Blog » Investor Letters

Dear Investor,

How do you become really, really good at something?

An entire strand of academia is dedicated to this topic. You don’t need to be a professor of mastery studies, though, to understand – and likely intuit – the main ingredients:

1. Do the thing a lot.
2. Do the thing under a wide variety of conditions.
3. Receive instantaneous feedback on how well you are doing the thing.
4. Break the thing into its component pieces. Do these many times, under various conditions, with instantaneous feedback.

This formula works really well for, say, becoming a better tennis player. You play a lot of tennis. You play on different courts, in different weather conditions, and against different opponents. You spend hours honing your serve and your net game. At all times, you learn within seconds how well you did.

Now, try to apply our formula to investing.

Investing “a lot” is a vague instruction. Investing lots of money won’t help you become a better investor than investing a little money. Nor will placing many trades, which simply put a previously formed investment decision into action. The best interpretation is to evaluate many potential investment opportunities and form an opinion about each. In other words, turn over a lot of rocks.

But how are we supposed to practice investing under a wide variety of conditions? We can’t control macroeconomic, political, or market conditions. Unlike a tennis playing switching to a clay court for targeted practice, investors cannot zoom off to practice investing in an oil glut or high-inflation environment. Our ability to practice investing in different circumstances is limited to our lifespans and the scenarios we’ve actually had thrown at us, which rarely repeat exactly.

The biggest problem, by far, is instantaneous feedback. When we buy a stock, we typically intend to hold it for at least three years. That means we must wait a long time until we can tally our score. Even then, our ability to attribute outcomes to skill is imperfect.

Say we buy a small manufacturing stock on the theory that margins will expand. Margins remain stubbornly flat, but Google swoops in and buys the company at a large premium because the manufacturing facilities play into its driverless car experimentations. Our investment is profitable, but our research was dead wrong. Reinforcing the behavior that led to the investment decision would be a mistake.

The opposite is also common. A stock tumbles after its long-time CEO is unexpected diagnosed with cancer or the company unwittingly loses a frivolous lawsuit. The investment decision may well have been sound. Calling it a failure and avoiding similar decisions going forward would be a mental blunder.

In a world where “victories and failures” are disconcertingly not interpretable as “successful behavior to be repeated and mistakes to be avoided,” how on earth are we supposed to get better at investing?

My answer is to focus on process.

I’ve sculpted my investment process to yield as much reliable feedback as possible. I’ve accomplished this four primary ways.

1. Write down expectations. If you were to peruse my research files, you’d find a document labeled thesis for every stock we own – and many we don’t. These documents lay out why I am making an investment decision and what I expect to happen. Years into a position, our recollection of our original expectations inevitably converges with the events that actually unfolded. Simply writing down our expectations breaks that spell and enables us to objectively evaluate our decision against its outcome.
2. Define outcomes carefully. To combat the markets’ faulty feedback mechanism, we redefine the results we measure so they are outside the markets. Rather than tracking stock prices or returns, I focus on business outcomes. In my theses, I’m laying expectations for margins, growth rates, investment spending – the key metrics vary from opportunity to opportunity, but they are always about the business, not the stock. Business outcomes still involve noise, but the signal is orders of magnitude stronger than in equity prices.
3. Fail vicariously. Take another look at those ingredients for mastery. They tell you to create a rapid feedback loop, then vigorously search for as many ways as possible to fail at your task. As long as you have reliable feedback, each failure offers a clear lesson: Don’t repeat that. Success, on the other hand, offers only a vague lesson: Some part of that is worth repeating.
   
   Improvement is predicated on failing in an organized way. But failing in investing is painful and expensive. Paper trading doesn’t help – you’d still need to wait years and suffer the same imperfect feedback loop. Instead, we can study the failures of other investors – and of others in general. Step into your typical executive office, and you’ll likely find a bookcase lined with biographies of successful figures. In my office, and you’ll find rows of books about failure.
4. Seek disconfirming evidence. After I’ve formed an opinion, the most valuable experience is having it disproven. Confirming evidence just tells me what I already know. Contradictory evidence, on the other hand, suggests that the process by which the opinion was formed can be improved – and it enables us to change course before the investment sours.
   
   Unfortunately, almost nobody hunts for disconfirmation. We naturally seek out opinions aligned with our own. We read authors with similar political views and spend most of our time with people whose perspectives align with our own. It’s both psychology and biochemistry – learning someone agrees with us is associated with pleasure centers in the brain, while new information that clashes with our opinions causes actual pain.
   
   Overcoming evolutionarily reinforced behavior takes more than willpower; it needs to be built into our process. To this end, I’ve long arranged “disconfirmation sessions” with other investors. In these, one investor shares an investment decision (say, buy Apple) and the argument behind it. The second investor, rather than merely poke holes in the argument, argues for the exact opposite decision (i.e., short Apple). If I still want to buy Apple after hearing a savvy investor argue for shorting it, I like my odds.

As you read the remainder of this letter, I encourage you to differentiate between investment outcomes and processes. The former may stir our souls, but the latter is the fountain of continuous improvement.

Best & Worst Performers

Stamps.com – held in all three portfolios – rose 40%, marking the second consecutive quarter this wonderfully wide-moat business notched the top performer spot. Stamps.com is one of just three companies holding a license to sell USPS postage, and it actually sells stamps cheaper than the post office. Unlike competitors, which peddle the reloadable postage scales behind countless office front desks, Stamps.com enables its customers to print postage using just a web browser and any available printer. (Since investing in the company, Huckleberry has become a customer, too.)

Markets are mostly efficient, but in some scenarios, they make predictable mistakes. One of those scenarios arises when a company’s financial statements fail to accurately reflect the underlying reality of a business. Accounting rules require Stamps.com to book the money spent to acquire a new customer as an expense, which implies the benefit is realized this year. But Stamps.com’s customers stick around for many years, and it costs next to nothing to keep them. The business has been growing by leaps and bounds, but the financial statements temporarily mask its profitability. Over time, the true business shines through, and the market wakes up to the stock’s true value.

Other strong performers for the quarter include Australian hedge fund manager HFA Holdings (+20%), behind-the-scenes financial markets firm Broadridge Financial (+20%), and our short of chicken producer Pilgrim’s Pride (+18%).

Our weakest performer, for the second consecutive quarter, was InfuSystem, down 14%. InfuSystem rents infusion pumps that deliver continuous drug treatment, part of the standard of care for certain conditions. The stock has been volatile for two reasons: 1) it’s a tiny company, and 2) there is some uncertainty about how new Medicare and Medicaid rules, which haven’t yet been spelled out, might affect the company’s bottom line. That latter part is why the stock was cheap enough to buy in the first place – that, and a stockpile of tax assets that mean the company won’t be paying taxes anytime soon. I recently spoke with management, and I’m impressed with the steps they are taking to further improve the business model and prepare for various Medicare outcomes. InfuSystem remains in Huckleberry Go-Anywhere as our smallest position.

Shares of Guess fell 11%, but our position on Guess – which includes an ongoing options strategy – netted an overall profit. Swatch fell 5% after the Swiss central bank untethered the country’s currency, leading to an historic 30% adjustment in exchange rates in a single day. American Tower fell 5% for no discernable reason. Welcome to the equity markets.

Process Trumps Fear

When we shorted Pilgrim’s Pride in December, we saw a commodity producer in a cutthroat industry trading at an unsustainably high price. As it turns out, many investors saw the same thing. Only 25% of Pilgrim’s shares trade freely, and before long more than half had been shorted. Heavy short activity doesn’t affect a business, but it can bruise egos of less-than-stewarding managers.

Pilgrim’s management fired back with a one-time $5.77 dividend. When you short a stock, you have to pay any dividends, and this move was intended to provoke the hedge funds to close out their short positions, ideally tripping over one another and driving the stock even higher. The stock did rise a bit after the news, but nowhere near the amount management must have hoped.

We took the opportunity to add to our short position. The already-price was now even higher. Further, Pilgrim’s was suddenly awash with debt, having shelled out in the dividend far more cash than they actually held. We reacted to the new information, not the emotion of the day, and we’ve reaped our reward.

Missed Opportunity

In January, I found a small European bank I liked. It is well capitalized, conservatively run, and has an effective monopoly on its market. Even better, it sported a sustainable 9% dividend yield. The bank is not in the Eurozone, though, and I found myself down a rabbit hole trying to decide how and how much to hedge the currency exposure once we established the position.

As I contemplated, the stock started rising. By the time I had a well-formed currency plan ready, the stock was no longer in buying territory. I’d formed an opinion diverging from that of the market but failed to implement it until it was too late. Upon striking the insight, I could have bought the stock and simply hedged the currency in full, then evaluated whether to modify the foreign exchange component. Divergent opinions are hard to come by, and the delay allowed this one to slip away.

We are pleased with our performance thus far in 2015 and hope that our clients are as well. More importantly, we ask that they place their trust, as we do, in the process whence that performance springs. Short-term returns can fluctuate widely. A strong process enables us, over time, to convert diligence and skill into favorable results.

You can reach me with questions, concerns, or disconfirming evidence at alex@investhuckleberry.com.

Sincerely,

Alex Pape, CFA

IMPORTANT DISCLOSURE INFORMATION

Huckleberry Capital Management, LLC’s (“Huckleberry”) enclosed performance data results reflects the results of Huckleberry’s three composite portfolios. All composite portfolio returns are net of actual fees, including Huckleberry Capital Management’s management fee and any applicable brokerage fees. All returns are time-weighted, and all performance results (including the Huckleberry composite portfolios and the Wilshire 5000 and CBOE Buy-Write Index as benchmarks) include dividends.

Please Note: Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that future performance will be profitable or equal the performance results reflected in the Portfolio. Please Also Note: Performance results do not reflect the impact of taxes.

For reasons including variances in portfolio account holdings, variances in the investment management fee incurred (as disclosed on its written disclosure statement, Huckleberry’s advisory fee is generally 1.00%, although it may vary upon the amount of assets that client places under its management, market fluctuation, the date on which a client engaged Huckleberry’s investment management services, and any account contributions or withdrawals), the performance of a specific client’s account may have varied substantially from the presented results.

In the event that there has been a change in a client’s investment objectives or financial situation, he/she/it is encouraged to advise Huckleberry immediately. Different types of investments and investment strategies involve varying levels of risk, and there can be no assurance that any specific investment or investment strategy, including the investments purchased or investment strategies devised or undertaken by Huckleberry, will be either suitable or profitable for a client’s or prospective client’s portfolio.

All performance results have been compiled by Huckleberry, and have not been independently verified. Information pertaining to Huckleberry’s advisory operations, services, and fees is set forth in its current disclosure statement, a copy of which is available from Huckleberry upon request.

ANY QUESTIONS: Huckleberry’s Chief Compliance Officer, Alex Pape, remains available to address any questions regarding the Portfolio or this presentation.

Dear Investor,

It brings me great joy to share our first set of investment returns, which encompass the final two months of 2014.

We’re pleased to report strong results – but don’t read into them too much. We aren’t.

Two months is the blink of an investor’s eye. We don’t know what’s going to happen over the next few weeks or even months. When we invest, we’re thinking three, five, or even ten years out. Our returns are best evaluated over periods of at least a year, and preferably longer.

Now, on to our results.

How did we do?

Both Huckleberry Go-Anywhere and Huckleberry Equity Income launched on November 1, 2014. From then through the end of 2014, our returns:

Our best and worst investments

The best performing stock for both portfolios was Stamps.com, up 29.7%. We used options to generate an incremental 6% on the position, bringing our total return to about 36%.

Go-Anywhere also profited by shorting the Direxion Daily Financial Bear 3x Shares ETF (say that five times fast), which fell 13%. Our worst performer was InfuSystem, our smallest position, down 21%.

Equity Income enjoyed a 6% return on our stock-and-options position on Guess. Our worst performer was Apollo Investment Corp., which fell 5%.

In both portfolios, stocks accounted for about two-thirds of the returns. Options generated the remaining one-third.

How much risk are we taking?

Let’s look at how our portfolios were allocated as of Dec. 31:

What do these terms mean? Here’s a quick-and-dirty guide.

· Long: Stocks we own.

· Short: Stocks we’re short (betting against).

· Cash: Uninvested cash we’re holding.

· Gross: Long plus short.

· Net: Long minus short.

For Go-Anywhere, focus on the 47.9% net exposure. For every $1 invested, only $0.48 was positively correlated with the market. However much the market were to rise or fall, you’d reasonably expect the portfolio to rise or fall only 48% as much.

But that’s not what happened. The Wilshire 5000 (our benchmark) rose 1.94%, and Go-Anywhere climbed the same amount. Our stocks performed better than the index. In a market downturn, we’d expect our cash position, along with those better stocks, to cushion the fall. This reflects Go-Anywhere’s target of capturing 100% of the market’s upside and only two-thirds or less of its downside.

For Equity Income, the long and cash exposures are more important. The portfolio is more conservative and focuses on generating yield, so we don’t use leverage or short stocks. (The tiny 0.2% short exposure reflects income-generating options strategies.)

Volatility is the option investor’s best friend, and falling oil prices brought it back to the market this fall. We took advantage by writing options on several stocks, including some we own and some we do not. Despite keeping the Equity Income portfolio conservatively invested – more than half remains in cash – we were able to outperform our benchmark.

Thus far in 2015, volatility remains high, and we remain on the lookout for the opportunities it inevitably creates.

An exciting ride ahead

We’re flattered that you’ve chosen to invest with Huckleberry, and we take seriously the responsibility you’ve placed in our hands. We manage your money as if it is our own. In fact, our personal money is invested right alongside yours.

We’re together for this ride. Let’s make it a great one.

If you have questions or comments about our returns, your account, or anything else, you can reach us at team@investhuckleberry.com.

Sincerely,

Alex Pape, CFA

Principal | Huckleberry Capital Management

IMPORTANT DISCLOSURE INFORMATION
Huckleberry Capital Management, LLC’s (“Huckleberry”) enclosed performance data results reflects the results of Huckleberry’s three composite portfolios. All composite portfolio returns are net of actual fees, including Huckleberry Capital Management’s management fee and any applicable brokerage fees. All returns are time-weighted, and all performance results (including the Huckleberry composite portfolios and the Wilshire 5000 and CBOE Buy-Write Index as benchmarks) include dividends.
Please Note: Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that future performance will be profitable or equal the performance results reflected in the Portfolio. Please Also Note: Performance results do not reflect the impact of taxes.
For reasons including variances in portfolio account holdings, variances in the investment management fee incurred (as disclosed on its written disclosure statement, Huckleberry’s advisory fee is generally 1.00%, although it may vary upon the amount of assets that client places under its management, market fluctuation, the date on which a client engaged Huckleberry’s investment management services, and any account contributions or withdrawals), the performance of a specific client’s account may have varied substantially from the presented results.
In the event that there has been a change in a client’s investment objectives or financial situation, he/she/it is encouraged to advise Huckleberry immediately. Different types of investments and investment strategies involve varying levels of risk, and there can be no assurance that any specific investment or investment strategy, including the investments purchased or investment strategies devised or undertaken by Huckleberry, will be either suitable or profitable for a client’s or prospective client’s portfolio.
All performance results have been compiled by Huckleberry, and have not been independently verified.
Information pertaining to Huckleberry’s advisory operations, services, and fees is set forth in its current disclosure statement, a copy of which is available from Huckleberry upon request.
ANY QUESTIONS: Huckleberry’s Chief Compliance Officer, Alex Pape, remains available to address any questions regarding the Portfolio or this presentation.