Fellow Partners,
One year ago we embarked on the journey of forming an investment partnership of applied practical wisdom.
We started with five partners and have grown to fourteen.
We were pleased to deliver strong performance in 2020, though even more pleasing was the response from the partnership, which could be summed up by what may have been my favorite email of the year:
Hell of a return! But wanted to call out that I'll be here to support and continue to invest with you even when the macro gets harder.
I have thoroughly enjoyed serving this partnership. Many days I wake up surprised and delighted that I get to do this full time.
In the past twelve months I cannot recall a single discussion with any partner asking about daily, weekly, monthly, or quarterly returns. That says a lot — this partnership “gets it”.
I have declined many services in the past year that have offered to introduce us to new capital. We would welcome that — but it absolutely must be the right capital. Business-focused, long-term oriented, and patient. I am continually surprised at the degree to which much of this industry is geared towards raising any capital and treating partners any way they can. We will never stoop to those behaviors.
The long game
You can hold a ballet and that can be successful. You can hold a rock concert and that can be successful. Just don't hold a ballet and advertise it as a rock concert.
Warren Buffett
Over the past year we’ve had interested parties join the partnership, decline to join the partnership, and in a few cases we’ve declined to offer them partnership. Our ability to be painfully clear on what we are — and are not — is crucial to our ability to leverage our key advantages.
We never set out to be “yet another fund” and could never do so if this partnership was built to serve any interested party with capital. We are tackling the investment problem in a unique manner, and that demands unique philosophy and application.
We focus first and foremost on quality: of thinking, of businesses, of business models, of management, of portfolio construction, of communications and relationship, and of the company we keep.
Like many funds we have the right to use leverage, short stocks, and use options and futures as there may be periods where these are useful — but we focus most of our time and efforts on finding and investing in high-quality businesses.
We do not make macroeconomic bets.
We do not trade hyperactively in response to the latest news.
We do not dabble in exotic financial instruments.
We do not seek to manage volatility (and unlike much of this industry we do not believe volatility is a good proxy for risk).
We seek to maximize returns, not assets.
We play a long, simple game which primarily involves buying a few intensively researched businesses, holding them for years, and doing so in a portfolio structure designed for long-term durability.
We report and audit annual performance — but this is not the objective (and why I regularly remind partners not to invest money they may need for another purpose within the next five years).
Expect big down years. Those who are a good fit will be biased to add to their positions at these times.
(We expect big up years as well — but know that volatility is the price of portfolio concentration.)
The above will repel most. Those that are not will find us engaged in these philosophies and optimistic about the long-term potential of these behaviors.
3,000 days
Many of you know that prior founding this partnership I spent nearly a decade with a team building an enterprise software firm in Europe and North America.
My tenure at the firm was just over 3,000 days.
In that time the firm’s valuation grew more than tenfold.
But we only knew the market value of the firm on three of those 3,000 days. Three days. The three days we raised capital.
Years went by with no market valuation. I never lost an ounce of sleep over the inability to grab my phone look up our stock price.
The other 2,997 days we woke up and got to work thinking about how to serve our clients well, build an exceptional product and team, and grow the business.
The valuation growth was a result of what we were doing on those 2,997 days. It was an outcome, not the target.
Quality is a phenomenal strategy, and over a long enough time horizon a quality business will receive a healthy valuation. In the long-run quality is all that matters.
Contrast this with how many market operators act. I am writing this sentence from a hotel lobby whilst the gentleman behind me is loudly engaged in a phone call predicting the price of stocks in the next 48 hours.
It’s a different mindset.
Real world businesses
We view our investments as fractional shares of businesses. Taking the proportion of each business we owned in 2020, our ownership stake in those businesses served thousands of customers — including about 1,000 new customers — through digital and social content, games, and on-demand work.
In 2020 our ownership stakes were responsible for selling thousands of semiconductors, 5,000 software units, and 600 gaming consoles.
Our ownership stakes were responsible for processing over $1m in transactions and connecting dozens of workers to remotely delivered on-demand jobs.
In aggregate our ownership stakes delivered $1.1m in revenue and $160k in profit.
Most did so with admirable efficiency and scale.
That’s a small sample of the many things our fractional ownership of several wonderful businesses accomplished, and a good example of how we analyze them.
Finishing first
To finish first, you first must finish.
Old Racing Quote
We’re not racing, but I think often of this quote. In a time that continues to call for the word “unprecedented” it is always worth stepping back and seeking to understand our present context and what could limit our ability to compound our capital at high rates over many decades.
In that respect, our patience is an enormous competitive advantage. Focus on short-term valuations eliminate one’s ability to benefit from the strengthening effect that crises can have on wonderful businesses.
Bad companies are destroyed by crisis, good companies survive them, great companies are improved by them.
Andy Grove, former CEO of Intel
Our concentration in only the highest quality businesses is another enormous competitive advantage. This positioning guarantees higher volatility, but makes rational sense when one’s objective is to hold businesses able to survive and thrive through most crises. Holding everything (i.e., indexing) is a very different strategy.
Having the ability to “fish where the fish are” — acknowledging that fish swim around — is a third competitive advantage. Many funds were stuck last year with a narrow mandate that required them to invest only in areas that the pandemic would obviously decimate (think small businesses with limited access to capital, or many aspects of the energy or corporate real estate sectors). The opportunity landscape shifted quickly and dramatically in 2020, and our ability to play across it benefited us greatly.
Finally, positioning our portfolio to weather certain types of low-probability but high-damage events (e.g., hyperinflation, and certain kinds of business disruption) is a fourth competitive advantage. We value the durability this positioning provides against certain scenarios that could impede our ability to cross the finish line decades from now.
Closing thoughts
Show me the incentives and I’ll show you the outcome.
Charlie Munger
I am often asked what potential partners should know about our partnership. The first thing I say is always the same: my family’s capital is invested alongside yours, and I am continuing to reinvest in the partnership (e.g., 100% of the performance fees earned in 2020 were reinvested into the partnership).
There is always room for disagreement of opinion, process, etc. But the structure of this partnership guarantees there are only two possible outcomes: we’re all happy, or all unhappy. It simply isn’t possible for me to succeed while the partnership does not. That’s how it should be.
I would like to extend my thanks to the broader Phronesis Fund Team for their pivotal roles in launching and growing the partnership through its first year.
In case anyone missed our latest audit, it was published alongside your quarterly statements in the investor portal earlier this year (in summary: clean bill of health).
I look forward to serving you in the coming year, and for many years to come.
As always, please reach out at any time.
All the best,
John
Founder and Managing Partner