RGA Investment Advisors commentary for the year ended December 31, 2021.
Q4 2021 hedge fund letters, conferences and more
January 1, 2022 marked 10 years since Elliot partnered with Jason to kick off the RGA Investment Advisors reformation and entry into active management. When we started together we were young, hungry and humble, not knowing exactly what the future might bring though confident that the Great Financial Crisis created a unique opportunity to deploy capital. We encouraged existing and prospective clients alike that despite the pains of the past decade, investments in high-quality and reasonably priced equities were well-timed and would be rewarded in the years to come. In our very first commentary together we phrased the opportunity as follows:
From December 31, 2000 to December 31 of 2011, the earnings per share of the S&P 500 grew at a compound annual growth rate of 5.12%, or 73% total, while the S&P 500 itself registered a negative 0.36% annual loss, or a cumulative 3.8% loss. The contrast is striking. While S&P 500 earnings grew at an average in excess of 5% per year, the price of the S&P 500 itself declined ever so slightly. In order to fully grasp the significance of this fact, it’s important to discuss how exactly a stock is priced. There are many theories as to stock prices and fluctuations, but at the very least there are two points about stock ownership that everyone agrees to: first, a stock is a fractional ownership interest in a business’ earnings, and second, a stock price is the average present value of the aggregate of the company’s expected future cash flows. Relative to the year 2000, today you can buy far more in earnings, for a slightly lower price.
On a comparative basis, that is a bargain, and over the long-term, owning equities in such situations has proven exceptionally profitable. In fact, you can buy 73% more in earnings for a discount to the Y2k price. This is the same as saying the market’s multiple has contracted. To further hammer home that point, let us just add that from 2010 to 2011, the S&P 500 earnings grew at 16%, while the market ended the year pretty much exactly where it began.
If you recall our early commentaries, they were predominantly focused on big picture, macro questions–the trends with new home sales; what household balance sheets looked like; S&P P/E ratios and EPS growth trends versus historical norms and interest rates, etc. These were questions important to both you and us. For you, we understood these questions to be critical in rebuilding confidence in equities as a great investment vehicle following a decade of woeful results. This helped stay invested through numerous corrections along the way. For us, we invested both with a top down and bottoms up lens. The top down informed where we would hunt for bottoms up opportunities. Through this decade we have increasingly evolved our focus and therefore our commentaries to be almost entirely bottoms up. We still aim for a deep top-down understanding and scour that context for interesting and important themes for generating ideas, but our process of researching companies is much deeper, more robust and true to bottoms-up business analysis.
In all respects, we have advanced much farther in this past decade than we ever imagined. We are humbled and grateful for the chance you took on us coming into this incredibly challenging industry, without a long public track record. We have made one commitment from the very beginning and that was to spend a portion of every day ensuring we are better investors tomorrow than we are today. Although it would feel better to emphasize this particular point coming off of a great year, we think it is even more important and powerful coming off of our worst performance year relative to the S&P since we started. We say this with equal parts confidence and humility.
- 2021: Two Steps Forward, One Step Back
In our conversations with you heading into 2021, we cautioned that 2020’s results were unique and, in many respects, borrowed against future periods. Had you told us in early January of 2021 that we would end slightly down on the year, we would have said “that sounds about right” and felt quite good about it. Had you told us in February that the portfolio would be down slightly at year-end (when portfolios had been up over 20% on the year), we would have said “that’s pretty farfetched,” though we would have accepted the notion that a breather was both overdue and inevitable. Had you told us all this would happen alongside a market that persisted higher throughout the year with no true pullbacks, we would have asked ourselves “how is that possible?” We have always been cognizant in portfolio structure about diversifying factors, understanding where correlations lie, diversifying both the risks and rewards (the key revenue and margin drivers) our portfolio companies are exposed to and having companies that cover a range of valuations within the GARP spectrum.
We knew that our portfolios had a wind at their back and thus likely had benefited from a concentrated factor force in 2020 and spent the early part of the year trimming from areas of most extreme enthusiasm and allocating to areas largely removed from the driving factor. That said, each of our companies are incredibly unique from one another and while the market is treating each as the same, we strongly disagree with the notion that they are remotely similar. We were largely content with how the year was playing out until November, when suddenly even those stocks that had nothing to do with one another became correlated in the worst of ways. We ended up down double digits in a month where the S&P was down less than one full percentage point. While nothing truly excelled in our portfolios, we will discuss each of our five most impactful losers below (most impactful is a function of position size multiplied by magnitude of the move). Before doing so, we want to make one critical point that is true both within this bucket of specific losers and more broadly on the average stocks in our portfolio that weighed us down. Only one of the bad stocks in November had been purchased within the last year. Leaving that one recent purchase aside, our average holding period of our severe laggards (8 total stocks) in November was 3.75 years, with an average return on the month of -19.4%.
One thing we keep reflecting on, in order to have had a terrible second half of 2021, with our strategy, one would have to go back on average nearly four years and think “I know the worst stocks to own for November 2021.” Now perhaps this is overly simplistic considering the view of some that each day you own a stock is a day you are choosing to buy that stock; however, our strategy and process has tremendously benefited from this kind of long-term, low-turnover approach with a predisposition towards inaction rather than action. We are left with the question as to whether we are guilty of overstaying our welcome in a large chunk of our portfolio or whether these are the lumps that come with buying great companies and holding for the long-run. We think time will show that our group of companies are incredibly strong, but we must still meditate on the question. Sitting through periods of underperformance like this, while uncomfortable, is the price we must pay for aspiring to own great companies for an extended period of time.
The following company reviews will be structured from the worst performer in the month to the least bad. Incidentally enough, the worst was the newest one in the portfolios and the only one we no longer own at year-end. But first, let us discuss what we think happened.
Although broader markets looked fine during the quarter, there was a darkness in the small and medium capitalization indices, in anything adjacent to technology and any company perceived as a COVID winner. To some degree, this was the market’s pursuit of normalization and grappling with what an “end of COVID” would look like, but in other ways, it was the market punishing areas of excess built up in the prior year.
The carnage unfortunately has been especially acute in our portfolio. The selloff started long before there were any “excuses” in the market. Perhaps the initial wave began with profit taking and new buyers in these perceived COVID winners were harder to find with the obvious challenging comparables as these companies hit the toughest of year-over-year comparable growth rates and the enthusiasm for “reopening trades” gained steam. Fast money throughout the year drove several fast cycles of the pendulum swinging from “COVID winners” to “reopening plays.” This bifurcation of the market persisted through October, but in early November, pains became more widespread, and a new bifurcation emerged: value and size versus growth. Consequently, the indices remained firmly buoyed by mega-cap companies like AAPL, MSFT, NVDA, TSLA and GOOG and the highly cyclical energy and financial sectors. Fortunately, we own one of these large cap companies, and that helped some. One could however say that these stocks “sucked the air out of the rest of the market.”
- The Inflation Boogeyman
There was one other underlying debate causing market tensions, with considerable ramifications—inflation and the imminent commencement of the first Federal Reserve rate hiking cycle in half a decade .
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
