<June 2, 2021>
On April 27, 2021, Charles de Vaulx, a prominent absolute return investor, died. While we didn’t know Charles personally, we were saddened by the news. As absolute return investors, we’re empathetic to the challenges of maintaining discipline throughout an entire market cycle. While refusing to overpay and protecting capital during periods of excessive overvaluation sounds easy, it is not. It’s one of the most difficult duties required by a portfolio manager and fiduciary. And while it’s never been easy, the current market cycle’s duration and extremes have made it the most challenging cycle of our careers. We can only imagine how hard it was on Charles.
Although we didn’t know Charles, we were familiar with his work, as he was one of the few investment professionals willing to remain disciplined and patient during periods of excessive overvaluation. He possessed the courage and conviction to be an independent thinker and contrarian. He was a true value investor. We also remember him from articles in which we were mentioned together; typically written about portfolio managers willing to hold cash. In an article published by Bloomberg, “Weitz to Yacktman Hoard Cash as Value Managers Find Few Bargains” managers such as Seth Klarman, Wally Weitz, Donald Yacktman, and Charles de Vaulx were all mentioned. Jayme and I were honored to be included with Charles and other managers we respected.
As we’ve aged with the current market cycle, many of the absolute return managers we fought with side by side are no longer with us. The longest and most expensive stock market cycle in history has reduced the number of managers willing to practice absolute return investing. It’s unfortunate to see so many talented, and in our opinion, desperately needed disciplined managers forced out of the industry. Equally disheartening is many absolute return managers have altered their strategies in an attempt to find greener pastures. And we’re not judging. We understand the career risk and other pressures associated with absolute return investing all too well, but we’re sorry to see them go and will miss their company.
For the remaining absolute return managers, it’s never been lonelier. Nevertheless, we remain committed to our strategy and philosophy. Regardless of seemingly endless Federal Reserve intervention and sky-high asset valuations, we will never knowingly overpay, and we will never invest for the sake of being fully invested or to conform. Instead, as necessary, we will remain patient and will allocate capital opportunistically when we are being adequately paid to assume risk. We—not the Fed, not our peers, and certainly not the consensus on Wall Street —will determine when the time is right.
Based on current small cap valuations, we believe the time is anything but right. In fact, small cap prices and valuations have never been higher—they are literally off the chart! As with many things this cycle, we’ve never seen anything like it. Will it persist? Maybe. In fact, prices and valuations could go even higher. But that does not give us the right to allocate other peoples’ money into what we believe is the most expensive small cap market of all time.
We believe Charles presented similar charts illustrating how expensive his opportunity set had become. In a letter published on 9/30/20 he wrote, “There is no doubt that the U.S. stock market today is again in bubbly territory. Market cap to GDP in the U.S. is approaching 200%, an unprecedented level. We have seen this movie play out before.”
Charles also touched a very important topic related to high-quality stocks that we believe does not receive sufficient attention. He wrote, “The valuation of many stocks is still quite elevated, especially amongst what we consider high quality businesses with safe balance sheets, good capital allocation, decent corporate governance, and strong franchise value.” We couldn’t agree more. Within our possible buy list, high-quality stocks are the most overvalued. In our opinion, unlike past cycles, quality will not protect capital when the current market cycle ends.
And finally, Charles summed up the dilemma facing disciplined value managers, saying, “This situation makes the valuation of many businesses today rather difficult, and we struggle in this environment to find enough suitable investment opportunities.” Instead of knowingly overpaying to keep up with the herd, Charles held an above average position in short-term investments, staying true to his investment objective and philosophy. He would not be deterred by the pressures to conform, stating, “In the meantime, we continue to stay the course and stick to our beliefs.”
Throughout his career, Charles de Vaulx remained steadfast in his beliefs and remained disciplined. Considering the investment environment over the past three decades, it was an amazing achievement. No, Charles, we didn’t know you personally, but we understand and admire the extraordinary actions you took to keep the absolute return flame lit within your firm and for your clients. We respect your beliefs and passion for absolute return investing. Your discipline and efforts to maintain the flame will not be forgotten.
Eric Cinnamond
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S&P 500: The S&P 500 Index, or the Standard & Poor's 500 Index, is a market-capitalization-weighted index of the 500 largest publicly-traded companies in the U.S.
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