Predicting rain doesn't count
Warren Buffett once said “predicting rain doesn’t count, building the ark does” so what does he mean? When investors analyze an investment, they often ask what the “worst-case” scenario is. Before the financial crisis, investors studied prior recessions to see how a company’s revenue growth or margins fared, but when the crisis hit in 2008, no prior scenarios except for the great depression proved comparable. In the ensuing decade, investors were confident we wouldn’t have such a bad scenario again for at least another century but when the pandemic hit, these predictions were fruitless. Many companies had to grapple with zero revenue or negative margins. Storms are difficult to predict and they come in all shapes and sizes. While we always focus on storms that we can see, predicting storms is not enough. Rather, you have to build a portfolio that can withstand any and all scenarios, some of which are impossible to foresee. So how does the Core Equities team do this? How do we build our ark?
First, we are laser focused on business quality and a significant portion of our portfolio will always be invested in companies that provide mission critical services irrespective of the environment. For example, our holding Marsh & McLennan is an insurance broker that advises F500 companies on their insurance needs. You do not cancel your insurance in a financial crisis. In fact, risks such as terrorism, climate change, pandemics, and cyber-attacks increase the demand for insurance advice.
Second, we put significant emphasis on management quality. We want to partner with management teams that think like us and prepare for the 100-year storm, which is why we avoid companies with excessive debt or strategies that sacrifice the long-term over short-term gains. Our holding in Berkshire Hathaway is the best example where the company holds a ~$200bn war chest of cash which allows it to weather any storm and gives it optionality to take advantage of investment opportunities during crisis.
Finally, valuation matters. The biggest defense is making sure we have a “margin of safety” meaning the companies we own are valued at a discount to what we think they are worth. Having a margin of safety means when we are right, we benefit from the share price converging to what we think its worth but in cases where we’re wrong or an unexpected storm damages the business, we’ve built an appropriate buffer so that our capital is protected.
The end goal of investing is to grow capital over the long-term, in many cases over the next 10, 20 or 30 years.
“This means that” while we always anticipate and prepare for risks that we see on the horizon, predicting the next storm is not enough. We are also focused on building an ark that can survive and thrive in any and all scenarios.
National Instrument 31-103 requires registered firms to disclose information that a reasonable investor would expect to know, including any material conflicts with the firm or its representatives. Doug Johnson and/or Pathfinder Asset Management Limited are an insider of companies periodically mentioned in this report. Please visit www.paml.ca for full disclosures.
Changes in Leverage. We are increasing the asset ceiling to 2.0 times the market value of equity for Pathfinder International Fund and Pathfinder Conviction Fund to be consistent with Pathfinder Partners’ Fund and Pathfinder Resource Fund.
*All returns are time weighted and net of investment management fees. Returns from the Pathfinder Partners’ Fund and Partners’ Real Return Plus Fund are presented based on the masters series of each fund. The Pathfinder Core: Equity Portfolio and The Pathfinder Core: High Income Portfolio are live accounts. These are actual accounts owned by the Pathfinder Chairman (Equity) and client (High Income) which contain no legacy positions, cash flows or other Pathfinder investment mandates or products. Monthly inception dates for each fund and portfolio are as follows: Pathfinder Core: Equity Portfolio (January 2011), Pathfinder Core: High Income Portfolio (October 2012) Partners’ Fund (April 2011), Partners’ Real Return Plus Fund (April, 2013), and Partners’ Core Plus Fund (November 2014).
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