While the personal computer business at HP Inc. (NYSE:HPQ) has improved, the company continues to struggle with the effects of a higher dollar and soft printer supplies revenue, though the overall business still generates large cash flows while trading at a low valuation. Spectrum Brands continues to offer price conscious consumers and retailers a value proposition that seems to resonate in today’s business climate. We admire the management and board of Spectrum in their ability to continue to identify and successfully integrate several acquisitions in recent years (as a reminder, we first bought Spectrum nearly five years ago at roughly one-fifth its current price).
Nevertheless, as in most sports, even good investment managers cannot avoid unforced errors. While renewing efforts to minimize process mistakes, we do own a few securities where the underlying businesses or management teams were unable to prove out our thesis in the last year. Some decisions on these must be made soon. Among these investments are Walter Investment Management, Dundee Corp., and Sears Holdings, which total less than 5% of the overall portfolio as we write.9 There is sometimes a small upside to mistakes – during the year and despite a significant overall economic gain, we were able to realize sufficient tax loss to avoid taxable distributions in 2016. While tax does not drive our investment decisions, we are aware that it does impact many of our shareholders. We try to manage these liabilities to benefit shareholders when such actions are not disruptive to the portfolio.
In today’s world, it’s worth reflecting a few thoughts on money flows in mutual funds (both specific to the GoodHaven Fund and to the industry generally). Most investors are emotional and a good number of the decisions they make turn out to be counterproductive. For example, in our first two to three years, our performance was solid and money poured into the Fund. In hindsight, it seems that many of these new shareholders represented “hot money” chasing recent performance. These investors did not think much (if at all) about business values or how we try to select businesses that have the potential to offer a competitive return on our capital going forward.
Following that period, we went through a roughly eighteen month performance lag, after which a cascade of money exited the Fund (the former hot money shareholders, mostly) with the crescendo of outflows occurring in late 2015 and early 2016 – just in time to miss a double digit performance rebound that handily exceeded the performance of many broad equity and debt indexes notwithstanding a healthy cash position that moderated risk.
Through these periods, we believe we have behaved consistently and overall turnover in the portfolio has been fairly low (our shareholders were trading us more than we were trading the portfolio). In effect, we went through a tough period where we were out of sync with markets – something that happens to all value investors from time to time – yet many decided that the short-term result was somehow a fatal flaw.
So why the large influx and outflow of shareholder money – which of course makes it more difficult to manage a portfolio? The answer is relatively simple – it’s human nature. Most people are not wired to behave in a way that really benefits from the volatility of markets. As Ben Graham once said, markets exist to serve you, not to educate you. It seems to us that a longer-term view and a tolerance for some volatility is becoming an increasingly valuable competitive advantage in the world of investing. Accordingly, we want to thank our like-minded shareholders for sticking with us and benefitting from our rebound this past year. Onwards!
From Larry Pitkowski's GoodHaven Fund 2016 annual letter.
