Allan Mecham's Arlington Value Capital 2014 Annual Letter

Allan Mecham‘s Arlington Value Capital annual letter to partners for 2014 – another impressive year for the value fund.

Also see The Next Warren Buffett? Allan Mecham – The Earlier Years

Dear Partners,

I’m thrilled to report that we collectively ended the year fat and happy. My streak of poor predictions remains intact as AVM Ranger gained 31.8% in 2014 versus 13.7% for the S&P 500. And what really carries weight around here (if you look close you may see the slightest puffing of chests): over 6.5 years we’ve compounded at 37.9% per annum vs. 9.9% for the S&P 500.

This 28% spread of relative outperformance is our main concern. Our scorecard is relative to the S&P 500 for one simple reason: most funds fail to beat the S&P 500 over time. If we can beat the S&P (after fees & taxes) then we feel we’ve added value to limited partners (LPs). If we can’t, we’ll find a new field of employment (we all know the world doesn’t need another fund padding pockets at investor’s expense). Also relevant to long time Arlington investors is our 15-year record. We’re happy that our record has been rewarding (so far) to those trusting souls who invested with Arlington at our grand opening; they have seen a 22% compounded annualized return over the past 15 years, outpacing the S&P by 18% per annum.

(I’ve chosen to report all figures gross of fees as some investors have adopted our fixed 2.4% fee, while others have chosen our 1-and-15 performance based structure.) One important note before we move on: we’ve had an amazing run over the past 6.5 years. We haven’t suffered a down year, we’ve beat our benchmark 5 out of 6 years, with one year being a dead-heat, and we’ve outperformed the S&P by a large margin. Unfortunately, none of these accolades are likely to continue. Our level of outperformance is certain to shrink, and the manner in which that occurs is likely to include both down years and years of underperformance.

Allan Mecham’s Arlington Value Capital: Portfolio Commentary

In reviewing the portfolio I try to dance a fine line, balancing pertinent information with readability, while not spoiling current investment ideas we may be interested in buying more of. I aim to provide a general sense of my thinking toward investing, including an example or two that “shows our work” so to speak, balanced against not going overboard with financial minutiae that bores some LPs and causes others to wish I’d stop writing and get back to work.

While last year’s letter rattled on about our sluggish investment behavior, this year we saw a change of pace, with a handful of ideas. And while intuition suggests that ideas drop as markets rise, our focus is on business values independent of market levels or short-term noise.

A culture that insulates us from the noise is important in a world of 24-hour news cycles and myopic measuring. Without it, the job would take on the feel of a financial track meet, as frenetic managers line up each year waiting for the gun to go off. A friend’s reply after asking about our year-end performance captures the culture: “enjoy next week, it all resets on January 1st.”

This near-sighted focus by outsiders (perpetually ailing fund managers) seems tethered to frequent reporting and portfolio transparency?two things we’ve long resisted. As any Facebook user can attest, when people know they’re being watched they have a tendency to alter behavior…

Our recent Berkshire Hathaway experience reinforces our conviction. Three years ago BRK represented a slam-dunk idea yet drew unease from outsiders that had read our letters, causing many to leave us at the altar due to our unconventional stance and commitment to our reasoning. Had increased reporting exposed us to additional angst, we would’ve been distracted at best, and abandoned the idea at worst, which would have been a huge mistake given the rarity of the opportunity.