Now, the key is to buy such a company — growing or not — at a margin of safety for an approximate appraisal to intrinsic value. The hard part is finding a company where you think the nature of the business gives you confidence in predicting future growth — after all it is a competitive world. Finally, if that predictable future growth is already well recognized, you may not be able to invest with a margin of safety. Predicting and assuming rapid growth as your thesis may work out fine if all goes perfectly, but it is a long way down if you hit a bump in the road.
As an example, a business that we acquired shares in during the COVID-19 pandemic is KKR & Co (KKR). They are a good example of a high-quality business with a strong track record of success and growth tailwinds, and we purchased it at a discounted price that we felt was a significant value. We paid a price that reflected market expectations of a severe economic slowdown which ascribed little value for its franchise, tangible assets on balance sheet, and potential for increased fees and earnings as a result of aggressively deploying assets under management ((AUM)) during the dislocation. We paid between about $16 and $24 for our KKR shares during March of 2020.
Today, KKR has approximately $19/share of balance sheet investments and a run rate of over $4/share of distributable earnings/share. Only two years after our buys, we in effect paid for their balance sheet investments and got the business which has approximately $371 billion of fee-paying AUM, for nothing. Although we were unable to precisely predict the probability of a prolonged economic slowdown at the time, we were comfortable with having a different view from the market which we felt was significantly undervaluing the business.
Hortz: What are the dangers you have mentioned of letting macro thinking creep too deeply into your investment process?
Pitkowsky: As a fundamental investor, we focus on what is knowable and important. There are a lot of things that are important, but not knowable. Predicting interest rates, recessions, and the like, fall into that category. It would be great to be able to predict them with a high degree of confidence. But we are confident we cannot make those predictions and we are suspicious of anyone who thinks that they can. It is not what you don’t know that can lead to bad decisions, it is often not knowing what you don’t know that does. What we focus on instead is trying to have a thoughtful, deeply researched and perhaps differentiated view about a not too long list of companies and invest in them for the long-term where we have an initial margin of safety between our purchases and underlying value.
Although we do not have strong views on which scenario will play out in the economy in the next few years, we respect the possible different macro scenarios and have exposure to some of these risk factors. We continue to hold a modest exposure to gold through our holding in Barrick Gold, a well-run gold miner led by CEO Mark Bristow that also has a material exposure to copper mining.
In a higher rate environment, financials stand to benefit and we have positions in banks including Bank of America where net interest income will expand and earnings should continue to grow even if the US were to experience a more typical economic slowdown. Finally, we discuss potential macro scenarios internally as a way to stress test the positions in our portfolio and generally avoid businesses that are consistently over levered with debt. It should be noted that the above exposures were established before the recent rise in interest rates and inflation, when few were talking about such things.
Hortz: Why have you chosen to dismiss broad diversification and continued developing your fund as a non-diversified concentrated portfolio?
Pitkowsky: We would rather know a lot about a smaller number of things than less about a longer list of holdings. In addition, as we strive to outperform over the long-term, to achieve a different result than the broad market you really must look different than the market. Hence our desire to have a higher concentrated “active share” of distinctiveness in our structure. Finally, as with everything we do at GoodHaven, this investment approach is how we are wired, how we are comfortable investing, and how we would invest if there were no clients or shareholders and it was a family office.
Our thinking is why would you want to own your 30th best idea when you can own more of your favorites? From a risk standpoint we do not think volatility is the same as risk. Risk to us is the risk of a permanent loss. Risk as defined by others is a measure of volatility. We fully expect more volatility with a concentrated portfolio, but we also think our deeper knowledge of each holding leads to less actual risk. Having said that, we also paid very careful attention to how we size our holdings, and which holdings deserve - from both a risk and a reward standpoint — to be the bigger positions.
Hortz: What is your strategy around fixed income securities and “special situations” you mention in your prospectus and how do you deploy them into your portfolio construction?
Pitkowsky: Leaving aside our ownership of fixed income securities, such as Treasury Bills, which are a cash equivalent. There are infrequent moments where distressed or higher yielding fixed income securities can offer equity like returns, and a margin of safety. We have invested successfully in these areas in the past and are comfortable fishing in those waters opportunistically. In addition, we maintain the flexibility to invest in “special situations” which might include a company that does not meet some of our usual criteria but has other attributes making it suitable for the portfolio and if sized appropriately. In addition, workouts, liquidations, or other “time value of money” investments fall into this bucket and are long consistent with value investing and may be employed periodically and opportunistically.
As an example, we currently own a basket of different series of preferred shares issued by Fannie Mae. Our cost is a material discount from the stated par value in each instance and the dividends have been suspended. While the company has been in conservatorship since the great financial crisis, we feel we have material upside and manageable downside should any move to recapitalize Fannie Mae (and Freddie Mac) materialize which has been discussed and tried from time to time.