Guy Spier: Reflections on his 2023 Partner Letter
My thoughts and notes from reading the 23' Annual Letter to Investors of Guy Spier's Aquamarine Fund.
Visualizing my personal Olympus of sacred investors, I surely find Guy Spier a convincing choice. Since the inception of his Aquamarine Fund in 1997, he accomplished a return of 9% per annum (S&P 500: 8.3%, MSCI World: 7.1%), thereby outperforming the indices and compounding the invested capital in a manner that would’ve turned an initial investment of $1 million into $9.74 million by the end of 2023. His approach makes the fund a true guardian of the pursuit of compounding, demonstrating vividly that holding good businesses patiently is winning over the long-term.
Therefore, I was eager to read his recently published annual letter1 to partners of his fund and share with you my findings and reflections.
The Game of Long-Term Compounding
As introduced at the beginning, I’ve learned a lot from Guy about the power of compounding. While beating the index by a small margin can seem minor, only an extended perspective of several decades is able to reveal the underlying force of compounding at these returns. Thus, extrapolating the funds’ annual return of 9% the initial investment of $1 million in 1997 would grow to $9.7 million today, $31.4 million in 2037 and even $74.4 million in 2047.
These numbers are a testament to the extraordinary power of steady compounding sustained over decades.
Visualizing the power of persistently compounding capital is delightful, but even more an exercise to reset one’s focus on the long term - a character trait so mandatory to make decisions today. Especially, as the default setting of human minds causes linear thinking and overweighting of short-term results, reminding oneself of the actual game we’re envisioning to play can be useful from time to time. As a consequence of this variety of manipulating biases, I recall a widespread sense of humility among the greatest investors with regard to protecting the momentum of compounding by all means. Reflecting on myself, I found this reverence to move away constantly as daily news of certain highflyers and quarterly results are being actively discussed, thereby unconsciously shifting my focus. Willing to take Guy’s letter as another chance to revive this effort, I found a section of him particularly helpful:
What I’ve come to realize is that the key is really to get just a couple of big ideas right. In our case, the big ideas have been remarkably simple:
Focus on long-term compounding by buying and holding good businesses.
Reduce friction by resisting the urge to trade the portfolio.
[…] You’ll do extremely well over the course of your investment life if you simply hold good businesses that keep compounding over many years—so long as you avoid self-defeating behavior like trading too much, shorting, leverage, or living beyond your means.
A Different Game
“Self-defeating behavior” is accurately describing my issues that I noted earlier. A tendency to act on the constant flow of information under the guise of making “smart decisions”, while actually just interrupting the power of compounding to unfold. This impression to act becomes particularly insistent when recognizing the performance of the companies that are currently everyone’s favorite and the new “must-have” for every portfolio. And while these companies certainly achieved great returns in the past, Guy recalls that “the momentum can reverse, and they could easily go nowhere for a decade”. So by reviewing the past performance, as well as the current valuation and future prospects, individually, we resist the urge to chase the current and avoid self-defeating behavior.
Of course, I wish that I had owned these stocks, and I should try to learn from my mistakes. At the same time, there’s an enormous danger that, in trying to correct for my mistakes, I end up lunging at dumb behavior.
The last thing I want to do is blindly chase whatever jackpot strategy has been working best in the casino today. After all, what worked today may not work tomorrow.
The reflections of his on the impulse to correct the past mistake of not having benefitted from these great companies are resonating deeply with me and will, as I find, perhaps also be of help to other private investors. Guy is lively describing the virtues of value investing through the analogy of different players in a casino. While everyone’s attention is focusing on the high-rolling gamblers that are constantly putting everything on one card, we’re overlooking the croupiers of the casino, who are earning a sustainable and low-risk return over the long-term. According to this narrative, the "dumb behavior" of the croupier, as Guy mentioned it, would be to suddenly change the previous strategy, give in to the urge for faster profits, and start chasing the big jackpot. However, as easy as it seems to avoid this behavior under favorable circumstances, e.g. an outperforming portfolio, things can quickly change once we’re faced with ongoing underperformance due to missing various highflyers. So was Guy Spier finding himself underperforming the S&P 500 in the last year, particularly due to the astonishing returns of the Magnificent 7 that are of low fraction in his fund’s portfolio. And while he’s surely taking the time to reflect on his strategy and principles, Guy is foremost sticking to his approach persistently, recalling to protect the momentum of compounding as more decisive. In the meantime, he shares with us the principles that he has found to be most practical when faced with a similar situation:
Accept the fact that, in any given period, I’m bound to underperform some other winning strategy that appears to be making other investors wildly rich in the short term.
Recognize that there will be pressure to stop doing what I’m doing and replicate what’s been working brilliantly for these other lucky or skillful investors.
Resist that temptation.
Focus instead on sticking resolutely to the strategy that I believe will work well over the long run, despite these intermittent periods of underperformance.
Make peace with the reality that my long-term strategy will, on a regular basis, make me look and feel stupid over shorter periods of time.
Focus exclusively on taking actions that are consistent with my long-term strategy.
Look back in 10, 20, or 30 years and see how few of those high-rolling gamblers made it successfully to the finish line.
Oak Trees
Nebst principles to persist the journey of compounding, Guy is also sharing valuable lessons for portfolio management. Deeply inspired by Buffett’s virtues, Guy is pursuing a strategy at the Aquamarine Fund that “is built on a bedrock belief in the benefits of owning exceptional businesses that are highly likely to compound at an attractive rate for many years to come.”
Accordingly, the portfolio contains businesses that developed to be a key holding as a consequence of continuous outperformance. These companies demonstrated their ability to be long-term compounders and own, what Guy describes as the economic high ground.
At the core of our portfolio, we hold a fairly concentrated selection of these long-term compounders, which occupy what I regard as the economic high ground. To put this another way, these companies remind me of oak trees — strong, resilient, and capable of enduring over long periods of time even under the most challenging conditions.
In his letter, Guy often returns to the analogy of portfolio holdings as growing oak trees, making his portfolio a forest of great ideas. In addition to its core holdings, the giant oaks, the fund’s positions include a few “younger, faster-growing saplings that could eventually turn into oak trees.” This concept immediately reminded me of my reflections on Rick Rubin's "The Creative Act", in which the producer also describes the process of generating ideas through seeds as "potential starting points that, with love and care, can grow into something beautiful." In this previous note, I already linked the concept to portfolio management, but I find Guy’s thoughts to be even more extensive and very helpful, so I added them here.
Coming back to Guy’s letter, one of these younger and faster-growing saplings is CARE Ratings, one of India’s leading credit rating agencies. It’s an example for the idea of starting new positions rather small, as saplings in the garden, while monitoring them closely to see, whether the company has the ability to grow and compound into a resilient tree.
If everything pans out and it [CARE Ratings] turns out to be a 20-bagger, I’ll regret not having owned a bigger position. But if, for whatever reason, it doesn’t work out, it won’t be painful. This is a good example of the way we plant a bunch of seeds in fertile ground and wait to see how they grow.
Perhaps I just have a weakness for these kinds of analogies, but thinking back to my earlier statements about practicing a long-term view, I find these concepts to be very useful. They're a great way to slow down the constantly stimulated mind and bring the focus back to the big picture with ease.
And while we're certainly planting our seeds carefully, we should be careful not to fall in love with them nor make a personal commitment to hold these companies permanently. In other words, Guy refers to these stocks as "core-for-now" holdings that, in the course of the aforementioned strategy, receive the “time and space to continue growing and compounding at a reasonable rate.”
Some of the investments really enjoyed their time of growing astonishingly in the grove, while opening up the challenge of letting these winners run. Although the fund started most of its positions with a reasonable small fraction, Guy recognized that the top seven holdings now account for nearly three-quarters of the fund's assets. Such a result can only be achieved by holding on to your winners, even if you may be facing overvaluation in the meantime.
I’m willing to live with moderate overvaluation, not least because I know how hard it is to buy a great business once, let alone twice. If a company is truly a long-term compounder, it may be worth holding even through periods of extreme overvaluation.
While his reasoning seems easy to understand, it can be a much harder challenge in practice. And Guy further elaborated on this by explaining his reasons for trimming his stake in Ferrari once again in early 2024:
On the one hand, Ferrari, like Hermès, is one of those rare luxury brands that are virtually impossible to recreate. On the other hand, the company could face significant risks in the coming years, including questions over the transition to electric vehicles. In the meantime, there’s a heady sense among investors that Ferrari can do no wrong. […] To me, it seemed clear that I had to scale back our position in Ferrari, given that the whole world is cheering for the company and that its stock is priced for perfection.
We see that even the world's greatest investors struggle to answer the question of whether a stock has become too expensive to keep, while simultaneously weighing the prospects of the underlying business and the intended pursuit to protect the momentum of compounding.
Nevertheless, I felt again deeply inspired by Guy’s writing, and hope that my reflections here were also a little bit of help to you. Again:
"We’re not rolling dice with the high rollers in a casino. We’re planting and nurturing our grove of oak trees.”
We’re playing a different game.
Thank you!