GoodHaven Fund 2013 Letter (Fairholme alums)
Dear Fellow Shareholders of the GoodHaven Fund (the “Fund”):
For the Fund, last fiscal year was a tale of two six-month periods. In a red-hotstock market, we ended the first six months up roughly 17%
, slightly outperforming the S&P 500 index despite a large cash position and maintaining a significan t advantage versus the S&P since inception. For the second six months, the value of the Fund rose further, as we ended the year up nearly 20%, but far less than the S&P 500 as the broad stock indexes continued to rocket higher. Since inception on April 8, 2011 and through November 30, 2013, we’ve earned about 14.7% per annum and have roughly kept pace with the S&P 500 Index. Relative returns are important, but absolute returns are ultimately what can be spent. In our opinion, we and our fellow shareholders have little reason to complain so far.
Without overly weighting recent results, we think it’s appropriate to identify for you the reasons why recent performance diverged from indexes – something we expect (in either direction) from time to time. First, there was a lack of volatility to help us purchase securities at advantageous prices. Second, general price levels rose significantly, with increasing ly speculative activity. In simple terms, investors decided to pay much higher prices for not much more in earnings. Third, we didn’t swing at some hittable pitches and paid a price for hesitating. Fourth, a few of the Fund’s holdings are insensitive to broad market movements, and are expected to modestly offset market declines – qualities that proved unnecessary and unprofitable over the last twelve months. Last and perhaps most importantly, large subscription inflows nearly doubled the Fund’s size since last November, temporarily leaving us
with more cash than sensible opportunities. Currently, cash and equivalent holdings are substantia l but down slightl y from mid-year as a percentag e of the overall portfolio despite inflows.
All of the above said, we are not overly concerned about short-term results, are not crying over positive double-dig it absolute returns, and are not changing the consiste ncy of our approac h or our strategy. During 2013, many asset classes experienced de minimus or negative returns.1 We are pleased that since the inception of the Fund, we have kept pace with the S&P 500 Index during a period of strong absolute returns while retaining significant liquidity, flexibility, and a risk profile we believe to be lower than many competitors.
Today,new opportunities seem more limited than those of a couple of years ago, and though we are optimistic about the long-term, the investment world has grown more ebullient than we prefer. However, like the weather on Mount Washington in New Hampshire, conditions on Wall Street can and do change fast. Berkshire Hathaway’s Warren Buffett and Charlie Munger have often observed that having liquidity when others don’t and being prepared to react quickly can be huge strategic advantages. The greatest difficulty for most is remaining sufficiently patient to allow these strategies to play out.
We belie ve that the Fund’s current liquidity may prove to be a significant advantage in today’s investment world at a time when many seem to think that risk has disappeared. Investors tend to hoard cash when securities bargains are plentiful and complain about it when its value (in terms of what it will buy) is about to soar. In 2013, after five years of market rally with leading indexes nearly tripling in price, investors treated cash holding as trash. We recognize that there has been an opportunity cost to holding cash this year, but too many managers are willing to accept the risk of large loss for small prospective returns. We won’t. We simply try to employ as much of the Fund’s cash as we think prudent given the opportunities we see.2
During our tenure, we have also tried to avoid large amounts of interest rate risk, given a common sense belief that the Federal Reserve’s quantitative easing and zero interest rate policies cannot permanently suppress bond yields at or near generational lows. Extended attempts to mani pulate bond yields lower are likel y to have significant negative effects. Though U.S. Treasury yields are still at absolutely low
levels, U.S. ten year notes and thirty year bonds saw recent yields bottom at 1.43% and 2.46%, respectively, and current yields now sit at approximat ely 2.97% and 3.88%.3 The three-decade tailwind of falling rates seems to have disappeared. What worked yesterday may not work tomorrow.
Investors should also be questioning whether recently low levels of inflation will persist. Historically, inflation has been a pernicious tax on low and middle-income citi zens and a problem for many businesses. Yet today’s central bankers are desperately trying to create it. Instinct says the bankers should probably be mindful of exactly what they are wishing for – once out of the bottle, the inflation genie doesn’t like to go back. Paul Volcker, former Chairman of the Federal Reserve during it darkest days of inflation fighting in the early 1980s, was an early skeptic of the benefits of inflation as an economics student. Volcker recalled,
“It all sounded too easy. Push this button twice and out pops full employment. Equations do not work as well on people as they do on rockets. I remember sitting in class at Harvard listening to [fiscal policy expert] Arthur Smithies say, ‘A little inflation is good for the economy.’ And all I can remember after that was a word flashing in my brain like a yellow caution sign: ‘Bullsh**’. I’m not sure exactly where that came from…but it’s a thought that never left me.”4
We think Volcker was right to inherently distrust inflation, which is more palatab le to politicians than unemploy ment, and remai n skeptical that current confidence in central bank policies is warranted. Ultra-low rates and significant money printing are historical ly assoc iated with inflationar y busts. Given high sovereign deficits, massive and growing sovereign debts, and accommodative central bankers, we believe investors should be concerned about the possibility of future inflation or associated currency weakness, though neither is yet evident in most government statistics.5
While limited with respect to certain investments, the GoodHaven Fund has the ability to invest in a wide variety of securities and asset classes. No matter the environment or potential clouds on the horizon, we assume that most of the time there will be potentially interesting investments to make out there – we just have to keep searching and find one or two that can move the needle. And while it is not
always apparent , we have been look ing dil ige ntly (see our discuss ion about Harbinger Group and Stolt-Nielsen below). However, rapidly rising equity prices mean that we are being asked (generally) to accept less value in exchange for our cash when we buy a new investment. Given the magnitude of Mr. Market’s price rise, we won’t automatically buy more of what the Fund already owns as new cash comes in unless the price is right for a new purchase.