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Wedgewood Partners 2Q17 Client Letter – The Fab Five

By Umair Tariq. Originally published at ValueWalk.

Wedgewood Partners letter to clients for the second quarter ended June 30, 2017; titled; “The Fab Five.”

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Henry Singleton

H/T Dataroma

James Montier: Markets Are Behaving Like The White Queen (Alice In Wonderland)

Review and Outlook

Our Composite (net-of-fees)i did not gain any ground (-0.08%) during the second quarter of 2017. This result compares poorly with the gain of +4.7% in our benchmark, the Russell 1000 Growth Index, as well as the S&P 500 Index’s gain of 3.1% during the quarter.

Our year-to-date gain of +5.9% lags considerably versus the gains of 14.0% and 9.3% in the benchmark Russell 1000 Growth Index and the S&P 500 Index, respectively.

Top second quarter performance detractors include, Tractor Supply Company, Schlumberger, Core Labs, Fastenal and Ross Stores. Top second quarter performance contributors include, PayPal, Edwards Lifesciences, Alphabet, Visa, and Cognizant.

During the second quarter, we increased our positions in Tractor Supply Company, Fastenal, and Ross Stores. We also initiated a position in Celgene.

Wedgewood Partners

A Word on Performance

We typically have not used our quarterly Client Letters to discuss investment performance in detail outside of the usual quarterly updates. Such conversations are best reserved for both direct client calls and in-person client meetings. That said, given that our relative returns over the past few years have lagged this continuous up market, it was high-time to bluntly and humbly discuss our returns in more detail, and to give some context on how we think about recent performance.

For those clients who have only invested with us since 2014, we need to address your concerns on our recent performance posthaste.

As we have repeatedly stated in client calls and meetings over the past two years, our better performing years and 25-year history are of little solace to clients who have hired us over just the past few years – and such client concerns and direct questions and boos are surely warranted, and in order. We know you that you fully understand that hiring a focused equity manager will result in a wider range and volatility of periodic investment returns measured in both absolute terms and relative to benchmarks and market indices.

We have had two other periods of sharp underperformance (1997 and 2006-2007) in our firm’s history, but the last few years has been the worst and the longest by far.

As we examine our results of late, we find that the incidents of underperforming stocks are the same in number and magnitude during most calendar years over our 25-year history. The exception to our return profile over the past few years has been the dearth of truly big winners. We saw this result back in our poor 2005-2007 period. Our defense-first investment philosophy is seemingly little match for an investing environment that rewards risk-taking to the sharp exclusion of the prudence of time-tested valuation disciplines.

That said, while we are disappointed that we have not navigated the challenging investment environment for more conservative investors over the past few years, we are in fact duly proud of how we have navigated the past 10 years of what can easily be described as some of the most extreme environments in stock market history. The last 10 years have been quite unique in stock market history in that they encompass one of the worst bear markets in a generation and one of the best bull markets in stock market history. In short, the past 10 years alone have been an unusually demanding, “career-type” test for any equity manager.

On top of that, does any of us truly believe that the current historic bull market would be well into its ninth year – with its last double-digit decline recorded way back in the fall of 2011 – if it were not for the world’s central banks flooding the world’s economy and financial market’s with over $16 trillion? If reversion to the mean has not been permanently deposited in the dustbin of market history, the rebound in active manager performance versus passive strategies may well define the next 10 years.

Wedgewood Partners

Cutting to the chase, the most pressing, direct question that we are being asked by our clients these days is, “Why Wedgewood?!”

Our humble reply is, “If our past 10-year (much less our 25-year) performance warrants any due consideration, we believe that you should consider investing even more in our strategy.”

Please see the 10-year performance reports at the end of this Letter.

We believe they tell a powerful story of full market-cycle investing and risk management:

Wedgewood Partners 10-year compounded, gross-of-fee return of +10.42%2:

  • Top 8% ranking versus 226 reporting Large Cap Growth equity mangers against the Russell 1000 Growth Index.
  • Top 4% ranking versus 883 reporting Large Cap (Growth, Blend, Value) equity managers versus the S&P 500 Index.

Again, while we have no doubt disappointed clients with our underperformance over the past few years, we humbly believe that longer-term performance results – particularly over a full market cycle – are the more relevant measure of a manager than just a few years.

We believe that the laws of intelligent, successful investing are immutable. For +25 years we have endeavored to own competitively advantaged, best-of-breed businesses that generate buckets of profitability without the use of excessive debt. Further, we must have the valuation discipline to invest in such growth companies when they are under-valued and out of favor. This is our craft. We resolve to continue the same whatever Mr. Market may tempt us with.

Wedgewood Partners

Our second quarter returns capped one of our most challenging relative performance periods in our 25-year history as our investment process continued to face substantial headwinds in the current binary stock market. The relative underperformance occurred evenly across the quarter, as well as year-to-date. Our technology (health tech and financial tech) surged and contributed the most to our gains, while nearly everything else detracted. Although we own a roughly 35% weighting in information technology and another 5% in biotech and med-tech, it simply was not enough to offset the performance of the rest of the portfolio. Again, our year-to date winners ranked are all “tech” stocks, which include PayPal, Priceline, Edwards Lifesciences, Apple, Visa, Cognizant Technology and Alphabet. The stocks that have underperformed our benchmark so far in 2017 include all the other stocks in our portfolio.

Relatedly, our year-to-date underperformance has mimicked the underperformance of value-based indices relative to growth indices. Much of this is coincidental, but we earnestly believe that there is a causal relationship as our growth company

The post Wedgewood Partners 2Q17 Client Letter – The Fab Five appeared first on ValueWalk.

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