April 2018

In a break from our usual format, Alastair MacLeod joined the Advisory Panel to bring a fresh perspective and keep the usual faces on their toes. Alastair has spent over twenty years in investment and hedge fund management, in London, Edinburgh and North America. We outline a couple of the topics discussed during the meeting below.

Diversified Holding Companies – aligned with long term investors
One of the topics that the Advisory Panel focused on, was why it is that diversified holdings companies (often large family-owned businesses) have outperformed over the last 20 years. John Elkann (CEO of Exor, the holding company controlled by the Agnelli family which owns Fiat Chrysler, Partner Re, CNH, Ferrari and the Juventus football team amongst other holdings) highlights some of the reasons in his excellent letter to shareholders after the 2017 year:

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

While Kennox are not (currently) invested in the holdings companies, we agree with the analysis that for fund managers with a long investment horizon, family owned businesses are likely to be well aligned. The S&W Kennox Strategic Value Fund owns several companies with large family or founder shareholders: almost half of all the companies we have ever owned have a significant shareholder (i.e. one that owns more than 25% of the float). Many of these are family owned or controlled.

A couple of other noteworthy points

On dividends: We are not an income fund, and whilst we enjoy being paid to wait, there are often times when companies should hold onto their cash. In the long term, equities have been able to make double digit returns on equity, is there not therefore a case for re-investing all of the cash at a 12% return, that is better than fund managers have done, and more tax efficient. At Kennox, we favour companies that balance shareholder returns with investment, and at times encourage management to cut dividends if we feel they would be better investing in their own business (sometimes to pay down debt, but at other times to invest in growth)

On measuring investments against book costs: Marking individual investments against their historic book cost (i.e. what the Fund paid for the investment) is pervasive in the investment industry, but is perilous and illogical. It encourages managers to hold companies that are below book cost, even when they have become poor investments, and It encourages managers to sell companies that have made a good return to “bank” the profits, when holding is often a better decision. At Kennox, we measure our portfolio against our estimate of their sustainable earnings (i.e. look at the multiple of Sustainable Earnings at which the investment is trading) to gauge whether an investment is a good one today, regardless of sunk costs or profits.

Peter Hollis, Russell Napier, Angus Tulloch and the Kennox investment team.