COMMENTARY ARCHIVE

 

Protecting Capital for the Long Run

 

ACR’s equity investment objectives, in order of importance:

 

1)      Protect capital

2)      Generate an equity-like absolute return in the long run

3)      Beat the market in the long run

 

Long run means through a full market cycle of both economic and stock market expansion and contraction.  Our updated results on that score:

 

EQR (Net 1.25%)1

S&P 500

2000-Present1

11.6%

3.9%

2008-Present

10.6%

6.9%

 

Generating the returns above has required special tactics in the market extremes that we have encountered since ACR’s founding in 1999.  We have maintained portfolios of companies with very different characteristics than the market and have at times held significant cash reserves.

 

Being defensive and sacrificing shorter term results relative to the market has been necessary to protect capital and generate the long term returns above.  ACR’s pattern of below market relative returns and satisfactory absolute returns is revealed in the two major bull market phases since our founding.

 

EQR (Net 1.25%)1

S&P 500

2003-2007

8.4%

12.8%

2009-Present

16.0%

17.7%

 

EQR beat the market in the three up years from the bottom in 2009 through 2011.  This bull market phase offered sound investment opportunities and was, in our view, the only non-speculative bull market since our founding.  In the past two years, markets have become frothier, and we have found more stocks to sell than to buy.  We are once again playing defense.  A dissection of the current bull market reveals these two phases.

 

EQR (Net 1.25%)1

S&P 500

2009-2011

16.2%

14.1%

2012-Present

15.9%

22.0%

 

1EQR (Net 1.25%) is the annualized total return (dividends and capital appreciation) of the Equity Quality Return Advised SMA Composite calculated net of a 1.25% hypothetical annual fee.  The EQR (Net 1.25%) return calculation is supplementary information based on the average recommended fee schedule across our client/partner base.  Please refer to our full composite performance presentation with disclosures published under the performance section of our web site at www.acr-invest.com.  Actual fees may be higher or lower than 1.25%.  ‘2000-Present’ begins April 1, 2000.  ‘Present’ period is as of June 30, 2014.

 

One of the most descriptive representations of our results is shown in our upside/downside market capture ratio.  This is the percentage of the market return we have captured when the market is going up, and the percentage of the market return we have captured when the market is going down.

The Upside Market Capture Ratio is calculated by dividing the monthly return of the manager during the up market periods by the monthly return of the market for the same periods. Generally, the higher the UMC Ratio, the better. The Downside Market Capture Ratio is calculated by dividing the monthly return of the manager during the down market periods by the monthly return of the market during the same periods. Generally, the lower the DMC Ratio, the better. ACR EQR returns in this chart are gross of fees.

 

Past performance is, of course, no guarantee of future results.  We do believe that, based on our current holdings and portfolio price fluctuations, we are in a very defensive position, and our portfolios should continue to offer solid downside protection.

 

Today we see complacency everywhere, reminiscent of past periods of market excess.  The Mark Twain quote – “History doesn’t repeat itself, but it does rhyme” – is certainly true of financial market history.  The interest rate spread between quality and junk bonds is near all-time lows, financial markets are placid with scant stock market volatility, stock prices continue to outpace more tepid increases in earnings, and theories abound which attempt to justify continued rising prices.  It feels like the calm before the storm.

 

Yet ACR never invests based on feelings.  We invest based on facts.  Our analysis of financial statements and business prospects reveals that excellent investment opportunities based on intrinsic values are scarce at current prices.  There are only 6 stocks on our 484 stock on-deck list that appear to be selling significantly below our estimate of their intrinsic value (80 cents on the dollar or less).  For comparative purposes, about half the stocks on our on-deck list appeared to be selling below our estimate of their intrinsic value in early 2009.

 

We believe that in a market like today’s there is potentially more to lose than to gain.  We will continue to protect capital by being relentless about not overpaying for the stocks we buy, and by not trying to keep up with the stock market Jones’ who are speculating on today’s prices at the expense of tomorrow’s results.

 

Nick Tompras, CFA

July 2014

 


 

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