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| October 4, 2007 |
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Dear Client,
For the first nine months of 2007 our average account was down -1.02%. It was a tumultuous quarter, which we seem to have weathered, and which even bids fair to be rewarding if some of our new positions turn out to be as promising as we hope. Still, we had forgotten just how trying these “buying opportunities” can be, and we don’t know that we need another anytime soon. Amidst the tumult we got some worried phone calls, and it got us to reflecting that most investors don’t get results as good as their money manager’s records. We are not hinting at chicanery in saying this. The investment management business is sufficiently well policed by the Securities and Exchange Commission that outright lying is a rarity. No, we mean the great majority of investors stack the deck against themselves by taking assets from managers when they are cold and giving money to them after they’ve been red hot. In 27 years of managing Levy, Harkins we know of exactly one case of a client actively seeking us out after we had underperformed, and said he was giving us more money because of it, and that fellow is a renowned investor in his own right. That was 9 years ago, in a cold patch worse than this, and it is interesting what happened next. From then to now, that is from the end of 1998 through September 2007, we compounded money at 16.46%. That’s more than 3 ½ times on your money, in a time when the Standard & Poor’s Index was up just over 40% in total. We have dozens of friends who are competitors, and our experience is not in the least unusual, so what accounts for this? To some degree we are describing fear, and in panic people do all sorts of things that they would never countenance on calm reflection. Panic was certainly in the air a month ago when we were on the brink of the commercial paper market imploding, something neither of us had witnessed in 1987, 1998, or any other time. When perfectly credit worthy entities can’t get credit, fear rises like a tidal wave. But that sort of event happens only once a decade or so, while the self-destructive behavior of chasing recent performance goes on all the time. Why do people sabotage themselves? Human nature has always longed for instant gratification, but that impulse gets quite a kick in the seat of the pants every morning when the daily stock market shows begin their rant. You may have felt yourself somewhat restless overnight, and who then is strong enough to hold out against a man dispensing investment advice with spittle flying and neck veins bulging? When the next fellow tones it down a notch he can say almost anything, no matter how loopy, and it will seem sane by comparison. You hired us partly because we said that even when we were just plain wrong, our style was likely to limit losses to very small sums. This year and last we couldn’t have been wronger in not owning oil stocks, we’ve just come through a tidal wave of fear, and we are just about even. Never having a large loss is the key to the compounding process. But after that you still have to find investments that grow fast enough, and sell for a reasonable enough price, that you can have periods of great out-performance, meaning when you get it right you get it really right. We think the recent collapse in confidence has put us a long way down that road, and while we are not yet going to give you chapter and verse why we say this, partly because we are still buying, you can see by the large number of new names entering your portfolio that we have been very active. Candor will not be served if we say nothing about the mortgage mess, or one of our prominent sales in the quarter. We lauded Countrywide Financial in our last letter, and sold it before the ink was barely dry. We have made a lot of money with Angelo Mozilo over the years, so we want to temper our next comments with that reflection, but we were very disturbed at Mr. Mozilo selling shares of his own at a very heavy clip while his company was under severe attack in the press. We joined him in selling, and were glad we did before a very disappointing quarterly earnings release was made. What riled us all the more was that at a private lunch in the Spring, Mr. Mozilo assured us his selling was at a measured pace for estate purposes. By Summer it had more than doubled. We are investors no more. On the other hand, we also lauded Bear, Stearns in the same paragraph, and they too have been much in the news, hardly any of it flattering. In that case however the chief investment officer, Jimmy Cayne, hasn’t sold a share. Neither have we, and we still think his firm will dominate in the mortgage business when the dust settles, and the mortgage business, despite hyped headlines, isn’t going away anytime soon. History never repeats itself, but it does rhyme, and to us what has gone on this summer is an eerie echo of 1998. If what comes next is any fraction of what followed last time, it will be good enough for us. Sincerely, Edwin A. Levy Michael J. Harkins |
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