloted by the lead singer, often shuttling loyal fans and crew along for a ride.

How can perennials endure and thrive in an impatient, flustered world demanding quick success? How can we make works and build businesses that achieve longevity? Is there a common creative mindset, behaviors and decisions behind work that lasts? Is there a pattern to perennials that both entrepreneurs and value investors can learn from? So that their success can be your success.

During the investment process, many investors are led astray by shortcuts. It’s hard to see how it could be otherwise when the experts and thought leaders wily talk us with shortcuts, hacks and tricks that optimize for quick and obvious success. How to build something that last through time and crises is a lifelong fascination and a calling for us at the Hidden Champions Fund where we seek to invest in the perennial compounders that last the distance to generate sustained returns.

Thus far, the Fund has generated over 26% in positive absolute returns for our clients since our inception in September 2015 and the Fund has continued to make steady progress in the month of August 2017 as the overall market gyrates and retreats because all our core portfolio stocks from Australia’s SeaLink Travel (ASX: SLK) (“Blue Highway and Tourism Boom”), Taiwan’s Nyquest Technology (GTSM: 6494) (“Supercycle in Microcontroller”) to India’s Emmbi Industries (NSE: EMMBI) (“India’s Water Conservation Revolution”) have continued to generate record profits in this recent earnings season, and our recent additions in new potential core portfolio stock, as depicted in our factsheet, has done well too with double-digit gains. At the Hidden Champions Fund, we expect to outperform when the market retreats as our Hidden Champions benefit from the flight-to-quality effect in which investors flee their speculative yield bets to seek shelter in companies with higher quality fundamentals and long-term growth prospects.

Picture George Lucas literally ripping out his own hair as he struggled to complete the first draft of Star Wars. Consider stories of struggling artists who give up everything – even steady meals – for their work. Think of the writer working into the night well after everyone in the house has gone to sleep because it’s the only quiet time she gets. Whether these are clichés or inspiring images, there is very real pain involved. From sacrifice comes meaning. From struggle comes purpose. If you’re to create something powerful and important, you must at the very least be driven by an equally powerful inner force. In the course of creating your work, you are going to be forced to ask yourself: What am I willing to sacrifice in order to do it? A willingness to trade off something – time, comfort, easy money, recognition – lies at the heart of every great work.

Having the Long View is critical in a time when many entrepreneurs whom we observe are running harder and harder to opportunistically chase after short-term gains just so to stand still. Taking the Long View to build a multi-year lasting wide moat means having an ecosystem approach towards building and scaling up the work with various key players in a win-win partnership, having the strategic mindset to cultivate a multiplier effect instead of thinking about merely the addition of capital in a show of might, and a willingness to sacrifice and reject short-term opportunistic gains in posturing up to look good and focus on what matters for the long-term.

We remain impressed by the Long View of SeaLink Travel’s (ASX: SLK) Jeff Ellison and his team in creating an ecosystem approach in building a multi-year perennial revenue model and recurring income stream that the market underappreciates substantially. As the largest tourism travel and transport group, SeaLink captures over 1.2 million international visitors, or 15% of Australia’s annual international tourist arrivals, and with continued market share gains nationwide in NSW, Queensland, Western Australia and South Australia, beyond the Kangaroo Island which SeaLink made famous as one of South Australia’s most popular tourist attractions. Some recent strategic multi-year growth initiatives as part of SeaLink’s Long View:

Creating a “Kangaroo Island 2.0” in Queensland with the $56 million Townsville Strand ferry terminal hub to be completed by mid-2020 together with a consortium of developers to replace the aging Breakwater terminal facilities in an announcement by the Queensland government on 17 August. This latest corporate development is a transformation in the business model with potential new recurring retail concession and rental income opportunity.

The new Strand terminal will boost connections between Townsville, the Great Barrier Reef Marine Park, Magnetic and Palm Islands with city-link ferry service which could connect key CBD site, the new stadium, and transform the area into a thriving tourism precinct with potential Terminal retail opportunities for SeaLink (link one, link two). Sealink looks to explore the option of (1) Becoming an anchor tenant in the building, thereby giving others the confidence to invest in the development; (2) Acquiring/ purchase the Terminal (retail) component of the development to secure its long-term position in that building; (3) Acquiring the full retail area, thereby allowing SeaLink the ability to attract the correct tenants to the retail space. The retail space of the development if acquired by SeaLink is estimated to under $10 million and SeaLink would not be looking to raise capital to fund the project which will be financed internally. Traffic on the current Breakwater Terminal site includes an estimated 1 million passenger movements per annum, 120,000 car movements and 10,000 bus movements annually. As a comparison, Kangaroo Island attracts 200,000 tourists annually. SeaLink is negotiating to secure a multi-year contract with the Queensland Government to operate the terminal exclusively and not shared with any other marine operators;

Pioneering the launch of the first-ever direct high-speed ferry transport service from Manly to Barangaroo in September 2017 as an integral part of the “Sydney Blue Highway” and NSW 20-Year Ferry Plan and transportation masterplan (link). The new ferry hub at Barangaroo to replace Darling Harbour King Street Wharf was built to be the second major terminal for the Sydney Ferries network after Circular Quay ferry terminal. Situated at the western edge of the Sydney’s CBD, the recently opened ferry hub in June 2017 will relieve the capacity constraints at Circular Quay and connect customers to the western and central parts of CBD. Importantly, it will be the single largest development in Sydney’s CBD over the next 20 years. Once fully occupied, Barangaroo will accommodate more than 20,000 office workers and 2,500 residents. Cultural and recreational facilities at the site are also estimated to attract around 33,000 visitors a day. Thus, besides capturing a large portion of the working crowd seeking to escape the peak-hour motorway traffic congestion of Sydney, the new Barangaroo ferry hub will serve the new commercial development at this site with plans for a significant proportion of commuters and visitors to access the site by ferry, representing exciting perennial growth for SeaLink.

Sydney’s Ferry Future (modernizing Sydney’s ferries along the blue highway)

With over 5.2 million Manly/Sydney ferry trips per annum, Sydney Ferries currently provides 36 return services on a weekday on this route. Back of the envelope suggests that if SeaLink could capture a modest 1,000 passengers/day for a return fare of approximately A$15, it would generate additional revenue of A$5.5 million. If 20% of the passenger volume from the Manly/Sydney route is captured by the Manly/Barangaroo path, or 2,800-3,000 passengers/day, SeaLink could generate over A$15 million in additional revenue. With Manly and Darling Harbour having the top 3 highest patronage by line, this route dominates a very critical path in Sydney’s Blue Highway as the government invests in more frequent ferries to service growing areas such as Rhodes and Meadowbank. We expect Sealink to gain a material share of these passengers over time given there is currently no water access to Barangaroo from Manly.

Launching of the Rottnest Island service in Western Australia in November 2017 (LINK). With over 550,000 visitors to that island annually and increasing due to its high-profile wine industry and pristine surf beaches, Rottnest Island is one of the jewels in the crown of Western Australia. Operating between Freemantle and the main jetty on the island, the service will be coordinated to tie in with SeaLink’s Swan River operations, providing a seamless transfer between the two renowned tourist destinations. While SeaLink is the third ferry operator on Rottnest Island, they fill an existing growing supply gap for ferry services during peak periods. SeaLink is also planning a new tourism offering for North Stradbroke Island for its Western Australia business, commencing late calendar 2017. Like Rottnest, North Stradbroke Island attracts over 600,000 visitors yearly.

On 16th August, Sealink released record sales and profits for FY2017, with sales rising by 13.5% from $177.5m to $201.4m, EBITDA increasing 12.1% to a record of $49.4m and EBIT rose by 6.3% to a record $37.5m. The company also announced a 6.7% increase in final cash dividend of 8 cents per share, a decent 3.5% dividend yield, to be paid on 16 October 2017 which we look forward to reinvest in the compounding growth of Hidden Champions in our portfolio. As commented by the management, “Overall 2018 has started ahead of with expectations. We are excited about the outlook for further organic tourism and transport growth opportunities throughout Australia, which the Company is very well-placed to identify and execute through economies of scale, well-proven fleet management and deployment capability, a very strong international and domestic sales and marketing infrastructure, and a strong continuing focus on controlling costs.” SeaLink continues to trade at an attractive EV/EBIT 12.6x, EV/EBITDA 9.6x while generating an ROE of 25.4% and ROA 15.7% with a multi-year lasting wide moat.

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