Fernbank Partners LLC
1200 North Garfield Street Suite 913
Arlington, Virginia 22201
2011 Annual Letter
April 12, 2012
Dear Fernbank Investor-Partners,
* Fernbank Partners earned 22.45% in 2011, despite holding on average over 30% of its net assets in cash throughout the year. We are pleased with these results, but not overjoyed (we’re saving our excitement for 2012).
* For the three months ended March 31, 2012, the Fund earned 6.57%.
* Since inception on September 1, 2010, the Fund has earned 46.27% despite holding on average over 30% of its net assets in cash for the period ended March 31, 2012.
The table below shows these performance figures.
Your individual results to date will vary depending on the timing of your investment. Neither leverage nor short selling was a significant factor in the returns displayed above.
Significant Investments (as of Dec 31, 2011)
We discuss MBIA Inc. (NYSE:MBI) , Inc. at length further below, however we would like to briefly introduce one of our other holdings, Newmarket Corporation, about which you probably know very little. Newmarket, headquartered in Richmond, Virginia, is a specialty chemicals manufacturer with a great business and a very strong, durable competitive position in the lubricant additives industry. This industry is controlled by only a handful of long established incumbents-none of which can supply the entire market, each operating within their own unique sub-industry niche.
About a decade ago the lubricant industry began a shift as technological and industrial specifications placed new demands on lubricant properties and performance. For instance, as little as ten years ago, it was quite common to have your car’s transmission fluid changed every few years, however most new car owners today will never have their transmission fluid changed. As lubricant performance demand shifted, so too did the industry’s economics and we believe this shift is here to stay. Scale advantages coupled with captive customers affords Newmarket significant pricing power. Strict regulatory hurdles, high start up costs, high customer switching costs makes entry into this market extremely difficult, in fact, uneconomical for potential entrants. We really like Newmarket’s business (as well as the current price) and unless the price increases substantially, we will be adding to this position going forward.
The Fernbank Approach
We measure our success by the annual rate at which our investors’ account balances increase over five year periods. If, over this time, we are unable to outperform your next best alternative on a risk adjusted basis, we have no business earning a living managing your money, and you should fire us on the spot.
Investment success requires a lot more than being able to identify the difference between good and bad investments which is, incidentally, far more difficult than it sounds. With only so much time in the day, it is critically important to avoid wasted efforts. Knowing where the most attractive opportunities are likely to arise before starting a search for mispricings gives us a huge edge. That said, it is irrational for us to expect to be able to find attractive opportunities every day. In fact, several months may pass before we identify something new of interest. Our job is not only to decide what to invest in, but when to invest. We are not talking about market timing, but rather standing by conservative principles of value, from which we refuse to deviate. Furthermore, our decision to buy or sell an investment will never be influenced by the opinions of other market participants, but rather upon our own measure of the business in which we have an interest. Our responsibility as money managers is to keep our heads when others have lost theirs.
We intentionally built Fernbank to be a long-term partnership for a small group of investor-partners. There is a good reason for this. The magnitude of our success will depend, to a varying degree, on two key items: (i) our ability to generate more investment successes than failures and (ii) your ability as investor-partners to recognize the difference between stated investment results and economic (actual) investment results. Having a small group of investors that understand our approach is extremely important to us because the latter item will never be understood by the typical investor. Focused, disciplined, rational investing will only appeal to a select group of rational like-minded people who have sound emotional temperament, patience and courage to follow through with their decisions despite the crowd’s opposing views; these are prerequisites to understanding item (ii).
This letter is intended to provide you with meaningful updates about the fund’s activities during the preceding year; information that will help you determine how well (or poorly) we have done. Although this sounds easy enough, understanding investment results, especially over short periods of time, can be very difficult. A large portion of this letter seeks to address this problem, however, it may be instructive to first bring a few industry issues to the forefront that are rarely, if ever, openly discussed by the general investment community.1
1 One notable exception among journalists is Jason Zweig of the Wall Street Journal. Anyone interested in first class journalism specific to investing, will want to check out Jason’s “Intelligent Investor” column which appears in the WSJ each Saturday.
The world is horribly confused and terribly misguided by Wall Street. Much of this confusion stems partly from a lack of basic investment knowledge among most investors and partly from a flood of misleading information (provided by Wall Street) about the way the investment world works. Incidentally, the investment industry benefits from client ignorance. Client obfuscation is beneficial to most of the investment industry because confusion and uncertainty are the reason individuals outsource their investment decisions in the first place. To make matters worse, these individual investors make decisions based upon information provided by institutional “experts” who make a living by advising others to do what is best for them. Additionally, these experts do not measure success by the long term rate of increase in the value of client accounts, but rather by client retention rates and the magnitude of new money they attract. It is hard to see how a rational person could, on the one hand, understand how the traditional money management industry operates, yet on the other hand, continue to allow their money to be managed by them.2 A system focused on retaining or increasing clients is naturally focused on market trends and the fear of short-term underperformance and since the vast majority of assets are held by relatively few institutions, the result is enforced mediocrity.3 That is, there is a huge incentive for these institutions to get big, and not much incentive to deviate from the indexes, more or less, because money managers that do about average tend to keep their clients. Unfortunately, the general public does not spend enough time learning