Q1 2023 Letter to Partners
Results and Reflections
Listen to this letter:
To March 31st, 2023:
In the period ending March 31st, the fund has appreciated 11.8%, compared to a gain of 6.8% for the VT Total World Stock Index, and a gain of 7.5% in the S&P 500.
The Results
While we are encouraged by the funds’ performance during the first quarter, we advise our partners not to overemphasize these short-term results. We ask that you judge our performance over a minimum of three years, and analyze our process by its merit and soundness. We find that in the investment field, success matters in that it is repeatable and sustainable throughout cyclical market conditions. That being said, the outperformance in Q1 is a step in the right direction as many of our portfolio companies experienced a strong run up due to positive business developments.
It is worth noting that these returns were achieved without the use of leverage, shorting, or financial derivative of any kind, nor do we plan to employ such techniques. Our strategy relies on opportunistically buying good companies at low valuations and holding them for the long-term. As the portfolio is highly concentrated and exposed to emerging markets, the outperformance in Q1 was driven mainly by (A) positive developments for our top three portfolio companies and (B) the weakening of the U.S. Dollar against the Brazilian Real and Chinese Yuan.
Portfolio Company Update:
Alibaba Group Holding ( BABA 0.00%↑) announced its most significant organizational overhaul in its 24-year history. The company will be restructured as a holding company with six individual business units, each with the ability of raising funds independently. This announcement sets the stage for IPOs and spin-offs, potentially unlocking significant shareholder value. The market welcomed the announcement as shares appreciated north of 18% into the end of the quarter.
At the time of writing, the development is still ongoing, with only a general plan having been announced. While we have minor concerns about future costs and data sharing-synergies, we view this as an overall net positive for the company (and our investment) in three major ways:
Greater Business Agility
Alibaba’s mission has always been to help small and medium sized businesses succeed. In doing so, they became a large business with many capabilities and resources. When we originally invested in Alibaba, we were attracted to this duality; the resilience that comes with a large business and the innovation that comes from entrepreneurs and small businesses. However, as Alibaba grew in size and scope, decision-making at the operational level became overly bureaucratic and complex. During a call discussing the reorganization, CEO Daniel Zhang told investors,
“We believe this will allow all of our businesses to become more agile, enhance their business decision-making, and respond faster to market changes.”
In a letter to employees, Zhang said that the holding company structure made sense for Alibaba since the nature of the six business groups were different, with various stages of development and disparate needs.
Easing Regulatory Concerns
Since late 2020, Beijing had become increasingly concerned over the concentration of power of large tech companies. Alibaba, in particular, was targeted with the unexpected suspension of the $37B Ant IPO; set to be the world's largest IPO at the time. In 2021, Chinese regulators fined Alibaba a record $2.8B following an anti-trust investigation for monopolistic practices. New policies were then announced targeting data collection practices such as the personal information protection law (PIPL), further signifying Beijing’s resolution to curb the influence of Chinese internet firms.
The decision to restructure is compatible with the general desire to avoid antitrust scrutiny moving forward. Splitting Alibaba into different business lines could help insulate the entire enterprise from future government regulations on specific sectors. It also helps remove the perception of Alibaba as a monopolistic entity that could one day potentially rival the CCP's influence on general society. In summary, smaller companies make for smaller targets from a regulatory risk standpoint.
Potential Valuation Re-rating
Dividing the business into six units allows the market to value each unit, potentially removing the “conglomerate discount” common in businesses with multiple non-adjacent segments. As such, we believe that the restructuring will motivate investors to value Alibaba using a sum-of-the-parts valuation over time. IPOs provide further upside for the valuation as they are typically promoted with high-profile roadshows that increase sentiment and liquidity for the offering.
For our original thesis on Alibaba, click here
The Big Ideas in Our Portfolio Companies
When choosing an investment, we are making an assessment based on our long-term view of the individual business. Embedded in this process, however, is a judgement on what the business environment will look like in the future. We believe that the following business trends have strong reinforcing momentum that will continue over the next decade:
Electronic payments will continue to gain share as the preferred method of payment.
E-Commerce will continue to gain share of total retail spend.
Digital Banking will continue to gain share over traditional banks.
Content will continue to become more decentralized through internet platform businesses.
On Demand Streaming will continue to gain share as the preferred method of consuming content.
Online advertising will continue to gain share of total ad spend.
Cloud Computing will continue to gain share of total IT spend as digitization increases the role of data.
Most of our hypotheses can be summed up as follows:
The physical world will continue to move toward digital channels as it is more productive and efficient for both businesses and consumers. Because capitalism rewards optimization with higher profits, the business world naturally adopts what is optimal over time.
The new, more efficient business processes becomes the standard once they are fully adopted by all business operators. This is intrinsic to the natural forces in capitalism and is why we are confident that our “Big Ideas” will become reality over time. We will continue to consider these themes when analyzing potential additions to the fund.
Our Competitive Advantage:
Outperforming the market is VERY difficult. The question then arises, how are we different from the ~84% of fund managers who fail to outperform over a five year period? Understanding our competitive advantage as investors is central to our goal of long-term outperformance. We believe that in investing, a competitive advantage can be achieved in the following ways:
Informational - knowing a fact that no one else does
Analytical- having deeper insights than others
Behavioral - having a superior psychological or temperamental quality
We do our best to be as informed about our portfolio companies as possible. This process is simple in that it requires a certain work ethic and commitment to research. We address the analytical advantage by investing only when we have a differentiated view from the market, backed by evidence and rationality. Thus, we spend a considerable amount of time questioning prevailing opinions and look for evidence to the contrary wherever possible. In regulating our behavior, we aim to be more patient than our peers. We do not concern ourselves with outperforming every quarter (or every year for that matter) provided we reach a favorable long-term destination.
Imagine for a moment that we informed you that over the next four years, we will achieve a 15% compounded annual return with the following order of returns: -10%, 5%, 38%, 35%. Reshuffle the order of returns in any particular fashion and you will come to find that the end result is the same. The order in which results fall are unimportant to us as long-term investors in our portfolio companies. As such, we ask that you judge the fund by its core principals and view the short-term results with a sense of equanimity.
The Portfolio
Since inception, we have made 12 investments in 7 industries as classified by Morningstar. While the investments span throughout various sectors, there is material concentration in the sectors of internet retail, financial services, and cloud computing. There is also a geographical concentration in Brazil and China. We anticipate high volatility in the fund due to portfolio concentration, emerging market risk, and a contrarian investment strategy. While we do not aim to take undue risk, we are aware of the nature of funds such as ours. We would like to remind our partners on the need for patience and thank them graciously for their continued support.
Sincerely,
Jack Beiro, MBA
JB Global Capital
For our investment case on STNE 0.00%↑ , Click here!
For our investment case on GOOGL 0.00%↑, Click here!
The information contained herein represents the author’s opinion and is for informational purposes only. Nothing in this newsletter should be construed as legal, tax, investment, or financial advice. No opinion expressed by the author should be construed as a specific inducement to make a particular investment or follow a particular strategy. The author may hold positions in securities mentioned in the newsletter and may buy or sell securities at any time. The author may express opinions based on information he considers reliable, but no guarantee or warranty is made with respect to such information’s completeness or accuracy, and the author is under no obligation to update or correct any information provided. Please consult your own financial or investment advisor before acting on any information provided herein.
Nice work!