January 2023
To Our Readers:
Enclosed is our 2022 Annual Report and Performance Review for the Nintai Investments LLC Model Portfolio. The Model Portfolio is the composite aggregate returns of all Nintai Investments investment partner portfolios. Each partner's portfolio is unique to their individual needs. The portfolios comprise holdings from the current 21 stocks on our investment list. The amount held in cash, the number of positions and the percentage make-up of each portfolio differ by partner investment goals and tax situation. We do not invest in any ETFs, mutual funds, or individual bonds. Returns discussed are for performance beginning in the autumn of 2018 when Nintai Investments began operations. Please note that returns for my previous company, Nintai Partners, are not included in any way in the returns discussed within this report.
2022 Annual Returns
Last year we opened our annual report with a 1942 quote from “Vinegar” Joe Stillwell discussing how the Allied armed forces had taken “a helluva beating” after being driven from Burma by forces of the Empire of Japan. At the end of the quote, Stillwell talked about finding out what went wrong and going back to retake Burma. In a similar vein, in last year’s annual report, we wrote about the mistakes we made in 2021 and what steps we took to avoid making them again. We will discuss this in greater detail further on in this report. But, for now, I’m very proud that the Nintai Investments Model Portfolio came back and outperformed each of its proxies in 2022.
For 2022, the Nintai Investments Model Portfolio generated a -15.23% (inclusive of fees) return versus a -18.11% return for the S&P 500 Index, a -20.44% return for the Russell 2000 Index and a -26.72% for the Russell Mid-Cap Growth Index. For the past three years, the Nintai Investments Model Portfolio generated a +5.80% annualized return versus a +7.66% return for the S&P 500 Index, a +3.10% return for the Russell 2000 and a +3.85% return for the Russell Mid-Cap Growth Index. Since Sept. 1, 2018, the Nintai Investments Model Portfolio has generated a +8.89% annualized return versus a +7.29% return for the S&P 500 Index, a +1.60% return for the Russell 2000 Index and a +5.66% return for the Russell Mid-Cap Growth Index.
Over the five years Nintai Investments has managed the portfolio, we have been able to outperform the broader markets in three years (2018, 2020 and 2022), roughly match them in one year (2019), and dreadfully underperformed in one (2021). As I’ve frequently written, investing is rarely about “how many times” but by “how much.” Our performance was so bad in 2021 that it took a history of significant outperformance and adjusted it to one of moderate outperformance over the long term. We are optimistic (but we must remember that past performance is no guarantee of future returns!) the portfolio is well-positioned from a valuation standpoint. Additionally, we are comfortable that each holding is remarkably strong financially, with deep competitive moats and outstanding capital allocators at the helm. Only time will tell if we are correct, but we like the prospects of each holding over the next decade or two.
Portfolio Changes
In 2022, we added two new companies to the portfolio – Monolithic Power Systems (MWPR) and Tyler Technologies (TYL, Financial). Monolithic Power Systems has been on our watch list for over four years. With the onset of the bear market and collapse in semiconductor (and, more generally, technology) stocks, we were able to pick up shares at a nearly 40% discount to our estimated intrinsic value. Monolithic has all the characteristics we look for in a holding – no debt, high free cash flow margins, high returns on invested capital and outstanding capital allocators at the helm. We look forward to partnering with the company for an extended period of time. Tyler was nearly a holding in the portfolio a couple of years ago, when the company acquired one of Nintai’s portfolio companies – NIC (now de-listed). At the time, we believed Tyler Technologies was overvalued, and we consequently sold our NIC shares and used the cash for new investments. With the Covid market crash, shares of Tyler took a severe tumble and we thought the value and quality compelling.
During the bear market in 2022, we used nearly every dollar of our cash reserves to add to existing holdings. Many of these were trading at compelling prices. Positions we added to include Genmab (GMAB, Financial), Veeva Systems (VEEV, Financial), Masimo (MASI, Financial), Skyworks Solutions (SWKS, Financial), T. Rowe Price (TROW, Financial) and Guidewire Software (GWRE, Financial).
We completely exited two positions during 2022. We invested in Citrix (CTSX) as we thought the business' long-term prospects were outstanding and that the management team in place would take the necessary steps to turn the company around. We were indeed wrong about the latter. That management team was replaced by a new one in 2021 (the fifth in six years) which promptly agreed to let the company be acquired for a discount to our estimated intrinsic value and a slight loss in our investment. There is no way this investment can be categorized as a success. Second, we exited Biosyent (BIOYF, Financial). We sold this company based solely on the fact that we needed cash to purchase (what turned out to be) Monolithic Power Systems. Monolithic has a wider moat, stronger financials and a higher future projected growth rate. It also traded at a significantly higher discount to our estimated intrinsic value versus Biosyent.
Winners and Losers
2020 turned out to be a year where losing less was a valuable tool in portfolio management (though we think that applies every year!). We had two stocks in health care that saw double-digit gains in a year where nearly every major index had double-digit drawdowns.
Novo Nordisk (NVO, Financial): Up +20.84%
In 2022, Novo Nordisk accounted for 30% of the global diabetes market and roughly half of the $20 billion insulin therapy market. Growth is mainly coming from GLP-1 therapies, which include daily Victoza, weekly Ozempic and innovative daily oral Rybelsus; strong efficacy and cardiovascular benefits to treatment should lead the $16 billion GLP-1 market to more than double over the next five years. In addition, we were pleasantly surprised at the success of the new obesity therapeutic sales with Wagovy (tempered by the supply chain issues resolved only in late 2022). We think the overall effect of the Inflation Reduction Act of 2022 will be relatively muted. Between the Medicare price caps and negotiation efforts, we see only a 3-4% impact on overall revenue and minimal impact on gross and net margins.
Biogen (BIIB, Financial): Up +15.42%
The rapid rise and equally rapid swoon in Biogen’s stock price (the effect of the approval and then the disastrous launch of Alzheimer's drug Aduhelm) has been offset by the highly unexpected results of Alzheimer's drug lecanemab's positive phase 3 data. Shares of Biogen rose from roughly $195 to $306 on the news. Biogen has gone from being a very successful investment to a very unsuccessful investment and back to a modestly successful investment, all in less than one year. Behind all this is a company with a wide moat, a tremendously successful neurology portfolio, and a deep research bench.
Guidewire (GWRE, Financial): Down -44.90%
Guidewire suffered from a market that lost faith in businesses that have significantly sacrificed profitability in the short term to help fund long-term (profitable) growth. Guidewire is well on its way to being the clear market leader in the Property & Casualty (PC) technology platform leader. The company continues to take market share, setting itself up for sustainable growth through its software suite of solutions. While never happy with underperformance, we used lows during the year to add to our position.
Masimo (MASI, Financial): Down -49.47%
We won’t beat a dead horse, but 2022 saw Masimo management engage in an acquisition that had us scratching our head for the entire year and forced us to sell the company out of the portfolio when the stock recovered most of its losses at the end of the year. We aren’t sure if the Sound United deal will work out, but it completely negated our investment case and made us question the company’s management team. We exited the entire position at the beginning of 2023.
T. Rowe Price (TROW, Financial): Down -44.54%
Many investors think that when a bear market sets in, almost any asset manager will pay a heavy price as AUM slips. Combined with the continuing migration from active investing to passive/index, share prices took a beating in 2022. However, we think concerns are overblown. T. Rowe Price continues to achieve outstanding returns for its investors. Combined with the amount of AUM in retirement accounts (and consequently far stickier), the company will see small single-digit losses in AUM over the next two to three years before achieving positive growth afterward.
Portfolio Characteristics
As of Dec. 31, 2022, the Abacus view shows that the Nintai Investments Model Portfolio holdings are roughly 8% cheaper than the S&P 500 and are projected to grow earnings at a 31% greater rate than the S&P 500 over the next five years. Combining these two gives us an Abacus Comparative Value (ACV) of +39. The ACV is a simple tool that tells us how the portfolio stacks up against the S&P 500 from a valuation and an estimated earnings growth standpoint. The numbers - as of January 2023 - are where we would like to see them. They represent a mildly cheaper portfolio with greater profitability and higher projected growth.
A higher ACV number doesn’t guarantee that the portfolio will outperform the S&P 500 in the short or long term. That said, we think a broad basket of extremely high-quality companies (as seen by higher return on assets, return on equity and return on capital) that trade at a discount to the greater markets with higher estimated earnings growth should increase the odds of outperformance over the long term.
If opportunities arise, I will add or reduce an individual position size. I might also swap out an entire position for a chance to invest in a situation with a better risk/reward profile (as we did with Biosyent). I will actively seek to take profits or find cheaper prospects over the next 12 to 24 months.
Portfolio Sectors
Traditionally, Nintai focuses on two sectors where we have significant experience – health care and technology informatics/platforms. This is reflected in technology and health care, which comprise over 80% of total assets. Even with two holdings giving us (very) small holdings in consumer cyclical and industrials, we still only have holdings in five of the S&P 500’s 11 categories. These include consumer cyclical, financial services, technology, industrials and health care.
The other remaining six sectors generally don’t operate business models which we seek in our holdings – low/no debt, high returns on invested capital, opportunities to reinvest capital and create opportunities for sustainably wide competitive moats.
Lessons from 2022
I’ve written extensively about what we learned from our mistakes in 2021 and how we worked diligently to apply those lessons in 2022. This process made us better investors and helped us outperform our proxies during the year. Here’s a quick summary of my thoughts on improving Nintai’s investment processes.
Stick within our circle of competence
Our most significant loss in 2021 occurred with our investment in New Oriental Education (EDU, Financial). We were in over our heads in every way with this purchase – no background in Chinese stocks, the Chinese markets, or Chinese education. We were blinded by the fact that our previous investment in the stock had (luckily) turned out well. A key learning from this investment was understanding that our circle of competence is much smaller than we’d like to think.
Improve our understanding of the risks for each holding
We’ve written frequently about our process of “getting to zero,” in which we try to find a way to get the valuation of a potential investment to zero. We do this in several ways – decreasing free cash flow, decreasing margins and increasing the weighted average cost of capital (WACC). However, one thing we didn’t do was create a model where the government regulatory body consciously decides to destroy the market of an investment holding (the case of New Oriental Education & Technology). The failure to develop such a case showed how little we understood the Chinese investment world and the role of the CCP in its capital markets.
Have faith in our valuation concerns
During 2021 and 2022, we often felt valuations were higher than we would like for initial investment in some of our holdings. The pressure we felt holding 30-40% of all assets in cash made us purchase several holdings earlier than we should have if we believed in our valuation tools. There was absolutely no pressure from our investment partners to hold so much cash. While not nearly as debilitating as our sin of commission for investing in New Oriental, we should have had more faith in our models (and our investment partners' patience) and waited for better opportunities to purchase several holdings.
Seen above is the investment model we have utilized since we began managing monies all those years ago at Nintai Partners. We have incorporated the previous three findings into this model. The most significant change we’ve made in the Nintai model is to try to reduce the risk of the permanent loss of capital. Drawdowns of 25-50% on an individual holding don’t concern us too much. All things being equal, we will likely purchase more if cash is available. What does concern us is the permanent impairment of capital like we saw in the New Oriental investment case. Our improved investment process focuses on aggressively reducing that risk.
We assume these will improve our returns in the future. Of course, nothing is perfect, and we certainly cannot assure our investment partners of outperformance every year. Overall, though, our investment process held up decently through the 2022 market crash and its significant drawdown. These process improvements helped our outperformance in 2022, and we hope to see more of it over the long term.
Final Thoughts
2022 will be considered the first post-Covid year. We aren’t entirely sure about that, but we began to see businesses open, commercial and holiday travel get back to pre-Covid levels, and the first signs of letup in the global supply chain breakdown. We will remember it as the year when sticking to our convictions and the investment process paid off. It wasn’t easy. In such a year as 2021, large drawdowns can impact your confidence as much as your returns. However, 2022 demonstrated that our focus on quality companies with financial strength and outstanding management still works. In 2023 we will continue doing what we know best – being patient value investors partnering with great capital allocators leading the highest quality companies. We believe this will lead to long-term outperformance of the greater markets over time.
To take such action, an investment manager needs partners who are willing to be equally patient and ride out the inevitable bear markets and times of underperformance. I can’t thank all our investment partners enough for allowing Nintai Investments the time and strategic freedom to implement its investment process. All of us at the firm thank you for your continued trust and support. I hope everyone has a safe, happy, and healthy 2023.
Thomas Macpherson
603.512.5358
DISCLOSURE: Nintai Investments and my personal portfolio own VEEV, TYL, MWPR, GMAB, SWKS, TROW, GWRE, NVO, and BIIB at the time of publication.
