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Kovitz Investment Management Spring 2014 Letter

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The Kovitz Investment Group® (KIG®) Equity Composite (Composite) increased in value by 0.1% (net of fees) during the first quarter, while our primary benchmark, the S&P 500 (INDEXSP:.INX), increased 1.8% over the same period. A poor quarter on a relative basis. Fortunately, long-term outperformance is not predicated on outperforming the benchmark over every short-term interval along the way. In fact, if you were to look at every 3-month rolling period since our performance inception date seventeen and one-quarter years ago, you would find that the Composite outperformed the benchmark only slightly better than 50% of the time – offering no better odds than correctly guessing the flip of a coin. Three months is simply not a meaningful period (up or down) in this regard. Given that our investment orientation is more long-term in nature, this result is unsurprising and, frankly, not a concern, and none of this is new to a long time reader of our newsletters.

As a matter of fact, we would go so far as to argue that an acceptance of underperformance over very short periods is what allows for consistent outperformance over more meaningful periods. This may seem counterintuitive, but attempting to outperform over short time periods means you are almost certainly basing your investment decisions on expectations of near-term stock price movements, which are largely unpredictable, rather than making decisions based on the ultimate value of the businesses underlying those stock prices.

For a concrete example of how we think about the trade-off between short-term and long-term performance, consider the activity surrounding our position in Hertz Global Holdings, Inc. (NYSE:HTZ) that took place towards the end of 2013. As part of the company’s third quarter earnings release, management lowered its earnings guidance for the full fiscal year by roughly 5% due to an expectation of weaker volumes in its U.S. airport segment, and the need to reduce excess capacity of its rental fleet. The excess capacity issues were widely known, and it did not surprise us that travel would be slightly impaired given the soft economy at the time. Our analysis indicated that these were short-term issues unlikely to impair longer-term earnings power. This meant our investment thesis was still intact: that Hertz Global Holdings (HTZ) should benefit from a more rational pricing environment, given industry consolidation. From our standpoint, the next quarter was irrelevant as we felt the positive structural changes occurring in the rental car industry were likely to play out over the next several years, and the valuation of Hertz did not reflect the earnings power these changes would produce. Other market participants thought otherwise, sending the shares down 15% in a single day.

With the discount to our estimate of Hertz Global Holdings, Inc. (NYSE:HTZ)’s intrinsic value now wider, our inclination was to buy more, which we did, making Hertz one of our ten largest positions. We weren’t under any delusions that increasing our stake in a company that just disappointed Wall Street would have any beneficial impact on our performance over the next few months. We did believe, however, that the company’s fundamentals would improve over the next two to three years, and our overall performance during this time period would be better off having a bigger stake in Hertz. By being more patient as to the ultimate outcome we accepted the trade-off between short and long-term performance.

As indicated, there is nothing magical – or even informative – in looking at performance over a three month period. Randomness alone can produce just about any outcome in the short run. In order to give a broader perspective of the success of our investment management approach, we provide the results for our complete history, which now covers more than 17 years. The following charts summarize both annualized and cumulative performance results from January 1, 1997 through March 31, 2014 for the Composite and the S&P 500 (INDEXSP:.INX).

See full document on Kovitz Investment Management Spring 2014 Letter in PDF format here.


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