Martin Capital Management 2013 AR

[giofranchi]

In recent years, holding cash is so completely out of favor that it has become the ultimate contrarian investment.

--Seth Klarman

 

There is nothing so disturbing to one's well being and judgment as to see a friend get rich.

--Charles Kindleberger

 

 

Gio

MCM_2013_Annual_Report.pdf

[ASTA]

Great quotes but looked at their performance figure and just skipped the rest.

Does anyone else feel the same way when one looks at AR by fund managers.

Time is limited in life so I rather read or listen too good performance managers or really bad ones as comparisons. 

 

Plus lets say FPA Cresent also does the absolute portfolio stuff but at least has some graphs and not just 25 pages about good knows what.

 

sorry if I come out as rude  :)

[Packer16]

He has a nice commentary but when does he admit he is wrong.  He has underperformed the S&P 500 by 53% over the past 10-yr (a negative alpha of almost 7% annually).  Another smart stock picker (his equity returns are great) destroyed by asset allocation.  He is not the first (remember Charles Allmon who was bearish since 1987 and Foster Friess going to cash) and will not be the last.  I think he illustrates the effect on returns that a long-term factor better can have a nice stock picker.  The factor bet has overwhelmed what he is good at stockpicking.  You can see the same effect at Fairfax.

 

Packer

[Guest wellmont]

there is more risk being out of the game than being in it. what really surprises me a lot about some of these records is why couldn't they find anything in 2009/2010 to invest in? it was an absolute banquet for the value minded investor.

[Packer16]

He did find things, look at his 2011 to 2013 equities performance (he even beat the market) he just let his bearish factor bet take over.

 

Packer

[stahleyp]

I'm not super familiar with this group but I do want to point something out. Yeah, his performance isn't that great compared to the market, but you guys also need to think about alternative universes that Taleb talks about. Let's say the bailout wasn't approved or if Europe fell apart (both could have easily happened...especially the bailout since it was already voted down once). If either of those scenarios would have happened, we'd probably be talking about how great his performance is.

 

He isn't the only one who didn't load up on stocks a few years back. I might be mistaken but I don't think any of the following guys have had great returns (ie market beating) the last several years Klarman, Einhorn, Gaynor, Watsa, Berkowitz, etc. Heck, I think even Buffett has underperformed the S&P 500 over the past 5 years.

[Packer16]

It is one thing think about alternative situations but by there nature they are more likely than not to happen.  I my opinion, the best way to play these is to buy out of the money call on these events.  This is what Fairfax did with CDS.  Treat them as most likely and orienting your portfolio that way is where it really hurts.  As to those investors, I think most of them invested in the decline very aggressively and have sold those investments in the past few years.  You also have to consider scale.  Guys like FFH, Markel, Baupost and Einhorn need large misspricings to move the needle but smaller guys like Martin do not.

 

Packer

[stahleyp]

No argument from me on those points, Packer. ;)

[Palantir]

Even after the bailout he would have had enough time to pick very cheap stocks...

[ASTA]

Thanks for replies.

 

I think I just had a bad moment there and I did read a bit of what he wrote. However, the point is that me as an individual investor can invest in FFH and LRE or other companies less impacted to whats going on. Which I have and have been a real drag on my performance the last three years. But I just have a mental model that says I am not going to invest in bonds until yields on the 10 t-bill is at 4% just simple rule I have at the moment. As for retired income portfolios just load up on pep,ko,bats,lre,pm and other until bonds reach 4%. and of course cash :D

   

[Kraven]

Frank Martin who runs the shop has a couple of books out. I think one is Speculative Contagion and the second was Decade of Delusions. They are basically compilations of his annual letters from the late 90s until around 2009 or 2010 with some updated material, some commentary, etc.  He's a good writer and a thoughtful and smart guy. That being said, I find his letters excruciating and couldn't even finish making my way through them. Anything that can be said in 10 words is said in 100 words.

[Munger_Disciple]

Very strange letter for a portfolio manager. No discussion of any of the securities the firms owns or recommends. Just  repetition of quotes from others. 

[randomep]

Very strange letter for a portfolio manager. No discussion of any of the securities the firms owns or recommends. Just  repetition of quotes from others.

 

That's just cos he has 73.4% in cash, holy smokes! Imagine you are paying him to hold your money in cash! The whole letter is justifying his cash position.

 

I'll read it though.

[giofranchi]

This is the way Warren Buffett commented “Speculative Contagion”:

For many years I’ve enjoyed reading Frank Martin’s letters. This collection contains much investment wisdom and, just as important, sets a standard for the advisor-client relationship.

If Warren Buffett enjoys reading Mr. Martin’s letters, I thought the latest letter of his would be an interesting read for this community too… Evidently, I was mistaken…!! ::)

 

Gio

 

[giofranchi]

One thing I don’t understand is your comments about Mr. Martin’s returns… For what I see, if I had invested with Mr. Martin since inception of his firm, today I would be worth 25% more than if I had invested in the S&P500… Moreover, this outperformance was accomplished in such a way that today I would hold a ton of liquidity to take advantage of future opportunities… I simply don’t understand what’s not to like about that! Which would you prefer?

1) to be worth 25% more and have 73% of assets in cash today, or

2) to be worth 25% less and be fully invested today.

Even Packer, arguably the most bullish poster on the board, recently is admitting that he is looking for opportunities outside the US to find value today… And I take that opinion, from such an astute and smart stock picker as we all know Packer certainly is, as the definitive evidence that today I would rather have a lot of cash than be fully invested.

Whoever looks at this pattern: 2003 87.2% of outperformance when stocks are fairly valued, 2007 42.7% of outperformance when stocks are overvalued, 2008 110.7% of outperformance when stocks are fairly valued again, 2013 25.1% of outperformance when stocks are overvalued again; should ask himself what the % of outperformance will probably be, when stocks become fairly valued once again. I guess it will be significant enough!

 

This being said, I am only defending something that I think is unjustly disparaged… But certainly I am not comparing Mr. Martin’s long-term returns to those achieved by the likes of Packer, Eric, Kraven, etc.. If you know how to invest like them, Mr. Martin’s defensiveness today cannot but look foolish to you!

 

Gio

 

[frommi]

Hey gio, don`t be upset :). Your time will come and being a lonely rider is not the worst position to be in the investment world. The problem is only that you are not so lonely as you think when you look outside this board. At the moment i feel that being a bull is a lot harder after the last year. Anyway, FFH is probably the only reasonable portfolio hedge one can think of and it was you that convinced me of that.

[ASTA]

Thanks for the replay Gio :D

 

I did not know that Warren had recommended his letters good to know.

However, like I mentioned one of the best absolute mangers around has to be FPA Cresent. They provide cool commentary and discusses their stock holdings which if are followed have been very good.

Plus I think I was in a bad mood and had never heard of this manager. Plus when I want to get some worldly wisdom and market temperature I read Oaktree memos.

Again sorry for coming of rude and please continue your contributions Gio. And as a contrarian I might be time to hold more cash as I am bashing a guy holding cash so maybe I am helping you in getting the market temperature for cash :D     

 

[Kraven]

Very strange letter for a portfolio manager. No discussion of any of the securities the firms owns or recommends. Just  repetition of quotes from others.

 

My recollection is that he says somewhere that he realizes these letters will be distributed publicly (very modest since most likely he's the one distributing them publicly) and he has a second letter which discusses their individual positions, etc that is distributed just to clients.

[gary17]

what’s not to like about that! Which would you prefer?

1) to be worth 25% more and have 73% of assets in cash today, or

2) to be worth 25% less and be fully invested today.

 

 

Gio, I don't understand

 

A) why would the portfolio be 25%less if someone has been fully invested...  His equity portfolio did really well and even if 70% invested probability beats the market by a wide margin

 

B) how do his clients get comfortable with when the manager will deploy cash effectively. He's had cash since 1999 and seem to have missed the dot com crash, the crash after 911 and the recent 2008 crash too. 

[Packer16]

Thanks for putting up on the board.  As historian and writer he is excellent also as a stock picker.  He has fallen into the fallacy of being a good market timer (which many in the past have also done).  Although he has outperformed the S&P 500 it depends upon the time frame examined.  If you look at the time from 2003, his portfolio has underperformed by 25% in aggregate.  Also, if you look at more appropriate benchmarks (such as small value indices) he has underperformed by over 300% since 2000.

 

I think what alot of these market timers forget is they are betting against the equity risk premium.  Although this can be small and acceptable for shorter periods of time (averaging 4 to 5% per year) over longer periods of time this compounds and many of these guys become the proverbial frog in boiling water.  In addition, I don't think I have ever met or know of a successful long-term market timer who can beat a fully invested investor.

 

Packer

[matjone]

Klarman, Graham, even Buffett have tended to adjust their exposure depending on the level of the market haven't they?

 

It's true he and his clients would have probably done a lot better if he had  stayed fully invested, and as long as stock earning yields are higher than bond yields then theoretically you are better off with them.  But my question is how little are you willing to accept?  I mean if bond yields are at 1% and stock earning yields are 2%, should you be fully invested because of the 1% advantage?

[Packer16]

In terms of the comparison I think over the LT you can expect an additional premium of 4 to 5% per year.  I don't think earnings yields are 2% (50 P/E) or you would be right.  The 10-yr bond is at 2.7% and the SPY P/E is at 15.3 or earning yield of 6.5% so an implied ERP of 3.8% for all stocks.  So the ERP cost of holding bonds is 3.8% per year and 6.5% per year for holding cash.

 

I think of these investors as opportunistic investors and will only be "invested" when the can find bargains (large in size in the case of Buffet and Klarman) with a margin of safety.  They not being invested only means they cannot find large in size bargains not that stocks are poor choice versus bonds or cash.  To make that decision you need to understand the opportunity cost of holding cash and bonds versus stocks.

 

Packer

 

Packer 

 

 

[frommi]

Klarman, Graham, even Buffett have tended to adjust their exposure depending on the level of the market haven't they?

 

It's true he and his clients would have probably done a lot better if he had  stayed fully invested, and as long as stock earning yields are higher than bond yields then theoretically you are better off with them.  But my question is how little are you willing to accept?  I mean if bond yields are at 1% and stock earning yields are 2%, should you be fully invested because of the 1% advantage?

 

I am 100% sure that even in that scenario you can find stocks with higher earning yields or alternative assets like junk bonds, corporate bonds or REITs that give you a better return. And yes as long as cash as an asset class is not beating inflation i don`t even think of going to cash. In the current environment you are losing purchasing power every month you are in cash, its like a ticking clock that works against you.

[giofranchi]

I think what alot of these market timers forget is they are betting against the equity risk premium.  Although this can be small and acceptable for shorter periods of time (averaging 4 to 5% per year) over longer periods of time this compounds and many of these guys become the proverbial frog in boiling water.  In addition, I don't think I have ever met or know of a successful long-term market timer who can beat a fully invested investor.

 

Packer

 

I don’t really think they are market timers… As you have also pointed out, and rightly so, FFH probably had never used equity hedges until 2002-2003… And of course I cannot know, but I guess they will not go on using them forever… Instead, I think both Mr. Martin and Mr. Klarman and Mr. Watsa, who I am sure would define themselves as “value investors” not “market timers”, at the beginning of the new millennium got scared by the combination of historically very high debts and very high asset prices. Throughout history very high debts alone or very high asset prices alone have usually caused a decent amount of trouble… but the combination of the two have many times wreaked true havoc! That’s why imo we have gone through a 10 years period in which value investors simply behaved much more conservatively than they usually would do and did in the past.

 

Let me be clear about this point: it is not that the concept of insurance is completely foreign to a value investor… Mr. Klarman in “Margin of Safety” asks the following question: person A compounds capital at 20% for 9 years, then loses 15% in year 10; person B compounds capital at 16% for 10 years; who has the largest capital in the end? You already know the answer, without the need to calculate. Therefore, the idea of forgoing some gains, to purchase safety in the form of insurance, is in the DNA of the value investor, who is more concerned about protecting capital than increasing it. What really changed during the last 10 years was the amount of cautiousness those value mangers believed was necessary to employ. And the reason, I believe, was that combination of historically very high debts and very high asset prices I have just referred to. The moment that combination is gone, they most probably will be back to business as usual!

 

Gio

 

[giofranchi]

Hey gio, don`t be upset :). Your time will come and being a lonely rider is not the worst position to be in the investment world. The problem is only that you are not so lonely as you think when you look outside this board. At the moment i feel that being a bull is a lot harder after the last year. Anyway, FFH is probably the only reasonable portfolio hedge one can think of and it was you that convinced me of that.

 

I am never upset! A bit lonely… maybe! But never upset! ;D ;D

 

Cheers,

 

Gio