One of the top value funds we know of, had another great year. Khrom Capital’s letter to limited partners (run by, Eric Khrom, who made it to the Forbes 30 under 30 list), was up 18% in 2014, according to a letter to investors reviewed by ValueWalk-
Full letter below – also see 2013 letter here and 2014 H1 here.
Khrom Capital’s half yearly letter to limited partners.
Dear Limited Partners:
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For the full year 2014, Khrom Capital’s Partnership returned 15.0% net of fees and expenses. On average, we held 19% of our assets in cash throughout this period.
Our investment process is to study businesses intimately to understand the earnings they might produce over their lifetimes. Our process is not about quarterly earning beats, not event driven situations, not M&A takeout values, nor peer relative valuations. It is not to look at what our return could be if we sold a certain business in a year or three years. Our niche is to assess what our return could be if we never sold a particular business.
This is a focus we like because few people look at stocks this way. Trying to assess the range of earnings a business could produce over its life—and then basing valuation just on that—is a methodology that is rarely taught. Even if it were widely taught, most investment funds would have difficulty practicing it because of their asset-liability mismatch. Should they try, their investments (assets) could take longer to work out than their LP capital base (liabilities) is willing or able to wait. Thanks to our Limited Partners, we do not suffer from such a duration mismatch. Not only do we have a structural advantage because of our lockup, but our ability to think long-term is further enhanced because our investors are a self-selecting group. Since we do not market Khrom Capital, we did not have to persuade Limited Partners of our philosophy; investing without regard for market turbulence was something they believed in before they called us.
We believe we have built a capital base that is calm in the face of stock price volatility. Over the seven years that Khrom Capital has existed, not once has a Limited Partner judged us on our short-term performance. This creates a virtuous cycle where we gain confidence in thinking longer-term, which helps improve our performance, which creates greater trust with our Limited Partners, which gives us greater freedom to think longer-term, and so on. Not only does our edge compound slightly as we improve the ever-expandable skill of predicting the lifetime earnings of a business, but it also compounds as we create a capital base that enables us to do so. As with our stocks, we like to look at the lifetime value of our relationships with Limited Partners.
This is not merely touchy-feely stuff. This has economic value. As you allow us to think longer-term, we can in turn focus on a time horizon few others are interested in. And a few times a year, that leads us to find mispricing that one would miss if they had to be concerned with a stock’s performance in the near term.
We think there is relatively less competition trying to predict what we choose to predict. In the years ahead, we will strive to capitalize on the duration gap that plagues the investment industry, expecting it will continue to lead to above average returns on your capital (and our own). Thank you for allowing us to do what we do.
Addition to the Khrom Capital Team
We are excited to welcome Vikram Vish to the Khrom Capital team. Vikram is a graduate of the University of Pennsylvania, where he was a triple major, studying Finance at the Wharton School, and Political Science and South Asian Studies in the College of Arts & Sciences. After graduating in 2011, Vikram worked as an analyst in the Investment Banking division at Goldman Sachs. While at Goldman, Vikram helped develop, structure, and execute transactions for the firm’s private equity clients, giving him his first exposure to managers with a long-term investment horizon. In 2013, Vikram left Goldman Sachs and joined SAC Capital as an analyst. There, he was responsible for making investments across the healthcare sector.
Vikram joined Khrom Capital in August 2014. We were not looking to add anyone to our team, but by patiently waiting for serendipity (like a lot of our investments), Vikram was introduced to me and it was immediately apparent how in-tune he was with our investment philosophy. In the short time since joining our firm, Vikram has proven himself to be very diligent with his work, in-depth with his research, and astute in assessing the unit economics of a business while also thinking holistically about an industry. Especially important to us, he has the temperament to be patient and think far into the future. The only downside to Vikram is that he consistently makes me look like I am leaving the office too early.
We remain as optimistic about our long-term future today as when we started in 2008. As it has been since inception, virtually my entire net worth is invested in the Partnership as I aim to compound my wealth alongside yours. As always, if you ever wish to discuss our current investments, please feel free to call me. I look forward to writing to you again in the summer.
Eric E. Khrom
Khrom Capital Management, LLC