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Read the first quarterly letter following the addition of Jolley Asset Management to Live Oak Private Wealth and learn about our two distinct investment styles.

Introduction

“Hoping for the best, prepared for the worst and unsurprised by anything in between.”
-Maya Angelou

“We will not run out of money.”
-Federal Reserve Chairman, Jay Powell, 4/20/2020

DOWNLOAD THE QUARTERLY LETTER FROM LIVE OAK PRIVATE WEALTH

 

As mentioned in our first quarter letter, Live Oak Private Wealth is privileged to welcome Frank Jolley and Jolley Asset Management into the family. Frank and his team have an impeccable reputation and outstanding long-term investment results. Frank and Bill will now be sharing the Chief Investment Officer role as well as the content for these quarterly letters.

One of the many reasons we merged our teams was the almost perfect alignment of investment philosophy between the two firms. Both of our firms are steeped in a conservative, capital preservation mindset. Yet strategy-wise, we have unique styles of portfolio construction, with Frank utilizing a traditional value investment style consistent with the classic value principles developed by Graham and Dodd in 1934. This value strategy (which can now be offered to all Live Oak Private Wealth clients) emphasizes a company’s financial strengths, first and foremost, and then seeks to invest in businesses trading at discounts to earnings, sales, and/or book values. Jolley’s legacy value strategy dates back to 1999 and has produced consistent, solid investment returns. What we will be attempting to do in these letters going forward is to share our collective thoughts around the investment climate and try to inform and educate you. Frank will contribute content specific to his style and portfolio and Bill will do the same for our growth and international portfolios. We welcome your comments and are grateful to have you as clients and privileged to share our thoughts with you.

Second Quarter Market Review

U.S. stocks just finished their best quarter since the fourth quarter of 1998, with the S&P 500 and Dow Jones Industrial Average returning 20.5% and 18.5%, respectively. It was a remarkable rally after the coronavirus pandemic brought businesses around the world to a virtual standstill. This was quite a contrast to the first quarter when major indexes lost approximately 35% in less than six weeks’ time. The rebound this quarter was driven by massive stimulus by the Fed and the CARES Act, which has an estimated cost of $2 trillion. U. S. stocks beat all other asset classes in the second quarter, including gold (+9.5%), corporate bonds (+9.3%), cash (flat), and long-term government bonds (-0.5%). All eleven sectors were up in the quarter, led by discretionary (+33%), technology (+31%), energy (+31%), and materials (+26%). On a year-to-date basis, only technology (+15%) and discretionary (+7%) were in positive territory. The worst performing sectors year to date are energy (-35%) and financials (-24%). For the year, the Russell 1000 Growth Index has trounced the Russell 1000 Value Index by 26%, which represents the widest annual spread in the Russell Index history (1979). The market rally slowed towards the end of the quarter as there has been a resurgence in coronavirus cases in parts of the U. S. and the civil unrest sparked by the killing of George Floyd. The economic picture remains bleak, with approximately 20 million jobs lost since February. Looking ahead, a Democratic sweep of the White House and Congress looms as a potential risk as a Democratic-controlled government would roll back tax cuts that were enacted in 2017, which would pressure profit margins. Goldman Sachs has estimated that the Biden tax plan would cut corporate earnings by 12%.

The market’s massive move off the bottom of March 23 has confounded most observers and probably many of you. This mystery of the markets puzzles many due to a perceived disconnect between dismal economic statistics, tens of millions unemployed and many afraid to even leave their homes, and a stock market almost back to where it was before the virus.

The notion that stock market returns and economic data are closely linked seems intuitive, but in reality:

  • Stocks are driven by earnings, not real growth in the economy or employment. Some companies can grow earnings even in very troubling times, and their stocks rise.
  • The economy many link the stock market to does not always relate to the United States. Globalization has made it possible for companies to prosper in other geographical areas not affected by a crisis or a bad economy.
  • Stock markets are discounting mechanisms or prediction machines in the short term, and typically there will be a six to nine month lag between markets and the economy.

With that said, many (including us) have been very surprised at the way the market roared back. Even Warren Buffett, who has always preached to “be greedy when others are fearful and fearful when others are greedy,” didn’t do much buying during March. Psychologists have documented that most people can’t tolerate losing and feel pain from a loss twice that of the pleasure of a gain. Therefore, most can’t tolerate the pain of stocks declining and sell and cut their losses.

One of the longest-running adages on Wall Street is, “You can’t fight the Fed.” Since March 23, investors have placed a great deal of confidence in the ability of the Federal Reserve and Treasury to engineer a recovery from this virus. The Fed has stepped up in a big way the purchases of bonds, which puts money in the hands of sellers and that money has to be reinvested. The reinvestment process, in turn, drives up the prices of bonds further (and indirectly stocks) while driving down interest rates and expected returns. The lower interest rates go, the lower the discount rate used to calculate a company’s future equity value. This can argue for higher stock valuations. Lower bond yields also offer less competition to stocks. What would you rather have for ten years, UPS stock with a 3.6% dividend or a UPS bond for 1.34%?

But now what? Have we come too far too fast? Have the massive inflows of Fed-driven liquidity acted as steroids for the market? By most measures, the market is quite expensive and momentum is driving things at the moment. Market participants are quite optimistic all of a sudden and may not appreciate the potential negatives that could loom ahead with the reopening of the economy, consumer confidence and the election risks.

Our concern is that volatility will only increase from here. Volatility trading on Wall Street, which we have discussed here too many times to mention, has grown so big that trading on expected market moves can itself move markets. In these letters, you have read our concerns about the market “structure,” which refers to the sheer amount of money traded by computers (machines) without rational human involvement. Today’s economic uncertainty means volatility trading, and therefore volatility itself is likely to stay elevated.

An investor we admire in Charleston, S.C., recently referred to what we experienced in March as analogous to a hurricane. He asked if we are in the eye now, or if the storm has passed completely? Shouldn’t we prepare maybe for the backside of the hurricane, which could be worse than the front? Now that we have recovered most of the losses from March, isn’t it time to analyze where you stand? Isn’t it time to revisit your specific goals and objectives for your money and re-check your positioning? If what we went through in March was too concerning for you, this is now the perfect time to reassess your risk tolerance. A little time spent now with one of our experienced certified financial planners might go a long way in helping you suppress the emotional side of investing.

Portfolio Discussion

PORTFOLIO(S) DISCUSSION AND COMMENTARY

Market Statistics as of 6/30/2020

Index 2020 2nd Qtr 2020 YTD 6 Months
DJIA 18.50% -8.40%
S&P 500 20.50% -3.10%
S&P 500 (equal weight) 21.90% -11.80%
S&P Mid Cap 24.10% -12.80%
Russell 1000/Growth 27.80% 9.80%
Russell 1000/Value 14.30% -16.30%
Russell 2000 25.40% -13.00%
NASDAQ Comp. 30.60% 12.10%

With the wonderful addition of Jolley Asset Management to Live Oak Private Wealth, our enhanced investment team now manages two distinct investment styles or strategies (Value and Growth at a Reasonable Price [GARP]) in addition to our international strategy. All are principally grounded in a conservative mindset with capital preservation and growth and income as objectives. Below we will break out separate commentary from Frank and Bill related to the markets and other varying portfolios.

Classic Value Strategy

Live Oak Private Wealth Classic Value Strategy Commentary and Thoughts (Frank Jolley) :

“The four most dangerous words in investing: This time it’s different.”
– Sir John Templeton

Is The S&P 500 Just a Mega-Cap Index?

While the second-quarter rally brought the S&P 500 Index within striking distance of where it began the year, the average stock has fared much worse. As of mid-year, 24 of the 30 Dow Jones components are down on the year and only six have generated positive returns.

The average stock in the Dow Jones Index is down approximately 10% for the year. As of June 30, the S&P 500 was down 3.1%, while the S&P 500 equal-weighted index was down 11.8%. As of July 3, 2020, the median stock in the S&P 500 was down 11%. Keep in mind, both indexes are comprised of the same 500 companies, however the S&P 500 Index is market-capitalization weighted, while the equal weight version holds equal amounts of all 500 companies. In a nutshell, the bigger, more expensive companies are performing better than the smaller, less expensive counterparts. According to a report from Bianco Research dated July 13, 2020, the S&P 500 Index is the most concentrated it has been in the last fifty years. The top five names in the index (Microsoft, Apple, Amazon, Alphabet, and Facebook) currently comprise just under 25% of the S&P 500 Index, and the top twenty names comprise over 38% of the entire index. As Carter Worth of Cornerstone Macro recently stated (July 8, 2020, on CNBC), “There is no S&P Index anymore. It’s just a few names.” To put things into perspective, the top 3 stocks by market cap represent 16.6% of the S&P 500 Index, which is a greater weighting than the bottom 300 names in the index. Along those same lines, the top 5 names in the index currently have a higher weighting than the bottom 350 names in the index, and the top 15 names have a market cap equal to the bottom 420 names.

S&P 500 Median Results (7/3/2020)

Source: Ycharts

Company Size P/E P/S P/B YTD Returns
Top 10 31.4 6.3 6.3 9.6%
Top 50 28.7 4.6 5.5 2.4%
51-100 26 3.8 5.3 (5.7%)
101-150 22.9 3.9 4.1 (1.9%)
151-200 26.4 3.0 4.1 (6.7%)
201-250 24.4 2.6 3.2 (9.3%)
251-300 23.2 2.6 3.3 (5.5%)
301-350 23.9 2.8 2.5 (8.5%)
351-400 22.1 1.8 3.0 (17.6%)
401-450 13.3 1.4 1.9 (22.6%)
451-505 13.9 0.8 1.2 (38.5%)
S&P 500 22.8 2.4 3 (11.0%)

The chart above probably does the best job of explaining the S&P 500 returns for the first half of 2020. The biggest companies by market capitalization are the most expensive based on valuation metrics such as P/E (price/earnings ratio), P/S (price/sales ratio), and P/B (price/book value ratio). The biggest companies have also produced the highest market returns, despite those higher valuations. The move higher in technology issues, while the rest of the world moves lower, seems unsustainable given current valuations. James Mackintosh, of the Wall Street Journal, on April 21, 2020, stated that “Stocks listed on the NASDAQ are worth as much as the MSCI World ex-USA Index, a benchmark that includes 1007 large and mid-cap stocks from developed markets outside the United States with a median market capitalization of $5.8 billion.“

Investment or Speculation?

In the typical economic recession, market participants traditionally attempt to hunker down, reducing portfolio risk and playing defense. During a market drawdown, such as was experienced in the first quarter of 2020, it is not unusual for investors to panic and/or capitulate. Even seasoned market professionals typically reposition portfolios to reduce risk to ensure that losses don’t become unmanageable. While certainly some investors panicked out, what has taken place since then is nothing short of amazing. As individuals were told to “stay at home” and that the government would help with a $1,200 stimulus check and enhanced unemployment benefits, it appears that quite a few became bored and a chunk of the money found its way into the equity markets.

Many inexperienced investors sensed a “generational buying opportunity,” evidenced by 1.2 million new account openings at Fidelity and Robinhood and trading volumes up by three-fold when compared with 2019. Ironically, this was going on when one might expect mutual fund liquidations and people exiting from the markets. Millennial investors (who some call speculators) have been attracted by a trading app that makes buying and selling stocks simple and free. The average Robinhood trader is thirty-one and trades forty times as many shares per dollar than the average Schwab customer. As pointed out by Nathaniel Popper in a New York Times article dated July 8, 2020, Robinhood encourages more trading as it gets paid by selling the order flow to various Wall Street trading firms like Citadel Holdings. With interest rates at zero and 80% of the S&P 500 index paying higher dividend yields than the ten-year treasury bond, perhaps investing is a wise move for people seeking some type of return on their money? It turns out that most Robinhood accounts are invested in speculative securities rather than dividend-paying securities.

While there is nothing wrong with speculation under appropriate conditions, we do not think it should be confused with long-term investment strategies. In the Intelligent Investor (published 1949), Benjamin Graham stated, “An investment operation is one which upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” Could the speculative trading on Robinhood be a form of entertainment/gambling? After all, the June 2020 unemployment rate is 13.3% (Bureau of Labor Statistics says true rate is over 16%). That, coupled with the fact that half of the workforce is now working from home, might help explain this newfound love for trading on the Robinhood platform. Some top stocks include companies such as Nikola, Workhorse Group, Ideanomics, Top Ships, Tesla and Hertz. Nikola’s (electric truck manufacturer) market cap recently exceeded that of Ford Motor Company even though they have yet to sell a truck. Hertz, which rallied some 883% after filing for bankruptcy, is another Robinhood most traded issue. In English folklore, Robinhood was an outlaw who took from the rich and gave to the poor. When looking at how they are selling their order flow, it appears that Robinhood takes from the millennial and gives to the high-frequency trader. While we are not here to judge Robinhood traders and/or the Robinhood platform, we are merely pointing out that this is not the typical behavior one sees when the economy is mired in recession. The current period is eerily similar to the 1999-2000 period when day-trading was all the rage and valuations were deemed irrelevant.

Steadfast Course of Action

While writing this section of this letter, we took some time to review the quarterly letters we sent to clients in 1999 and early 2000. While history doesn’t always repeat itself, it often rhymes. The similarities of the two periods include not only the day-trading mentioned above, but includes many other parallels such as: 1) divergent returns between S&P 500 index and S&P 500 equal weight index, 2) top heavy S&P 500 index with largest names (mainly technology names) driving the index, 3) the tech heavy NASDAQ generating outsized returns, while average stock was in a bear market, 4) media infatuation with technology highflyers, 5) some of the highest market returns coming from unprofitable companies, 6) 1999 analysis focused on “eyeballs” while 2020 market focuses on TAM (total addressable market) and, 7) investment legends such as Warren Buffett, Grantham etc. deemed to be washed up and done. Below is an excerpt of our Investment Outlook from January of 2000 and in our judgment continues to be relevant today:

Jolley Asset Management is a disciplined value investor. We believe that in the long-term stock prices are ultimately driven by the earnings and cash flow of a business, and the risk in that enterprise is largely related to the sustainability of those cash flows. The company’s competitive position is extremely important, and we prefer to buy companies where we believe the business franchise offers us a “margin of safety.” While we pay attention to relative risk, we are more concerned with absolute risk when we purchase a security. We are just as focused on the balance sheet and downside as we are the potential for capital gains. We also believe that dividends are an important component of total returns. The bifurcation of today’s markets creates wonderful buying opportunities to the contrarian value manager, such as Jolley Asset Management. We believe we are at a critical inflection point, where an investor must be willing to swim against the tide, even if it means foregoing short-term performance. It is our belief that great long-term investment records are made by making tough decisions, which many times may mean going against the herd mentality. Buying what is popular has never worked on Wall Street. That is precisely why Jolley Asset Management was formed, to provide a vehicle whereby our focus and discipline could be preserved. We firmly believe our clients will be rewarded handsomely.

As we have communicated with you over the past few months, our excitement over our combination with Live Oak Private Wealth is largely based upon the similarities in our investment philosophies and the quality and integrity of the people. After our first full quarter as part of the Live Oak Private Wealth team, I can honestly say I feel even stronger that this combination will prove to be extremely positive for our clients. Thanks again for the confidence you have placed in our firm.

Ten Largest Positions
Live Oak Private Wealth Classic Value Strategy
June 30, 2020

Sony Corp
Intel Corp
Qualcomm, Inc.
Dominion Energy
Alphabet Inc., CI A

United Parcel Service, Inc.
Cisco Systems, Inc.
ServiceMaster Global Hldgs, Inc.
CVS Health Corp
Merck & Co., Inc.

During the second quarter of 2020, we initiated a position in Charles Schwab (SCHW). This is a company that we are extremely familiar with, as they serve as our primary custodian for client assets. Schwab recently announced that is acquiring TD Ameritrade, which should add scale and cost synergies. Schwab shares have recently been under pressure (34% off 52-week high) due to the fact that earnings will be depressed by the zero-interest rate environment. We also initiated a position in Unilever during the past quarter. Unilever (UL), is headquartered in the Netherlands and is a global consumer goods company. Unilever has a 3.2% dividend yield and trades at a large discount to Procter & Gamble on a valuation basis. During the quarter we exited our position in Loews, a conglomerate which operates in the hotel, property and casualty insurance and energy industry. All these sectors face major headwinds due to COVID-19.

Performance Attribution
Live Oak Private Wealth Classic Value Strategy
June 30, 2020**

Top Five Performers

Bottom Five Performers

Apple +51% Berkshire Hathaway B +1%
ServiceMaster Global Hldgs +40% Pfizer, Inc +3%
Applied Materials +40% Verizon Comm +4%
Qualcomm, Inc +38% Merck & Co., Inc +5%
Invesco Ltd +34% Coca-Cola +6%

Focused Opportunity Strategy

Live Oak Private Wealth Focused Opportunity Growth Strategy – Commentary and Thoughts (Bill Coleman):

After the wild market action from the first quarter, we sat idle for the second quarter. We, of course, are constantly engaged in our typical daily research routine; reading research reports and white papers and listening in on numerous conference calls with managements and many educational podcasts. Travel has been limited for now, but we have been engaged in reviewing second-quarter company earnings and management presentations.

Trading activity was much lighter than the first quarter. The only activity was selling two spinoffs we received from the Raytheon/United Technologies merger. Those two spinoffs were Otis Elevator and Carrier Air Conditioning. We debated doing a deep dive into each and contemplated adding significantly to these small positions and making them key players in the portfolio. However, after much consideration, we sold them and opted to focus on more attractive businesses we know better, as well as replenish some of the cash we invested in March.

The incremental investments we made in March have helped our portfolios to a varying degree. While it is not fair to grade them yet, we will attempt to anyway. When the selling started in earnest around March 6, the earlier purchases we made in Disney on March 10 and Markel on March 11 have not really earned us much yet. As the selling intensified into the middle of March, the additional investments made in Mastercard and Berkshire Hathaway have helped more, and the Microsoft addition was fortunately made closer to the bottom. The ultimate outcome of these decisions will not be known for several quarters. Patience and timing are very important in portfolio allocation decisions, and looking back, we feel pretty good about the decisions. Our number one objective was to increase the quality of the portfolio on the weakness. We did that, maybe not at the bottom on March 23, but at reasonable prices that will hopefully generate solid returns in the future.

We have a few positions on our watch/sell list. We will either be trimming the position sizing out of price discipline or selling outright and looking for better risk/reward opportunities.

Ten Largest Positions
Live Oak Private Wealth Focused Opportunity Growth Strategy
June 30, 2020

Microsoft
Berkshire Hathaway
United Healthcare
Mastercard
Google Alphabet CIC

Disney
Apple
Charter Communications
Federal Express
Bank of America

Performance Attribution
Live Oak Private Wealth Focused Opportunity Growth Strategy
June 30, 2020**

Top Five Performers

Bottom Five Performers

Carmax +51% Wells Fargo -4%
Apple +51% Comcast 0%
Schlumberger +46% Berkshire Hathaway +1%
Axalta Coatings +38% Charles Schwab +2%
Microsoft +34% Verizon +4%

International Strategy

Live Oak Private Wealth International Strategy Commentary and Thoughts (Bill Coleman):

International stocks advanced during the quarter, led by information technology, consumer discretionary, and the communication services sectors. Outperformance in companies we own in Chinese social commerce played a key role in our quarterly performance. JD.com and Tencent Holdings continue to offer positive growth from network effects and consumption growth in China. In the Eurozone, Schneider Electric and Ferguson offset weakness from the aerospace sector’s investments in Airbus and Safran. Non-U.S. equity valuations were attractive before the coronavirus outbreak and are now even more so in this bifurcated, mega-cap tech weighted U.S. market. There are many incredibly successful and competitive companies based outside the U.S. Our long-standing position in Nestle, coupled with consumer stalwart Unilever offer “blue chip” characteristics and good relative dividend yields. In Europe, where weak travel and tourism are crucial segments of the economy, there have been bright spots nonetheless with Linde, the industrial gas business and pharmaceutical companies Sanofi and Novartis racing towards vaccines for the virus.

Trading activity for the second quarter was light. We exited Fiat after pending changes from the large merger with Peugeot eliminated the special dividend we expected. Also, our thesis behind our investment in Exor was weighted heavily towards the divestiture of PartnerRe, which was scrapped this quarter due to the coronavirus. Our investment thesis in both of these changed dramatically and our discipline triggered the sales.

Ten Largest Positions
Live Oak Private Wealth International Strategy
June 30, 2020

Nestle
Alibaba
New Oriental Education
Vivendi
JD.Com

Tencent Holdings
Ferguson
Linde
Airbus Group
Safran

Performance Attribution
Live Oak Private Wealth International Strategy
June 30, 2020**

Top Five Performers

Bottom Five Performers

Siemans AG +49% HLS Systems +4%
JD.com +47% Novartis +8%
Lanxess AG +44% Nestle +9%
Ferguson +43% Unilever +12%
Schneider Electric +41% Alibaba +15%

Final Thoughts:

Notwithstanding the surprising V-shaped snap back in stocks we witnessed this quarter, it is still a challenging time for us as investors. It has been an even more challenging time for teammates, friends and families. Each of us on our team is striving to keep ourselves, our families, and our colleagues as safe as possible. We continue to function at 100% while still choosing to work at times remotely. We are intellectually “all-in” and all hands-on deck, because the essence of what we do is safeguarding client assets and investing them prudently and we remain laser-focused.

Challenging times in markets and with money like we have witnessed, reminds us how fortunate we are to have such a strong group of investors like you. Many of our friends and acquaintances at other firms in our industry were bombarded with calls from panicked investors with finicky capital, while the majority of the calls we received were from clients looking to increase their relationship with us. We are very fortunate to have a group of high-quality clients that understands what we do, has the confidence to let us do it, and the courage to add capital to their accounts when many others are fleeing in fear.

So, as we continue to endure the fits and starts and openings and closings on the back of a lot of recent optimism in the markets, questions and concerns remain present.

  • What are the possibilities, timeline, and efficacy for a vaccine for the novel coronavirus?
  • Where will the impacts be on the economic recovery if the return to work is slow and many small businesses never reopen, and millions of jobs are permanently lost?
  • What are the impacts of potentially permanent change in the world of retail, shopping centers, office buildings, travel, and sports?
  • What are the potential election risks to political and financial considerations that would alter the Federal Reserve and/or Treasury efforts to provide stimulus to combat a further slowdown?

The markets have rallied a lot and have gotten very optimistic in our opinion. Possibly, the markets are not looking ahead far enough to gauge the concerns noted above. We believe a majority of the rally has been driven largely by the Federal Reserve’s liquidity actions and the Treasury’s stimulus payments. This “bridge” has been tremendously important, but we don’t know how long the bridge needs to be. Stock prices feel like they are ahead of themselves, especially with the election uncertainty looming. We end the quarter with an eye towards caution and thinking defense versus offense.

We find ourselves again humbled and appreciative by your willingness to compensate us for doing something that we enjoy doing (even in turbulent times) and is so important to us all. Our entire Live Oak Private Wealth team looks forward to our continued shared success in this partnership.

With warmest regards,

Frank G. Jolley
Co-Chief Investment Officer

J. William Coleman, III
Co-Chief Investment Officer

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 attribution charts represent a simple point-to-point price percentage change for the five best and five worst portfolio positions for the second quarter ending June 30, 2020 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. Additionally, there is no guarantee that all portfolios will own any or all of the companies mentioned.

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) 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.

5) 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.

6) 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.

7) Live Oak Private Wealth is a subsidiary of Live Oak Bank. Investment advisory services are offered through LOPW, LLC, an Independent Registered Investment Advisor. Registration does not imply a certain level of skill or training.

8) Opinion and thoughts expressed are those of Bill Coleman and Frank Jolley and not Live Oak Bank.

9) Not all portfolios will necessarily own all companies mentioned, due to factors such as legacy positions, capital gain constraints, sector concentration, time, and other considerations.

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

DOWNLOAD THE QUARTERLY LETTER FROM BILL COLEMAN

 

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:

  1. Strong predictable cash generation
  2. Sustainable returns on capital, and
  3. 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
Google 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

DOWNLOAD THE QUARTERLY LETTER FROM BILL COLEMAN

 

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.

  1. Focused Opportunity
  2. Select
  3. International

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:

  1. A very important political election.
  2. Potential effects of tightening liquidity conditions against a backdrop of ever-increasing corporate debt levels.
  3. Potential for the economics of the past to result in some wage inflation given the strong U.S. consumer and low levels of unemployment.
  4. 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.
  5. Excessive optimism. Most all sources of measuring investors’ sentiment are showing extreme optimism (highest in 15 years).
  6. Continued cold war of trade globally between the U.S. and China and Brexit with the European Union.
  7. 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
Google 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 Facebook 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%
Facebook +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.