ACM Commentary 4Q 2020
Last year was one for the history books. In our view, historians and scientists will look back and be aghast at the sheer lack of preparation and ineptitude at all levels of government to deal with the COVID-19 outbreak. We hope you and your family are staying safe and healthy during this pandemic.
Alamar’s equity portfolio was up 40.9% last year while the S&P500 was up 18.4%. Since starting in 2010 our equity portfolio is up 15.8% annualized while the S&P500 grew 14.0%. A client who invested $1 Million with us at our inception would now own a portfolio of stocks worth over $5 Million. A large portion of the performance of the S&P500, once again, came from just a few stocks (FAMAA – Facebook, Apple, Microsoft, Amazon and Alphabet). In fact, more than half the performance of the S&P500 last year came from just these 5 stocks! Most large stock indices such as the S&P500, Russell 1000 and the NASDAQ 100 are now overly reliant on these 5 stocks, plus Tesla and Netflix, to power their performance, a very precarious position, in our view. We have never owned any of these stocks. We are pleased to report Morningstar recently ranked our performance against our peers and the Alamar Equity portfolio was awarded 5 Stars, their highest ranking, in all time frames. In addition we received the top risk-adjusted ratings (performance when adjusted for the risk incurred) when compared to our competitors. Avoiding the crowded and popular investments has served us well.
The economy is set to boom this year. Both fiscal and monetary policies are extremely accommodative. The biggest headwind facing the economy is the spread of the COVID-19 pandemic; however, we believe we are close to turning the corner as explained in this note. We will also explore the cost of being overly cautious or indecisive when investing in public equities.
THE HIGH COST OF DITHERING
When new clients join Alamar, they are usually moving from another investment manager. The clients are typically dissatisfied with the performance of their investments, the poor client service, or both. When evaluating their existing investments we inevitably see an equity portfolio with anywhere from 10 to 20 ETFs and mutual funds, sometimes sprinkled with a few popular names such as FAMAA, Netflix or Tesla. A portfolio composed of 10 or more ETFs/Mutual funds is destined for mediocrity. It exposes a lack of investing acumen or experience. Each ETF or mutual fund may own anywhere from 100 to over 1,000 securities. As a result the client effectively has invested in a portfolio of over 2,000 securities without realizing what has occurred. A portfolio with such a large number of securities indicates a lack of conviction and analysis. The managers are unwilling or unable to make a decision on where to focus their attention, to look for mispriced securities, to have a viewpoint on the economic fundamentals and to perform the hard work required to unearth great investments. Such a portfolio is doomed to mediocre performance. We looked to see if this was a widespread phenomenon and found a working paper written by Professors Sandeep Dahiya and David Yermack1. The paper looks at the investment returns of almost 30,000 endowment funds from 2009 to 2017. For 2018 and 2019 we used the returns from the NACUBO survey of 774 colleges and affiliated foundations. While these are not completely comparable, a large portion of the total endowment assets are managed by colleges and universities.
Figure 1 depicts the performance of the average endowment compared to an Alamar equity account and a simple 60/40 index (60% in S&P500 and 40% in a bond index such as the Barclays US Aggregate). We have left out the 2020 performance for endowments since they are unavailable as of this writing but we expect roughly 7% returns from early reports disclosed so far. The series are not entirely comparable because college endowments get access to many illiquid investments through venture capital, private-equity, real-estate and hedge funds while Alamar’s portfolio is composed entirely of liquid, publicly traded stocks in the US. However, we invest in a fairly concentrated portfolio of 35 to 50 securities while an average endowment probably has well over 100 once the ETFs and funds are fully decomposed. Therefore the average endowment may be less aggressively positioned or embracing less risk than Alamar.
As seen above, the average endowment, by spreading its bets across many asset classes and securities, has woefully underperformed Alamar and even the 60/40 allocation. The clients who join us from other managers have experienced similar performance.
OUTLOOK FOR 2021
The economy is set to grow rapidly this year. Tailwinds include:
A very accommodative Federal Reserve (real interest rates are negative across most of the yield curve)
Large fiscal deficits
Control of the Presidency, House and Senate with one party making it easier to pass large spending bills.
A weak US Dollar boosts exports and also provides benefits when companies translate overseas sales.
In addition, we believe the news from the COVID-19 pandemic should soon start to get better. A recent paper in the Journal of American Medical Association (JAMA) 2 estimated that roughly 14.3% of the US population had been infected with the SARS-COV-2 virus as of November 15, 2020. Assuming a similar growth trajectory in the infection rate we estimate roughly 30% of the population will have been infected by the end of this month. In addition, with the advent of mass vaccination with vaccines from Pfizer/BioNTech and Moderna, we forecast another 10% of the population will be vaccinated by the end of January. As a result, roughly 40% of the population will have either been exposed to the virus or vaccinated very shortly, getting close to the herd immunity threshold of 60% (assuming a 2.5 reproduction number). New infections should start to materially decrease as we get closer to the immunity threshold. Needless to say, our forecasts are based on assumptions gathered from our readings of numerous publications of the CDC, JAMA and others. We are closely monitoring the ongoing spread to determine if it follows our projections.
A growing economy and a slowing infection will fuel corporate profits. Current estimates call for a rapid increase in profits this year. Figure 2 plots operating profits for the S&P500 since 1960. After dropping 23% in 2020, profits are expected to get back on trend this year, growing 36% to roughly $165 per share. Given the aforementioned tailwinds there is no reason not to expect continued growth in profits next year and beyond.
With such a favorable backdrop, we expect many investment opportunities throughout this year. After a long drought, a plethora of companies have begun to tap the public markets. The recent change by the SEC to allow direct listing by private companies to raise new capital is a very exciting and material development. We expect many companies to tap this route as it avoids the costly and time consuming roadshow to go public. It is also a far more equitable way to allocate scarce shares of newly public entities.
Similarly, we expect a spate of mergers & acquisitions this year as managements gain more confidence in the economic prospects. Interest rates are low, capital is plentiful and banks have plenty of capacity to lend. We have already had one of our largest investments, RealPage, receive a proposal to be acquired by a private-equity firm for over $10 Billion. At the buyout price we will have made over 3 times our investment since we purchased the stock 4 years ago.
CONCLUDING THOUGHTS
Clients who have been with us over the last 11 years have enjoyed a great return. While we cannot expect to repeat the spectacular performance achieved last year, we do believe a long-term investor in our equity strategy will continue to reap rewards as we uncover new opportunities. As we have mentioned before, the pace of change is accelerating and entire industries are being disrupted. New innovative companies led by great management teams are reimagining the playbook. Investors, meanwhile, are overly enamored with a few popular stocks (FAMAA plus Tesla and Netflix), leaving plenty of opportunities for us to prospect. Focusing on a few good ideas provides a much better outcome in the long run than spreading your bets far and wide. As long-term investors, we embrace the magic of compounding returns in a very tax-efficient manner.
We are optimistic our great scientists will get the upper hand on this novel virus. After a troubling initial rollout, the progress on testing and vaccination should accelerate as bottlenecks are removed, getting us closer to herd immunity. The fiscal and monetary stimuli coupled with a waning pandemic should unleash growth across the economy. We are well positioned to participate as opportunities arise.
Thank you for your continued trust and confidence in Alamar Capital Management.
Sincerely,
George Tharakan, CFA
george@alamarcapital.com
1 Investment Returns and Distribution Policies of Non-Profit Endowment Funds, Sandeep Dahiya and David Yermack, SSRN March 2020
2 Estimation of US SARS-CoV-2 Infections, Symptomatic Infections, Hospitalizations, and Deaths Using Seroprevalence Surveys, Angulo et. al. JAMA Jan 5, 2021
Disclosures
The views expressed in this note are as of the date initially published and are subject to change without notice. Alamar has no obligation or duty to update the information contained in this note. Past performance is not an indication of future results. Risk is inherent in investments and involves the possibility of loss.
This publication is made available for informational purposes only and should not be used for any other purpose. In particular, this report should not be construed as a solicitation of an offer to buy or sell any security. Information contained herein was obtained and derived from independent third-party sources. Alamar Capital Management, LLC believes the sources are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information.
This publication, and the information contained herein, may not be copied, reproduced, republished, or posted in whole or in part, in any form or media without the prior written consent of Alamar Capital.