Greetings from Middleburg. We hope this finds you well and enjoying the start of fall.
The Fund’s third quarter 2023 performance for the Institutional share class was -4.10% compared with S&P 500 Total Return at -3.27%. Performance for the trailing 12-month period ending September 30, 2023 for the Institutional share class was 20.61% compared with S&P 500 Total Return at 21.62%.
Thus far, each calendar quarter of 2023 has had its own distinct investment theme. The first quarter was characterized by concerns over an incipient banking crisis brought on by the sudden failure of Silicon Valley Bank.
The second quarter narrative abruptly changed to bullishness on all things artificial intelligence (“A.I.”) and gave rise to a new group of market darlings, the “Magnificent 7.” Besides seeing strong share price appreciation, these seven companies have the added distinction of being among the largest capitalization companies on earth. Tesla (TLSA) and Meta (META, Financial) are by far the smallest of the seven, each with a market cap of just around $ 800 billion. For the S&P 500, a market-capitalization weighted index, this means the so-called Magnificent 7 were largely responsible for the index’s 13.07% total return year-to-date through September. Excluding these seven companies, the total year-to-date return of the “S&P 493” drops to 3.18% according to Bloomberg. Our Fund owns none of the Magnificent 7 names but has returned 10.32% year-to-date through September, well in excess of the “S&P 493.”
Obviously, we cannot selectively include or exclude benchmark constituents. However, we might still substantiate our view that the Fund has performed respectably despite not owning the handful of names largely responsible for the broader market advance. Specifically, the equal-weighted S&P 500 index includes the Magnificent 7 but weighs them equally with every other index constituent to remove the effect of market capitalization on index returns. Year-to-date through September, the S&P 500 Equal Weighted Index had a total return of just 2.38%.
During the third quarter, the narrative turned negative again due to a growing consensus that interest rates will be “higher for longer” with a commensurately higher risk of recession. Recession has been anticipated for the last 18 months and counting, starting with the Federal Reserve’s first rate hike in March of 2022. Whether a recession materializes is only of interest to us to the extent it provides opportunities to buy fractional ownership stakes in businesses at attractive valuations. Besides ensuring that we have adequate cash, we will not meaningfully reposition an already well-positioned portfolio in an attempt to dance between the raindrops of a recession. Moreover, the enduring quality of the businesses we own means that sunshine would surely follow.
The top five positive contributors to performance during the quarter were KKR (KKR, Financial), Adobe (ADBE, Financial), Mastercard (MA, Financial), Danaher (DHR, Financial) and Roper Technologies (ROP, Financial). Nothing noteworthy to call out.
The top five negative detractors from performance this quarter were American Tower (AMT, Financial), Moody’s (MCO, Financial), Topicus.com (TSXV:TOI, Financial), CoStar Group (CSGP, Financial), and Brookfield Corp. (BN, Financial). Except for software company Topicus, it strikes us that rising interest rates and/or a real estate orientation were common denominators weighing on this group of detractors.
In the case of Moody’s, rising interest rates and spreads weigh on rated debt issuance volumes and act as “gravity” on equity valuations broadly.
The real estate factor applies to American Tower, CoStar and Brookfield Corp. American Tower plays in the “vertical” real estate space in the form of cellular towers and is organized as a Real Estate Investment Trust. CoStar is a real estate information services and marketplaces business. And lastly, Brookfield Corp. is a significant owner of commercial real estate, in particular Class-A office space.
Real estate can be especially susceptible to rising interest rates given its typical dependence on financial leverage and the use of cap-rates for valuation purposes. However, we believe these real estate-oriented businesses are demonstrably superior to more typical real estate businesses. American Tower’s real estate is more akin to critical infrastructure and features multi-year non-cancellable leases with contracted or CPI-based price escalators. The business typically enjoys low-single digit annual revenue churn. CoStar’s data and analytics are mission-critical to commercial real estate participants and have commensurately high retention rates in the 90s, while the value provided to advertisers from CoStar’s marketplace businesses (such as Apartments.com and LoopNet) actually increases when vacancies rise. As an owner of office properties, Brookfield Corporation is more challenged than American Tower or CoStar. However, the majority of Brookfield’s on-balance sheet office portfolio is comprised of premium office properties that have continued to experience strong tenant demand throughout the global work-from-home experiment. These properties are 95% leased and increased net operating income by 4% over the past 12 months. Brookfield’s current valuation imputes very little value to this portfolio of office properties, further mitigating risk.
Cash and equivalents stood at 6.1% of the Fund as of September 30.
We wish you a wonderful fall and thank you for your continued support.
Sincerely,
John
Performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Fund performance current to the most recent month-end may be lower or higher than the performance quoted and can be obtained by calling 1-877-862- 9556. The Fund’s annual operating expense (gross) for the Retail Class shares is 1.30% and 1.04% for the Institutional Class shares. The Fund imposes a 1.00% redemption fee on shares held less than 30 days. Performance data does not reflect the redemption fee, and if reflected, total returns would be reduced.
