Patient, Disciplined, Opportunistic
The Intrinsic Value Portfolios were created with the goal of providing disciplined, actively managed value portfolios that are easily accessible for all. Every aspect of the portfolio design, from the businesses we own, to the minimum investment and the fee structure, all begin with the investor’s best interest in mind.
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We take great pride in our integrity and transparency, placing utmost importance on not just providing these services, but educating our clients about our view on markets, businesses, and economies, empowering investors to have confidence in their investments.
Structure
The Intrinsic Value Portfolios are concentrated, absolute return portfolios designed for long term capital appreciation with lower fundamental risk. They seek to outperform the market over an entire business cycle.
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The portfolios seek to provide safety of principal through companies with attractive fundamentals such as no debt, cash rich, contractual revenues and therefore low valuation multiples.
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The portfolios primarily invest in individual equities and may use ETF's to target entire sectors that are identified as undervalued.
Buy Discipline
The single largest factor in any investment’s return is the price you pay. We rely on intensive research and strive to purchase great businesses at fantastic prices on behalf of our investors.
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The buy discipline begins with a conservative calculation of the business' intrinsic value, which is determined through calculating the firms's Net Asset Value (NAV) and sustainable Earnings Power Value (EPV) of an entire business cycle.
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Businesses are then purchased below their Intrinsic Value by applying a Margin of Safety, typically between 25-50%. The size of the required Margin of Safety is based on the attractiveness of qualitative factors such as competitive advantages, competent/incentivized management, industry headwinds/tailwinds etc.
Sell Discipline
The most difficult aspect of investing is selling. In order to avoid psychological pitfalls, we follow a strict selling discipline. We will sell at the greater of the Intrinsic Value, or the average premium to the Intrinsic Value witnessed over the last ten years. We understand the powerful force of mean reversion, and barring any underlying fundamental disruptions, there is little reason we see that a business would not return to its historical average level of overvaluation.
IV Realization
The market may continue to undervalue some businesses for extended periods of time. While we prefer to invest in companies with a catalyst, we are investing for the long term. This means we patiently wait for the Intrinsic Value to be realized, which will typically happen one of two ways. Either slowly, as individuals in the market come to the same conclusion we have, or rapidly if the company gets acquired by another firm who recognizes its Intrinsic Value.
Avoiding Psychological Pitfalls
Charlie Munger gave a famous speech in 1995 at Harvard University, titled "The Psychology of Human Misjudgment." In it, he outlined the 25 most common causes of human misjudgment and how they relate to investing.
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Understanding these behavioral tendencies is critical for investment success. Awareness alone can help one to gain insight into the behavior of the "herd" in the current prices of assets, as well as enabling one to devise processes to help avoid succumbing to them.
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By nature of humans being involved in the investment process, it would be nearly impossible to avoid them all. However, the IV Portfolios strive to circumvent as many as possible through the systematic process and rigorous psychological checks and balances by the investment committee.
Challenging Conventional Ideas
We fundamentally believe that the relationship between risk and reward is not linear, and therefore reject the Capital Asset Pricing Model (CAPM), Modern Portfolio Theory (MPT), and the Efficient Market Hypothesis (EMH). Through this perspective, we inherently reject the following conventional ideas which are all implications of a theoretical linear risk/reward relationship:
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"Risk" being defined as price volatility
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"Beta" being used as a measure of "Risk"
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"Cost of Equity" being calculated by using "Beta" and a "Risk Free" rate.
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We define risk as the probability of permanent loss of capital, most commonly observed when a company goes out of business. Modern Portfolio Theory (MPT) uses convenient math and assumes that risk is instead the volatility of a company's stock price. This has no bearing on the probability of permanent capital loss, and instead is singularly focused on short term price action. Great investments often have significant volatility, therefore MPT systematically under-weights them. Furthermore, in assessing a client's "risk" tolerance, we are truly assessing their "volatility" tolerance, which is their ability to withstand short term price volatility and stick to an outlined investment strategy.
Beta measures the volatility of one security compared to the volatility of the broad market. Since risk is the probability of permanent capital loss and is completely independent of volatility, Beta cannot be used as a measure of risk, and instead should only be used to measure volatility.
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The discount rate is the most important number in all business valuations. It is comprised of the Cost of Debt (COD), and the Cost of Equity (COE), which are the two components of any capital structure. The COD is straightforward, as it is calculated using factual data about a business' total debt and weighted average interest rate. The COE however, is much more esoteric. The conventional formula for determining the COE is the Capital Asset Pricing Model, which utilizes Beta. In practice, the volatility of a company's stock should not impact the inherent cost to the company in issuing new equity, so should not be included in any COE formula.