GreensKeeper Value Fund Q3 2024 Letter

Skin in the Game

The Value Fund was up +4.7% (net) in the third quarter, +16.7% year to date and +24.4% over the past twelve months. The US dollar lowered our returns by about -1.1% in Q3.

The broader markets had a strong quarter and are all solidly in positive territory for the year: S&P/TSX +17.2%, DJIA +16.3% and S&P 500 (SP500, SPX) +24.6%.(1) The major indices rallied following the Federal Reserve’s decision to cut interest rates by 50 basis points in September, with the DJIA and S&P 500 ending the quarter at all-time highs.

Markets reacted fiercely to updates from the central banks of China, Japan, and the United States each announcing changes to key interest rate targets, influencing local economies and global trade. Additionally, rising geopolitical tensions and the upcoming US presidential election increased volatility across the indices.

At GreensKeeper, we avoid companies heavily reliant on debt, and we shy away from situations that expose us to significant foreign exchange risk. Thus, many of the events that garnered front-page attention in newspapers and countless hours of debate on television, like the Japanese carry trade, were of little relevance to us and our portfolio companies.

We remain confident that the companies in the Value Fund will continue to grow their intrinsic value regardless of the federal funds rate, the results of the US election, or changing foreign exchange rates. With this in mind, we continue to diligently search for attractive long-term investments that present themselves when markets react to short-term news. We will leave it to others to spend their time debating whether the Fed will cut interest rates by 0.25% or 0.50%.

As our employees at GreensKeeper have all their investable assets invested alongside our clients, our goal has always been to protect and compound capital over decades, not to predict quarterly swings in the market. As we discuss below, we believe having skin in the game aligns our firm’s interests with our clients. But first, a brief portfolio review.

Index returns are for the total return indexes, including dividends and measured in Canadian dollars, the Value Fund’s reporting currency.

Portfolio Update

Our top contributor in the third quarter was portfolio stalwart Berkshire Hathaway (BRK.A, BRK.B), which returned +13.1%. Although the railroad and utilities segments continue to face headwinds, the insurance and manufacturing businesses are producing robust profits, with BRK delivering its highest quarterly operating profit in recent history. The company’s remarkable cash generation allows BRK to reinvest capital into its individual businesses throughout the highs and lows of business cycles, a luxury many competitors cannot afford. Augmented by the sale of equity holdings, BRK ended the quarter with over $270 billion in cash on its balance sheet—proof that Buffett continually operates from a position of strength.

American Express (AXP) was our second-largest contributor this quarter, with a return of +17.1%. AXP continues to invest in its customers beyond traditional credit card rewards, recently enhancing its Global Dining Access to provide Platinum cardholders with exclusive reservations at premier restaurants worldwide. This focus on unique experiences has attracted a younger demographic, with millennials and Gen Z driving most of the customer acquisition and card spending growth in recent quarters. Exclusive events are more challenging to replicate than standard point reward systems, presenting a challenge for competing card issuers that lack AXP’s scale and concentrated base of affluent consumers. AXP has fine-tuned its offerings over decades to strengthen its network effect and shows no signs of slowing down.

Fiserv (FI) was our third-largest contributor this quarter, returning +20.5%. Our initial investment in Fiserv followed its merger with First Data in 2020, and we subsequently increased our position after the stock sold off amid rising fintech competition in 2022. Since then, Fiserv has executed exceptionally well across multiple areas—strengthening its balance sheet, returning capital to shareholders, and entrenching its presence with merchants by adding integral software solutions to its payment processing and core banking solutions. The company is on track to achieve its 39th consecutive year of double-digit earnings per share growth, and we remain optimistic about our investment’s potential to compound in the years ahead.

Alphabet Inc. (GOOG,GOOGL) was our largest detractor this quarter, declining by -8.8%. Global antitrust pressures have intensified, with the U.S. Department of Justice and the European Commission targeting several dominant technology companies, including Alphabet. Historically, Alphabet has signed agreements with Apple to serve as the exclusive default search engine for the Safari browser—a practice that a US court recently ruled violated antitrust law. Despite the growing possibility that Alphabet will be required to end its exclusive distribution agreements with Apple, we believe that when faced with a choice screen, the vast majority of users will continue to select Google as their preferred search engine due to its quality advantage over competitors. In EU countries where Google was previously compelled to terminate similar agreements, 97% of users opted to retain Google as their default search engine when given a choice. A similar outcome in the United States would likely have an immaterial impact on GOOGL's earnings power. Alphabet is also facing other regulatory cases, which we monitor closely.

Merck & Co. (MRK) was our second-largest detractor this quarter, declining -8.3%. MRK’s leading HPV vaccine, GARDASIL 9, faced challenges internationally due to inventory buildup within its Chinese distributor, which is expected to reduce shipments for the remainder of 2024. Despite this short-term impact, the long-term outlook for GARDASIL 9 remains promising. Meanwhile, the company’s $27 billion Keytruda cancer juggernaut continues to grow at a healthy clip, powering earnings growth.

In the third quarter, we decided to exit our investment in Cisco Systems (CSCO), as we believed the stock had become fully valued and reallocated the capital to one of our international positions. We also initiated a new position in a Canadian company shortly after the quarter ended. As we may still accumulate shares, we will defer discussing this new holding for the time being. Our top ten positions are detailed in the table below. Further portfolio disclosures, including performance statistics, are available on the pages immediately following this letter.

For millennia, food tasters and cupbearers have been employed in royal courts to sample food and drink to confirm they were safe to consume before they touched the monarch’s lips. If the taster fell ill or even died, the royal was spared from an assassin’s poison, and the food taster was replaced by another poor soul. King Joffrey’s gruesome demise in Game of Thrones may well have been prevented if he had the foresight to employ a royal cupbearer.

It may surprise you to learn that what seems like an archaic practice continues to this day. Vladimir Putin, Barack Obama, George W. Bush, and other world leaders have all been reported to have used them.

But when you think about it, it strikes us that there is an even better solution. Shouldn’t the food taster be the chef who prepared the food? Under this modified arrangement, the chef has an added incentive to ensure the ingredients are unadulterated and the kitchen staff trustworthy. Food for thought.

In 1975, the inventor of the bulletproof vest was having a hard time convincing police departments that his invention worked. Shooting bullets into an empty vest just didn’t cut it. So, Richard C. Davis put on the vest, shot himself at close range and jumped to his feet no worse for wear. Skeptics suddenly became believers, and the rest is history.(2)

During the 2008 financial crisis, Charlie Munger spoke about systemic failures requiring systemic solutions and accountability: people making the decisions must bear the results of those decisions.(3)

Munger told the story of Roman bridge builders being forced to stand under their newly constructed bridges when the scaffolding was removed. Charlie’s point: senior executives whose reckless behaviour had contributed to the financial crisis should be made to pay a price for their sins.

Instead, senior executives of the companies at the center of the financial storm (AIG, Bear Stearns, Countrywide, Lehman) walked away multimillionaires, and the employees, shareholders, and taxpayers were left holding the bag. These executives were incentivized to take huge risks as the consequences of failure would largely fall on others. Regrettably, the incentive structure for senior executives has barely changed: succeed, and you get insanely rich; fail, and you lose your job but still retire a multimillionaire.

“Show me the incentives, and I'll show you the outcome.”-- Charlie Munger (1995)

What do food tasters, bridge builders, bulletproof vest inventors, and executive compensation have to do with wealth management? These stories demonstrate the importance of having skin in the game and aligning interests.

If we were interviewing a potential wealth manager and were able to ask only one question, it would be this:

‘How much of your own money do you have invested alongside your clients’?

Would you trust a chef who isn’t prepared to eat their own cooking? Would you traverse a newly constructed bridge its builder was unwilling to stand beneath? Of course not. That’s why it surprises us that so many people are prepared to entrust their money to someone who doesn’t have skin in the game.

Various studies have estimated that less than one in five managers has skin in the game. That lack of conviction and alignment of interests should tell you something. Unsurprisingly, a Morningstar study demonstrates that fund managers who eat their own cooking tend to do better than those who don’t.(4)

Since I founded GreensKeeper some 13 years ago, my household has invested 100% of its portfolio alongside our clients, and we remain one of the firm's largest clients. My first outside clients were those who knew me best: my siblings, parents, and close friends. Our full-time employees have also freely decided to do the same. Managing money for those closest to you may not guarantee results, but I can assure you that it focuses the mind.

Like commercial airline pilots, our team is incentivized to get you to your (financial) destination safely. We own the same stocks as our clients, our portfolios will deliver similar results, and we are accountable for our portfolio decisions. As a result of this alignment of interests, we view our clients as partners. We want to make money with our clients, not off them.

When a wealth manager doesn’t have their own money on the line, they are incentivized to focus on marketing and growing assets under management. Portfolio construction and stock picking receive far less attention, and as a result, returns often suffer.

I have long believed that if wealth managers were forced to eat their own cooking, reckless behaviour would largely disappear, clients would be better served, and their returns would improve. But we don’t make the rules. We simply take a different approach, which has led to attractive results for our clients and has driven our firm’s success. For now, it is up to the market to demand a better deal from their advisors.

Firm Update

Q3 was an eventful quarter at GreensKeeper. I am excited to announce that industry veteran Rob McMullan has joined the firm as our Chief Revenue Officer. You can find Rob’s bio and those of our growing team here.

We also went live with a refreshed website, which you can find here. It features plenty of great content (videos, podcasts, newsletters, book recommendations) for you to discover.

Michael P. McCloskey

President, Founder & Chief Investment Officer

Original Post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.