Volatility remained high in October as uncertainty about the upcoming US election weighed on investors’ conviction to build long term positions. Our long term focus led us to build positions in extremely attractive businesses when their valuation opened very attractive risk-reward profiles.
October brought the start of the Q3 earnings season. Most of our businesses performed at or above our expectations. The market hasn’t yet rewarded our portfolio for this. As Benjamin Graham said: “In the short run, the market is a voting machine but in the long run, it is a weighing machine”. Based on reported performance, our longs are putting on weight at a fast rate. We are voting for them while confidently waiting for the market to bring its scale.
At the request of some institutional investors we are adding a few new metrics to the attached performance sheet.
I encourage you to consult your financial advisor to get acquainted with these metrics. In the meantime, you can also check our Risk Manager’s glossary at: http://www.northstarrisk.com/glossary
As an introduction, we would like to give you a less scientific but more intuitive explanation of the new metrics:
Correlation to S&P – this measures how closely Somar’s returns follow those of the overall US equities market. One of Somar’s goals is to provide superior risk-adjusted returns, and to do so with exposures that will provide diversification to our investors to simply owning a basket of US equities. So from our perspective, we aspire to have a low correlation to S&P.
Sharpe Ratio – A measure of how much return was achieved per unit of risk (as measured by volatility of returns) incurred. While we all hope for the highest possible return on our portfolios, when analyzing performance it is important to balance that with the level of risk built into the portfolio. Let us illustrate what investors try to measure with the Sharpe Ratio with an extreme example: Portfolio A just returned 12% while portfolio B just returned 10% after a good economic and financial year. Under an adverse scenario (economic recession) Portfolio A would have returned -10% while portfolio B would have returned 7%. So looking at reported returns alone, doesn’t allow the investor assess the full performance of the two portfolios (clearly A performed better than B). Using the Sharpe ratios, we can calculate (after a few assumptions) that B has a much higher Sharpe ratio than B and therefore offers higher returns per unit of risk.
Volatility – Institutional investors measure the riskiness of portfolios based on the volatility of its returns. Therefore, the higher the volatility we report, the higher the perceived riskiness of our portfolio. We don’t fully espouse this view. We see risk as the probability and amount of permanent capital loss. As an extreme example, if an investment has a high range of possible outcomes but virtually all of them lead to an investment gain, we see it as very low risk while the stock and outcome may be highly volatile until harvest. Just like Warren Buffett, at Somar we much rather prefer a bumpy 15% than a steady 6%.
Concentration of top 5 positions – A way to assess how much of return comes from a select few ideas. Concentration will give investors the ability to understand how susceptible the portfolio is to stock-specific adverse events.