‘Exor set’ missiles

“Investing is one of the simplest fields run by people who believe in their souls that they’ll do better if they make it more complicated..

“Some of the richest people are the worst money managers I’ve seen. When money loses the power of scarcity you stop caring about leaks that are meaningful when you’re poorer. And when your life gets complicated you’re more likely to outsource decisions to middlemen who may not have your best interest at heart. It’s an overlooked irony. “Enough money to care but not enough to not care” is the sweet spot for management.”

– From Some Things I’m Pretty Sure About by Morgan Housel.

Within our ‘value’ fund – which happens to be our only fund – we typically allocate to two specific types of equity investment. The first type is a specialist regional collective fund managed to essentially the same investment philosophy that we espouse: a belief that our investors will be well served over time by investments in a portfolio of high quality, well managed companies, run by principled, shareholder-friendly management, when shares in those companies can be purchased at no great premium to their inherent value. Such funds will likely be ‘capped’ – that is, not always open to new investors, so that the underlying manager of the regional fund in question can concentrate on conducting research and trying to deliver superior investment performance, rather than simply gathering assets. We look for regional specialists a) because we like to cast our net as widely as possible to maximise our opportunity set and b) because, being based in London, there are regions in the world we would like to invest into on a bottom-up valuation basis, but where we lack ‘boots on the ground’. (As Dirty Harry once correctly observed, a man’s got to know his limitations.) The second type of investment we endorse is the diversified listed holding company run along exactly the same lines (i.e. by principled, shareholder-friendly managers, with a sustained track record of superior returns) – especially when shares in those holding companies can be bought at close to, or ideally below, their fair market value. What is the essential difference between the first and second type ? We can really think of only one: the diversified holding company saves us a layer of fees. In all other respects, they are identical, in that diversified holding companies offer a variety of different business exposures much as a collective fund does.

In his latest letter to shareholders, John Elkann, Chairman and CEO of Exor N.V., asks why so many diversified holding companies trade at a discount to their net asset value. He offers two plausible reasons to account for the discrepancy:

1. Holding companies are perceived to give disproportionate advantages to their controlling shareholders instead of delivering returns to all shareholders;

2. Buying shares in holding companies is seen as less attractive than buying shares in the listed businesses within their portfolios because of the reduced transparency and the additional holding cost.

Notwithstanding the discount issue, he then goes on to demonstrate the performance of diversified holding companies versus the broad market. Over the last 20 years they produced approximately 5 times the return of the MSCI World Index in USD. They also outperformed the businesses they own by 50% while their holding cost was, on average, less than 20bp of assets. Elkann used data from 14 diversified holding companies internationally with a market capitalisation of at least $10 billion and the results are shown below:

Not to be outdone, Elkann twists the knife with regard to the rise of ETFs over the same period:

In a period characterized by the over-performance of passive indexes, it is interesting to note that these strong results come from companies which actively allocate capital and are proactive owners of their businesses..

While past performance may not be a reliable indicator of future returns, what might account for the recent outperformance of diversified holding companies ? Elkann offers four distinct operational characteristics:

1. They tend to be prudent in how they are run, particularly in relation to financial matters, which means they remain robust when they face downturns, crises and unexpected events;

2. They have the patience not to act when action is unnecessary and resist the pressure to do so. As Charlie Munger says, “Success means being very patient, but aggressive when it’s time.”

3. They are aware of changes in the world and are able to adapt when those changes require it;

4. They have strong cultures, clearly defined purposes, and a sense of responsibility. Their cultures, rather than pay, help them to retain talent and to grow leaders internally.

William Thorndike has literally written the book about these types of businesses and the executives who run them. The book is called The Outsiders and it makes for superb reading. Among the managers featured is Henry Singleton of the conglomerate Teledyne:

Conglomerates were the Internet stocks of the 1960s, when large numbers of them went public. Singleton, however, ran a very unusual conglomerate. Long before it became popular, he aggressively repurchased his stock, eventually buying in over 90 percent of Teledyne’s shares; he avoided dividends, emphasized cash flow over reported earnings, ran a famously decentralized organization, and never split the company’s stock, which for much of the 1970s and 1980s was the highest priced on the New York Stock Exchange (NYSE). He was known as “the Sphinx” for his reluctance to speak with either analysts or journalists, and he never once appeared on
the cover of Fortune magazine.

Singleton was an iconoclast, and the idiosyncratic path he chose to follow caused much comment and consternation on Wall Street and in the business press. It turned out that he was right to ignore the skeptics. The long-term returns of his better-known peers were generally mediocre—averaging only 11 percent per annum, a small improvement over the S&P 500.

Singleton, in contrast, ran Teledyne for almost thirty years, and the annual compound return to his investors was an extraordinary 20.4 percent. If you had invested a dollar with Singleton in 1963, by 1990, when he retired as chairman in the teeth of a severe bear market, it would have been worth $180. That same dollar invested in a broad group of conglomerates would have been worth only $27, and $15 if invested in the S&P 500. Remarkably, Singleton outperformed the index by over twelve times.

But Singleton, although his results were outstanding, was not unique. The Outsiders highlights a further eight CEOs of conglomerates and their businesses, all of which would go on to outperform the stock market by a huge margin.
Needless to say, they all had something in common. The inhabitants of what Thorndike refers to as the intellectual village of Singletonville all understood, amongst other things, that:

• Capital allocation is a CEO’s most important job.
• What counts in the long run is the increase in per share value, not overall growth or size.
• Cash flow, not reported earnings, is what determines long term value.
• Decentralized organizations release entrepreneurial energy and keep both costs and “rancour” down.
• Independent thinking is essential to long-term success, and interactions with outside advisers (Wall Street, the press, etc.) can be distracting and time-consuming.
• Sometimes the best investment opportunity is your own stock.
• With acquisitions, patience is a virtue . . . as is occasional boldness.

Henry Singleton outperformed the S&P 500 stock index by over 12 times over a 28 year period that incorporated several protracted bear markets. Henry Singleton never once appeared on the cover of Fortune magazine. Fortune, on the other hand, chose to make Elon Musk their 2013 Business Person of the Year. Go figure. As regards Exor and its diversified holding company peers, in the ongoing battle for investment returns, they may yet be among the most powerful munitions in any investor’s armoury.