Turtle Creek Q2 2017 Quarterly Manager Commentary
Since the start of the crisis at the end of April, we have had conversations about Home Capital with a large number of our investors. The most common question has been to ask what we have learned from this experience.
Rather than walking away with a number of new insights, instead, this experience has served to confirm some of our long held beliefs. For instance, we have always made note of the boards that govern our companies but recognize it is very difficult to assess their quality: how well they function, how hard working the directors are, the boardroom chemistry, just to name a few considerations. We have served on many public and private company boards in the past, and recognize that looking at the backgrounds of each director doesn’t help much in determining board effectiveness. It is difficult to know in advance just how well a board will behave in a crisis. On the face of it, Home Capital’s former board seemed capable enough. The crisis proved that assessment incorrect.
Home Capital’s crisis of confidence also provides a great example of how few investors are truly reflective and independent in their thinking – with most overreacting to every new rumour or innuendo. Coincidentally, through this period, we have been reading a book called ‘The Knowledge Illusion’ authored by two cognitive scientists. They point out that while as a group, humans have done amazing things, we are error prone and sometimes irrational. The fundamentally communal nature of intelligence and knowledge explains why we often assume we know more than we really do and why false beliefs are so hard to change. We were reminded of this fact almost daily as the Home Capital drama played out. If you have the time to read the book, we highly recommend it.
To be fair, we did gain one insight: we have a remarkable investor base. A year ago, we announced that we would soon be closing our flagship fund to additional capital. In the months that followed we received substantial new capital from both existing and new investors and closed the fund earlier this year. A few months later, Home Capital was the lead news story across the financial press and we weren’t sure how our new investors would react. As we said at the outset of this commentary, we think it is important that our investors develop a sound understanding of our investment approach. A key element of that understanding includes the reality that unit price volatility, at times, is inherent in managing a focused portfolio of mid-cap public companies. While we try our best to manage expectations regarding this volatility, it is our experience that, until an investor experiences a drop themselves, you don’t know how they will react. To our pleasant surprise, virtually all of our new investors have been remarkably understanding and supportive.
We have always believed in Benjamin Graham’s observation that in the short run the market is a voting machine but in the long run, it is a weighing machine. However, a company has to ensure it can withstand the negative short term ‘voting’ in order for the long term ‘weighing’ effect to take over. It seems only fitting then, that the most famous student of Ben Graham has become the largest shareholder of Home Capital – giving the company the time to prove the naysayers wrong.