Dear partner,

In our last quarterly letter, we suggested that the summer might be quite volatile, mainly because trading volumes tend to be lower due to professional parties being on holiday. Well, the opposite turned out to be true. After a weak July, August and September were actually very calm months. This wasn’t just true for the portfolio as a whole; price swings for individual companies were also generally limited. Is this the calm before the storm?

We certainly feel it is. We won’t bore you again with how expensive the US stock market is, or how investors today only seem to be thinking about buying and quick price increases, completely forgetting that the market can also fall.

You’ve probably noticed it yourself with family, at parties, or at work: the conversation is increasingly turning toward investing. When I recently went out for dinner with ‘the guys’ (all childhood friends), I couldn’t help but overhear the table next to us. They were also men, in their thirties, having an intense discussion about stocks, crypto, and investing. I’ll just share, as an anecdote, that the content of the discussion was often based on bad information.

I’m noticing it personally, too. If I meet new people now and they ask what I do, a full conversation follows, often about their most profitable positions. Six years ago, when I mentioned I was full-time in investing, it was often followed by a deafening silence and a quick change of subject.

That calm before the storm can go in two directions, depending on where we are now in the cycle.

It seems pretty clear that we’ve long passed Optimism and Belief (see the image below). Thrill might still be possible, but Euphoria seems more likely. Or was the dip in April already a sign, and are we now in Complacency?

Unfortunately, we can’t predict exactly where we are; that’s why they say you can’t time the market. However, it’s enough to know that we are somewhere in that region. Simply put, we are approaching the peak of a market cycle, regardless of where the exact spot is.

A peak like this often feels like a safe spot to a lot of investors. Everything’s going well, profits are up. But this is actually the most dangerous point in the cycle, because prices are high relative to valuations, meaning there’s a real risk of loss. Conversely, when we hit Anger or Depression, nobody wants to invest, even though those are the safest periods in the market.

As Howard Marks says: you can’t time the market, but you can prepare for it. Knowing roughly where you are is enough to start making those preparations. For value investors, that usually means: selling off stocks that have run up a bit and being extremely selective with new purchases. Only open new positions if you think there’s a specific reason they could rise in the near term. You need what’s called a catalyst—a reason why the stock might be ‘discovered’, such as a takeover, a merger, or something similar.

Buying a stock because it’s cheap and counting on a return to the average is simply not a viable strategy in this phase of the market anymore.

Sleeping like a baby

We’ve already started placing some opportunistic sell orders ourselves, even for stocks that we believed we were selling below their intrinsic value. We also got rid of Kamux because the crisis in the auto market is causing a huge shortage of used cars, which consumers want to buy. For the moment, consumers are wary of expensive second-hand electric cars. In short, we don’t see a catalyst for the stock to move towards its intrinsic value in the short term (which for us is between now and three years).

The money freed up was invested in the protective options fund we’ve discussed before. Instead of cash, we’ve invested 21% of our portfolio in the Enigma Fund. This options fund is specifically designed to perform well during major market downturns that come with high volatility.

We’ve previously run the numbers on how a cash position works when the market drops, but we’re happy to repeat it.

Imagine you have a portfolio of $250,000 that is fully invested. If your stocks fall by 50%, you are left with $125,000.

Now, if instead of being fully invested, you had $200,000 invested and $50,000 in cash, your portfolio would still be worth $150,000 after the drop. So, cash acts as a significant buffer when the market crashes, even if it’s only 20%.

But here’s the best part: you can invest that $50,000 cash after the 50% decline, allowing you to buy at rock-bottom prices and then benefit even more from the recovery.

When the market returns to its original level in the years that follow (a 100% rise!), the first investor without cash has their $250,000 back. The second investor, who bought at the bottom with their cash, now has a portfolio worth $300,000.

The first investor has a 0% return, while the second investor realized a 20% return on the total portfolio. Same market movement, same investments, but the cash makes all the difference.

50% may sound extreme, but it’s not. In my investing career (since 1999), I’ve seen two drops of more than 50%.

Now let’s add the options fund to the mix. At the moment of a crash like that, the options fund will make a profit. How large that will be depends on the drop and the accompanying volatility. Previous market corrections indicated a rise of over 40% for the options fund.

Let’s stick to a safe calculation and assume 25%. That means our equivalent cash position will have grown to $62,500 at that point. If we reinvest that, our portfolio grows to $325,000, or a 30% gain instead of 20%.

At the same time, we’re counting on ourselves and our other managers to be able to snap up some fantastic bargains precisely during a sharp market correction, ensuring our portfolio doesn’t just recover but shows extra outperformance at that critical time.

This story shows the power of negatively correlated positions, to use a fancy mathematical term. And that’s exactly what we’re actively seeking: even stronger than simple diversification is ‘negative correlation’. That is precisely what the options fund brings us. When you combine that with rebalancing, you have a highly robust portfolio that can flourish in both good times and bad.

As we’ve said before, we don’t aim to be the top-performing fund in any single year. We do, however, want to always be in the top half. If we achieve that, we automatically belong to the best-performing funds after ten years.

You now understand why we are sleeping soundly despite our concerns about the market’s current price. We are prepared, ready to strike.

In addition to the options fund, we also subscribed to a second fund at the beginning of October—a young, eager attacker on our football team. We are also very close to finalizing a third manager where it’s just a matter of dotting the i’s and crossing the t’s, and we are in the final stages with two other fantastic managers as well. These are also tried and true in the market and ready for what lies ahead.

We are making haste slowly—Festina Lente—as the Roman Emperor Augustus taught us.

The Fund

On October 1st, the T-share class was converted into the A-share class. The A-class is a closed class, specifically for our anchor investors. New investors can now subscribe to the W-class, which was opened on October 1st.

Given this merger and the fact that the performance is running parallel, we’ll only be discussing the A-class below.

In the third quarter, we had a weak July, followed by two months with very little movement. The result after this meager third quarter is a gain of 6.41% since the start of the year.

You’ll no doubt notice the sharp drop in the orange line. The blue line is the fund’s price, and the orange line indicates what we calculate as the intrinsic value of our fund, based on adding up the intrinsic values of all our underlying stocks.

The reason for this drop is that we sold quite a few positions in September in anticipation of the subscription to the Enigma Fund, which we couldn’t execute until the very end of the month. If we sell stocks before their intrinsic value has been reached, the orange line drops. Full potential wasn’t achieved. However, it was clear to us that protecting the blue line is much more important than any possible potential return.

Unfortunately, we will also no longer be able to display this intrinsic value in the future. For example, determining the intrinsic value of the Enigma Fund is simply not possible. Moreover, we place our trust in our fund managers. We can’t go and recalculate every position they hold. Without that trust, we obviously wouldn’t invest with them. Not every manager provides us with such an intrinsic value, so we can no longer report this to you on a reliable basis.

Of course, we will still ensure the necessary transparency. If you are like us, you want to know what you own, and we will continue to provide that information.

We can already tell you that our goal for the coming months is to evolve toward:

• Approximately 30% in our own equity positions
• Approximately 20% in the protective options fund (negatively correlated)
• Approximately 50% in 6 to 10 exceptional value investors (not correlated)

Top Contributors to Performance

Top Detractors to Performance

Largest Holdings

Transactions

The most important transaction has already been mentioned above: the entry into the Enigma Fund for almost 21% of our portfolio.

We chose to sell Kamux, Semapa, Trigano, Manitou, F.I.L.A., and Wickes. You already read why Kamux was sold. The other stocks were sold to make room for the investments in the various funds. Except for Kamux, these stocks were sold with profits ranging between 8% and 38%. Not spectacular gains, and as we explained regarding intrinsic value, not at their full potential either. It’s also not the case that we suddenly lost faith in these companies. The primary reason for choosing these specific stocks was the lack of a clear catalyst that could push the price higher.

Companies

In the future, our own direct investments in companies will only make up about 25% to 30% of the portfolio. Therefore, in these quarterly letters, we’ll be focusing more on the underlying funds and the overall performance.

We will, however, reserve more detailed information about our specific company holdings for the online meetings for our partners (In English on request, in Dutch each quarter).

Kind regards and thank you,

Sam & Joël