We are willing to invest in a number of countries around the world as long as we believe we are receiving good value for the capital we commit to an investment. In general, we hold no views about the direction of currencies during our investment timeframes. As we’ve discussed before, we believe that currency fluctuations will impact our long-term returns less than the performance of the underlying businesses, though currency fluctuations can certainly have a strong impact on performance during shorter timeframes. Because of this impact, we’ve chosen to partially hedge some of our currency exposure when investments denominated in a given foreign currency become a significant part of the portfolio.
We had a partial hedge on the GBP leading up to the June 23rd “Brexit” vote. In the couple of days before the vote, as it appeared that a “Bremain” vote was the most likely outcome, the GBP rallied and we decided to increase our hedged exposure a little, in case of any surprises. And since a surprise outcome did occur, this had a minor dampening on our GBP currency loss, though our remaining exposure and the quotational loss that occurred on a couple of our holdings from the vote until the end of the quarter had a larger effect.
Since the vote, we’ve had many family members and friends outside of the investment business ask for our opinion on Brexit, which must mean that the financial news media did a great job of spreading fear and getting people’s attention. This may have contributed to the sell-off that occurred in the markets the day after the vote. But this fear and worry appears to have been short-lived, as equity markets soon rallied to new all-time highs.
As to our opinion on Brexit and its effects, we will defer to someone far wiser on this matter. In the week after the Brexit vote, Oaktree Capital Management Co-Chairman Howard Marks spoke with Forbes, and this excerpt of his reply sums up our basic opinion on the matter:
“The one thing I’m sure is right is that nobody knows [the consequences of Brexit]. Nobody knows in what form it is going to be implemented, or by whom, or when. The effects and the knock-on effects—the second-order consequences—are so numerous and so complex that I don’t think this falls within the realm of what’s knowable. I just think there’s far too much that’s unknown for anybody to have a solid grasp on the outlook… Brexit is hard stuff. These are enormous questions that, in my opinion, verge on the unknowable. So the mere fact that something is important, doesn’t mean you can make money from it. I was talking to [Warren] Buffett sometime in the last year, and he said that to be actionable, every piece of information has to satisfy two qualities: It has to be important, and has to be knowable.” –Howard Marks (June 29, 2016)
We go to great lengths to make sure we have a sufficient margin of safety to protect us from the unforeseen and the unknowable before committing capital to an investment, and we still believe we have that with our three larger UK investments. Here is a brief summary of how we currently view those three:
- Electronic Data Processing is currently in the process of a strategic review. We continue to expect the company to either find an acquirer or pay out a significant portion of its excess cash in the form of a dividend to shareholders during the next few months.
- BrainJuicer, which we discussed in more detail in our most recent letter, has a partial natural currency hedge, as two-thirds of 2015 revenue was transacted in currencies other than the GBP. Indeed, the U.S. recently became the company’s largest revenue contributor, at 37% of the total. While the stock being quoted in the GBP can have a near-term effect on our reported results, and some of the company’s clients could get worried about Brexit and reign in spending until things are more clear, we think the value Brainjuicer provides to clients and the runway it has in the years ahead keeps the investment thesis well intact. In fact, we wish the stock would have declined like some others in the UK after Brexit, as we would have been happy to buy more shares.
- Cambria, which sells large-ticket discretionary items only in the UK and purchases much of its inventory from non-British manufacturers, had the biggest impact on our performance. It was our largest holding entering the quarter, and after peaking at £0.82 per share during the quarter, Cambria dropped to a low of £0.58 after the Brexit vote, and closed the quarter at £0.66. The company, along with many other businesses tied to the UK consumer, could certainly experience a slowdown in sales and earnings if the worry that the UK will experience a recession as a result of Brexit comes to pass. But, we believe that the valuation and industry trends in place during the next 5-10 years, along with a conservative balance sheet and well-aligned management team, continue to make Cambria worthy of its place at or near the top of our portfolio.
“The essence of [Charles] Darwin’s disruptive genius was his ability to think about nature not as fact—but as process, as progression, as history.” –Siddhartha Mukherjee, The Gene: An Intimate History
It’s important in investing not to get anchored on an initial opinion or to let an initial decision keep one from constantly assessing new information. Questioning whether one’s previous conclusions may be flawed is vital in any decision-making process, but it’s especially important in the investing process. The progression of industries, their competitive landscapes, and the evolution of each individual business makes the constant search for facts and their objective interpretation a necessary part of trying to achieve success over time.
Whether studying our own successes and mistakes, or assessing how the companies in which we invest respond to changes in their own environments, we realize that concrete reasons and hard truths are rarely as clear as our brain would like them to be. The human mind is wired to remove doubt and quickly draw an arrow between cause and effect. But the future is a path of probabilities, and so was the past before it became the past. As investors thinking about something like Brexit or a similar big-picture (and unpredictable) event, we’ve described ourselves as risk-identifiers, as opposed to being forecasters. We think about how a range of risks might affect a potential investment under many different scenarios, and then only look to invest when we believe we are being well-compensated for those risks and—in addition to that compensation—also have a margin for error in case our assessment proves to be wrong. That description of our approach continues to be valid today.
This post has been excerpted from the Boyles Asset Management Q2 2016 Letter to Partners.