For the first quarter of 2014, The Capital Ideas Fund and Capital Ideas Trust were up 3.7%1 and 3.6%1 respectively. As we enter the second quarter, the market appears to be correcting, but as of this writing, we appear to have held on to the gains made earlier this year.
As we look into the balance of 2014 we see a couple of themes emerging. Stock market valuations have become rich while monetary stimulus, which has been reflected in low interest rates, remains strong. As such, the portfolio is close to fully invested, although we have taken profits in some of our more expensive winners. In summary, finding companies that can earn a consistently high ROE (20% or better) remains relatively easy, but finding such companies with low valuation multiples is becoming increasingly difficult.
In terms of sector themes, we remain heavily weighted in the “knowledge based industries”, which include a concentrated basket of companies that operate in the software, IT services and pharmaceutical industries. Within the natural resources sector, the only commodity that excites us at the moment is natural gas, and in this area we now have a weighting of close to 13%. We expect to make a good return on all four of our natural gas investments even if natural gas stays at the $4.70MCF level, but we believe that natural gas prices will go higher.
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What can sports teach us about investing?
I have two wonderful sons and an equally wonderful daughter, none of whom has expressed any interest in following their father into the financial services industry. All three of my children are strong students and accomplished athletes and the closest area of overlap between what I do professionally and what interests them personally is the area of sports. If I attempt to talk to my children directly about things related to my profession such as P/E ratios, competitive advantage, or return on capital, they quickly tune out (and who could blame them?). When I engage them about topics related to the analysis of sporting events, competitions or statistics, however, I quickly regain their interest and typically find myself in the midst of a wonderfully nuanced discussion. During a recent visit to baseball spring training in Florida with my younger son, I had a chance to talk with him about some of the things that I have learned from sports that have made me a better investor. Here are a few of the things we talked about.
Charles Ellis and the Loser’s game
In 1975, Charles Ellis, the founder of Greenwich Associates, wrote a famous article for the Financial Analyst’s Journal titled The Loser’s Game. The purpose of the article was to identify factors that explained why professional fund managers struggled to beat the market. Ellis’ article would have been a somewhat dry read for a non-finance professional but what makes it far more interesting to the general reader (and to my son in particular) is Ellis’ reference to the sport of tennis, which allows him to make some very fascinating analogies between tennis and investing.
In developing his thesis, Ellis cites the work of Dr. Simon Ramo, author of Extraordinary Tennis for the Ordinary Player. Ramo noted that the most skilled tennis players in the world won primarily by making points, whereas the typical amateur won by making fewer mistakes than his opponent. As Ellis points out “after extensive scientific and statistical analysis, Dr. Ramo summed it up this way: Professionals win points, amateurs lose points. Professional tennis players stroke the ball with strong, well-aimed shots, through long and often exciting rallies, until one player is able to drive the ball just beyond the reach of his opponent….. (in amateur tennis)…the victor in this game of tennis gets a higher score than the opponent, but he gets that higher score because his opponent is losing even more points.”
See Full PDF here: DKAM-Newsletter_April_2014_Final_Draft
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