Sterling Partners Equity Advisors Portfolio Commentary – Fall 2022
I had the pleasure of recently attending an investment conference hosted by the Hawk Center at UW-Madison, in conjunction with UW’s Applied Security Analysis Program (ASAP). ASAP is a pioneer in applied investment education and, not coincidentally, a program from which I am an alumnus. It was a pleasure reconnecting with Professor Hawk, former classmates and colleagues and hearing a few good investment ideas. But at least as interesting for me was the eagerness of the students to learn important lessons from seasoned veterans, so valuable in such a volatile and uncertain time.
Learn from seasoned veterans? What advice do we really have? I listened to one panel discuss how the advances in technology over our careers have helped investors but may have made things worse for professionals by making markets more efficient, fees lower, and has left the computers managing more money than the humans. I heard another panel discuss how the current period is unlike any in long careers, leaving the lessons of past cycles somewhat lacking to deal with this one. Clearly, these are challenging times. But for those just entering the business, if neither technology nor experience is helping, what are the lessons of experienced careers in the industry?
Technology has brought faster computing speeds and a ubiquitous internet that has led to many new tools for investors that can measure and visualize the causes of portfolio volatility and performance in real-time. Obviously, this has led to a majority of assets under management being managed by computers applying various forms of modern portfolio theory, first developed in the 1950s. There is now no shortage of data or the computer power to manipulate that data and graph it in HD, a functionality transforming all industries. Since fiduciaries typically need to see whatever level of granularity is available, this leads to even long-term active managers having a deeper understanding of what’s going on day-to-day in the portfolio than ever before. But are these advances helping investment returns or competing them away?
Even for active managers who don’t manage to the real-time volatility and performance attribution information flow and instead continue to value businesses based on the present value of future cash flows, technology has entirely changed the time and access to the information flow that is at the heart of the research process. SEC filings, news releases, management communications, databases, and product demonstrations- the currency of investment research are now available in real-time. There was a time when SEC Filings were only available on the day of filing in SEC regional offices in six cities in the U.S., each with a copy machine that required exact change! Technology has also automated the process of idea discovery, screening, and financial modeling. It has allowed testing a broader range of assumptions to hone estimates of cash flow and, ultimately, business value. But while these are great new tools, they have also vastly expanded access to information and the power to analyze it for the market in general, making markets more efficient and potentially eroding the alpha available to dedicated institutional investors.
As far as experience, in our shop, we hand-make financial models that attempt to predict the future by making judgments about market share changes within product categories and by making judgments about the amount of capital necessary to run those businesses. Are the products winning in the marketplace? Are they faster, better, cheaper, or more convenient? We largely try to predict the future by talking with people smarter than we are about what they think. We make intrinsic value estimates of businesses and expected return estimates from that. This approach was invented a long time ago and was dramatically aided by the invention of the telephone. Our edge is to care less about the present that no manager can talk about — and care a lot about the periods out a few years from now that they can talk about. Arbitrage the time value of information. Invest for the long run. This is an equity practitioner’s lesson: Trust the raw data, make well reasoned valuation judgments, and hold managers accountable for outcomes.
We like companies with little analyst coverage and little institutional interest because it hopefully leads to a better understanding of the intrinsic value than the average participant may have and the potential for rising demand later on. These days, that effort is made easier by the large ownership percentage of many stocks by ETFs, which trade with no concern for the valuation of any individual name. With an average four-year holding period, we normally find ourselves waiting for the stock’s price to move toward our estimate of intrinsic value as market participants come to believe what we believe, and demand slowly moves the stock higher. That is another practitioner’s lesson, patience. Being first in line means you won’t miss the event, but you may be waiting around a while.
In our strategies currently, we are waiting around for the gap to close between market prices and our estimates of intrinsic value. Our expected return estimates on our holdings have rarely been higher over our 20-year history; in that sense, this period feels very much like 2008. Our short-term returns have been holding steady against the benchmark since March or so but remain farther behind than usual year-to-date, again like in 2008. We have detail on our performance and our recent best and worst performers later in this newsletter written by our Director of Research, Nathan Schmidt.
If you have managed to read this far, the best lesson we can offer after a long career managing equity strategies is to own good long-term profitable businesses that sell necessary goods and services and own them at reasonable prices. If we can continue to do that, we can continue to deliver good long-term returns to clients. I don’t think it is really any more complicated than that.
Click here for our most recent performance, and please open the .pdf below to see our Director of Research’s thoughts about our best and worst contributors to our performance in the quarter.
Thank you for your interest in Sterling Partners Equity Advisors.
Kevin E. Silverman, CFA
Chief Investment Officer
Please direct any inquiries to:
Timothy A. Knight
Director of Operations