East Coast Asset Management annual letter for the year ended December 31, 2015.
I have just three things to teach: Patience, simplicity, and compassion. These three are your greatest treasures. -- Lao Tzu – Dao de Jing – 500 B.C.
Gates Capital Management's ECF Value Funds have a fantastic track record. The funds (full-name Excess Cash Flow Value Funds), which invest in an event-driven equity and credit strategy, have produced a 12.6% annualised return over the past 26 years. The funds added 7.7% overall in the second half of 2022, outperforming the 3.4% return for Read More
Time and tide wait for no man. -- Geoffrey Chaucer (1343 – 1400)
We have a light upon our house, and it gives hope to all who sail upon the stormy seas. Do you know what it means to have a light burning atop your home? It is safety, a place of refuge, seen by all as a signal that ye stand for something greater than this world, greater than us all. -- James Michael Pratt - The Lighthouse Keeper
A ship in harbor is safe, but that is not what ships are built for. -- John A. Shedd – (1859 – 1935)
It is better to light a candle than curse the darkness. -- Eleanor Roosevelt (1884 – 1962)
East Coast Asset Management 2015 Annual Letter
To: East Coast Asset Management Clients and Interested Parties
From: Christopher M. Begg, CFA – CEO and Chief Investment Officer
Date: February 12, 2016
Re: 2015 Year-End Letter - Twin Lights
In our year-end letter, in the section titled Twin Lights, I will discuss how the beacons of Distinction and Safety shape our investment philosophy. As is our standard practice, our market overview and strategy update as well as client reporting, including performance and positioning, have been sent under separate cover.
East Coast Asset Management - Market Summary
Military theorist Carl von Clausewitz wrote the widely influential book On War, which is often quoted for a commander’s ability to reason strategically in the “fog of war.” Clausewitz referred to a leader’s ability to make rapid, highly consequential decisions with incomplete, dubious, and often erroneous information while experiencing high levels of fear, doubt, and excitement. On this topic he wrote, “All action takes place, so to speak, in a kind of twilight, which like a fog or moonlight, often tends to make things seem grotesque and larger than they really are.”
Today we find ourselves in a “fog of war” where there is misinformation, fear, doubt and excitement swirling about nearly every global asset class and capital market. History reveals that volatility takes place in this kind of twilight where things seem larger, more devastating, and more grotesque than the likely truth of the situation. We believe distinguishing signal from noise, fact from fiction, sensible apprehensions from nonsensical unknowable concerns, and the myopic, frenetic short-term from the calm, collected, reasonable long-term is paramount to any successful investment strategy. The ability to derive these distinctions is what differentiates superior results from mediocrity.
Toward this end, a focus on cash flows, moats, and valuations provides the long-term investor, who expects these tidal moments, with something tangible in a fog of panic. We believe that our per-share ownership of businesses in our portfolio have improved as certain companies have gained market share from distressed competitors and through opportunistically repurchasing shares. We are grateful to have clients and partners who allow us to look at these periods with a proper perspective and with the appropriate time horizon, as this is an essential ingredient if we are to attempt to achieve superior risk-adjusted compounded returns over the mid to long-term.
East Coast Asset Management - The Logarithmic Path:
T.S. Eliot opened his magnum opus the Four Quartets with an epigraph – a quote from the Stoic philosopher Heraclitus: “Although the logos is common to all, most live as though they had an individual wisdom of their own.” The epigraph introduces the primary concern of the Four Quartets, the connection between the individual and the universal, the temporal and the eternal.
The secret of anything that grows logarithmically is the connection between the universal and the eternal in contrast with the individual and the temporal. In terms of growth we can conceptually think of two paths – the logarithmic path (upward sloping) and the linear path (dotted line). The etymology of logarithmic comes from the Greek root word logos, meaning the way or the path, and rhythmic, meaning number. Although the logarithmic path may be a common objective, most arrive on the linear path testing their individual wisdom.
The linear path is typically the path most people end up taking, where applying individual wisdom bears the burdens of biases, blind spots, and human instincts. The linear path is seductive as it advertises the here and now versus waiting for a future reward. The linear path is well travelled giving us the perceived sense of safety and community with the “in” crowd. What’s more, the linear path generally starts out higher, where contrastingly the logarithmic path requires a prepayment period with an unknown, unquantifiable reward. Patience and delayed gratification were not useful instincts to our hunter-gatherer ancestors so they handed down very little DNA to assist in logarithmic ambitions. Planting seeds for future harvest is not intuitive. Perhaps that’s why the rewards are so great for those that can crack the code 27-18-28.
Well-intentioned logarithmic pathfinders find themselves confined to the linear due to intermittency and variability of action toward intention. Many lives play out like the Greek tragedy of Sisyphus who was forced to push a boulder partially up a mountain only to see it roll back down to the bottom and start over again. The plight of the linear is pausing when things get too tough. Mediocrity is derived from the Latin word medius, meaning half, and ocris, rugged mountain. The linear path of mediocrity literally means – half way up the mountain. Staying on the logarithmic path is constant work and it requires habits that if not genetically embedded, need to be programmed into our being with focus and frequency. To enjoy the views from the top of the mountain by way of the compounding path requires sacrifice, delayed gratification, a longterm focus, and most of all a plan to fight off the foes of intermittency and variance when they rear their idle heads. Outliers find a way to clutch and cling to the logos.
Today’s global equity markets are a case in point. There are so many temptations for an investor to take refuge and lower one’s gaze to focus on the perceived reality of the manic depressive nature of price. The volatility of energy prices, China’s hard landing, rising U.S. interest rates, the “what if” scenarios, and the terror of the bad actors in the geopolitical theater are just a few of the reasons to convince our human instincts to choose mirages of safety over a more intelligent, logical path that has been paved by reason and fundamentals.
Our stay-put behavior reflects our view that the stock market serves as a relocation center at which money is moved from the active to the patient. -- Warren E. Buffett – 1991 Chairman’s Letter
We are committed to a life-long study of the characteristics that should enable businesses to earn superior returns and sustain them over a long duration. Toward this end, we focus on expected per share cash flows that a business should generate over an appropriate time horizon. As the expected returns and our margin of safety are revealed with independent research, we can construct a portfolio around what we believe to be the most attractive risk-return businesses. We believe this path to be superior, intelligent, logical, and the most businesslike compared to other employed investment strategies. We only have to look to Warren Buffett and Charlie Munger to see just how rewarding the patient, logarithmic path can be.
Perhaps the logarithmic outcome is made possible by the collective aggregate of the linear. In the case of compounding, logarithmic paths and linear paths are not opposing forces but are one reality. Logarithmic success is born by the contrast of the linear crowd – a statistical force of nature driven by Pareto-like principles.
And the ragged rock in the restless waters, Waves wash over it, fogs conceal it; On a halcyon day it is merely a monument, In navigable weather it is always a seamark To lay a course by, but in the sombre season Or the sudden fury, is what it always was. -- T.S. Eliot – Four Quartets – Dry Salvages
The misperception of risk, fueled by fear and envy, is often the reason investors abandon logarithmic paths. We have learned that risk is the ragged rock in restless waters. Waves wash over it and it’s often concealed by fog when things are going well in calm, halcyon upward-sloping markets where risk is merely a monument, a seamark to lay a course by. Yet, in the sudden fury, risk is what it always was. We believe that business-like reason guided by the beacons of Distinction and Safety and the foghorn of a proper perspective of Time will allow us to stay on a logarithmic, compounding course. And as for risk, folly and hubris – we do not need the somber season or the sudden fury to remind us that the ragged rock is what it always was.
East Coast Asset Management - Twin Lights:
Gloucester Daily Times – February 24, 1919
Steamer George Washington bearing President Wilson and party returning from abroad and her destroyer escort might have come to grief on Thacher’s Island yesterday afternoon at 3 o’clock while the craft and convoy were making for Boston, but fortunately the danger was discovered in time. The craft was coming nearly head-on in the snow squall which set in about that time when the danger was learned and the big liner stopped, sent full speed astern and anchored. …
When the Fog Lifted
The destroyer Paulding came close alongside and the heliographs got going. Then from over the starboard bow came the doleful, steady wail of a foghorn-dealing out its warning. Officers recorded the blasts by stopwatch, hoping to identify the station by its manner of blowing. Meanwhile Captain McCauley (USS George Washington) flashed a heliograph message to the Paulding to proceed cautiously and attempt to identify the signal. In a moment the destroyer got under way, splitting long trails of black smoke from her funnels, but she had hardly started when the wind shifted and drove the snow flurry off to the north, the fog lifted and one of the officers perched on the upper deck sang out:
“Thachers Island Dead Ahead!”
Through the dissolving mist the two lighthouses of the Cape Ann station became visible and the suspense was over. The Washington and her convoy had been headed toward shore just above Eastern Point Gloucester and still further north from Marblehead.
On that fateful day, President Woodrow Wilson was returning from the signing of the Treaty of Versailles in Paris. He directed Captain McCauley to redirect the convoy’s destination from New York to Boston so he could make a speech to drum up support for his League of Nations agenda. The 722 foot USS George Washington was carrying over two thousand soldiers including the then Assistant Secretary of the Navy, Franklin D. Roosevelt and his wife Eleanor. It would be only 13 years later that FDR would become our 32nd President and be called upon to guide us through a Great Depression and World War II. Eleanor Roosevelt serving as “First Lady of the World” would go on to achieve historical progress in human rights.
Maurice Babcock is one of the unsung heroes in our country’s history. Acting as Thacher Island Third Assistant Keeper, Babcock saw a large ship heading for the island through a break in the fog. He incessantly blew the foghorn until he saw the ship shudder to a stop and turn away at the last minute before hitting the Londoner reef or the Dry Salvages reef just to the north. Babcock was unaware this was the USS George Washington and it wasn’t until days later when a story appeared in the Gloucester Daily Times (referenced above) that Babcock read just how consequential his efforts were.
The Twin Lights had remained hidden in plain sight for my twenty years living on Cape Ann. Having grown up on Cape Cod with lighthouses scattered about, my conscious mind perhaps filtered what it had considered commonplace, as is typical of most blind spots in life. I have spent countless mornings admiring a sunrise casting light on the Twin Lights at our local surf break in Gloucester, yet I never knew their history. Why two? And why were they there to begin with? There was always this comfort and essence to their presence; the beauty of their symmetry and how nature would change around them throughout the seasons. They remained sentinels of my subconscious. The veil of ignorance was lifted this past summer when a friend, who has considered the island his refuge since he was a boy, invited my daughter and me to join him on his boat to explore the island and climb the towers.
The Twin Lights were built in 1771 after John Hancock, who had a large shipping business in the area, petitioned the Massachusetts government to build a lighthouse on the island. Once the American Revolution ended, President George Washington believed lighthouses were so important to trade that the ninth act of the newly formed Congress created the U.S. Lighthouse Establishment to build and maintain lighthouses along the East Coast. In 1792, Alexander Hamilton signed the actual appointment letter for the first lighthouse keeper at Cape Ann Light.
The Twin Lights were particularly important, as it was the first sight that ships arriving from Europe saw before working their way south to Boston Harbor. The island guarded the extremely dangerous Londoner reef that sits a half-mile off its southeastern shore and Dry Salvages reef just to the north. Several English wrecks occurred in this area, which was why the reef was named the Londoner. The Twin Lights are particularly noteworthy for two reasons:
1. Distinction: The reason two lighthouses were built on Thacher Island was so ships could determine which lighthouse it was before an intermittent light system was invented, called light characteristics, to mark distinction. Specifically it was important to distinguish between Portsmouth Light to the north and Boston Light to the south. Building Twin Lights was the best way to mark a distinction without any shadow of a doubt. The North-South alignment of the Twin Lights also serves as a range light to determine one’s navigational heading. The Twin Lights are one of only eight Twin Lights ever built and today they remain the only ones still lit and in operation.
2. Safety: The Twin Lights were the first station built in the United States to mark “a dangerous spot in the ocean” as all other stations at the time simply marked harbor entrances.
The reason for the existence of Twin Light’s, coupled with their steadfast duty of saving lives and assisting ships over the last 250 years, share two foundational principles we apply to our investment process: Distinction and Safety.
See the full letter below.