Akre Capital Management's Akre Focus Fund 4th-Quarter Commentary

Better writers than us will capture the significance of what the year 2020 has meant to the United States and the world. Our society has been stressed and continues to be tested in unprecedented ways, but the stresses of 2020 also serve to spotlight resilience. In this respect, we are proud of our colleagues at Akre Capital Management and the steadfast way they have served our clients during this trying year.

The Akre Focus Fund's fourth quarter 2020 performance for the Institutional share class was 5.74% compared with S&P 500 Total Return at 12.15%. Year-to-date performance through December 31 for the Institutional share class was 20.70% compared with the S&P 500 Total Return at 18.40%. This was not our best year in terms of calendar year performance, but the exceptional circumstances of 2020 highlighted both the soundness of our investment process as well as our disciplined adherence to it. 2020 also offered some insightful examples into how we manage capital--yours and ours together. Let us elaborate with a recap of the year across several important dimensions.

Cash. The Fund ended 2019 with 17% cash. We made no secret of our view that valuations for the businesses the Fund owned or wanted to own were not tempting us to part with cash at that time. Whether the cash position is 1% or 20%, cash is reserved for opportunities that we believe can compound at or above our mid/high-teens hurdle rate. "But wait!" you may say. "Cash earns almost nothing! Would it not be better to deploy the cash into equity holdings even at expected rates of return lower than your hurdle?" A fair question.

We certainly understand that cash earns virtually nothing. But the interest earned on cash is not the full extent of its value. Rather, as Morgan Housel writes in his excellent book, The Psychology of Money: "If that cash prevents you from having to sell your stocks during a bear market, the actual return you earned on that cash is not 1% a year—it could be many multiples of that, because preventing one desperate, ill-timed stock sale can do more for your lifetime returns than picking dozens of big-time winners."

We strongly believe that the value of cash lies primarily in the staying power and opportunity for outsized returns it enables during turbulent markets. That is why we feel no pressure to stay "fully invested" at all times and dovetails with our maxim that cash levels do not determine our interest in buying stocks; stocks determine our interest in using cash.

Cash is a crucial part of our investment process. So is our buying discipline.

Buying discipline. By the time the S&P 500 initially peaked on February 19, 2020, the cash position in the Fund was approximately 16%. The Fund actually held more cash than it did at the end of 2019 due to inflows, but cash amounted to a lower percentage weighting due to the appreciation of the equity holdings. Our reason for holding cash: we did not consider valuations on the businesses of interest to us conducive to the long-term returns we target. Period. In no way did we anticipate a global pandemic or any other exogenous shock that might change that state of affairs, let alone the timing of any such event. Our only strong opinion related to what we wanted to pay for the businesses under consideration, and what we observed in the early part of 2020 was that prevailing prices were routinely 25% to 40% above our buy targets.

Therefore, cash stayed cash with no view on timing. As the pandemic and its significance took hold, the S&P 500 plunged by nearly 34% from February 19th to March 23rd, the sharpest, shortest bear market in modern history.

Suddenly share prices were below our previously distant buy targets. Far from panicked, we were prepared. The Fund had ready cash to put to work without being forced to sell stocks at bear market prices. Over the course of 2020, we invested a total of $2.06 billion of cash, over 55% of that in March. By December 31, 2020, those collective 2020 purchases had appreciated by nearly 51% excluding dividends, corroborating our view that opportunistically deployed cash can be an accelerant rather than a drag on returns.

Returns from cash put to work in 2020 helped to overcome a lackluster return from American Tower (AMT, Financial), our largest position coming into the year as well as one of our few detractors from performance in 2020. While American Tower weighed on 2020 results, it provides an example of our buying discipline and what we strive to do as portfolio managers.

American Tower's share price declined by 2.33% during calendar 2020 and, including dividends, its total return was negative 0.48%. Oft-cited reasons for American Tower's 2020 share price performance included possible competitive threats to macro towers from emerging satellite networks, upcoming churn from T-Mobile's consolidation of Sprint's tower leases, and continuing challenges to growth in India.

But in our view, the simplest and most compelling explanation for American Tower's 2020 stock price performance is the peak valuation reached in early 2020 as investors rightly concluded that American Tower, with its hell-or-high water lease revenue, qualified as a "safe haven" from COVID. The subsequent pullback from peak valuation is one we consider both healthy and most explanatory of American Tower's 2020 share price performance.

"But wait," you might say again. "If you were aware of how richly valued American Tower shares were in early 2020, why did you not sell? Why did you do nothing to mitigate the risk that your largest holding might decline substantially from a record high valuation, which is precisely what happened in 2020?"

Another fair question. The answer centers on our buying discipline and our goal of compounding capital at an attractive compounded annual rate over a 5-year time horizon. The time horizon is crucial, because, to paraphrase Benjamin Graham, we want to align ourselves with the market's more sober weighing of our businesses over many years, not the more fickle voting taking place over shorter intervals. We fully expect the businesses we own to be alternately richly valued and attractively valued over the course of what we hope will prove a long holding period. American Tower's 2020's share price performance underscores the importance of buying discipline and why we routinely wait years between adding to positions so as to do so opportunistically.

Had we instead put cash to work in American Tower in late 2019 or early 2020 at below-target rates of return in the name of staying "fully invested" we might have a very different view of 2020's experience. That experience—losing principal in the midst of an otherwise strong stock market— might tempt an investor to "change lanes" by selling the offending American Tower and replacing it with a different investment that is "working."

Which brings us to our final topic in this review of 2020. An investment track record reflects actions both taken and not taken. The next topic describes the latter variety.

Changing lanes. The year 2020 witnessed extremes of investor fear and greed—from panic selling in March to fear of missing out as the year progressed. That growing greed has manifested in two notable ways: 1) increasingly crowded momentum trading in a handful of stocks that have fueled a relatively narrow advance to new highs for many indices, and 2) year 2000-esque investor appetite for untested novelty in the form of Initial Public Offerings ("IPOs") and Special Purpose Acquisition Companies ("SPACs"). Novelty has been a particularly rich vein to mine for investors looking to buy what "worked" during 2020. Most IPOs performed spectacularly out of the gates and only 10% priced below the initial offering price range. A popular IPO index revealed that 2020 IPOs produced price appreciation 7-8x that of the S&P 500 during the year. In other words, IPOs offered easy pickings for fast returns in 2020. Moreover, the number of SPAC offerings in 2020 (241 as of this writing) eclipsed the total of the prior 12 years combined (211) as investor appetite soared for these "blank check" companies offering less disclosure than required of traditional IPOs. Per The New York Times on December 26th: "With more than 447 new share offerings and more than $165 billion raised this year, 2020 is the best year for the IPO market in 21 years, according to data from Dealogic." The parallels to the year 2000 are ominous. Margin debt is at record levels. Throw in bitcoin reaching all-time highs along with the not-coincidental IPO filing of cryptocurrency exchange, Coinbase, and the picture of a highly speculative market becomes just about complete.

In short, there was a clear and well-hyped "fast lane" for investors in 2020. The 2020 fast lane convoy included the IPOs, SPACs, Tesla, a number of nose-bleed-valuation tech and e-commerce-oriented names, and work-from-home COVID plays. While our portfolio experienced some very strong individual share price performances during the year, by and large we did not own the momentum-fueled superstars of 2020. As evidenced by the Fund's trailing 12-month 3% turnover ratio as of November 30, 2020, not much lane changing took place in the Akre Focus Fund. The Fund had a good year. But our lane was not the fast lane in 2020.

Whether as drivers or investors, we all know that frequent lane changing eventually leads to problems. The temptation is powerful, particularly in a year like 2020, with its clear and swift-moving fast lane just at hand. The temptation cannot be avoided, but it can be managed. We endeavor to manage it through the approach to cash and buying discipline discussed earlier and by maintaining perspective on how the cash we have put to work continues to perform over many years, not just one.

2020 was a solid year performance-wise. More importantly, 2020 exemplified not just what we do, but why we do it. The reasons why are timeless.

With gratitude for your support,

John & Chris

Performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Fund performance current to the most recent month-end may be lower or higher than the performance quoted and can be obtained by calling 1-877- 862-9556. The Fund's annual operating expense (gross) for the Retail Class shares is 1.31% and 1.05% for the Institutional Class shares. The Fund imposes a 1.00% redemption fee on shares held less than 30 days. Performance data does not reflect the redemption fee, and if reflected, total returns would be reduced.