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Massif Capital 2Q17 Letter To Investors

By VW Staff. Originally published at ValueWalk.

Massif Capital letter to investors for the second quarter ended June 30, 2017.

Passive Investing ETFs Account For 6% Of Market But Active Managers Still Rule

Dear Investors,

For the quarter ending June 30, 2017, the core portfolio was down 2.43% net of all fees and expenses compared to a gain of 4.68% for the MSCI All Cap World Index. Year-to-date the core portfolio is down 4.06% net of all fees and expenses compared to a gain of 13.36% for the MSCI All Cap World Index. Since inception in June 2016 through the end of the second quarter 2017, the core portfolio has returned 13.48% net of all fees and expenses compared to 20.59% for the MSCI All Cap World Index. Returns in separately managed accounts may differ from the core portfolio based on initial investment date. For the quarter ended June 30, 2017, all accounts were down 1.68%, YTD all accounts are down 2.81%, and since inception, all accounts are up 9.02%.


The end of the 2017 second quarter marks the first full 12-month period of operations for Massif Capital.

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2nd Quarter 2017 Commentary

Markets in 2017 continue to be difficult to interpret. New highs are being made on a regular basis by the major indices, and consumer confidence is at a sixteen year high, but the backdrop is domestic and international political tension, record corporate and sovereign debt levels and years of tepid economic growth. In short, numerous conflicting signals have made judging where we are in the business cycle difficult.

Not wanting to be caught off guard by an overly stubborn adherence to my negative interpretation of the data, I reexamined some of the conflicting signals this quarter to see if I had not only misinterpreted them but also to try and find a more coherent narrative to explain how all the pieces fit together. I sought to understand how we could have a bull market in equities and high corporate profits but have tepid economic growth and a toxic political environment.

I started my review by looking at the way I had characterized this post-election leg up in the markets, specifically the view held by myself and others that this was a very narrow bull run confined to a few sectors, and dominated by the FAANGs.1 As it turns out, this characterization appears wrong, or more specifically, the idea that the degree to which 2017 index gains have been atypically driven by just a few names is wrong. This suggests that the breadth of the bull move is not out of step with historical bull moves.

Recent work by hedge fund AQR indicates the degree to which this year’s returns and last year’s returns have been driven by just a few names is completely normal. The top five contributors to S&P 500 performance last year, and thus far this year, have made performance contributions to the index in line with the average performance contributions of the top five return contributors dating back to 1994. Unfortunately, this fact makes my recent underperformance all the more disappointing as it means we have not only missed out on the nice rally since the November Presidential Elections but we have missed out on a relatively broad rally as well.

Attempting to understand why I missed the rally led me to examine the portfolio’s exposure to companies held by ETFs, and it is almost zero. From my perspective, this is a new wrinkle/risk (I can’t decide which it is) for active investment managers. When a company is not part of an ETF, it misses out on huge flows of value insensitive capital into the market. At the same time, the lack of attention paid to such names creates opportunities for investors focused on fundamentals. This tension warrants further study as the growing allocation to passive investments puts the value discovery mechanism of markets at risk.2

The core portfolio’s largest position at the current time is CNXC Coal Resources. According to Morningstar, CNXC is owned by one ETF and that ETF has a position roughly the same size as our position. The fund’s second largest position, Diamond Offshore, is owned by far more ETFs, roughly 55, but that is our only position owned by more than 5 or so ETFs. Given that the number of ETFs now traded on US public equity exchanges outnumbers the number of publicly traded companies I am surprised I have managed to construct a portfolio so insulated from the tsunami-like flow of money into passive investments.

I am encouraged by the fact that the portfolio is made up of mostly overlooked investments, which means I am doing something very different than everyone else, and that is the only way to generate returns that are above average in the long run. At the same time, I am wary of what the trend towards passive might mean for the time it takes markets to recognize the value of assets not held by an ETF.

I spent significant time this quarter thinking and reading about what the passive investing flows into the market might mean for the long run. Most people believe the move to passive is the result of the underperformance of active managers. I agree that has played a role, but I am unconvinced that is all that is going on. Traditionally, the narrative around significant flows of money into risk assets like equity would be a that it is a sign of optimism. Currently, such a narrative does not appear to fit with the world around us or the economy.

The only counter explanation for this odd situation is to suggest that passive investments, regardless of what assets they flow into, should be considered low confidence decisions by investors, not only in regards to the ability of active managers but the market system in general. As Peter Atwater, a financial consultant who studies the impact of societal mood on markets recently noted in an interview on Real Vision TV passive investments are: “almost a capitulatory, I’m never going to get it right, it’s gamed against me, I’m going to go for the lowest cost option and hold my nose and just commit.” I am sure there are less pessimistic ways of looking at it, but this interpretation seems more in keeping with sluggish economic data and a low volatility rise in the markets than to suggest investors are optimistic enough about the future to be rushing into risk assets in the way that capital flows into passive investments might suggest.

The last data point I studied this quarter was corporate profits. Specifically, how to explain record high corporate profits and years of sluggish economic growth. These two facts seemed the most conflicting of all the macro economic data floating around these days until I pulled out an Econ 101 textbook and reread the section on monopolies. For those who took Econ 101 many years ago, a brief reminder: monopolies are price makers, as they don’t

The post Massif Capital 2Q17 Letter To Investors appeared first on ValueWalk.

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