Your Fund ended the second quarter with net asset value of $4,431.80 per unit, an increase of $258.21 from the December 31, 2023 net asset value of $4,173.59 per unit [after distributions]. Year-to-date, June 30th, your fund returned: 6.2%.

 

2024 has been a tale of two different stock markets. Looking under the market hood and delving a little deeper, one soon notices that the S&P 500 advance is not broad based. There is tech mega cap and the remaining 490 stocks. “A handful of winners against hundreds of laggards”. AI fever has been powering this year’s advances, especially Nvidia and Microsoft.

 

Below is a breakdown of what’s been occurring in the trenches over these past 6 months: 

 

 

1. S&P 500: +15.3%

2. S&P 500 Equal Weight: +4.96

3. Dow: +4.79

4. Russel 2000: +1.62

5. TSX Composite: +6.05

6. Berkshire Hathaway: +14.06

 

 

Most of the above indices show no performance resemblance to the S&P 500 index. Is it 2022 all over again? For example, the S&P 500 equal weight index has the same number/names of stocks as the S&P 500, but has vastly underperformed. Why?

 

The S&P 500 is a market cap weighted index, which means the highest valued companies make up the largest weights in the index (think: Amazon, Apple, Microsoft, Nvidia, etc..). Obviously, due to the strong performance of a handful of large tech companies the index has outperformed the Equal Weight index.

 

The Equal Weight S&P 500 is one way to combat “concentration risk”. The stocks in this index holds an equal proportion of each stock that makes up the index. This translates into a roughly 0.2 percent holding for each company in the S&P 500 equal weight index.

 

Nvidia alone accounted for nearly one-third of the S&P 500’s total return in the first half of 2024, according to S&P Dow Jones indices. Throw in Microsoft, Amazon, Meta and Eli Lilly (weight loss drugs), and 55% of the market’s returns come from just these five stocks.

 

For the record, Berkshire has also struggled to match the S&P 500 in recent years, due in part to the index’s narrow, tech-dominated rally. Without its significant stake in Apple, the Berkshire portfolio would have underperformed by even more. (Berkshire’s 2024 YTD return: +14.06%)

 

Barring a major acquisition in 2024, Berkshire will have a cash pile of almost $200 billion dollars. It is important to realize that some of Buffet’s landmark investments have come during crises – such as his investment in Goldman Sachs during the 2008 financial crisis. Obviously, a severe recession/bear market would play in Berkshire’s favor with this “mother lode” of cash (presently earning 5%).

 

It is important to understand that Berkshire earnings can be very volatile due to a 2018 rule change from the financial accounting standards board. That year, the “accounting geniuses” ruled that if a corporation holds common stocks, they need to mark them to market every quarter and report these short term equity gains and losses as if they were earnings.

 

That 2018 rule change makes Bershire’s earnings figures “worse than useless”. Berkshire holds hundreds of billions of common stock, many for decades.

 

Shareholders really want to know how the company’s operating businesses – Geico, Dairy Queen, BNSF Railroad and others have fared. Conversely, Berkshire’s stock portfolio (Apple, Coca Cola, Bank of America etc…) may fluctuate widely from year to year, day to day. However, over the longer term, they show massive capital appreciation.

 

Thus, as Buffett has pointed out many times, Berkshire’s GAAP results show $90 billion in earnings from 2021, $23 billion in losses in 2022 (the year of bear markets), and $96 billion in earnings in 2023. In a nutshell, Berkshire’s earnings as shareholders think of them are drowned out by stock market gains and losses from the company’s huge passive equity holdings.

 

Looking at Berkshire’s operating earnings (and ignoring stock market paper gains & losses) one sees a much clearer and stable picture:

2021: +27.6 billion, 2022: +30.9 billion, 2023: +37.6 billion.

 

Buffett has made it clear that Canadian Greg Abel is in line to eventually succeed him. Only time will tell if Greg is another Tim Cook. Tim successfully took the reins at iconic Apple upon the death of Steve Jobs. He has proven himself an incredible steward of Steve Jobs’ legacy. Hopefully, Greg will have similar successes at Berkshire! (FYI: Todd Combs and Ted Weschler will be ably managing Berkshire’s equity portfolios.)

 

During the quarter, we reduced or eliminated a number of positions in the Fund’s portfolio. Your manager wanted to streamline the portfolio, reduce risk, and take profits on positions that had limited growth potential (A&W, Telus, Pershing Square).

 

A&W was a classic contrarian investment that was made during the pandemic. The company was one of the few former income trusts that temporarily eliminated its distributions during the onset of the pandemic. This decimated the stock and was our buy-in catalyst. The distribution was reinstated after only three months, as drive-throughs were a saving grace for fast food chains. With ultra low interest rates relegated to the history books and A&W’s distribution growth subdued, your manager believes that we could put our money to better use elsewhere.

 

Pershing Square Holdings was another name in which we reduced the bulk of our position. This closed-end equity fund, managed by star hedge fund manager Bill Ackman, was purchased in the mid teens and recently sold in the low fifties. We bought this vehicle (composed of 10-15 great businesses) at a 30%-35% discount from net asset value. Today, the discount has dropped to the low 20s. It was an opportune time to take advantage of this temporary lower discount.

 

This July, Ackman will be going public with a new IPO, his Pershing Square USA Fund. It will be listed on the New York Stock Exchange. However, unlike the old Fund, the new Pershing USA fund will have no performance fee. On paper, this makes the new fund more attractive to investors.

 

Ackman will thus manage 2 very similar strategy closed-end funds. The USA fund, trading in New York, and Pershing Square Holdings fund trading in Europe (Amsterdam/London). Better yet, the new USA fund will have no 20% performance fee. The old fund will retain a performance fee, but to make it more attractive to investors, will going forward, have a scheme whereby part of the management fees earned on the new fund will be compensated over to the old fund. Thus lowering the existing management fees on the old fund.

 

Important questions remain. Which of the two funds will have the lower expense ratio, and which fund will receive First Dibs on Ackman’s stock picks? The old European-listed fund or the new (lower fees) USA fund? It’s not a totally clear picture, as there exists many potential conflicts of interest. We will wait until the dust settles to revisit this investment – and see which fund sports the biggest discount combined with lower fees.

 

There was a time, during the period of ultra low interest rates, when most Canadian bank stocks were “flying high”. Some investors have questioned why a Canadian portfolio should hold anything but mostly outperforming Canadian bank stocks? Simply stated, this would be a recipe for industry overconcentration, and lack of prudent diversification. When everyone is screaming for “overloved” Canadian bank stocks – it’s a time to be cautious.

 

Bottom line, you need both company and industry diversification in a portfolio. One never knows when a pandemic will hit, or a BP oil platform will explode in the Gulf of Mexico, causing thousands of miles of pollution and billions of dollars of cleanup costs.

 

This leads us to the recent trials & tribulations of TD Bank. In May, our largest Canadian holding, TD Bank, was put in the penalty box due to its role in an alleged money-laundering scheme. According to some analysts, the “worst-case” scenario is a huge 1x fine ($2 billion) and strict limits on the lender’s U.S. growth (no acquisitions/new branch openings).

 

In short, the U.S. Department of Justice is investigating the bank over how Chinese crime groups used TD and other banks to hide money from U.S. fentanyl sales.

 

The major issue investors are worried about is the prospect of U.S. penalties which could include an asset cap on U.S. growth or restrictions on U.S. mergers and acquisitions for a period of potentially years.

 

Although we are obviously not happy about the recent weakness in TD’s stock price, the bank may (in the medium term) have actually dodged a bullet as a result of this money laundering investigation. These AML issues caused an expensive takeover of First Horizon Corp. (at $25) to not be approved by U.S. regulators.

 

At $25, TD was paying approximately 2x tangible book value for an “ok” bank, “tarted up” become of its supposedly “sexy” Southeast USA “high growth” locations. (An excuse to overpay).

 

Talk about TD’s overpaying and poor timing! By early 2023, there was a run on small to medium sized U.S. bank stocks in light of the Silicon Valley Bank failure/run. Thus, TD’s $25 takeover offer was soon looking at a $10 Horizon public stock price. Today, two years later, Horizon is trading at $15-$16, well under the TD’s offer of twenty five dollars.

 

Yes, TD has to spend hundreds of millions to fix this 1x AML problem at the bank. But, this is not a structural problem attached to the TD business model. It’s a fixable problem. TD is in the penalty box and its U.S. business may very well be growth-constrained for a few years.

 

On the positive side, perhaps its for the best that TD was unable to complete, in our opinion, a “hyped” and ill-timed U.S. acquisition.

 

Since the acquisition announcement:

 

1. Interest rates have risen significantly - negatively affecting U.S. bank profits.

2. Loan quality has deteriorated.

3. Economic growth in the south east is slowing.

4. TD's capital ratios will now remain stronger. 14-15% range, instead of the 11-12% range post-acquisition.

5. TD can now use its excess capital to make accretive buybacks of its own shares, instead of overhyped First Horizon stock at $25.

6. A Trump win - would be positive news for a more relaxed banking regulatory environment. Maybe less time in the penalty box?

 

Historically, when TD goes shopping in the U.S. banking sector, it seems to overpay, while making its purchases near the top of the cycle. In hindsight, TD's takeover failure with First Horizon may look very "lucky" (wise).