Morgan Creek Q4 Letter – Reflexivity: The Virtuous & The Vicious

Morgan Creek Q4 Letter – Reflexivity: The Virtuous & The Vicious

Morgan Creek Capital Management letter to investors for the fourth quarter 2014, a copy of which was obtained by ValueWalk. The fund had stong performance and has interesting analysis on Soros, Buffett and more. Letter below

Due to a coincidence of the calendar, I write my Q4 letter each year during Super Bowl week and the hype surrounding the event has provided inspiration in prior years for the theme of the letter from the 2013 HarBowl (Brothers Jim and John faced off as opposing coaches) where we talked about how Defense Wins Championships (defense ruled again on the last play of this year’s game, unfortunately for us Seahawks fans) to the improbable run of Kurt Warner with the Cardinals in 2009 where he was nearly run out of town for a run of poor performance early in the season before confounding his skeptics and leading them to the Super Bowl (which they should have won, but for one of the most amazing passes in Super Bowl history by Ben Roethlisberger). Warner’s heroic performance was another reminder that recent performance is not a good predictor of future returns despite the predilection for investors to pick managers that way.

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Morgan Creek – Investment lessons in the 2015

There was clearly a lot of great material for investment lessons in the 2015 Super Bowl to come up with a theme for this letter, from the rise of two underrated quarterbacks (late round draft picks) who have become the best in the game despite all the quantitative analysis that predicted they would never amount to much (statistics still can’t measure heart and field smarts), to the unlikely rookie hero who didn’t forget that you have to stay focused on every snap because you never know when the ball is coming your way (even when everyone else in the stadium knew, for sure, it was going to be a run, not a pass, on the last Seahawks play; well, everyone but Pete Carroll), to defense wins championships again as it was the Patriots defense that kept the prolific Seattle offense out of the end zone in the fourth quarter which allowed Tom Brady’s heroic performance (Super Bowl records for most completions and most all time TD passes) to become MVP worthy rather than a footnote in stories about Russell Wilson’s MVP award, to the importance of understanding the difference between probabilities and possibilities when making critical decisions, in football and in investing (it was possible that a slant pattern would work when everyone was crushed together at the one yard line, but it was probable that Marshawn Lynch (#BeastMode) would get the last yard given three downs and a timeout…). But, this year, we will take a break from the football analogies and talk about an MVP worthy performer in the investment business that has provided many pearls of wisdom (and a little philosophy) over the years that we can apply to the current investment environment.

Morgan Creek – George Soros’ track record

George Soros is widely regarded as one of the preeminent investors of our time after compiling a track record over four decades from 1969 to 2009; that is, without question, Hall of Fame material. Given that there are simply not that many investors who have track records of this duration, it is tough to make direct comparisons at all, and making comparisons across decades is tough because of the very different economic and market environments that exist from decade to decade. For example, making good returns from 1969 to 1982 was pretty darn tough as the S&P 500 was essentially flat during those 14 years, while it was pretty easy to make solid returns from 1982 to 2009 as the S&P 500 compounded at 12.3% and went up nearly 20 times (when you put the whole 41 year period together the S&P 500 compounded at 9.4% and turned a $10,000 investment into just under $400,000).

Interestingly, there is one investor who was in the market the entire time as Soros (and is often touted as the world’s greatest investor, for some pretty good reasons related to consistency and longevity) and actually has a track record that we can stack up side by side with George to gain some perspective. Warren Buffett closed his private partnership (BPL) to new capital in 1966 and, by 1969, had transitioned to running as a closed end fund named Berkshire Hathaway (named after the original textile manufacturer that he bought a controlling interest in and later took outright control). So when Soros started taking outside capital into his Double Eagle partnership in 1969 (where he was an Associate at Arnhold and S. Bleichroeder), we had ourselves a horserace. George eventually spun himself out in 1973 into a private firm, Soros Fund Management, and later established the Quantum Fund as their primary investment vehicle. Soros was the primary Portfolio Manager for many years, but was very successful in building an extraordinary team of very talented investors to work at Quantum and he eventually ceded the CIO responsibilities to Stanley Druckenmiller (who also has a Hall of Fame track record of his own in compounding client wealth in his fund, Duquesne Capital). Soros became less active in the late 2000s and Quantum actually returned all outside capital in 2011, converting to a Family Office to concentrate on running the Soros family and Foundation assets.

Morgan Creek – Quantum vs. Berkshire

So for the 41 years from 1969 to 2009, we have good data on Quantum vs. Berkshire (thanks to Veryan Allen at @hedgefund who collected the information and calculated the returns) and the results are nothing short of astonishing. Warren compounded wealth over that period at a stunning 21.4% (more than double the S&P 500 return over the period) and would have turned a $10,000 investment into $28.4 million. Soros, however, did a just little bit better, compounding at 26.3% (which doesn’t sound like that big a difference) and, through the miracle of long-term compounding, turned that same $10,000 original investment into an extraordinary $143.7 million. Now clearly very few investors benefited completely from any of these three track records. Those numbers assume that you reinvest all the dividends, never take any distributions and invested at the beginning and stayed invested until the end. Forty-one years is a long time to stick to one strategy. In fact, to provide some perspective on how hard it is to stick to any strategy long-term, we have data that shows that over the past 20 years (a period only half as long as the Soros period) the S&P 500 Index has compounded at 8%, yet the average investor in mutual funds has only made 3% (from the Dalbar Study) because investors are not very good at sticking to a strategy and letting compounding work for them.

As famous stock operator Jesse Livermore once said, “It was never my thinking that made the big money for me, it was always my sitting.” Understanding full well that most investors only earn a fraction of what is available in any investment strategy, simple math says that a fraction of George or Warren’s performance is far superior to a fraction of the S&P 500 performance. The primary point of all of the performance math here is to establish that George Soros is one of the world’s greatest investors and we would probably be wise to pay attention to any lessons he is willing to share with us and, fortunately, he has been willing to share many of them over the years. I have compiled a collection of “Sorosisms” from various sources over the years and have tweeted many of them individually to provide insight on a particular event or opportunity in the market, but for this letter I have selected my favorite 23 (many from a great compendium of 50 of George’s best at to discuss the Soros philosophy of Reflexivity and make the case for why it is so important for investors to understand, particularly today.

See full PDF below.

Marcato Capital 4Q14 Letter To Investors by ValueWalk

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