Dear Partner,
In the first quarter of 2022, Woodbridge Capital Partners (the “Partnership”) returned -9.79% while the S&P 500 returned -4.60% (with dividends reinvested). Since its inception in April 2020, the Partnership has returned 166.7% compared to the S&P 500’s 75.4%.1
Early in the quarter, we made one minor change to the composition of our portfolio. Our portfolio took on 10% leverage in February. Our rationale is fairly simple. We are very confident that our investments will produce positive returns over the long term, and leverage enables us to amplify these positive returns. Leverage introduces the risk of a margin call in the case of a major downturn. To mitigate this risk, we’ve adopted a conservative amount of leverage that will produce a modest increase in expected long-term returns with negligible risk of a margin call—our portfolio would have to decrease in value by nearly 90% to trigger a margin call. This introduction of leverage means we will experience a commensurate increase in the volatility of our portfolio (as was the case this quarter), but that is a small price to pay for superior long-term returns.
We will be the first to admit that the timing of our leveraging was suboptimal, coinciding with some distressing headlines. Perhaps the most prominent of them are the highest annual inflation rate since 1982, rising interest rates, and Russia’s invasion of Ukraine. In spite of this unfavorable backdrop, we believe our portfolio is sufficiently attractive on an absolute basis that leverage will be a net positive in the long term. Since we avoid attempts to time the market on the basis of our nebulous hypotheses about macrotrends and investor psychology, we decided against waiting for “the perfect time.”
Russia’s invasion of Ukraine has been unequivocally tragic. Its ramifications on the global order and political environment may be immense. However, global politics is well beyond my circle of competence, so I’ll refrain from giving my two cents. As it pertains to our investments, the clearest potential impact we see is the accelerating movement away from off-shoring—less dependence on global supply chains and bolstering domestic production. One of our businesses is poised to benefit from this movement toward domestic production. The remaining 90% of our portfolio is unlikely to be substantially impacted.
As mentioned in our Q3 2021 letter, we anticipated the threat of inflation and are positioned accordingly. As of February 2022, the purchasing-power of each dollar was eroding at a rate of 7.9% per year with no signs of slowing down. “Cash is trash” as Ray Dalio so eloquently put it. Jesse and I have been happy to exchange these dollars for equity in profitable businesses.
The Fed has their own response to rising inflation: hiking interest rates. Our portfolio is, relative to other businesses, largely neutral to these hikes. Higher interest rates accompanied by a corresponding increase in interest expenses are generally considered a negative for debt bearing businesses, but, since most of our businesses have very little debt, that is not a huge concern. On the flip side, one of our businesses stands to benefit handsomely from higher interest rates. This seemingly “win-win” scenario should be qualified by the fact that rising rates typically slow down the economy, sometimes significantly, by reducing credit availability.
In theory, higher interest rates should also lead to multiple contraction in stocks: As bond yields increase, investors demand higher yields on stocks. Although multiple contraction (i.e. a decrease in the valuation of stocks) may not seem attractive at face value, long-term investors can rejoice at the opportunity to buy profitable businesses for cheaper. To be clear, multiple contraction in the backdrop of higher interest rates is what should happen in theory. I personally do not feel comfortable attempting to time the market on the basis of such prediction. Borrowing the words of Yogi Berra: “In theory, there is no difference between theory and practice. In practice, there is.”
We remain confident that the Partnership will outperform the S&P 500 over the long term. Your patience and trust has been a blessing for which we are grateful. We do not take that trust lightly. If you ever have questions or concerns about your investment, please do not hesitate to reach out to us. As always, we remain committed to your investment success.
Thank you,
Kyosuke Mitsuishi & Jesse Flowers
1https://finance.yahoo.com/quote/%5ESP500TR/history?p=%5ESP500TR