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The year 2020 was a prime example of how difficult forecasting financial markets can be. Learn why investing with a margin of safety is so important–and why it drives everything we do.
Download the full first quarter 2020 letter to learn more about Live Oak Private Wealth’s portfolio activity, performance characteristics and comments from the team.
Introduction
“To buy when others are despondently selling and to sell when others are greedily buying requires the greatest fortitude and pays the greatest reward.”
– Sir John Templeton
Unprecedented
un·prec·e·dent·ed
Adjective, without previous instances never before known or experienced; unexampled or unparalleled: an unprecedented event.
– Merriam-Webster
“If you are going through hell, keep going.”
– Winston Churchill
These letters are never easy to write. I wouldn’t have imagined just a few short weeks ago, I would be writing about the swiftest bear market to affect us in modern-day market history, 23 days to be exact. The S&P 500 crashed 30% almost in a straight line over the course of 13 trading days. This has been a painful period for our portfolios. There are many sayings in the investment community and a couple of them resonate currently. One saying is “risk happens fast” and another one is that stocks “take the stairs up and the elevator down.” This recent scenario is another sharp reminder that actual risk is the highest when perceived risk is the lowest. We spent the first month of the quarter enjoying the spillover from a marvelous year in 2019. Everything that seemed so certain has vanished. Numerous valuation metrics were near all-time highs, but the trade war was settling down, there was some clarity around the Democratic race for president and expectations were bright. Risk happens fast.
Countless lives and financial markets have been completely turned upside down over the course of just a few weeks. We, as many did, failed to have the imagination needed to quantify a risk such as a global viral pandemic. No one envisioned something that would cause the global economy to come to almost a full stop. Who would have ever contemplated travel bans from Europe, an empty Times Square, NCAA March Madness canceled and children home from school for the rest of the semester? Shelter in place…no more than 10 people together, beaches closed…virtual Zoom everything…this has all been hard to process.
Thankfully, I can report that all of the Live Oak Private Wealth team is healthy and functioning. While we are dispersed in our respective shelters, we are operating at near 100%. Live Oak was already accustomed to working remotely when needed and with our state-of-the-art cloud based technology, our team hasn’t missed a beat, except personally seeing each other daily. We built Live Oak Private Wealth with strong operational, trading and compliance infrastructure. During these extremely volatile days of thousand point moves in the markets, we managed the portfolios just as if we were in the office. But we, like you, can’t wait to get back to normal. Additionally, we have long-standing “disaster recovery” procedures. Our ability to access client information securely, work with third parties to effect transactions and/or money movement and actually “do investment work” is undiminished amidst the chaos.
History does not always repeat, but it does rhyme as Mark Twain stated. Studying stock market history shows that over a long period of the last century, there have been three types of catastrophic events that have greatly disrupted markets and triggered large declines.
- Economic Catastrophes: The financial crisis of 2008-2009, The Depression in the 1930s and the stagflation of 1974-1975.
- Social Catastrophes: World wars, the terrorist attack of September 11th.
- Financial Market Structure Catastrophes: The crash of 1987, the flash crash in 2010 and the bursting of the .com bubble in 2000.
Now we seem to have a fourth type of catastrophe affecting the markets negatively…a global natural health disaster, COVID-19. This type of coronavirus is unique and a novel event in stock market history. We have never seen a global natural disaster that has led to most all economies in the developed world shutting down in near unison. This is without precedent. Historically, economic catastrophes like the depression and the 2008-09 crisis led to large-scale disruptions and much long-term permanent impairment to value. Financial market structure catastrophes usually recover in due time without much permanent impairment to stock values. Since this scenario is so novel, it is hard to predict the range of outcomes, timing and winners and losers.
So I want to go back to the 23 day, warp speed bear market for a minute. I want to revisit my soapbox regarding the risks that were inherent in the popular computerized quantitative factor strategies. I don’t want to diminish the significance of the unplanned pandemic and a justified correction, but there were significant technical factors at play here. Market volatility, or VIX in our world, creates massive selling (and buying at times) that is fueled by hedging and trading strategies that reside inside Wall Street “black boxes” or computers. I’m not going to begin to explain “short-gamma positioning” because I don’t even fully understand it, but this type of paradoxical trade is crazy to this old, simple investment manager. This momentum-driven trade buys stocks when they are rising and sells them when they are falling. You read that right. Data provider SqueezeMetrics estimated that tens of billions of dollars of S&P 500 futures had to be sold for every percentage point the S&P 500 went lower during the last week of February. Last I checked, the more something declined in price or went on sale (think steaks, airfare, your favorite shoes) the more prone you were to buy because of the great value.
Shelby Davis, noted value investor, said years ago, “You make most of your money in a bear market, you just don’t realize it at the time.” None of us welcome fear and panic, but we like the bargains that are presented. Buying pieces of really good businesses on sale is rare and it’s valuable. Rational investors buy really good businesses after prices have declined, they do not sell. The lower the price paid for a good stream of company earnings, the higher the future returns available. Investing 101.
Emotion — Panics — Pendulums
Prices of stocks in our portfolios have temporarily diverged from their business values. The current prices reflect the extreme emotions of this moment. They are not careful appraisals of sustainable business value. One of the most significant factors that holds back investors’ success is their tendency to assess the world with emotionalism rather than rational objectivity. During extreme emotionally scary periods like we are in, investor psychology rarely allows us to equal weight positives and negatives. We are biased to the moment. We don’t understand why investors have such short-term memories or why we suffer from recency biases, but we have seemed destined to do so. Consider these hindsights:
October 19, 1987 | Black Monday market crash saw the Dow drop more than 20% in a single day. |
January, 1994 | The great bond market massacre which triggered more than $1 trillion in losses. |
October 27, 1997 | The Dow plunged 550 points (-7%) due to the Asian financial crisis. |
August, 1998 | Russia defaulted triggering the failure of Long-Term Capital Management and the first Federal Reserve bailout of a corporation or entity. |
September 11, 2001 | Markets were closed for four days after the 9/11 terrorist attacks and fell -7% when markets reopened. |
August, 2011 | U.S. Government debt downgrade, triggering -17% stock declines, bank stocks -40%. |
All of these panic selloffs, in just my career, proved to be great opportunities to invest. I would imagine we will look back on this time in a few short years and feel the same. All panics seem to wind up in hindsight as mini panics in history. I’m constantly reminded each time there is a major selloff by the timeless words of wisdom from the great Peter Lynch, who managed Fidelity Magellan, “The key to making money in stocks is not getting scared out of them.”
Investors rarely maintain objective, rational and neutral positions during panics. They are either highly optimistic, greedy and risk tolerant or pessimistic, fearing everything and avoiding risk. In the world of investing, human emotion and perception seem to swing from flawless to hopeless. Noted investor Howard Marks refers to a pendulum that swings from one extreme to another, spending little time in the middle. Emotion is one of the investor’s greatest enemies. You must try to control your inner pendulum of human emotion and minimize error by remaining as balanced or neutral as possible during difficult times such as these.
Portfolio(s) Discussion and Commentary
Our investment team manages three equity portfolios in addition to our fixed income solutions. Each of these three equity portfolios are unique with different approaches. Please see individual commentary at the end of this letter.
- Focused Opportunity
- Select
- International
To say the investment team was busy this quarter would obviously be an understatement. January and early February saw us scouring hundreds of analysts research reports and sitting in on numerous conference calls. We attended several analyst days from portfolio companies. We made our annual trip to Columbia Business School on February 7 for their investment conference. We caught up and visited with other portfolio managers in New York we trust and admire. We discussed the bear market in energy stocks among other things. In the 36 hours we spent in New York with several managers and a day long conference, there was no talk or worry about the risks of a global pandemic such as the coronavirus. Airplanes, hotels and restaurants were packed. There was no sense of insecurity…including yours truly.
Before the selling really accelerated in late February and March, we made two significant decisions in our Focused Equity Portfolio. After much debate and hand-wringing we elected to trim our long-held position in Apple. We just felt that sentiment had become overly optimistic and the valuation was elevated. We opted to sell almost half of our position. Connor was finally able to convince me to sell General Motors after holding it for roughly five years with no real performance to show for it, except for dividends. He has been spot on about peak auto and I should have listened to him earlier. So in hindsight now…those were two good trades.
We started buying meaningfully when the heavy selling started in early March. It is not easy buying stocks when they are falling. The entire Private Wealth team spent a lot of time supporting each other and debating cash levels in accounts and asking if we were buying too soon. Prices were getting cheaper by the day and therefore, the relationship between price and intrinsic value was widening. We knew we couldn’t time the bottom as it can only be recognized in retrospect.
Our main objective was to upgrade the portfolios and add quality where we could. We wanted to further concentrate in our highest conviction businesses while they were on sale. We therefore:
- Bought Wells Fargo on February 28th
- Added significantly to Disney on March 10th
- Added to Markel on March 11th
- Added to Mastercard on March 11th
- Added to Berkshire Hathaway on March 12th
- Bought Exor on March 16th
- Added to Microsoft on March 17th
We believe these additional allocations of capital should prove profitable in the long term as these companies embody our definition of high quality and we purchased them at attractive discounts to their long-term earnings power. They possess:
- Strong predictable cash generation
- Sustainable returns on capital, and
- Attractive growth opportunities.
Needless to say, we also revisited the balance sheets of all of our portfolio companies and went back through our stress tests on each. We also were able to finally find several attractive fixed income investments due to the massive dislocations in the bond market during the last 10 days of the quarter. As an example, we were able to buy 1-year investment grade bonds yielding 4% that a month prior yielded 1.5%. Again, please see the individual commentary on the three equity sleeves at the end of this letter for further information.
Now for some really exciting, positive news to report. I’ve been waiting for this part of the letter to elaborate on our recently announced merger with Jolley Asset Management.
I have known of Frank Jolley and his firm’s reputation for many years. I always snuck a peek at his quarterly SEC Filing 13F to see what he was buying and selling, as he and his team have an enviable long-term track record of compounding client capital. Live Oak Private Wealth was not looking for an acquisition or merger, but we heard from a close friend that Frank was looking to merge his firm with someone who offered additional muscle and expertise in comprehensive financial planning, trusts and estate work. We started exploring possibilities last August and after much consideration on both sides, we finalized the merger April 1, 2020. Jolley Asset Management brings much experience and bench strength to Live Oak Private Wealth. Frank has a talented staff including two Chartered Financial Analysts (CFA) and one Certified Public Accountant (CPA), who dovetail perfectly into our client-focused culture. Frank Jolley and his great team of Bill Collier, Terry Sapp, Jan Robillard and Stephen Bishop will remain in Rocky Mount, North Carolina and operate as a Live Oak Private Wealth business. We look forward to the day soon whereby we can get out and introduce them to you.
I feel strongly that we will get through this very disturbing time in our lives and our country’s history. It hasn’t been easy and it could continue for a while but I wouldn’t lose sight of this thought…booms plant the seeds of busts yet busts do the same in the opposite direction. The recent boom times made us all too complacent and assets expensive which allowed us to discount how good things were. It usually is in hindsight that we look back and realize how oblivious we were to hidden risks. But now we are more alert to unimaginable risks. The Federal Reserve and the government are providing massive stimulus and stocks are now priced for better future returns.
Looking back at history during very difficult times, there are many ways humans could have envisioned the world ending. But it pays to bet on humanity. Optimism during times like these never sounds “smart.” Pessimism always sounds “smarter.” But history has proven that it pays to bet big on humanity. Martin Fridson authored a book, “It Was A Very Good Year,” where he wrote that many of the best 10 years in the market in the 20th century all came after a truly horrible period like we are in.
In the future, we will have a broader imagination towards hidden threats. We are going to get through this. I believe we have many exceptional years ahead. We should feel optimistic because:
- The market will bottom
- The economy will bottom
- Humanity will prevail
- There will be better days
The other morning, I read a blog post from Morgan Housel of the Collaborative Fund that really resonated with me. When you drive by the Pentagon today, there is no trace of the plane that crashed into its walls almost 19 years ago. But drive three minutes down the road to Reagan National Airport, and the scars of September 11 are everywhere. Shoes off, jackets off, belt off, toothpaste out and empty your water bottle.
We will recover from this virus. Stores will reopen in the future. We will take a plane somewhere, stay in a hotel, go out to a restaurant and attend a Broadway play or a ballgame. The current wounds will heal just like they did after September 11. Speaking on behalf of our great team in Wilmington, Missy, Amy, Daniel, Susan, Andy and Connor, we are grateful for our health, friendship and resiliency. We are appreciative for your willingness to compensate us for doing something that is hard to do at times, but is so meaningful to us all. We remain humbled by the opportunity you have entrusted us with to protect and grow your family’s wealth.
This too shall pass.
J. William (Bill) Coleman III, CIO
and the Live Oak Private Wealth team
Focused Opportunity
Focused Opportunity Commentary and Thoughts
Our Focused Opportunity Portfolio is our signature investment portfolio which carries our highest conviction opportunities. This portfolio has unlimited flexibility to shift among styles and can appear uncomfortably idiosyncratic at times. Bargain investments can usually be found around controversial events on a company, general pessimism or those that have been performing poorly of late. Focused Opportunity invests across the capitalization spectrum and is conviction weighted to our most attractive companies.
In the first quarter, the Focused Opportunity Portfolio returned -22.24% (gross) and was down -22.24% YTD (gross).
*(See disclosure.)
Ten Largest Investments
March 31, 2020
Year Acquired | Year Acquired | ||
---|---|---|---|
Berkshire Hathaway | 1998 | Disney | 2015 |
Microsoft | 2006 | Charter Communications | 2007 |
UnitedHealth Group | 2012 | Fed Ex | 2018 |
Mastercard Inc | 2018 | Bank of America | 2013 |
2008 | CVS Health Corp | 2018 |
During the first quarter, we bought Wells Fargo, added to Disney, Mastercard, Berkshire Hathaway and Microsoft.
Performance Attribution
Contributors | Detractors | ||
---|---|---|---|
Bank of America | -40.00% | ||
Walt Disney Co | -33.00% | ||
Fed Ex | -20.00% | ||
CVS Health Corp | -20.00% | ||
Mastercard Inc | -19.00% |
Focused Opportunity Featured Company:
Dollar Tree (DLTR)
Dollar Tree is an operator of discount variety stores. The company operates almost 15,000 stores in 48 states and D.C. and Canada. Its segments include Dollar Tree and Family Dollar. Dollar Tree is accelerating the turnaround at Family Dollar by closing unprofitable locations, renovating others with a larger consumables assortment. We are expecting same store sales growth under the new format to grow by 10%. Dollar Tree Plus, which is being tested, offers merchandise for between $1 and $5, which could offer upside potential. The stores are highly cash generative and potential is there for Dollar Tree to earn $6 per share in 2020. This scenario supports a price of about $100 a share.
Select Portfolio
Select Portfolio Commentary and Thoughts
Our Select Portfolio might be best understood using a sports analogy. Select consists of our “bench players” or our “on deck circle” of companies. These are companies we admire and ones who compliment positions in Focused Opportunity. Select would be considered an all-cap core portfolio that is style agnostic. It invests across the capitalization spectrum yet leans towards growth. Select is also conviction weighted to companies we view have the best price to value relationship.
In the first quarter, the Select Portfolio returned -23.73% (gross) and was down -23.73% YTD (gross).
*(See disclosure.)
Ten Largest Investments
March 31, 2020
Year Acquired | Year Acquired | ||
---|---|---|---|
Markel Corp | 1998 | Wal-Mart, Inc | 1998 |
Fox Corp A | 2019 | Comcast Corp | 2004 |
Lowes Companies | 2018 | Anthem | 2002 |
J.P. Morgan Chase & Co | 2007 | Citigroup | 1998 |
Cisco Systems | 1998 | Moody’s Corp | 2018 |
Portfolio Activity: During the first quarter, we added to Markel Corp.
Performance Attribution
Contributors | Detractors | ||
---|---|---|---|
Citigroup | -47.00% | ||
Fox Corp A | -36.00% | ||
J.P. Morgan Chase & Co | -35.00% | ||
Lowes Companies, Inc | -28.00% | ||
Anthem | -25.00% |
Select Portfolio Featured Company:
Moody’s (MCO)
Moody’s Corporation is a provider of credit ratings, credit, capital markets and economic related research, data and analytical tools; software solutions and related risk management services. Moody’s, along with S&P rate more than 90% of all bonds receiving credit ratings worldwide, for a fee. Positive trends continue to favor debt issuance. Inherent in any powerful duopoly, the company possesses strong pricing power and excellent operating leverage and low reinvestment needs. Historically, Moody’s has compounded free cash flow and earnings in the low teens. Moody’s is therefore justifiably expensive at 20 times earnings, but we are comfortable with its long-term sustainable business and competitive moat.
International Portfolio
International Portfolio Commentary and Thoughts
International Portfolio: Our International Portfolio is also highly concentrated in what we feel are superior, growing businesses. The portfolio’s objective is to expose us as long-term investors to other opportunities worldwide. The mandate allows for unlimited geographical reach and can own any size capitalization business. The majority of the world’s growth is outside the U.S. and therefore, we hope to capitalize on that.
In the first quarter, the International Portfolio returned -27.85% (gross) and was down -27.85% YTD (gross).
*(See disclosure.)
Ten Largest Investments
March 31, 2020
Year Acquired | Year Acquired | ||
---|---|---|---|
Nestle | 2002 | Ten Cent Holdings | 2018 |
Alibaba | 2018 | Ferguson | 2019 |
New Oriental Education | 2018 | Safran | 2018 |
Unilever | 2018 | Novartis | 2018 |
ID.Com | 2018 | Baidu, Inc | 2018 |
Portfolio Activity: During the first quarter, we bought Exor.
Performance Attribution
Contributors | Detractors | ||
---|---|---|---|
JD.Com | +15.00% | Unilever | -15.00% |
Ten Cent Holdings | +2.00% | Novartis | -13.00% |
New Oriental Education | -11.00% | ||
Alibaba | -8.00% | ||
Nestle | -5.00% |
International Portfolio Featured Company:
Exor (EXXRF)
Exor is an Italian holding company for the Agnelli family which holds Fiat, Ferrari, CNH Industrial and soon to be disposed PartnerRe. The investment case for Exor is the capital allocation acumen of John Elkann, the grandson of Gianni Agnelli. His track record of meaningfully compounding business value over time coupled with the incoming proceeds ($9B) of PartnerRe constitutes a golden opportunity in our opinion. There is currently a misperception in the market as to the value of Exor, due to the many complexities and layers of ownership in the corporation. Exor will evolve tremendously over time as it intelligently deploys the proceeds from the sale of PartnerRe. Exor could possibly be valued currently at a 50% discount to its NAV or its sum of the parts.
Appendix
Live Oak Private Wealth Investment Philosophy
Three Pillars
We consider potential losses before gains. We think about multiple scenarios that could affect us. We ask how much we might lose before we ask how much we might make.
We focus on absolute returns, not relative returns. Our goal is to lose less than the market. We don’t manage to a benchmark.
We do not focus on the macroeconomic environment. We focus on truly great businesses we can invest in at a fair price.
Our Beliefs
We believe your lifetime investment results will be mostly governed by two variables: behavior and asset allocation.
We consider the three quotes below by two very famous investors daily in our thoughts, research and work.
“To buy when others are despondently selling and to sell when others are avidly buying, requires the greatest
fortitude and pays the greatest reward.”
John Templeton
“Be fearful when others are greedy and greedy when others are fearful.”
Warren Buffett
“Price is what you pay, value is what you get.”
Warren Buffett
Guiding Principles
- A share of stock represents a share in the ownership of a business.
- A stock exchange is nothing more than an auction place that provides a convenient means for exchanging your ownership in a business for cash and vice-versa.
- Our investment approach would be akin to applying a private equity mindset to investing in public markets.
- We limit our search for qualifying investments to good businesses. They have identifiable, sustainable competitive advantages.
- Risks to us is permanently losing capital over a five-year time horizon. Market volatility is not risk to us.
- Our primary return goal is to compound capital at real rates of return (4-5%) in excess of inflation over our five-year time horizon.
- Compounding capital at 7% doubles your assets in 10 years.
Disclosures
1) Past performance is no guarantee of future results and future performance may be higher or lower than the performance shown. The performance results for each equity sleeve are calculated for us by Orion Services and does not reflect investment management fees, custody and other costs or taxes. All of which would be incurred by an investor in any account managed by Live Oak Private Wealth.
2) The performance results for each equity sleeve assumes a full and static investment in the respective sleeve for the periods stated, whereas an account managed by Live Oak Private Wealth may not have a full and static investment in each position and may hold a cash position. A client’s actual net performance of their account would most likely be different and generally would be lower.
3) The performance results for each equity sleeve does not and is not intended to indicate past or future performance for any account or investment strategy managed by Live Oak Private Wealth.
4) There can be no assurance that our portfolio management or any account managed by our investment managers will achieve a targeted rate of return or volatility or any other specified parameters. There is no guarantee against loss resulting from an investment.
5) Investment objectives, returns, and volatility are used for measurements and/or comparison purposes only and are only a guideline for prospective investors to evaluate our investment strategy and the accompanying risk/reward ratios.
6) Comparison to any index is for illustrative purposes only. Certain information, including index and benchmark information, has been provided by third-party sources, and although believed to be reliable, has not been independently verified and its accuracy cannot be guaranteed.
7) The information contained here is not complete, may change, and is subject to, and is qualified in its entirety by, the more complete disclosures, risk factors, and other important information contained in Part 2A or 2B of Form ADV. This presentation is for informational purposes only and does not constitute an offer to sell or as a solicitation.
8) Live Oak Private Wealth is a subsidiary of Live Oak Bank. Investment advisory services are offered through LOPW, LLC, an Independent Registered Investment Advisor.
9) Opinion and thoughts expressed are those of Bill Coleman and not Live Oak Bank.
Download the final letter of 2019 to learn more about Live Oak Private Wealth’s portfolio activity, performance characteristics and comments from the team.
Introduction
“The reasonable man adapts himself to the world, the unreasonable one persists in trying to adapt the world to himself. Therefore all progress depends on the unreasonable man.”
– George Bernard Shaw
What a difference a year can make. I would have never imagined this time last year that 2019 would have produced the best stock returns since 2013. The market as measured by the S&P 500 missed having the best year since 1997 by a mere 20 points or less than 1%. 2019 couldn’t have looked any more different than 2018. In 2018, every asset class closed down on the year, except cash.
Stocks around the world closed out one of the best years of the past decade, defying all of the pundits (including me) who began the year expecting the late-stage economy and roaring bull market to be upended by all of the worries we ended last year with. The backdrop was all doom and gloom, as the global economy seemingly was weakening, the Federal Reserve was tightening monetary policy and that in turn would accelerate the slowdown turning the market towards a protracted downturn, versus just a two-month correction.
Now, we close out the year with stock indexes from the U.S. to Europe to Brazil up more than 20%. Considering the decade we just finished, the Wall Street Journal calculates the Dow Jones Industrial average’s return was 170% from 2010-2019. This was the fourth best decade in the last 100 years. According to Howard Silverblatt of Standard and Poors, the S&P 500 Index returned over 250% over the decade. S&P data from the time they started tracking it in the 1930’s, showed the best decade on record was the 1950’s when the market produced 19% average annual returns. It wasn’t too long ago that we remember the worst decade of stock performance, the 2000’s (2000-2009). Stocks remarkedly fell almost 1% compounded annually, as the decade was bookended by the dot.com tech bubble crash in 2000-2001 and then the financial crisis in 2008.
Considering the fact that I’m finishing my third full decade (1990’s, 2000’s and 2010’s) in the investment business, it’s quite enlightening to see the variation of returns over 10-year periods. But never in my 34-year career would I have ever imagined that, conceptually, “money is free” for creditworthy investors. Fixed income investors are accepting negative or very, very low interest rates and don’t require having their principal paid back for the foreseeable future. There are over $15 trillion of government bonds worldwide that now trade at negative yields because central banks are buying up financial assets in a futile attempt to produce growth in GDP and other economic activity and get inflation up.
The ultra-low yields globally are sending signals we haven’t seen before. Many interpret these signals as proposing that yields are now more affected by sustained demand for long-term government bonds, in part because of demographics and an aging society and deficits. One thing for sure, I think …. is that the ultra-low and negative rates have fueled extra demand for equities. Interest rates are a key input in quantitative, passive “factor” investing strategies who (a machine) picks stocks based on categories such as growth, momentum, quality or value. This year saw another liquidity fueled flow of funds into the growth factor arena. The ultra-low rates have been the rocket fuel for the momentum behind the move up in growth stocks, especially technology (more on this later).
2019 was a very good year for Live Oak Private Wealth, the business. We were privileged to have many new clients join our firm and for the benefit of them especially, I always try and revisit our investment philosophy and write a little about our process in these letters for new readers. Please also see our appendix for additional details about our core beliefs and process.
Our investment philosophy is deeply rooted in a strongly held conservative belief in being very careful with money. We understand the mathematics of compounding and therefore concentrate our decision making around avoiding losses as much as possible. We do that from continued learning and experience we have gained from the study of the world’s most accomplished investors, such as Benjamin Graham and Warren Buffett. Graham’s key insight and the basis of Buffett’s success is that investing is successful when it’s businesslike. We don’t focus on “stocks, bonds or markets”…we look at the businesses these securities represent. Businesslike investing has another important distinction. Most traders and market participants seldom recognize, and typically ignore, the fundamental distinction between price and value. We seek to buy businesses whose value exceeds their price. When we have found suitable securities, we combine them into portfolios. Since there are always factors outside of our control, we try to manage these with some degree of diversification. But, we want to concentrate our capital in a relatively small number of what we believe to be growing and competitively advantaged businesses. These kinds of businesses are rare and are only periodically available for purchase at attractive valuations. With this in mind, we do our best to hold these businesses for the long term, so that our capital may compound as the business grows.
Since our wheelhouse is the public securities market in most part, we deal daily with “the market.” We view the public market or exchanges as what they really are….auctions, where money is exchanged for pieces of a business. You don’t go to an auction every day and you certainly shouldn’t go there if the price of whatever you are considering exchanging cash for isn’t to your advantage. The public spends much time talking about “the market.” The media (social, print and cable), spews chatter, noise and hype about it daily. All of this stuff about the market is unknowable. Is the market going up or down? What about the impeachment? What about an inverted yield curve? This is the longest bull market in history….yadda, yadda. This is where the distinction between speculation and businesslike investing comes from. Investing, is the craft of the specific and legendary investor John Train, even wrote a book about this titled The Craft of Investing. Therefore, specifically at times, without regards to the level of a market, there can be very good specific intelligent investments to make. We see several presently, even with the U.S. market at an all-time high.
Much of the current market phenomenon centers around the more expensive growth stocks increasing in value while many of the least expensive stocks remain relatively cheaper and more reasonably attractive. As we sit currently, the U.S. market is at an all-time high, yet fewer stocks are contributing to the rally. You may hear about “styles” of stocks that are categorized as either growth or value, and growth stocks outpacing (outperforming) value stocks. We don’t spend too much time worrying about style boxes such as these, as we spend much time identifying, researching and hopefully buying extraordinary businesses run by exceptional people with abundant reinvestment opportunities. We look for these great businesses to have copious amounts of excess cash at the end of each year and intelligent uses for that cash for reinvestment. Imagine the concept of “earning money on top of earnings.” This is the compounding we speak to. This is how patient investors over the years in companies such as Walmart, TJ Maxx, Southwest Airlines, Starbucks, etc., have made vast fortunes in businesses like these. They continued to compound due to the many opportunities to invest the excess cash flow each year. Many of our portfolio companies have experienced much success as well as holdings such as United Healthcare, CarMax, Apple, Charter Communications and Google have compounded at rates in excess of the public markets.
An experienced and talented money manager I know in Rocky Mount, N.C. asked me recently what I thought of “the market.” I replied that it felt a lot like the late 1990s where momentum was very strong. The period from 1997 to 2000 saw growth style stocks outperform value style stocks, like today. There was concentration in a few big tech stocks that powered the indexes, like today. The important distinction between now and then is that the total market is not priced at excessive and dangerous levels as it was in 1999-2000. But, there are some similar dangerous undercurrents we are watching. Consider these statistics: As of September 30, 2019, six businesses – Facebook, Amazon, Netflix, Microsoft, Apple and Google (FANMAG) had a combined capitalization of $4.3 Trillion, representing nearly 14% of the total U.S. market capitalization (according to Research Affiliates). If these six stocks were viewed as a single nation, the country of “FANMAG” would be more valuable than the entire publicly traded markets of the United Kingdom, China, France or Germany. If we were to remove these six stocks from the market’s technology sector, we would be left with a sector now “smaller” than either the financial or healthcare sectors. Apple and Microsoft (which we own) combined are worth more than the entire Russell 2000 Index.
We worry that these most dominant companies, 7 of the 10 largest global companies by market cap, all come from just one sector of the market, technology. Interestingly, at the top of the dot.com bubble in 2000, the technology sector was less dominant than it is today. The top technology stocks from 2000 underperformed the S&P 500 over the next decade and two companies disappeared entirely. Many of you probably don’t remember a company called Palm. They made the PalmPilot (I had one) which was disrupted out of business by Blackberry who was disrupted out of business by Apple’s iPhone. Palm was once more valuable than General Motors. The Live Oak Private Wealth Investment Team is watching the valuations of our large tech stocks very carefully.
Portfolio(s) Discussion and Commentary
Our investment team manages three equity portfolios in addition to our fixed income solutions. Each of these three equity portfolios are unique with different approaches. Please see individual commentary on each at the end of this letter.
As the markets rose materially in the fourth quarter, many companies met or exceeded our valuation metrics. We have fairly stringent screens for companies to pass through to remain relevant in our portfolio sleeves. Given the level of the markets and where we feel we are in the economic cycle, as well as the geo-political risks that are still with us….we have combined two of our investment sleeves into one. Equity Income and Select are now one sleeve. Several businesses in these two sleeves were not making it through our price to value filter and from a risk management perspective, we opted to consolidate the 50 or so positions down to 25 by positioning “new” Select in our best risk adjusted businesses. Additionally, we don’t want to dilute our research time and efforts by not having the ample resources for our best ideas.
The Live Oak team has been busy during the fourth quarter with other analysis as well. We participated in three “Investor Days” with United Healthcare, Liberty Media and Brookfield Asset Management. After hearing from all levels of management with these companies as well as getting updates and prospects for 2020, we remain very comfortable with these investments.
So we now find ourselves at the dawn of a new year and new decade. Lots of considerations, risks and rewards to contemplate. We had a phenomenal year in 2019. Most all of us find ourselves at a high-water mark with our investment account values. Now is the time to revisit your comprehensive financial plan and asset allocation. It could be an opportune time to rebalance and gain a better position for what may lie ahead. Don’t hesitate to reach out to any one of the Live Oak Private Wealth team to schedule a comprehensive financial planning review.
So, what may lie ahead? I have a long list of worries and considerations that our team will be monitoring as we go through the year:
- A very important political election.
- Potential effects of tightening liquidity conditions against a backdrop of ever-increasing corporate debt levels.
- Potential for the economics of the past to result in some wage inflation given the strong U.S. consumer and low levels of unemployment.
- Continued struggles of “unicorns” accessing the public markets via I.P.O.’s. Private Equity deal making, and venture capital speculation is rampant, fueled by continued low interest rates.
- Excessive optimism. Most all sources of measuring investors’ sentiment are showing extreme optimism (highest in 15 years).
- Continued cold war of trade globally between the U.S. and China and Brexit with the European Union.
- My long-standing worry about the markets structure and the risks inherent in quantitative factor investing driven by computers and fueled by the sheer size of ETF’s.
I could go on, but I’ll stop. I will remind you though that our job is to do the worrying for you and to make as many intelligent investment decisions for you as we can without having a crystal ball. Our job too is to educate you about what we are doing and why. We strive to remind you that one of the most important things you can do to help your chances of success is to take a long-term view. Many times, investors fail to earn the rate of returns the markets produce due to investors letting their emotions (fears) get the best of them and cause them to sell at inopportune times or chase a fad too long.
To continue to be successful creating wealth in the public markets, you have to take a multi-year view. Consider these facts, courtesy of J.P. Morgan…since 1950, the range of stock market returns as measured by the S&P 500 in any given year has been from +47% to -37%. But over any 5-year period the range is +28% to -3%. For any given 20-year period, the range of outcomes contracts still further to +17% to +6%. In short, since 1950, based on J.P. Morgan data, there has never been a 20-year period when investors did not earn at least 6% in the market. Obviously, history can sometimes not repeat, and this historical data is by no means a guarantee of the future, but history has shown that keeping a long-term time horizon pays off.
In conclusion, we had a fantastic year! I want to thank you for your steadfast support of Live Oak Private Wealth. We have worked tirelessly to assemble what we feel is the best team of people, offerings of investment strategies and financial wealth planning. I read several books this quarter but Excellence Wins by Horst Schulze, co-founder of the Ritz Carlton hotel company resonates well where I view Live Oak Private Wealth as we end the year and decade. Horst Schulze’s vision for the Ritz Carlton was to strive for the exceptional. He had a vision and he crafted people-focused standards that made the Ritz into what it is. We are trying to create a culture of service modeled after his vision. Under Schulze’s leadership, the company committed to the highest standards of professionalism and created systems to achieve them. Our team at Live Oak Private Wealth has made great strides this year refining and executing on our vision of the “best of the best” in the wealth management industry. Our team implemented new systems during the fourth quarter to leverage our service commitment to you. Therefore, our experienced people, skills and innovation is our competitive advantage and we will continue to strive for excellence in all aspects of our relationship.
Thank you for allowing us to innovate and strive to get better every day. We are fortunate to have resources for investment in systems and professional development to get even better serving you. We are grateful and appreciative for your willingness to compensate us for doing something that we love to do and is so meaningful to us all. We are humbled by the opportunity you have given us to protect and grow your family’s wealth.
Speaking on behalf of our great team … Missy, Amy, Daniel, Susan, Andy and Connor, we look forward to our continued shared success in this partnership.
With warmest regards,
J. William (Bill) Coleman III
and the Live Oak Private Wealth Team
Focused Opportunity
Focused Opportunity Commentary and Thoughts
Our Focused Opportunity Portfolio is our signature investment portfolio which carries our highest conviction opportunities. This portfolio has unlimited flexibility to shift among styles and can appear uncomfortably idiosyncratic at times. Bargain investments can usually be found around controversial events on a company, general pessimism or those that have been performing poorly of late. Focused Opportunity invests across the capitalization spectrum and is conviction weighted to our most attractive companies.
In the fourth quarter, the Focused Opportunity Portfolio returned 10.13% (gross) and was up 32% YTD (gross).
*(See disclosure.)
Ten Largest Investments
December 31, 2019
Year Acquired | Year Acquired | ||
---|---|---|---|
Berkshire Hathaway | 1998 | United Healthcare | 2012 |
Apple | 2011 | CarMax | 2018 |
Microsoft | 2006 | Charter Communications | 2007 |
Bank of America | 2013 | CVS Health Corp | 2018 |
2008 | Abbot Labs | 2016 |
Portfolio Activity: During the fourth quarter, we conducted a tax swap with FedEx and made additions to Dollar Tree.
Performance Attribution
Contributors | Detractors | ||
---|---|---|---|
United Health Group | +35.00% | Dollar Tree | -17.00% |
Apple | +31.00% | CarMax | -1.00% |
HCA Healthcare | +26.00% | ||
Charles Schwab | +26.00% | ||
Bank of America | +24.00% |
Focused Opportunity Featured Company:
United Health Group (UNH)
United Health Group is the nation’s largest publicly traded managed care company. It operates through two business segments, United Healthcare and Optum. United Health is a diversified healthcare company dedicated to helping people live healthier lives and helping make the health system work better for everyone. From an investor’s standpoint, UNH boasts best in class health costs per member, allowing it to price its insurance offerings more attractively to drive above-peer enrollment growth. Their strategy of pursuing scale across multiple healthcare services verticals creates inherent synergies that solidify its competitive position. Strong continued trends should result in $16-$17 per share in earnings in 2020 continuing the trend of solid earnings growth.
Select Portfolio
Select Portfolio Commentary and Thoughts
Our Select Portfolio might be best understood using a sports analogy. Select consists of our “bench players” or our “on deck
circle” of companies. These are companies we admire and ones who compliment positions in Focused Opportunity. Select
would be considered an all-cap core portfolio that is style agnostic. It invests across the capitalization spectrum yet leans
towards growth. Select is also conviction weighted to companies we view have the best price to value relationship.
In the fourth quarter, the Select Portfolio returned 6.99% (gross) and was up 29.04% YTD (gross).
*(See disclosure.)
Ten Largest Investments
December 31, 2019
Year Acquired | Year Acquired | ||
---|---|---|---|
Google A | 2009 | Comcast | 2004 |
Fox Corp A | 2019 | Anthem | 2002 |
Citigroup | 1998 | 2019 | |
Lowes Companies | 2018 | Mohawk Industries | 2018 |
Markel | 1998 | J.P. Morgan | 2009 |
Portfolio Activity: During the fourth quarter, we performed a deep dive into the appraisals of price to value on all Select and
Equity Income positions and consolidated the two sleeves into what we now consider the best of the best.
Performance Attribution
Contributors | Detractors | ||
---|---|---|---|
Anthem | +27.00% | Boeing | -13.00% |
Target | +21.00% | Restaurant Brands | -10.00% |
Liberty Sirius XM | +18.00% | American International Group | -6.00% |
Citigroup | +17.00% | Cheniere Energy | -3.00% |
+17.00% | Markel | -2.00% |
Focused Opportunity Featured Company:
Markel (MKL)
Markel is a financial holding company based in Richmond, Virginia and was formed in 1930 to sell insurance to taxicabs and buses. Today the company underwrites specialty insurance products in a variety of markets around the world. Markel possesses an outstanding investment track record, similar to Berkshire Hathaway. Management, culture, investing acumen and flexibility are all hallmarks of Markel. Markel has compounded book value at 20% since 1980 versus 10% for the S&P 500. Its stock price has compounded at 17% since going pubic 27 years ago. Currently we find its stock price to book value relationship quite attractive.
International Portfolio
International Portfolio Commentary and Thoughts
International Portfolio: Our International portfolio is also highly concentrated in what we feel are superior, growing businesses. The portfolio’s objective is to expose us as long-term investors to other opportunities worldwide. The mandate allows for unlimited geographical reach and can own any size capitalization business. The majority of the world’s growth is outside the U.S. and therefore, we hope to capitalize on that.
In the fourth quarter, the International Portfolio returned 12.75% (gross) and was up 29.29% YTD (gross).
*(See disclosure.)
Ten Largest Investments
September 30, 2019
Year Acquired | Year Acquired | ||
---|---|---|---|
Nestle | 2002 | Vivendi | 2019 |
Alibaba | 2018 | Safran | 2018 |
New Oriental Education | 2018 | JD.Com | 2018 |
Fiat Chrysler | 2018 | Ten Cent Holdings | 2018 |
Ferguson | 2019 | Airbus Group | 2018 |
Portfolio Activity: During the fourth quarter, we initiated a new position: Vivendi and sold Prosus which was spun off from Naspers.
Performance Attribution
Contributors | Detractors | ||
---|---|---|---|
Alibaba | +28.00% | Safran | -2.00% |
JD.Com | +25.00% | ||
Baidu | +24.00% | ||
Ferguson | +22.00% | ||
Fiat Chrysler | +15.00% |
Focused Opportunity Featured Company:
Vivendi (VIVHY)
Vivendi is a French conglomerate whose major asset is Universal Music Group. UMG is the largest music label in the world and drives the majority of the earnings of the company and represents the majority of Vivendi’s value. Our thesis behind the purchase of Vivendi is somewhat of a sum of the parts story as well as a play on the growth of music streaming. UMG is the major player in the streaming music industry supplying most of the music to the likes of Spotify, Pandora and Apple Music. Growth is robust and Vivendi is monetizing a small piece of UMG and will be buying back shares with the proceeds. We estimate Vivendi is undervalued by 30% or more.
Appendix 1
Live Oak Private Wealth Investment Philosophy
Three Pillars
We consider potential losses before gains. We think about multiple scenarios that could affect us. We ask how much we might lose before we ask how much we might make.
We focus on absolute returns, not relative returns. Our goal is to lose less than the market. We don’t manage to a benchmark.
We do not focus on the macroeconomic environment. We focus on truly great businesses we can invest in at a fair price.
Our Beliefs
We believe your lifetime investment results will be mostly governed by two variables: behavior and asset allocation.
We consider the three quotes below by two very famous investors daily in our thoughts, research and work.
“To buy when others are despondently selling and to sell when others are avidly buying, requires the greatest
fortitude and pays the greatest reward.”
John Templeton
“Be fearful when others are greedy and greedy when others are fearful.”
Warren Buffett
“Price is what you pay, value is what you get.”
Warren Buffett
Guiding Principles
- A share of stock represents a share in the ownership of a business.
- A stock exchange is nothing more than an auction place that provides a convenient means for exchanging your ownership in a business for cash and vice-versa.
- Our investment approach would be akin to applying a private equity mindset to investing in public markets.
- We limit our search for qualifying investments to good businesses. They have identifiable, sustainable competitive advantages.
- Risks to us is permanently losing capital over a five-year time horizon. Market volatility is not risk to us.
- Our primary return goal is to compound capital at real rates of return (4-5%) in excess of inflation over our five-year time horizon.
- Compounding capital at 7% doubles your assets in 10 years.
Disclosures
1) Past performance is no guarantee of future results and future performance may be higher or lower than the performance shown. The performance results for each equity sleeve are calculated for us by Orion Services and does not reflect investment management fees, custody and other costs or taxes. All of which would be incurred by an investor in any account managed by Live Oak Private Wealth.
2) The performance results for each equity sleeve assumes a full and static investment in the respective sleeve for the periods stated, whereas an account managed by Live Oak Private Wealth may not have a full and static investment in each position and may hold a cash position. A client’s actual net performance of their account would most likely be different and generally would be lower.
3) The performance results for each equity sleeve does not and is not intended to indicate past or future performance for any account or investment strategy managed by Live Oak Private Wealth.
4) There can be no assurance that our portfolio management or any account managed by our investment managers will achieve a targeted rate of return or volatility or any other specified parameters. There is no guarantee against loss resulting from an investment.
5) Investment objectives, returns, and volatility are used for measurements and/or comparison purposes only and are only a guideline for prospective investors to evaluate our investment strategy and the accompanying risk/reward ratios.
6) Comparison to any index is for illustrative purposes only. Certain information, including index and benchmark information, has been provided by third-party sources, and although believed to be reliable, has not been independently verified and its accuracy cannot be guaranteed.
7) The information contained here is not complete, may change, and is subject to, and is qualified in its entirety by, the more complete disclosures, risk factors, and other important information contained in Part 2A or 2B of Form ADV. This presentation is for informational purposes only and does not constitute an offer to sell or as a solicitation.
8) Live Oak Private Wealth is a subsidiary of Live Oak Bank. Investment advisory services are offered through LOPW, LLC, an Independent Registered Investment Advisor.
9) Opinion and thoughts expressed are those of Bill Coleman and not Live Oak Bank.
Download the full third quarter 2019 letter to learn more about Live Oak Private Wealth’s portfolio activity, performance characteristics and comments from the team.
“Basically, price fluctuations have only one significant meaning for the true investor. They provide them with an opportunity to buy wisely when prices fall sharply, and to sell wisely when they advance a great deal. At other times, he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.”
– Benjamin Graham, Columbia University professor
Introduction
Before we get into the investment thoughts and highlights from the third quarter, Live Oak Private Wealth is excited to report that we have launched corporate trustee services led by our skilled fiduciary professional, Daniel Hughes. This local, personalized service dovetails perfectly into our existing trust and estate services, which help protect personal wealth today and for generations to come. Make sure to visit our website to read Daniel’s recent blog post about our trust offering as well as other important content from the team regarding goal-based financial planning, retirement cash flow planning, investment tax considerations and charitable giving.
We all know time flies, especially as we age, but it is hard to believe that Live Oak Private Wealth is a year old! What a first year we have had. We are all excited with what we have built thus far and where we are going with our team’s collective vision of wealth management. If any of you are reading this and haven’t yet met our entire team and seen our beautiful campus, please do so. We have a compelling story to share with you.
The U.S. market, as measured by the S&P 500, managed to squeeze out a slight increase in the third quarter. By doing this, the U.S. market held on to its largest year-to-date gains in recent memory. This has continued to prolong one of the longest bull markets in history. Bonds rose as well and declining interest rates have helped drive stock market returns upward, while at the same time reflecting the uncertainty investors feel about the global economy, trade wars with China and the Fed’s decisions around easing or tightening. The U.S. economy, as measured by the consumer, remains on strong footing, yet there are concerns that the longer the trade war with China rolls on, the higher the probability that the U.S. consumer will start to feel the negative effects and become more cautious.
While the quarter ended quietly, it was loud and volatile underneath the surface. Stocks ramped up to new highs in July but then dropped hard in August only to claw its way back up to a slight gain in September. Every quarter that goes by, it seems that there is more and more uncertainty, volatility and unease. Most of this directly relates to geopolitics and especially Washington. When I think about it, never in my 33-year investment career have I seen so much seemingly revolving around what will happen from a political perspective. There is massive polarity when contemplating the agendas of the two parties. When studying past market and presidential election cycles, typically if the U.S. economy is doing well and unemployment is low, inflation is in check, the incumbent president is usually re-elected. This next election will be more than interesting.
U.S. politics, elections and other global geopolitics tend to move markets more now than ever in history. This is most likely due to the significant change in the public stock market structure now that passive assets outweigh active assets and algorithmic computerized trading of exchange traded funds is leading to increased volatility. You, as a reader of these letters, may be as tired of reading about the risks we see related to the computerized trading as we are about writing about them. But the influence of “rules based” computerized trading strategies, that key off interest rates, geopolitics, trade and tweets, continues to grow more extreme by the quarter. According to J.P. Morgan, passive strategies now control 60% of U.S. equity trading volume while quantitative funds control another 20%, a staggering 80% combined. And based on a recent report by Thomson Reuters, algorithmic trading systems are now responsible for 75% of global trading volumes. None of these strategies have been tested in a recession. Exchange traded funds, especially the dominant capitalization weighted ones, have not been tested to see if the “daily liquidity” that the “machines” thrive on, pairs well with the far less than daily liquidity of the assets underlying the ETFs. It’s unclear and unnerving to us whether modern market makers will provide the liquidity necessary to
stabilize markets in the event of a crisis.
One of the core tenants of Live Oak Private Wealth’s investment philosophy is understanding and recognizing that in investing, you win more by losing less. Many investors today pay more attention to returns than risks, while our approach argues for the opposite: Pay more attention to risks than returns. Risk is omnipresent, and managing it is about assessing the variations of risk such as computerized trading or excessive valuation of recent “unicorns” that have come public. Some form of risk is inherent in all aspects of long-term investing and the key to mitigating it is being aware and conscious of it daily.
Now that we are ten years into this bull market cycle since the financial crisis, thankfully most all investors are enjoying a high-water mark of wealth. Most investment accounts are fairly flush, and the balances are large. We focus on that because you always lose money downward from a bigger number and gain money upward from a lower number. Remember this example: if your investment portfolio is worth $1,000,000 and you expose it to a 50% loss, it becomes $500,000. Then you need for your $500,000 portfolio to double (go up by 100%) simply to break even. It is very tough to find stocks or markets with 100% upside. It can take years to get back to break even. On the other hand, if you can keep your portfolio exposed to say a 20% decline or $800,000, your opportunity to recover is easier and shouldn’t take as long. If you are in retirement or getting close to retirement, this mathematical principal is very important to your financial longevity. We get it.
Having now recovered, enlightened and informed by my travels to Italy and Croatia this summer, I was surprised by the level of global tourism I witnessed. It had been a while since I was last in Europe, and it was eye opening to see the number of global travelers, especially in that region of the world. It was so exciting to see firsthand what we hear about in regard to a growing middle class in the world. All I could think about was one of our research theses around global transportation. It was hard for me to appreciate the statistic below, yet I experienced it for myself by the sheer numbers of global travelers I saw from all over the world.
United States as a percent of the world’s population | 5% |
United States as a percent of the world’s GDP | 25% |
It is hard to comprehend the effects of a growing global middle class, especially travel and tourism. Based on statistics by the United Nations and the OECD, the global middle-class population was 1.8 billion in 2009 and is estimated to be 3.2 billion next year and 4.9 billion in 2030. Middle class spending is increasing and shifting from the U.S. to the rest of the world. Again, using estimates from the OECD, consider these statistics:
2009 Middle class spending | $21 trillion | 26% U.S. | 74% rest of the world |
2020 Middle class spending (est.) | $35 trillion | 17% U.S. | 83% rest of the world |
2030 Middle class spending (est.) | $55 trillion | 10% U.S. | 90% rest of the world |
Considering our investment thesis around global transportation, the world’s transportation infrastructure has not kept pace with the rising demand for travel by this massive growing percentage of middle-class individuals globally, therefore we have investments in French airplane manufacturer Airbus Industries and airplane engine maker Safran. Given that some statistics show miles flown growing at 6% a year, we can see hopefully a long-term trend benefitting us.
One of the many core competencies of the Live Oak Private Wealth team is knowing as much as possible about our businesses we are invested in. Our research effort casts a wide net. This quarter, we traveled to New York in September to attend two investment conferences, both of which also eluded to the many global investment opportunities. We split our time over the two days trying to gather as much research and understanding as possible. I attended a conference put on by MOI Global called Latticework, which has been lauded as a uniquely impactive interactive forum of the best minds from the MOI Global community. There were many takeaways, but a presentation by Rupal Bhansali from Ariel Investments was particularly insightful and led me to read her recent book, “Non-Consensus Investing.” Connor was in different meetings with other contacts and trying to connect with a prominent money manager who was attending Mastercard’s (another core portfolio holding) analyst day at the New York Stock Exchange. The next day we both tag-teamed a day of research with the global investment team at Davis Advisors. We came home that night with strong convictions around several businesses we are invested in, such as New Oriental Education, United Technologies, Alibaba and financials such as Bank of America. We are fortunate to have such a well-rounded and diversified team at Live Oak Private Wealth and to be able to travel to these types of conferences to learn from those smarter than us and benefit from variant perceptions that you gain by getting away from your daily, biased, home-research routine.
So, as we look out to the fourth quarter, 2020 and beyond, we remain confident in the long-term fundamental strength of the American economy, yet in the next 14-15 months we will undoubtedly experience politically based volatility unlike anything seen in more than a generation. This volatility will occasionally feel quite uncomfortable and we will be working overtime to try and separate real risk from perceived risk during these uncertain times. We will be trying to 1) figure out what we know, 2) figure out what we don’t know and 3) figure out what we can’t know. We will remain diligent towards risk management at the possible expense of returns. We are keenly aware of the fact that much of your savings you are entrusting us with is irreplaceable. We understand that survival is the key to investment success and to finish first, you must finish. Above all else, we will maintain our steady course of intelligent, long-term investing…always looking for quality businesses that are undervalued or misunderstood to opportunistically capitalize on with our shared capital.
Our team reads many quarterly letters such as this one from many other smart, successful investment teams. We were reading one from Don Yacktman where he referenced “Hakuna Matata,” which translates as “no worries,” and is a popular song from “The Lion King,” the Disney blockbuster movie and Broadway show. The philosophy of “no worries” has prevailed for quite a while during the last ten years and the market returns pan that out. We believe when people are not worried, you should worry. “Hakuna Matata” didn’t work out well in “The Lion King” and is not an intelligent investment approach by our standards. We believe it is important for you to have a team of advisors and investment professionals like us who will worry for you. We have experienced volatile environments and risks before, and we will navigate through them in the future by focusing on our disciplined investment strategy. We will remain vigilant toward the risks that are inherent today.
We remain humbled and appreciative by your willingness to compensate us for doing something that we love to do and is so meaningful and rewarding to us all. Our entire Live Oak Private Wealth team looks forward to our continued shared success in this partnership.
With warmest regards,
J. William (Bill) Coleman III
and the Live Oak Private Wealth Team
Portfolio(s) Discussion and Commentary
Our investment team manages four equity portfolios in addition to our fixed income solutions. Each of these four equity
portfolios are unique with different approaches.
Focused Opportunity
Focused Opportunity Commentary and Thoughts
Our Focused Opportunity Portfolio is our signature investment portfolio which carries our highest conviction opportunities. This portfolio has unlimited flexibility to shift among styles and can appear uncomfortably idiosyncratic at times. Bargain investments can usually be found around controversial events on a company, general pessimism or those that have been performing poorly of late. Focused Opportunity invests across the capitalization spectrum and is conviction weighted to our most attractive companies.
In the third quarter, the Focused Opportunity Portfolio returned 2.08% (gross) and is up 19.31% YTD (gross).
Ten Largest Investments
September 30, 2019
Year Acquired | Year Acquired | ||
---|---|---|---|
Berkshire Hathaway | 1998 | United Healthcare | 2012 |
Apple | 2011 | CarMax | 2018 |
Microsoft | 2006 | Charter Communications | 2007 |
Bank of America | 2013 | CVS Health Corp | 2018 |
2008 | Abbot Labs | 2016 |
Portfolio Activity: During the third quarter, we sold Bank of New York and made small additions to Charles Schwab and Fed Ex.
Performance Attribution
Contributors | Detractors | ||
---|---|---|---|
CVS Health | +14.82% | Schlumberger | -13.10% |
Apple | +11.12% | Fed Ex | -10.68% |
+11.03% | HCA Healthcare | -10.50% | |
Brookfield Asset Mgmt. | +10.10% | United Healthcare | -10.44% |
Verizon Communications | +6.53% | Walt Disney | -8.00% |
Focused Opportunity Featured Company:
Berkshire Hathaway
Berkshire is currently trading at one of the widest discounts to intrinsic value in many years. Being a conglomerate, Berkshire is one of the least followed and misunderstood large cap companies in the market. Berkshire’s value is derived by almost half insurance and half in diversified operating companies such as MidAmerican Energy, Burlington Northern Railroad, Clayton Homes, Shaw Carpet, Benjamin Moore and others. Many, including us, value Berkshire at a multiple of 14 times earnings, which we feel are understated in the current low interest rate environment. Given Berkshire’s cash hoard of over $100 billion, we expect a sizable accretive acquisition during the next downturn. Berkshire has also adjusted its buyback policy which should continue to enhance our returns.
Select Portfolio
Select Portfolio Commentary and Thoughts
Our Select Portfolio might be best understood using a sports analogy. Select consists of our “bench players” or our “on deck circle” of companies. These are companies we admire and ones who compliment positions in Focused Opportunity. Select would be considered an all-cap core portfolio that is style agnostic. It invests across the capitalization spectrum yet leans towards growth. Select is also conviction weighted to companies we view have the best price to value relationship.
In the third quarter, the Select Portfolio returned 1.24% (gross) and is up 20.28% YTD (gross).
Ten Largest Investments
September 30, 2019
Year Acquired | Year Acquired | ||
---|---|---|---|
Google A | 2009 | Comcast | 2004 |
Fox Corp A | 2019 | Anthem | 2002 |
Citigroup | 1998 | 2019 | |
Lowes Companies | 2018 | Mohawk Industries | 2018 |
Markel | 1998 | Liberty Sirius XM | 2007 |
Portfolio Activity: During the third quarter, we made no portfolio changes.
Performance Attribution
Contributors | Detractors | ||
---|---|---|---|
Lennar Corp. | +16.16% | Mohawk | -17.68% |
Medtronic PLC | +10.72% | Anthem | -15.08% |
Liberty Sirius XM | +8.96% | Apache | -12.33% |
Lowes | +7.59% | Fox Corp A | -12.21% |
Markel | +7.01% | Cheniere Energy | -10.07% |
Focused Opportunity Featured Company:
Comcast (CMCSA)
Comcast is the largest U.S. cable system operator with more than 30 million customer relationships. Comcast also owns NBC Universal, theme parks and SKY, a Pan-European Satellite TV broadcaster. It’s been about a year since the bidding war between Comcast and Disney for the Fox and SKY assets and Comcast’s business results continue to improve, notwithstanding the slow melting ice cube of the cable TV bundle. The broadband internet business continues to promote healthy subscription growth as it fills the cord-cutting streamers’ appetite. Comcast currently trades at a multiple of 8-9 times operating income and is well positioned to continue to grow and prosper as a true diversified media content and distribution juggernaut.
Equity Income Portfolio
Equity Income Portfolio Commentary and Thoughts
Our Equity Income Portfolio, like our other three, is a concentrated portfolio. Equity Income consists of high-quality companies with sustainable competitive advantages with average to above average dividend yields, along with the potential for dividend growth. The portfolio’s objective is to offer the opportunity for attractive total returns with the possibility of slightly higher income.
Equity Income, like Select, Focused Opportunity and International, is a go anywhere portfolio that is style and capitalization agnostic.
In the third quarter, the Equity Income Portfolio returned 5.02% (gross) and is up 17.59% YTD (gross).
Ten Largest Investments
September 30, 2019
Year Acquired | Year Acquired | ||
---|---|---|---|
JP Morgan | 2007 | Home Depot | 2004 |
Walmart | 1998 | Bristol Myers Squibb | 2018 |
Exxon | 1998 | Intel | 2019 |
Chevron | 2017 | Target | 2018 |
Cisco Systems | 1998 | Pepsi | 2009 |
Portfolio Activity: During the third quarter, we made no portfolio changes.
Performance Attribution
Contributors | Detractors | ||
---|---|---|---|
Newell Brands | +23.00% | Invesco Ltd. | -17.53% |
Target | +22.97% | Cisco Systems | -9.74% |
UPS | +16.36% | Exxon | -7.77% |
Home Depot | +10.34% | Cummins Inc. | -5.89% |
Bristol Myers Squibb | +9.81% | Chevron | -5.00% |
Equity Income Portfolio Featured Company:
Newell Brands
Newell is an American worldwide marketer of consumer and commercial products such as Rubbermaid, Coleman, Paper Mate, Elmer’s, Graco, Calphalon, Mr. Coffee and Yankee Candle just to name a few. Newell’s debt-fueled acquisition of many of these brands over the years has not panned out as successfully as management hoped. The sentiment around the company seems to be changing as more aggressive cost cutting and non-core asset sales seem to be starting to move the needle in optimizing the portfolio of companies. By focusing on the brands with the most attractive margins and growth potential, Newell can drive operational efficiency while improving financial flexibility and free cash-flow productivity. Newell is tremendously underearning its potential and could offer quite a bit of upside with the shares around $16.00.
International Portfolio
International Portfolio Commentary and Thoughts
Our International portfolio is also highly concentrated in what we feel are superior, growing businesses. The portfolio’s objection is to expose us as long-term investors to other opportunities worldwide. The mandate allows for unlimited geographical reach and can own any size capitalization business. Most of the world’s growth is outside the U.S. and therefore, we hope to capitalize on that by owning great businesses at fair prices.
Ten Largest Investments
September 30, 2019
Year Acquired | Year Acquired | ||
---|---|---|---|
Nestle | 2002 | Safran | 2018 |
Alibaba | 2018 | JD.Com | 2018 |
New Oriental Education | 2018 | Ten Cent Holdings | 2018 |
Fiat Chrysler | 2018 | Development Bank of Singapore | 2018 |
Ferguson | 2019 | Airbus Group | 2018 |
Portfolio Activity: During the third quarter, we made no portfolio changes.
Performance Attribution
Contributors | Detractors | ||
---|---|---|---|
New Oriental Education | +12.54% | Teva Pharmaceutical | -26.18% |
Safran | +7.57% | Baidu.com | -12.92% |
Sanofi | +6.33% | Siemens AG | -10.68% |
Nestle | +6.13% | Encana | -10.51% |
Ferguson | +2.26% | Ten Cent Holdings | -10.43% |
International Portfolio Featured Company:
New Oriental Education
Formed in 1993, New Oriental is the largest and most recognized provider of private educational services in China. The company has over a 38.1 million student enrollment. The company has a network of 1,100 learning centers, schools and bookstores. The mission of New Oriental is primarily to provide after-school tutoring and entrance exam prep as well as private schooling. China has tremendous barriers to college entry with roughly only 1 in 50 students qualifying. The college entrance exam process is extremely difficult without the testing prep classes New Oriental provides. Occupancy is growing by 20% per year, driving 30%+ increases in revenue and profit for New Oriental. The stock is not cheap, but the runway for growth appears very attractive.
Appendix 1
Live Oak Private Wealth Investment Philosophy
Three Pillars
We consider potential losses before gains. We think about multiple scenarios that could affect us. We ask how much we might lose before we ask how much we might make.
We focus on absolute returns, not relative returns. Our goal is to lose less than the market. We don’t manage to a benchmark.
We do not focus on the macroeconomic environment. We focus on truly great businesses we can invest in at a fair price.
Our Beliefs
We believe your lifetime investment results will be mostly governed by two variables: behavior and asset allocation.
We consider the three quotes below by two very famous investors daily in our thoughts, research and work.
“To buy when others are despondently selling and to sell when others are avidly buying, requires the greatest
fortitude and pays the greatest reward.”
John Templeton
“Be fearful when others are greedy and greedy when others are fearful.”
Warren Buffett
“Price is what you pay, value is what you get.”
Warren Buffett
Guiding Principles
- A share of stock represents a share in the ownership of a business.
- A stock exchange is nothing more than an auction place that provides a convenient means for exchanging your ownership in a business for cash and vice-versa.
- Our investment approach would be akin to applying a private equity mindset to investing in public markets.
- We limit our search for qualifying investments to good businesses. They have identifiable, sustainable competitive advantages.
- Risks to us is permanently losing capital over a five-year time horizon. Market volatility is not risk to us.
- Our primary return goal is to compound capital at real rates of return (4-5%) in excess of inflation over our five-year time horizon.
- Compounding capital at 7% doubles your assets in 10 years.
Disclosures
1) Past performance is no guarantee of future results and future performance may be higher or lower than the performance shown.
2) This performance composite represents results from all actively managed, fully invested accounts at the firm. The composite results include all accounts managed for capital appreciation and income.
3) There can be no assurance that our portfolio management or any account managed by our investment managers will achieve a targeted rate of return or volatility or any other specified parameters. There is no guarantee against loss resulting from an investment.
4) Performance is presented net of fees. Calculated using Orion standards. Periods greater than one year are annualized. This information has been obtained from sources that were deemed reliable, but cannot be guaranteed nor verified.
5) The method for calculating the composite returns includes a monthly weighted (weighting of monthly beginning values, adjusting for time-weighted average returns to derive quarterly and annual returns).
6) Investment objectives, returns, and volatility are used for measurements and/or comparison purposes only and are only a guideline for prospective investors to evaluate our investment strategy and the accompanying risk/reward ratios.
7) Comparison to any index is for illustrative purposes only. Certain information, including index and benchmark information, has been provided by third-party sources, and although believed to be reliable, has not been independently verified and its accuracy cannot be guaranteed.
8) The information contained here is not complete, may change, and is subject to, and is qualified in its entirety by, the more complete disclosures, risk factors, and other important information contained in Part 2A or 2B of Form ADV. This presentation is for informational purposes only and does not constitute an offer to sell or as a solicitation.
9) Live Oak Private Wealth is a subsidiary of Live Oak Bank. Investment advisory services are offered through LOPW, LLC, an Independent Registered Investment Advisor.
10) Opinion and thoughts expressed are those of Bill Coleman and not Live Oak Bank.
Download the full second quarter 2019 letter to learn more about Live Oak Private Wealth’s portfolio activity, performance characteristics and comments from the team.
“At heart, uncertainty and investing are synonyms.”
-The Intelligent Investor, Benjamin Graham(1949)
Introduction
Recently, our teammate Bill Coleman celebrated his 60th birthday. He and his wife are on a much-deserved vacation and celebration trip to Italy and Croatia. So, this quarter’s letter is a team effort.
Uncertainty reared its head again during the second quarter, especially in May. Most investors hate uncertainty, but as the quote above puts it, investing is an exercise in making decisions under conditions of uncertainty.
After a solid first quarter, stocks continued their advances in April. Perceptions related to the U.S. and China trade war shifted in early May as President Trump issued a deadline to increase the 10% tariffs to 25% on imports. For good measure, he also threatened Mexico with tariffs because of unresolved border and immigration issues. Consequently, May returns were the worst since 2010. The S&P 500, the Nasdaq, Russell 2000 delivered minus 7.93%, 6.64% and 6.69% returns respectively. Meanwhile, bond yields collapsed. Ten-year Treasury bonds now yield only 2.13%, down from 3.25% in the past six months.
We all seem to have short memories these days, so let’s go back nine months to October 2018. Yields were climbing, and the Fed was looking to raise rates due to positive economic data. Consequently, stocks tanked almost 20% in November and December due to worries that HIGHER bond yields would hurt stocks. However, the trade war started affecting the economies abroard and at home. Mario Draghi, President of the European Central Bank, was the first to announce monetary accommodations and the Fed soon followed suit discussing lower rates. Remember, that the price paid for a stock today represents the discounted present value of the future stream of earnings of the stock. A key component in the discount of the future stream of earnings is the interest rate. The lower the interest rate used in the discounting, the higher the present value of the stock. With the announcement of lower rates, the market took off, and yields decreased.
This market volatility was exacerbated by the computer trading that we have written about in previous letters. Programs are created to trade on headline news and market trends versus company fundamentals. For example, when news hit about new tariffs, markets traded down rapidly due to the program algorithms. Although such down days and volatility are scary, we use such events as opportunities to enhance positions or buy new positions. With our experience and battle-tested process, we know when companies are trading at attractive valuations. So, while we do not like that 20 – 30% of the market trading is driven by these computers, we do use their illogical trading to buy good companies at reasonable prices.
The big question is, where do we go from here? The bond and stock markets are priced in the 0.25% rate cut in July. Stocks are at all-time highs. In the early stages of earnings season, corporate profits seemed to be flat to modestly higher. There is no doubt that the record-long expansion is showing its age, but falling interest rates are propping the economy and companies. It seems like we have heard this song before—don’t fight the Fed. We believe that even if we receive good trade and economic news, the market would extend its gains, but not replicate the first two quarters.
So, we are back with market uncertainty for the last half of the year. If you have ever read a book about Naval SEALs, there seem to be two underlying common themes:
- Have a plan.
- When things change, you can only control what is in your reach–your wingspan.
We believe these two principles apply to Wealth Management too. Live Oak Private Wealth believes in every client having a financial plan that clearly outlines your goals and objectives. Through appropriate allocation, it shows a path to achieving your life dreams and gives peace of mind. But things change. The market certainly has volatility-trade wars, the 2020 election, etc. We can’t control that uncertainty. However, Live Oak Private Wealth can control its research (our wingspan) and the companies we invest in. We’re focused on companies with competitive moats, solid management, a good balance sheet and positive cash flow. So, when markets change, we know what we own and feel good about the companies in our portfolios.
Thank you for trusting Live Oak Private Wealth with your family’s planning and investing.
Live Oak Private Wealth on the Road:
The highlight of the second quarter (besides Bill’s 60th) was his annual pilgrimage to the Berkshire Hathaway annual meeting. He was fortunate to be included in the 2019 Value Investor Conference hosted by the University of Nebraska at Omaha Business School, which preceded the Berkshire meeting. You may be wondering why we share this with you. It directly relates to our collaborative research network. For example, in a break-out meeting, Bill posed a question about Google (which we own in our portfolio) to one of the noted speakers at the confer ence. Bill met the speaker’s analyst on break and continued the discussion. Since the meeting, they have had several conversations and e-mails, and they will be attending a fall conference together in New York. The next night, Bill met a noted portfolio manager from New York. That meeting led to an invitation to a conference in Richmond, Virginia that Connor attended. While there, Connor bumped into an acquaintance working for a fund in Dallas. He shared the fund’s insight on Facebook and their firm’s investment philosophy and process. We are steadily spreading our research network.
This lengthy anecdote is a perfect example of why we are different. Coupling our goals-based planning and research-focused investing helps us better understand risks and opportunities in the public markets, helping us construct better portfolios for you to achieve your goals and objectives.
Portfolio(s) Discussion and Commentary
Our investment team manages four equity portfolios in addition to our fixed income solutions. Each of these four equity portfolios is unique with different approaches. Each of the four portfolios is broken out below with separate commentary for each.
- Focused Opportunity
- Select
- Equity Income
- International
Our economy in the U.S. is still in a long expansion. It may be slowing slightly now due to trade war issues, and the geopolitical risks we eluded to in last quarter’s letter (rise of populism and threats to capitalism). But to u s, our economy shows no sign of impending recession. The Fed remains more than accommodative as inflation (by their measure) is low. Therefore, interest rates are ridiculously low. On a PE basis, bonds trade at 40 times earnings vs. stocks 17 times. Dividend yields on many stocks, which grew 10% in the last year, exceed yields on 10-year bonds. Corporate profits are healthy. Unemployment is at a 50-year low, and household net worth is at an all-time high. Things are good. Stock prices reflect this, yet they are not unreasonably high as in 2000. We feel positive about our portfolios, yet we still worry every day. Welcome to the world of the Live Oak Private Wealth investment team.
“Our money” is not an anonymous pool of capital. It’s your money, our parents’, our in-laws, partners’, mentors and friends’ money. It’s a privilege to help you manage these vital assets. Our team will continue to invest your capital alongside ours with a long-time horizon. We will also continue to treat it like it is our money—because i t is. Thank you for the opportunity to grow your family’s capital alongside ours.
We remain humbled and blessed by your willingness to compensate us for doing something that we love to do and is so meaningful and rewarding to us all. The Live Oak Private Wealth team looks forward to our continued shared success in this partnership.
Sincerely,
The Live Oak Private Wealth Team
Focused Opportunity Portfolio
Focused Opportunity Commentary and Thoughts
Our Focused Opportunity Portfolio is our signature investment portfolio, which carries our highest conviction opportunities. This portfolio has unlimited flexibility and can appear uncomfortably quirky at times. Bargain investments are usually found when a company has experienced a controversial event, general pessimism or poor performance. This portfolio invests across the capitalization spectrum and is conviction weighted to our most attractive companies.
In the second quarter, Focused Opportunity returned 4.84% (gross) and is up 16.28% to date (total).
Ten Largest Investments
June 30, 2019
Year Acquired | Year Acquired | ||
---|---|---|---|
Berkshire Hathaway | 1998 | Google C | 2008 |
Microsoft | 2006 | Carmax | 2018 |
United Healthcare | 2012 | Charter Communications | 2007 |
Apple | 2011 | HCA Healthcare | 2014 |
Bank of America | 2013 | Visa | 2013 |
Portfolio Activity: During the 2nd quarter, we increased our positions in Google and United Healthcare.
Performance Attribution
Contributors | Detractors | ||
---|---|---|---|
Carmax | +41% | Bank of New York | -16% |
Disney | +22% | Schwab | -14% |
Microsoft | +19% | Schlumberger | -12% |
Mastercard | +16% | Fed Ex | -10% |
Visa | +16% | CVS | -6% |
Focused Opportunity Featured Company:
Disney (Walt) Co
We are all familiar with Disney. But many fail to recognize the unique, unrepeatable assets Disney has. These assets are a competitive advantage that provides healthy margins and pricing power. Since recently acquiring the assets of 21st Century Fox, Disney’s position is bolstered by its leading position in media content and distribution. Disney owns 60% of HULU and is now rolling out a new over the top (OTT) subscription-based streaming service called Disney+. This platform could further leverage all of Disney’s properties and allow for deep cohesiveness to develop, share and promote (sell) more Disney content. Content is king, and Disney is incredibly well-positioned. The stock at its current price is a little expensive but should be a solid core investment for years to come.
Select Portfolio
Select Portfolio Commentary and Thoughts
Our Select Portfolio might be best understood using a sports analogy. Select consists of our bench players or our on-deck circle of companies. These are companies we admire and ones who compliment positions in Focused Opportunity. Select would be considered an all-cap core portfolio that is style agnostic. It invests across the capitalization spectrum yet leans towards growth. Select is also conviction weighted to companies we view have the best price to value relationship.
In the second quarter, the Select Portfolio returned 2.65% (gross) and is up 18.81% YTD (gross).
Ten Largest Investments
June 30, 2019
Year Acquired | Year Acquired | ||
---|---|---|---|
Google A | 2009 | Markel | 1998 |
Citigroup | 1998 | Anthem | 2002 |
Fox Corp A | 2019 | Delta Airlines | 2017 |
Lowes Companies | 2018 | 2019 | |
Comcast | 2004 | Mohawk | 2018 |
Trading activity for the 2nd quarter: During the quarter, we sold Qualcomm and DowDupont. We increased our positions in Fox, Anthem and Lowes.
Performance Attribution
Contributors | Detractors | ||
---|---|---|---|
American International Corp | +23% | Boeing | -17% |
+19% | Apache | -15% | |
Ecolab | +16% | Anthem | -8% |
Delta Airlines | +16% | Liberty XM Sirius | -8% |
Medtronic PLC | +11% | Google A | -5% |
Select Portfolio Featured Company:
Fox Corporation (FOXA)
The Fox Corporation is an American television broadcasting company headquartered in New York. It has reformed this year from the acquisition of 21st Century Fox by Disney. Fox Corporation was a spinoff from 21st Century Fox as a stand-alone company in March of this year. Fox offers “must-have networks” that are mainly immune to disruption from cord-cutters and over the top providers. The must-have networks are Fox News, Fox Sports, to name a few. Netflix said this about Fox in their letter to shareholders last year: “New Fox appears to have a great strategy, which is to focus on large simultaneous viewing of sports and news. These content areas are not disrupted by on-demand viewing in the way TV series and movies are, so they are more resilient to the rise of the internet.” Fox owns part of Roku and is underleveraged and converts almost all income to free cash flow. Fox possesses valuable tax deferrals as well.
Equity Income Portfolio
Equity Income Portfolio Commentary and Thoughts
Our Equity Income Portfolio, like our other three, is a concentrated portfolio. Equity Income consists of high-quality companies with sustainable competitive advantages. They all have average to above-average dividend yields, along with the potential for dividend growth. The portfolio’s objective is to offer the opportunity for attractive total returns with the possibility of slightly higher income.
Equity Income, like Select, Focused Opportunity and International, is a go-anywhere portfolio that is style and capitalization agnostic.
In the second quarter, the Equity Income Portfolio returned 2.48% (gross) and is up 11.97% YTD (gross).
Top Largest Investments
June 30, 2019
Year Acquired | Year Acquired | ||
---|---|---|---|
JP Morgan | 2007 | Home Depot | 2004 |
Walmart | 1998 | Intel | 1998 |
Exxon | 1998 | Bristol Myers | 2018 |
Chevron | 2017 | Target | 2018 |
Cisco Systems | 1998 | Lockheed Martin | 2018 |
Trading activity for the second quarter: There was no trading activity.
Performance Attribution
Contributors | Detractors | ||
---|---|---|---|
Air Products | +26% | Walgreens | -18% |
Target | +19% | 3M | -16% |
Lockheed Martin | +17% | Bristol Myers | -15% |
Pepsi | +13% | Eli Lilly | -14% |
Walmart | +13% | Intel | -10% |
Equity Income Portfolio Featured Company:
Air Products & Chemicals, Inc. (APD)
Many people don’t know about Air Products and their value as a business. They supply industrial gases to thousands of customers, which helps them become more efficient and sustainable. The company makes enormous quantities of hydrogen for energy companies to use to make gasoline, not to mention helium for our birthday balloons. Many also don’t know the everyday daily use of their gases. They provide high-priority gas to chill and freeze everything from shrimp and chicken to Sara Lee pound cakes. We all understand the concept of welding metal for automobiles and thousands of other metal products. It takes Air Products’ gas to make the welding torches work. The industrial gas business, which Air Products is the leader in, is a boring behind-the-scenes American business that is very profitable and sustainable. Our manufacturing economy could not function without them. We remain very comfortable as a long-term investor in Air Products.
International Portfolio
International Portfolio Commentary and Thoughts
International Portfolio: Our International Portfolio is also highly concentrated in what we feel are superior, growing businesses. The portfolio’s objective is to expose us as long-term investors to other opportunities worldwide. The mandate allows for unlimited geographical reach and can own any size capitalization business. The majority of the world’s growth is outside the U.S., and therefore, we hope to capitalize on that.
In the second quarter, the International Portfolio returned 1.91% (gross) and is up 19.81% YTD (gross).
Ten Largest Investments
June 30, 2019
Year Acquired | Year Acquired | ||
---|---|---|---|
Nestle | 2002 | JD.Com | 2018 |
Alibaba | 2018 | Safran | 2018 |
Fiat Chrysler | 2018 | Ten Cent | 2018 |
New Oriental Education | 2018 | Development Bank of Singapore | 2018 |
Ferguson | 2019 | Naspers | 2018 |
Trading activity for the second quarter: We sold Daimler and Fairfax Financial and added Hollysys Automation Technologies Ltd. and Schneider Electric.
Performance Attribution
Contributors | Detractors | ||
---|---|---|---|
Linde | +19% | Baidu | -28% |
Allergan | +19% | Alibaba | -8% |
New Oriental Education | +17% | Fiat Chrysler | -6% |
Schnieder | +15% | DNB Asa | -3% |
Nestle | +14% | Lanxess | -1% |
International Portfolio Featured Company:
Hollysys Automation Technologies Ltd. (HOLI)
Founded in 1993, Hollysys is a provider of automation and control technologies and products. In fact, they’re the leading
provider in China. Hollysys has a nationwide presence in 60 cities. Their proprietary technologies and products are tailored to
industrial, rail, subway and nuclear industries. This product line includes:
- Sensors that enable automated production lines to function
- Sensors that control robots, like human eyes
- Technology that relates to the train and subway systems in Asia
- A bullet train one-speed protection mechanism that enables optimal rail logistics in the Asian region
We like the long-term prospects of Hollysys as the leader in artificial intelligence and technology automation.
Appendix 1
Live Oak Private Wealth Investment Philosophy
Three Pillars
We consider potential losses before gains. We think about multiple scenarios that could affect us. We ask how much might we lose before we ask how much we might make.
We focus on absolute returns, not relative returns. Our goal is to lose less than the market. We don’t manage to a benchmark.
We do not focus on the macroeconomic environment. We focus on great businesses we can invest in at a fair price.
Our Beliefs
We believe your lifetime investment results will be mostly governed by two variables: behavior and asset allocation.
We consider the three quotes below by two very famous investors daily in our thoughts, research and work.
“To buy when others are despondently selling and to sell when others are avidly buying requires the greatest fortitude
and pays the greatest reward.” – John Templeton
“Be fearful when others are greedy and greedy when others are fearful.”
“Price is what you pay; value is what you get.” -Warren Buffett
Guiding Principals
- A share of stock represents a share in the ownership of a business.
- A stock exchange is nothing more than an auction place that provides a convenient means for exchanging your
ownership in business for cash and vice-versa. - Our investment approach would be akin to applying a private equity mindset to investing in public markets.
- We limit our search for qualifying investments to good businesses. They have identifiable, sustainable competitive
advantages. - Risks to us are permanently losing capital over a five-year time horizon. Market volatility is not a risk to us.
- Our primary return goal is to compound money at real rates of return (4-5%) above inflation over our five-year time
horizon. - Compounding capital at 7% doubles your assets in 10 years.
Disclosures
1) Past performance is no guarantee of future results and future performance may be higher or lower than the performance shown.
2) This performance composite represents results from all actively managed, fully invested accounts at the firm. The composite results include all accounts managed for capital appreciation and income.
3) There can be no assurance that our portfolio management or any account managed by our investment managers will achieve a targeted rate of return or volatility or any other specified parameters. There is no guarantee against loss resulting from an investment.
4) Performance is presented net of fees. Calculated using Orion standards. Periods greater than one year are annualized. This information has been obtained from sources that were deemed reliable, but cannot be guaranteed nor verified.
5) The method for calculating the composite returns includes a monthly weighted (weighting of monthly beginning values, adjusting for time-weighted average returns to derive quarterly and annual returns.
6) Investment objectives, returns, and volatility are used for measurements and/or comparison purposes only and are only a guideline for prospective investors to evaluate our investment strategy and the accompanying risk/reward ratios.
7) Comparison to any index is for illustrative purposes only. Certain information, including index and benchmark information, has been provided by third-party sources, and although believed to be reliable, has not been independently verified and its accuracy cannot be guaranteed.
8) The information contained here is not complete, may change, and is subject to, and is qualified in its entirety by, the more complete disclosures, risk factors, and other important information contained in Part 2A or 2B of Form ADV. This presentation is for informational purposes only and does not constitute an offer to sell or as a solicitation.
9) Live Oak Private Wealth is a subsidiary of Live Oak Bank. Investment advisory services are offered through LOPW, LLC, an Independent Registered Investment Advisor.
10) Opinion and thoughts expressed are those of Bill Coleman and not Live Oak Bank.
Download the full first quarter 2019 letter to learn more about Live Oak Private Wealth’s portfolio activity, performance characteristics and comments from the team.
“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in the corrections themselves.”
-Peter Lynch
Introduction
Wow. What a rebound. The last five months have proven that market timing is a futile exercise. Equity markets reversed course and marched steadily higher in the first quarter. The fears that drove the market down in November and December were alleviated this quarter as prospects for a trade deal with China, and a complete 180 by the Fed regarding rate hikes provided the fuel for a strong rally. The first quarter produced very strong returns for global stock markets. The S&P 500 was up 13.6% on a total return basis. This was almost a mirror image of the fourth quarter of 2018 when the S&P 500 was down 13.5%. This quarter’s gains were still not quite enough to make up for last quarter’s losses, as it takes almost a 15% gain to offset a 13.5% loss.
One of the highlights of the quarter was our annual trip to the Columbia Business School Investment Conference in New York. We try and attend as many of these types of conferences, filled with thought leaders, as our budget allows us to learn and hopefully hear about an investment opportunity. In our experience, a great investment is the serendipitous result of a prepared mind encountering and acting upon the right opportunity. We didn’t leave New York with a lot of specific ideas, but we derived tremendous value from the time spent with many smart investors.
An amusing anecdote to the trip (that relates to our portfolios) goes something like this: The journey began with an alarm beeping on a smartphone made by Apple, (which has 62% of market share in the U.S.) followed by our uneventful flight to New York on Delta Airlines (17% market share in the U.S.). We paid for our taxi trip into the city with a piece of plastic issued by Mastercard (we own Visa, too), which controls 70% of the credit card market. We checked Google hundreds of times for information (60% of the internet browser market). Our Apple smartphones, transmitted over Verizon’s network (one of three that controls 78% of the telecom market) and our laptops by Microsoft running on AZURE in the cloud, provided us with information as if we were sitting in our offices.
The firms above involved in the journey made profits last year of over $150 billion and had a median return on capital of 26%. An equally weighted basket of their shares has outperformed global stock markets by a large percentage over the past ten years.
The point of the anecdote is that we approach investing from a commonsense, business person’s point of view. The businesses above are commonplace in our lives today and possess many of the attractive attributes we look for in an investment. We don’t just “put money in the stock market” we thoughtfully invest as co-owners in attractive businesses we think we can understand and are engaged with daily such as Apple, Delta, Mastercard, Visa, Google, Verizon and Microsoft.
Attractive businesses such as these are durable franchises that have high barriers to entry, expensive switching costs, enjoy healthy stable margins and most importantly, generate lots of free cash flow. We want to invest alongside management owners who allocate this free cash flow in a manner that maximizes our wealth in the long run.
There are only a few options for management to allocate free cash flow:
- Expand current business operations
- Pursue business opportunities in adjacent or unrelated areas
- Make acquisitions
- Accumulate cash
- Return cash to shareholders
When considering the first four options a company has from the list above, capital allocation of free cash flow must generate an attractive incremental rate of return on that reinvested capital. If this is not possible, it should be returned to us as shareholders. Dividends and share repurchases are the most common form of returning the cash to the shareholders.
Dividends are the most straightforward way for the return of excess capital, but it is the least flexible and most impacted by tax consequences. The cash generated by the business has already been taxed once and then our dividends get taxed again when we receive them.
If executed with price discipline, a share repurchase program can be a very efficient means of returning capital to shareholders. The only taxes that may be imposed would be on those who sold their shares. Share repurchases have been a political football these days in the financial media. Politicians on the left seem to think that if companies repurchase their shares, they are not reinvesting in their business and benefiting the economy. This is a misguided view in our opinion as it presumes that the “reinvested cash” is somehow lost to the economy rather than reinvested elsewhere or consumed which might have positive feedback effects.
Politics and investing are getting more blurred by the year, especially now with the rise of populism and the threat to capitalism.
Ray Dalio at Bridgewater and Howard Marks at Oaktree have been commenting a lot recently about significant social and economic trends that have contributed to increases in economic inequality, and thus the rise of populism. Ray Dalio put out a fascinating post on January 28 titled Populism + Weakening Economy + Limited Central Bank Power to Ease + Elections = Risky Markets and Risky Economies. Howard Marks commented in his recent letter to investors that he is drawn to the following passage in Dalio’s post:
“Disparity in wealth, especially when accompanied by disparity in values, leads to increasing conflict and, in the government, that manifests itself in the form of populism of the left and populism of the right.”
Marks adds: “As a rule, populists of the right (who are usually capitalists) don’t know how to divide the pie well, while populists of the left (who are usually socialists) don’t know how to grow the pie.”
The role of capitalism and its wealth creation has been a boon to America. Our investment team is keenly aware of social changes underfoot in the U.S. and the upcoming elections. The increasing conflicts and risky markets that Dalio speaks to are front and foremost in our minds as we weigh the risks and reward opportunities of the current investment climate.
The quarter to quarter extreme bullishness and bearishness we just witnessed is based on emotional mood swings by investors as they handicap the probabilities of slowing economic growth around the world. Continual worries about the fate of a trade pact between the U.S. and China as well as the central banks’ decisions to deploy additional stimulus, combined to exacerbate investor fears. There was fear at the beginning of the quarter that major economies around the world were decelerating faster than expected. By the time the quarter closed out, many of these fears were abated somewhat by the expectation of further Fed easing policy.
All of this is being played out in the markets as the current bull market is turning ten years old. March 9th marked the 3,653rd day since the market bottomed at the end of the financial crisis. The 305% rise since March 2009 ranks as the 3rd largest bull market run. This run could be tested as we enter the second quarter and most stocks face the potential for a pullback in corporate profit growth. Several companies we own or follow have already warned that their profits will be less than expectations. Valuations have crept up during the quarter and are now back to the upper end of the historical range. Much of the concern about slowing profit growth is due to the high mark set during last year’s tax cut fueled earnings boom, making year over year growth comparisons hard to meet without further economic stimulus. We will be watching closely to see if increased wage gains that have been reported are starting to affect corporate margins.
Portfolio(s) Discussion and Commentary
Now settled in at Live Oak Private Wealth with our feet firmly planted on the ground, it’s time to enhance the format of these quarterly letters, especially since we have new strategies and new clients. Our investment team manages four portfolios with different approaches. We’re going to be breaking out separate commentary for each that will be listed at this end of this broader commentary.
So the pendulum continues to swing – moving way beyond at times what fundamentals justify in both directions as we have witnessed in the last 180 days. Our primary objective remains to reduce risk and to protect your capital. We will also continue to limit our investments to companies with stable values and to compound your money at rates above inflation and create real wealth for your family. Please revisit our Live Oak Private Wealth Investment Philosophy, beliefs and guiding principles in the appendix to this letter.
A lot is going on in the world today. Many challenges are apparent such as the threats to capitalism and real issues around income inequality and populism. Many people on our team have been entrusted with client capital for a long time. The future is always uncertain, but thoughtful and active value investing is more of a certainty. With artificial intelligence, robotic investment models and the masses convinced passive investing is the holy grail, those of us who remain fundamental practicing investors in businesses will endure with solid returns.
Our focus remains a long-term orientation which affords us the privilege to look further on the horizon to capture investment returns that are just not available to the masses who are focused on the next data points. We all continue to study broadly to prepare our minds for potential investments that may appear. We feel like this focus on study, along with a long-term perspective coupled with experience and discipline, is our competitive advantage at Live Oak Private Wealth.
In closing, it remains a privilege for our team to report to you on our progress. We are grateful and appreciative for the opportunity to help grow your family’s wealth. It was a busy, productive quarter and we regained almost all of the fourth quarter declines.
We are blessed with great technology at Live Oak, and we are trying our best to utilize it. We have an excellent, secure, client portal that you can access through our Live Oak Private Wealth website, www.liveoakprivatewealth.com. We encourage you to utilize this client portal as we will be delivering more and more important and pertinent information and documents to you through the secure portal. These would include quarterly progress reviews, performance reports, cash flow plans as well as these investment commentaries. Please let any of us know if you need help in getting into our secure client portal.
Our entire team is humbled and blessed by your willingness to compensate us for doing something that we love to do and is so meaningful and rewarding to us all. We look forward to our continued shared success in this partnership.
Focused Opportunity Portfolio
Focused Opportunity Commentary and Thoughts
Our Focused Opportunity Portfolio is our signature investment portfolio which carries our highest conviction opportunities. This portfolio has unlimited flexibility to shift among styles and can appear uncomfortably idiosyncratic at times. Bargain investments can usually be found around controversial events on a company, general pessimism or those that have been performing poorly of late. Focused Opportunity invests across the capitalization spectrum and is conviction weighted to our most attractive companies.
In the first quarter, Focused Opportunity returned 10.71% (gross).
Position Weightings – March 31, 2019
Berkshire Hathaway | 8% | Fed Ex | 4% |
Charles Schwab | 6% | Charter Communications | 4% |
CVS Healthcare | 5% | Disney | 3% |
United Technologies | 5% | Abbot Labs | 3% |
Bank of New York | 5% | United Healthcare | 3% |
Carmax | 5% | Dollar Tree | 3% |
Apple | 5% | Visa | 3% |
Microsoft | 4% | HCA Healthcare | 3% |
Bank of America | 4% | Axalta Coatings | 3% |
Brookfield Asset Mgt | 4% | Verizon | 2% |
Mastercard | 4% | Schlumberger | 2% |
General Motors | 4% | AON | 2% |
Google C | 4% | Verisign | 2% |
Top 5 positions 26%
Top 10 positions 49%
Top 15 positions 69%
Portfolio Activity: During the quarter, we received shares of Disney and (new) Fox for our existing 21st Century Fox shares.
No other portfolio activity.
Contributors | Detractors | ||
---|---|---|---|
Berkshire Hathaway | 8% | Fed Ex | 4% |
Mastercard | +25% | CVS Health | -18% |
Verisign | +22% | Fox A (new) | -3% |
Charter Communications | +22% | Berkshire Hathaway | -2% |
Brookfield Asset Management | +22% | United Healthcare | -1% |
United Technologies | +21% |
Focused Opportunity Featured Company:
United Technologies (UTX)
UTX is a high-quality industrial conglomerate which owns market-leading businesses such as Pratt & Whitney, Rockwell Collins, Otis Elevator and Carrier HVAC. The conglomerate company is undertaking a value-creating three-way separation of its main businesses to realize the full potential of its franchise assets. As standalone businesses, each of them should benefit in the long run from a more focused corporate strategy, more flexibility in allocating capital, better alignment of management incentives and generate strategic optionality. Estimates of 20% of UTX’s market cap or $20 billion could potentially be unlocked due to higher multiples assigned to the individual businesses versus the conglomerate. During 2018, UTX’s organic revenue grew 8% and earnings 14%, yet its stock declined. We think the upcoming spinoffs will likely serve as a catalyst for future significant share price appreciation.
Select Portfolio
Select Portfolio Commentary and Thoughts
Our Select Portfolio might be best understood using a sports analogy. Select consists of our “bench players” or our “on deck circle” of companies. These are companies we admire and ones who compliment positions in Focused Opportunity. Select would be considered an all-cap core portfolio that is style agnostic. It invests across the capitalization spectrum yet leans towards growth. Select is also conviction weighted to companies we view have the best price to value relationship.
In the first quarter, the Select Portfolio returned 15.77% (gross).
Position Weightings March 31, 2019
Citigroup | 6% | Delta Airlines | 4% |
American International Corp. | 5% | Oracle | 4% |
Comcast | 5% | Lowes Companies | 4% |
Mohawk | 5% | Apache | 4% |
Liberty SiriusXM C | 5% | 4% | |
DowDupont | 5% | Analog Devices | 3% |
Goldman Sachs | 5% | Danaher Corp | 3% |
Lennar | 5% | Anthem | 3% |
Honeywell | 4% | Ecolab 3% | |
Medtronic PLC | 4% | Cheniere Energy | 3% |
Moodys | 4% | Restaurant Brands Int’l | 2% |
Google A | 4% | Boeing | 2% |
Markel | 4% |
Top 5 positions 26%
Top 10 positions 49%
Top 15 positions 69%
Trading activity for the first quarter: During the quarter, we sold non-core positions Celgene and Norwegian Cruise Lines. Celgene’s price recovered dramatically on a proposed buyout by Bristol Myers.
Contributors | Detractors | ||
Celgene | +47% | Markel | -4% |
Apache | +32% | ||
Moody’s | +29% | ||
+27% | |||
Lennar | +25% |
Select Portfolio Featured Company:
Mohawk (MHK)
Mohawk is the world leader in flooring. Mohawk ranks #1 globally in ceramic tile, yet with just 3% global market share. The majority of Mohawk’s sales of flooring are for remodels as new construction comprises less than 20% of revenue. Mohawk is establishing a leadership position in luxury vinyl tile (LVT) which is growing at double-digit rates. Mohawk trades at a discounted valuation of fewer than 13 times earnings and a multiple of ten (10) times enterprise value to EBIDTA. There has been insider buying of Mohawk stock by board members at higher prices. Recent growth capital expenditures are likely to decline in the coming quarters, improving free cash flow.
Historically, Mohawk’s stock has outperformed the S&P 500 over the past 5, 10, 20 and 25 years. Equity Income Portfolio Commentary and Thoughts.
Equity Income Portfolio
Our Equity Income Portfolio, like our other three, is a concentrated portfolio. Equity Income consists of high-quality companies with sustainable competitive advantages with average to above average dividend yields, along with the potential for dividend growth. The portfolio’s objective is to offer the opportunity for attractive total returns with the possibility of slightly higher income.
Equity Income, like Select, Focused Opportunity and International, is a go anywhere portfolio that is style and capitalization agnostic.
In the first quarter, the Equity Income Portfolio returned 9.28% (gross).
Position Weightings – March 31, 2019
Bristol Myers | 7% | Target | 4% |
Newell Brands | 6% | Travelers | 4% |
UPS | 5% | 3M | 4% |
Home Depot | 5% | Air Products | 4% |
JP Morgan | 5% | Walmart | 4% |
Cummins | 5% | Lockheed Martin | 4% |
Invesco | 5% | Chevron | 3% |
Abbvie | 5% | Exxon | 3% |
Intel | 5% | VF Corp | 3% |
US Bank | 4% | Eli Lilly | 3% |
Cisco Systems | 4% | Pepsi | 2% |
Walgreens | 4% | ADP | 2% |
Top 5 positions 28%
Top 10 positions 52%
Top 15 positions 72%
Trading activity for the first quarter: There was no trading activity.
Contributors | Detractors | ||
---|---|---|---|
Cisco Systems | +25% | Abbvie | -13% |
Target | +21% | Bristol Myers | -8% |
Cummins | +18% | Walgreens | -7% |
UPS | +15% | ||
CVX | +13% |
Equity Income Portfolio Featured Company:
J.P. Morgan (JPM)
J.P. Morgan is arguably the most dominant bank in the United States. JPM leads in investment banking, commercial banking, credit cards, retail banking and asset wealth management franchises. J.P. Morgan benefits from a nearly unrivaled combination of scale and scope within the U.S. JPM has about $1.5 trillion in deposits. J.P. Morgan recently earned $9.2 billion in the quarter while generating a 19% return on equity. Management led by Jamie Dimon is best in class and has performed better than virtually all of its global peers. Trading at 11 times earnings and paying a 3% dividend, we remain quite comfortable with JPM.
International Portfolio
International Portfolio Commentary and Thoughts
Most major U.S., global and international developed markets enjoyed double-digit increases in the first quarter as concerns around continued monetary tightening, increasing odds of a hard Brexit, trade war fears, and a slowing growth outlook lessened. Investor sentiment towards international stocks, especially China, improved. The move up in the first quarter positively impacted virtually all equity sectors, industry groups and individual securities. The ongoing volatility in global equity markets over the last several quarters continues to produce improved opportunity sets for investors such as us. These opportunities are particularly true for specific companies outside of the U.S.
In the first quarter, the International Portfolio returned 17.57% (gross).
Position Weightings – March 31, 2019
Fiat Chrysler | 8% | Ten Cent | 4% |
Alibaba | 7% | Daimler | 4% |
New Oriental Education | 6% | Linde | 4% |
Development Bank of Singapore | 6% | Teva Pharmaceuticals | 3% |
Safran | 6% | Nestle | 3% |
Ferguson | 5% | Sanofi | 3% |
JD.Com | 5% | Baidu | 3% |
DNB Asa | 5% | Fairfax Financial | 3% |
Siemens | 4% | Lanxess | 3% |
Encana | 4% | Novartis | 2% |
Naspers | 4% | Allergan | 2% |
Air Bus Industries | 4% | Unilever | 2% |
Top 5 positions 33%
Top 10 positions 56%
Top 15 positions 75%
Trading activity for the first quarter: There was no trading activity.
Contributors | Detractors | ||
---|---|---|---|
New Oriental Education | +64% | None | |
JD Com | +44% | ||
Airbus | +39% | ||
Alibaba | +33% | ||
Encana | +25% |
International Portfolio Featured Company:
Safran S.A.
Safran S.A. is a French multinational aircraft engine and aerospace component and defense company. The global industry landscape for aviation is very solid with many positives. Air traffic globally is expected to double in the next 20 years. There is currently pressure in capacity with peaking load factors and substantial profits for airlines–this bodes well for engine replacements as well as aircraft replacements with new efficient engines. Safran has both the know-how and operational excellence and is well-positioned for success. They also have a clear growth line of sight for the next 15 years. Safran’s stock performance over the last 20 years has been nothing short of extraordinary. There is a total shareholders’ return (2008-2018) of 23% per year.
Appendix 1
Live Oak Private Wealth Investment Philosophy
Three Pillars
We consider potential losses before gains. We think about multiple scenarios that could affect us. We ask how much might we lose before we ask how much we might make.
We focus on absolute returns, not relative returns. Our goal is to lose less than the market. We don’t manage to a benchmark.
We do not focus on the macroeconomic environment. We focus on great businesses we can invest in at a fair price.
Our Beliefs
We believe your lifetime investment results will be mostly governed by two variables: behavior and asset allocation.
We consider the three quotes below by two very famous investors daily in our thoughts, research and work.
“To buy when others are despondently selling and to sell when others are avidly buying requires the greatest fortitude
and pays the greatest reward.” – John Templeton
“Be fearful when others are greedy and greedy when others are fearful.”
“Price is what you pay; value is what you get.” -Warren Buffett
Guiding Principals
- A share of stock represents a share in the ownership of a business.
- A stock exchange is nothing more than an auction place that provides a convenient means for exchanging your
ownership in business for cash and vice-versa. - Our investment approach would be akin to applying a private equity mindset to investing in public markets.
- We limit our search for qualifying investments to good businesses. They have identifiable, sustainable competitive
advantages. - Risks to us are permanently losing capital over a five-year time horizon. Market volatility is not a risk to us.
- Our primary return goal is to compound money at real rates of return (4-5%) above inflation over our five-year time
horizon. - Compounding capital at 7% doubles your assets in 10 years.
Disclosures
1) Past performance is no guarantee of future results and future performance may be higher or lower than the performance shown.
2) This performance composite represents results from all actively managed, fully invested accounts at the firm. The composite results include all accounts managed for capital appreciation and income.
3) There can be no assurance that our portfolio management or any account managed by our investment managers will achieve a targeted rate of return or volatility or any other specified parameters. There is no guarantee against loss resulting from an investment.
4) Performance is presented net of fees. Calculated using Orion standards. Periods greater than one year are annualized. This information has been obtained from sources that were deemed reliable, but cannot be guaranteed nor verified.
5) The method for calculating the composite returns includes a monthly weighted (weighting of monthly beginning values, adjusting for time-weighted average returns to derive quarterly and annual returns.
6) Investment objectives, returns, and volatility are used for measurements and/or comparison purposes only and are only a guideline for prospective investors to evaluate our investment strategy and the accompanying risk/reward ratios.
7) Comparison to any index is for illustrative purposes only. Certain information, including index and benchmark information, has been provided by third-party sources, and although believed to be reliable, has not been independently verified and its accuracy cannot be guaranteed.
8) The information contained here is not complete, may change, and is subject to, and is qualified in its entirety by, the more complete disclosures, risk factors, and other important information contained in Part 2A or 2B of Form ADV. This presentation is for informational purposes only and does not constitute an offer to sell or as a solicitation.
9) Live Oak Private Wealth is a subsidiary of Live Oak Bank. Investment advisory services are offered through LOPW, LLC, an Independent Registered Investment Advisor.
10) Opinion and thoughts expressed are those of Bill Coleman and not Live Oak Bank.
Download the full fourth quarter 2018 letter to learn more about Live Oak Private Wealth’s portfolio activity, performance characteristics and comments from the team.
“You make most of your money in a bear market; you just don’t know it at the time.”
– Shelby C. Davis
“I think it is almost impossible…to do well in equities over a period of time if you go to bed every night thinking about the price of them. I mean, I think about the VALUE of them. Focusing on the price of a stock is dynamite because it really means that you think that the stock market knows more than you do….The stock market is there to serve you and not to instruct you.”
– Warren Buffett
Welcome to the first of many quarterly letters from Live Oak Private Wealth. Since beginning work at Live Oak Private Wealth on September 4, I have been reminded almost daily what a special place this is. There is no doubt in my mind we have put together the best team in the wealth management business. I feel truly blessed to have such an experienced and dedicated team to help make a difference in clients’ financial lives.
I’ve spent much of my time these first several months marveling at the gorgeous campus we are part of. The Live Oak culture and entrepreneurial technology vibe are very energizing. As I meet many of the young, bright folks here, I’m reminded of the power of our collective community and reassured about the move here and the brightness of our future.
I feel fortunate and thankful that the majority of our clients have joined us. I won’t kid you; it was quite a challenge to plan and execute this transition. Not to mention that Hurricane Florence hit Wilmington directly during our first week in business. Nothing like a challenge of six days without power to make it even more interesting! I joked with the team after the hurricane that about the time we get recovered and up and running, the market will go into a tailspin. Boy did it ever! Partner Andy Basinger’s wife, Ashley, said: “no one said it was going to be easy.” Never underestimate a woman’s intuition.
So, here we are. Letter one at Live Oak Private Wealth. Download the full fourth quarter 2018 letter to learn more about Live Oak Private Wealth’s portfolio activity, performance characteristics and comments from the team.
Introduction
I have had to restart quarterly performance statistics as of September 30, 2018, at Live Oak Private Wealth. We have created two performance composites just like I have had in the past. Also as in the past, each client’s actual performance results may differ from that of the composites due to several factors. So starting in a big hole, our Equity Composite returned -10.51% net for the quarter versus the market’s return of -13.5% for the S&P 500 and -11.70% for the Russell 1000 value. Our Balanced Composite returned -8.9% net for the quarter versus the market’s return of -7.58% for the 60 S&P 500/40 BGCI.
As for the year, 2018 started where 2017 left off. The 5.7% gains in January were the best since 1997. The market would then sell off hard in February and March and claw and climb to an increase of 5% by the time it peaked in September. The move down in the fourth quarter was staggering, especially December. $3.7 trillion in market cap was erased which is equal to the entire GDP of India. The sentiment or bearishness led to the first 20% correction since 2009. December ’18 was the worst December since 1931. The big year we had in 2017 did a classic job of discounting the record “good news” about the economy to come this year. 3.7% unemployment, record consumer confidence, 3% + GDP growth, huge tax cuts, 25% earnings growth was I guess sniffed out in advance during 2017’s +22% year.
My last letter (June 30, 2018) referenced the rising risks in the market. The length of the economic recovery since 2009 was getting long in the tooth. The corresponding nine-year bull market might need to pause. I wrote about the effects of rising interest rates and shrinking liquidity, not to mention the concentration in large-cap tech stocks (FAANG). I underestimated the potential for a policy error around our trade policy. Comments from the Federal Reserve chairman during the first part of October related to interest rates was the trigger that started the volatile selloff. As I have written on multiple occasions, “our markets are unfortunately dominated by computer-driven systematic algorithmic trading of index baskets of stocks.” This exacerbated the selloff as it fed on itself during the quarter.
Trend-following speculative strategies, like these based on algorithms, have become a significant force in the markets. They went from bullish to bearish in the fourth quarter to a degree not seen in a decade. Recent volatility has pitted humans against these machines as the machines reinforce instability since they react to significant price swings by piling on the same trade and exacerbating the moves.
The charts below, courtesy of Alpha Simplex and the Wall Street Journal, reinforce this phenomenon in the markets today. The “chaos bet” as it was referred to:
So, we know what the market did during the end of the year, but how about the performance of the businesses we own? A massive disconnect in my humble opinion. The businesses we are invested in performed quite well, but their stocks did not. In the short run divergences like these occur. By the time the year was over, the decline in stock prices coupled with higher corporate earnings had reduced the multiple on 2019 consensus S&P estimates to less than 14 times. This multiple is about 15% below its historical average. The 10-year Treasury yield is less than 3% and therefore, doesn’t warrant this low of a P/E. Looking at the last 40 years, the 10-year Treasury has averaged over 6%, and stocks averaged a higher P/E. From this starting point, I would expect stocks of good businesses to outperform bonds by a long shot.
Portfolio Activity Since June 30, 2018
We established a new position in FedEx during December at the cost of $187. We also doubled up on our Schlumberger position for tax reasons on November 30th and sold the other half of the position bought previously. The original Schlumberger purchase, in hindsight, was a mistake, but by lowing our cost basis in this sound company, we should start to benefit from rising needs in energy engineering and services. FedEx is unmatched in its global network. FedEx links more than 99% of the world’s GDP by serving 220 countries and territories with 675 aircraft and nearly 180,000 motorized vehicles. FedEx sold off hard during December on disappointing earnings related to the China trade issues and poor results from their European division. FedEx dropped from a high earlier in the year of $274. At our entry price, we were paying the equivalent of 11.5 times earnings for one of the world’s most significant businesses.
Performance Characteristics From Calendar Year 2018 Focused Opportunity Model
Comments On Portfolio Positions
General Motors
GM is the 8th largest holding in our Focused Opportunity Model. We have owned GM since March of 2014 at the cost of $33.40. We owned GM long before the company acquired Cruise Automation, its autonomous vehicle unit. In May of 2018, Softbank announced a $2.25 billion investment in Cruise for a 20% stake. GM only paid $1.0 billion for Cruise. Then in October, Honda made an investment in Cruise that implied a valuation of $14.6 billion. That value is 20% of GM’s total market cap and isn’t even profitable yet. GM still trades in the mid-30s having gone into the mid-40s twice. Since GM went public in 2010 at $33, the company has cumulatively earned more than $33 per share and paid out over $7 per share in dividends. Some bullish GM analysts think just the truck and SUV division is worth the current stock price even before considering what Cruise might be worth. GM sells at a very modest six times 2019 earnings and offers a well-supported dividend yield. GM remains a particularly compelling investment opportunity in my view.
Brookfield Asset Management
We have owned Brookfield for as long as I can remember. Brookfield is the world’s largest global hard asset manager in the world. By hard assets, I mean real estate, utilities, and infrastructure. In today’s world, many advisors promote “alternatives.” I would put Brookfield’s management and performance up against any alternative strategies. Brookfield has delivered 16.8% compounded total returns for the last 14 years compared to 8.5% for the S&P 500 and no telling how much less for the “alternative” funds. According to a recent OECD report, by 2040, the world is going to need to invest nearly $100 trillion in additional infrastructure to support a fast-growing and rapidly urbanizing population. Brookfield’s excellent track record of high returns and trusted brand means it stands to benefit significantly from these trends. Brookfield trades at a very favorable 8.6 times its funds from operations.
Charles Schwab
Schwab continues to rapidly expand its banking subsidiary which has helped to blunt some weakness in its core asset management business. Schwab has done an excellent job of executing lo w-risk strategies with its balance sheet, which has yielded outsized returns and should serve to offset revenue volatility associated with quarters like we just witnessed. Hopefully, higher net interest margins will accompany higher interest rates in 2019, and along with prudent expense management and excess capital to deploy for buybacks, I expect Schwab to have a good year.
Apple
Apple was a lightning rod stock recently. On the fundamental front, in their most recent earnings report, Apple reported +20% sales growth, driven by a 30% increase in iPhone revenue and a 20% increase in software and services revenue. Management recently guided down expectations for future revenue due to a sudden slowdown in demand for the iPhone in China. Despite this near-term bearishness, I think Apple has a solid strategy for growth over the next several years. Also, I think the next few years of faster growth in higher margin software services will lead to stickier gross margins at the company. Apple trades around 12 times 2019 earnings estimates of $12.00 per share. That is a substantial discount to the market and one that Apple’s management will take advantage of through large share buybacks.
There have been several comments lately about a recession. Much of it is in reaction to the market’s selloff. I don’t know about you, but it sure feels like we are quite a w ays away from a recession. Yes, there is some slowing in economic conditions, especially globally. Yes, the effects of growth are currently hampered by the ongoing trade skirmish. There are typically a few items always present at the onset of a recession and corresponding prolonged bear market in stocks.
1) Problematic inflation: if wage inflation is around 3.5% or higher, it’s a problem (it’s currently well below that). Core consumer prices more than 3%, which we do not see either.
2) A hostile Federal Reserve: raising rates well above neutral (in this case 2.5-3%). The Fed is gradually lifting rates and is data dependent not to be hostile.
3) Valuation: current multiples are not extended related to history and certainly not related to current interest rates.
I would expect that global policy issues related to trade, gradually rising interest rates and reduced liquidity, will most probably cause short-term earnings pressures on our portfolio companies. I feel that we are sufficiently compensated for that risk given where current stock prices are. As many of you know, I am an optimist and I remain patient and believe that owning these businesses at these prices will allow us to endure the fears of today.
I believe successful investing requires the knowledge to be able to accurately value businesses for investment as well as an understanding of market psychology. As mentioned many times in letters before, the stock market’s cyclical nature produces periods of overvaluation, fair valuation and then undervaluation, before reversing and repeating itself. Investor emotions drive this classic market cycle during each period. The understanding of these market cycles is critical to your success as an investor so that you do not make the mistake of following the herd mentality and suffering as a result. It is hard to determine precisely when we enter each of these periods, and we can’t predict with accuracy when the next significant market buying opportunity will occur. All we can do is remain patient and aware of opportunities. To be a successful investor, you need to not only buy when it is emotionally the hardest, and sell when it is emotionally the hardest, but also sit patiently and do nothing for long periods while good businesses compound.
For the benefit of new readers of these quarterly letters, I have been writing them four times a year for 19 years. Investors do all kinds of exercises to make sense of the world – modeling scenarios in spreadsheets, conducting diligence on managers, or reading pitch decks. But few activities help clarify your thoughts better than writing. Writing is the ultimate test of whether your ideas make sense or are merely gut feelings. Putting your thoughts on paper forces them into an unforgiving reality where you have to look at the words and interpret them as another reader will see them. If you are reading this letter for the first time, it may be helpful for you to understand our beliefs, investment philosophy and guiding principals. These core beliefs typically drive a lot of our thoughts that we are writing about. Therefore, our Live Oak Private Wealth investment philosophy, beliefs and guiding principals are found in the appendix to this letter.
In closing, it is a privilege to write to you and report on our progress as a new investment firm. There is no doubt in my mind that Live Oak Private Wealth is the best team in the wealth management business. I’m personally blessed to be a part of an extraordinary team. Your trust in our team is a responsibility we do not take lightly. We are all thankful and appreciative for the opportunity to continue working with you at Live Oak.
We feel privileged and humbled by your willingness to compensate us for doing something that we love to do and is so meaningful and rewarding to us all.
On behalf of the team, we look forward to our continued shared success in this relationship.
Warmest Personal Regards,
J. William Coleman, III
Managing Director
Chief Investment Officer
Appendix 1
Live Oak Private Wealth Investment Philosophy
Three Pillars
We consider potential losses before gains. We think about multiple scenarios that could affect us. We ask how much might we lose before we ask how much we might make.
We focus on absolute returns, not relative returns. Our goal is to lose less than the market. We don’t manage to a benchmark.
We do not focus on the macroeconomic environment. We focus on great businesses we can invest in at a fair price.
Our Beliefs
We believe your lifetime investment results will be mostly governed by two variables: behavior and asset allocation.
We consider the three quotes below by two very famous investors daily in our thoughts, research and work.
“To buy when others are despondently selling and to sell when others are avidly buying requires the greatest fortitude
and pays the greatest reward.” – John Templeton
“Be fearful when others are greedy and greedy when others are fearful.”
“Price is what you pay; value is what you get.” -Warren Buffett
Guiding Principals
- A share of stock represents a share in the ownership of a business.
- A stock exchange is nothing more than an auction place that provides a convenient means for exchanging your
ownership in business for cash and vice-versa. - Our investment approach would be akin to applying a private equity mindset to investing in public markets.
- We limit our search for qualifying investments to good businesses. They have identifiable, sustainable competitive
advantages. - Risks to us are permanently losing capital over a five-year time horizon. Market volatility is not a risk to us.
- Our primary return goal is to compound money at real rates of return (4-5%) above inflation over our five-year time
horizon. - Compounding capital at 7% doubles your assets in 10 years.
Disclosures
1) Past performance is no guarantee of future results and future performance may be higher or lower than the performance shown.
2) This performance composite represents results from all actively managed, fully invested accounts at the firm. The composite results include all accounts managed for capital appreciation and income.
3) There can be no assurance that our portfolio management or any account managed by our investment managers will achieve a targeted rate of return or volatility or any other specified parameters. There is no guarantee against loss resulting from an investment.
4) Performance is presented net of fees. Calculated using Orion standards. Periods greater than one year are annualized. This information has been obtained from sources that were deemed reliable, but cannot be guaranteed nor verified.
5) The method for calculating the composite returns includes a monthly weighted (weighting of monthly beginning values, adjusting for time-weighted average returns to derive quarterly and annual returns.
6) Investment objectives, returns, and volatility are used for measurements and/or comparison purposes only and are only a guideline for prospective investors to evaluate our investment strategy and the accompanying risk/reward ratios.
7) Comparison to any index is for illustrative purposes only. Certain information, including index and benchmark information, has been provided by third-party sources, and although believed to be reliable, has not been independently verified and its accuracy cannot be guaranteed.
8) The information contained here is not complete, may change, and is subject to, and is qualified in its entirety by, the more complete disclosures, risk factors, and other important information contained in Part 2A or 2B of Form ADV. This presentation is for informational purposes only and does not constitute an offer to sell or as a solicitation.
9) Live Oak Private Wealth is a subsidiary of Live Oak Bank. Investment advisory services are offered through LOPW, LLC, an Independent Registered Investment Advisor.
10) Opinion and thoughts expressed are those of Bill Coleman and not Live Oak Bank.