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Trust the process

By George Cipolloni, Sub-investment Manager of the Global Cautious Fund

“If you want to have real success you have to very often be willing to do something different from the herd…You will have to be contrarian…You have to be willing to think long-term. You have to be willing to be misunderstood for long periods of time." - Sam Hinkie, Former General Manager, Philadelphia 76ers

The 2017-2018 Philadelphia 76ers won 52 of 82 games (63 percent) and they won their first playoff series in six seasons. They also boast one of the most talented, young rosters in the National Basketball Association (NBA) and they are clearly one of the teams with the brightest futures in the league.  But it was not always this sunny in Philadelphia.

Between 2012 and 2017, the Sixers lost more games than any other team in the NBA. Under the leadership of Sam Hinkie, the team embarked on a controversial strategy that required large amounts of both suffering and sacrifice.  Hinkie’s theory was that if the Sixers could gather enough high-draft picks; talented, young players; and financial flexibility, the team would not only become competitive again, but would become elite for a long period of time.  Hinkie’s strategy required a steel stomach and patience.  It required intense diligence in research and analytics; superb decision making; and a bit of good fortune but staying the course would result in the 76ers becoming the ultimate value play, the ultimate “turnaround”. 

During the years of suffering, Hinkie consistently preached long-term versus short-term thinking and would repeatedly ask fans to “Trust the Process”. So much so that “Trust the Process” became the team’s mantra and its enigmatic, star player Joel Embiid even adopted part of this tagline as his own nickname – Joel “The Process” Embiid.  As Embiid played more and his talent became evident to the league, the progress of The Process became correlated to his improving play and the Sixers future success.

Value investing lagging growth

“It’s much more comfortable to have people generally agreeing with you…There has been much criticism of our approach. There will be more. A competitive league…necessitates a zig while our competitors comfortably zag. We often chose not to defend ourselves against much of the criticism; largely in an effort to stay true to the ideal of having the longest view in the room” - Sam Hinkie, Former General Manager, Philadelphia 76ers

As the global equity markets have rallied to all-time highs, growth investing has trounced traditional value investing over the past decade. The market’s momentum, highlighted by the popularity of FAANG stocks (Facebook, Amazon, Apple, Netflix and Google/Alphabet), is leading many investors to believe that nothing will go down.  In these periods of growth stock popularity, the traditional values of value investing tend to become an afterthought.  Good balance sheets, low valuations and steady long-term fundamentals are no match for the excitement generated from the possibility of perpetual future growth.  To quote a recent Barron’s article: “Since 2006, growth stocks — shares of companies whose earnings are growing at an above-average rate — have outpaced value stocks, especially in the U.S. This has caused consternation and speculation: Is value dead?”

“The strategy we settled on was straightforward, even if arduous.” - Sam Hinkie, Former General Manager, Philadelphia 76ers

For contrarian value investors, these are the lean years, particularly when traditional ideals are ridiculed and the sexier blockchain technology wins most of the favor and attention. Why earn solid, steady returns, when an increase in risk is garnering far better returns in the short term?  Who cares about high levels of debt and balance sheet quality when access to capital is easy?  Why does price matter when everything is going even higher? As Sam Hinkie would say during his team’s lean years when the sports media would criticize his strategy: “Trust the Process”:

  • Risk does matter.
  • Balance sheets and debt levels do matter.
  • The price an investor pays for an asset/security matters.

The hallmarks of an investment process are never so clear, never so emboldened as during the times when they are openly questioned. Although it would be much easier to buy what everyone else is buying or to give in to high valuations – we stick to the process because we know that over the long term:

  • Value investing works.Being contrarian works.
  • Buying the securities of companies trading at depressed prices that are undergoing positive fundamental change works (to add return).
  • Avoiding high valuations, tight credit spreads and low yields works (to reduce risk).

The greatest honor in the investment industry - trust

“That means you have to find some way to have a differentiated viewpoint from the masses. And it needs to be right. Anything less won’t work.” - Sam Hinkie, Former General Manager, Philadelphia 76ers

As Hinkie so succinctly puts it in the quote above, just being contrarian is not enough.  As fund managers, we also have to be correct.  We cannot hide behind a mantra.  We cannot be arrogant to the point of alienating shareholders.  We need to deliver on the track record and investor expectations that have been set over the course of many years.

The greatest honor, in our investment industry, is earning the trust of an investor. We work countless hours trying to seek ways to add value to benefit our shareholders.  We avoid the risks for them that they otherwise might be attracted to.  We need to earn our keep and keep the faith that has been placed in us as fiduciaries.  We need to communicate frequently and clearly to ensure that the faith that has been placed in us is well-informed and understood.  And while we will not be infallible, we need to recognise, accept and learn from any missteps so that we will continuously improve our craft. 

Because while we ask investors to accept our value ideals and to “Trust the Process”, we know that we need to produce solid long-term performance that is in line with investor expectations. We believe that our process – led by our five key tenets:  Value, Contrarian, Bottom-up, Independent Research and Long-term point of view – will continue to help shareholders achieve their objectives whether the world agrees with this philosophy or not.  We will continue to work diligently to make sure that our process is worthy of your trust.

“We should attempt to gain a competitive advantage that had a chance to be lasting...A goal that lofty is anything but certain. And it sure doesn’t come from those that are content to color within the lines.” - Sam Hinkie, Former General Manager, Philadelphia 76ers

 

Sources:

https://www.libertyballers.com/2018/4/12/17229012/excerpts-from-the-sam-hinkie-letter

https://www.barrons.com/articles/are-value-stocks-ready-to-grow-again-1524877217

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