2022 H1 Review
Better lucky than smart
Editor’s Note: Huh? 2022? What year is it? Yes - I know. It’s a weird feeling, hitting a publish button on this one. This is a memo I wrote for myself, summarizing H1 in July 2022. I didn’t publish it at the time because [insert some bad excuse] but I was re-reading this recently and thought it might be worth sharing.
The piece has been lightly edited for grammar.
Performance Overview and Review
2022 H1 was a transition period for Panoramic Capital. I went through a liquidity event in January, and for much of H1, the vast majority of the portfolio remained in cash. I deployed cash throughout the period but still ended up with roughly 70% net cash weighting as of June 30th. As a result, the overall portfolio was down mid-single digits.
This wasn’t due to some brilliant macro or market forecasting. I just couldn’t find enough good ideas that were attractively priced vs the changing operating environment.
But enough about getting lucky. It was not a good half-year. Given the transition, performance is tricky to calculate, but I think the three numbers below are sufficient to get a sense of how terrible it was:
The time-weighted return figure on my personal account: -28%. This number is skewed by Q1, when the portfolio had very few investments, but them’s the numbers.
The average return of my buys in H1: -15%. This is the simple average of all of the buys I had during the half year. This figure is also skewed, as shares I bought in Q2 trade near their purchase prices.
Performance of my pre-liquidation portfolio: -24%. I used to run a small-cap portfolio. This figure takes the portfolio as of Jan 1st and rolls it forward as if I’d gone fishing for the last 6 months.
These performance figures, while disappointing, are actually not outside of expectations. In a period with multiple headwinds - CPI hitting 10%, rates backing up rapidly, war and energy crisis in Europe, to name a few - this level of volatility is to be expected from a portfolio of microcap companies.
Nevertheless, drawdowns are where sins of the past are revealed, and I made more than my fair share of mistakes. While the exact figure is impossible to nail down, my current estimate is that these mistakes cost the fund around 800bps in performance during the first half of 2022.
What did I get wrong? Mistakes fall into two basic categories:
MoS: I was not quick enough in selling down negative margin of safety names. These account for 10% of the portfolio, and were down 50% on average during H1, costing me 500bps of performance. Note that all of these names were being sold down - I was just not quick enough, because a) I drew a false sense of security from the fact that these traded at a good discount to other parts of the market, and b) I did not have good enough alternative use for the cash.
Risk: I made some dumb mistakes in risk assessment. These accounted for 15% of the portfolio and were down 44% on average, costing me 660bps of performance. This came in two varieties: a) cash burn, and b) analysis risk: getting into situations where a small bit of bad news will make me lose confidence in the thesis, along with the market.
Quick note for those of you saying - hey wait a minute, that’s 1160bps, not 800bps! The difference comes from the fact that those funds would have been reinvested into other companies, which were down 15%.
When I look back, there were three main drivers behind the mistakes.
First, the 2020 Q4 and 2021 Q1 bull market broke my brain slightly. The combination of making too much money, too quickly, and having to replace many ideas at once led me to be too carefree.
Second, my analytic framework and decision making process were not good enough. It could not handle the volume and speed of decision making required during these turbulent markets. Ultimately, its weaknesses showed up as mistakes.
Third, I drew a false sense of security from the fact that many of my portfolio companies were trading at a significant discount to comparable issuers. “My portfolio is at a big discount.” “These valuations still make sense, compared to the insane stuff I’m seeing elsewhere”… these rationalizations allowed me to ignore the basic fact that I implicitly bet on a benign operating environment and market conditions in the medium term.
Mea Culpa. Upgrades have been made and I hope to do better going forward.
Markets, Risk Taking, and Pro-Cyclicality
The easy lesson here would be to resolve to sell everything when valuations run hot and pull back from taking risks. Alas, that would be the wrong conclusion to draw. To explain why, we need a bit of a detour.
There is this trope of a “shrewd, contrarian investor.” Someone who is ultra skeptical of everything, and zigs when everyone zags, selling everything during bull markets and buying in the depths of crisis at rock bottom prices.
This is an incredibly sexy image for anyone weaned on the words of Ben Graham and Warren Buffett. It is also flawed, for two reasons:
In general, businesses grow, and markets go up over time. Bear markets exist, but they tend to be short and severe. Being a forever-contrarian means you are going against this nature of progress.
It also assumes that you have the opportunity, and the ability to bottom tick. In fact, in order to make up for the lost returns, you almost have to bottom tick, which has you wait for opportunities that never arrive except for in the direst of circumstances.
Given this, in reality, the vast majority of these “shrewd investors” end up becoming “scared investors.” I’m sure you know the type - those who have been using Tesla as the proof that market has been in a bubble since 2015. Those who argue how unnatural QE is and have been arguing that there is hyper inflation coming since 2010.
I think the goal should be slightly different: bear markets and drawdowns are something to survive - but beyond this, it helps to be optimistic in nature. Our job as investors is not to avoid risk altogether. It’s to take a responsible amount of risks, where you are more than fairly compensated for doing so.
Now, this is not to downplay the importance of surviving downturns. It’s hard to come back from a -50% or -75% year. However, I don’t think that short-term relative performance against the market is something to focus on as the in all be all metric of responsible risk-taking. Your goal as an investor isn’t to have a low-down capture. It’s to outperform the market in the long run.
Now - how does this apply to the portfolio?
From 2017 to 2021 year-end, the risk-taking mentality brought 10-15% of alpha each year. In 2022 H1, it took away 8%. Even with the fuck up, all in all, the trade-off was worthwhile.
In addition, while portions of the portfolio have gotten whacked - and we have incurred some permanent losses, we’ve survived as a portfolio.
Yes - I’ve taken it on the chin. I wish I avoided it, and I will certainly aim to do better. But to a large degree, volatility and mistakes are simply the realities of being an enterprising investor.
What am I doing now?
I’m deploying, though it’s a really tricky environment to be doing so.
Yes, the macro picture is pretty terrible: inflation is high, rates are backing up, GDP growth is negative, and geopolitical tensions are running high. But this is where high forward returns are born. The time to be scared is when everything seems to be going well, with no worries on the horizon, as prices reflect a perfect future. While the overall market isn’t screaming bargain, and there are still plenty of “fully priced” companies out there, there are some pockets that have gotten decimated. And there are a lot of opportunities out there.
My generic approach has remained the same: to own a diversified portfolio of high-quality companies with good growth prospects, at prices that significantly undervalue their future.
Onwards,
[redacted]
Epilogue: At the time, I thought it would take me 3-4 months to get fully deployed. It ended up taking me 13 months.