Kinetics Mutual Funds conversation transcript with Peter Doyle from the second quarter conference call.
Continued from part one... Q1 hedge fund letters, conference, scoops etc Abrams and his team want to understand the fundamental economics of every opportunity because, "It is easy to tell what has been, and it is easy to tell what is today, but the biggest deal for the investor is to . . . SORRY! Read More
Peter Doyle: Thank you, Bob. And thank you, everyone, for joining us today. I’m continually impressed with our entire wholesaling staff’s level of knowledge regarding the individual holdings in our portfolios, who is running the companies, and any relevant new reports affecting those companies. One thing I thought I’d expand upon was what led us to this point in terms of valuations and how people are putting money to work in the market: it’s really the story of the rise of indexation.
Over the last two generations, the academic community has helped shift the portfolio management industry towards the belief that a basket of stocks chosen without research and without regard to valuation will deliver results that are superior to a concentrated portfolio of businesses that have thoroughly been researched and are trading at attractive valuations. We categorically reject that notion. And we offer a clear dividing line between what the academic community and what most investment professionals are doing today and what we are actually doing. Therefore, if you want to be off the beaten path, then we believe the Kinetics Mutual Funds are certainly the place to be.
For example, our flagship product, the Paradigm Fund, has a 99% market active share1. Active share is a measure of the percentage of holdings in a portfolio that differ from a benchmark index, and 99% is about as high as you can possibly get relative to the S&P 500 Index (“S&P 500”). Further, as of March 31—and it’s not radically different through today—the top 10 positions in the Paradigm Fund account for roughly 55% of the assets in the Fund. That means that we’re concentrated and that we’re actually doing something radically different than overall market proxy benchmarks.
It logically follows, that, if you’re doing something radically different, then you will have wide deviation from the benchmark. And it further follows that there will be some periods of time when you will underperform and some periods of time when you will outperform. However, if you subscribe to our belief that better returning businesses with more attractive valuations will ultimately outperform, then it pays to remain patient. During the last 15 years that the Paradigm Fund has been up and running, we have underperformed the benchmark, as measured by the S&P 500, in just three of those years, and our long-term performance is actually quite good.
Kinetics Mutual Funds: Peter Doyle – Money inflows into ETFs
Over the last six or seven years in particular, there’s been quite a flood of money coming into exchange traded funds (“ETFs”). And that’s just another name for indexation. Those ETFs are truly rules-based. And I know we’ve spoken about this before, but I think it requires further commentary. The sponsors of those ETFs are going to buy securities based on those rules, irrespective of the valuations. If money is flowing into a sector ETF, for example, then that ETF is going to go out and buy those securities whether they trade at 5x earnings, 15x earnings, or 35x earnings. And, as a result, you’re seeing the stock prices of companies that really have had very poor business results over the last several years still increasing, and skewing valuations.
In our opinion, it’s very hard for investors to achieve good long-term results if their basic, fundamental methodology is that investing in rules-based indexed products is the solution. We’re of the belief that that is going to come to an end. And it’s going to come to an end for the very simple reason that, 1) the businesses actually have to produce and if they don’t produce, people are going to become dissatisfied, and the stock prices are going to reflect that. And 2) as more and more money has flowed into indexation, the pricing of those indexed products has come down rather dramatically.
As a result of the fee compression, more and more institutions are looking to allocate assets using a combination of what we call active and passive. They might use passive for the bulk of their exposures to an asset class, but they’re still going out and finding active managers who historically have set the prices at the margins and have determined where the securities trade, in order to be allowed to charge more to their clients. If you’re going to put somebody in the S&P 500 and you can get that exposure for roughly five basis points, it is very hard to justify a 1% management fee. Unless you find somebody that’s doing something a little bit different, and actually providing true diversification, you’re not going to be able to charge a premium price for your product or your services. Now, we’re starting to see some of that backlash. And if that backlash continues, then the pricing at the margin will be set by the active value managers, which is the way it has been historically. We believe that puts us in good stead.
With that, I’m going to stop and allow James to talk about some of the dynamics that have occurred in the low interest rate environment of the last several years, and then he’ll delve into some portfolio names.
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