Author: Steven Kiel, Arquitos Capital
Covestor model: Hayek Fund
We have indeed at the moment little cause for pride: as a profession we have made a mess of things. – Friedrich Hayek
Our Covestor portfolio fell 6.19% in September, while the S&P 500 dropped over 7% and the Russell 3000 fell 7.9%.
I’m pleased with our recent performance. There has been a great deal of uncertainty in the overall markets for a variety of reasons, but the stocks in The Hayek Fund have generally performed well over the past year because of their entrepreneurial leadership and their ability to generate a large amount of free cash.
At the same time, I continue to be worried about the economy, both in Europe and the United States. I consider Europe to be a manufactured crisis resulting from the inability of profligate Euro member nations to control their own monetary policy. The potential for today’s problems have been widely known since the introduction of the Euro, and can now logically have one of two conclusions: the break-up of the Euro as a common currency or a near complete integration of the EU as a political entity with resulting control over formerly sovereign countries – not unlike the way the U.S. treats its states. My bet is that Europeans will not allow more integration. Member states each have very disparate cultures, with different language, temperament, and work ethic. Hard working German citizens will soon tire of subsidizing welfare recipients in Greece. And Greek citizens will soon tire of being told how to run their affairs by bureaucrats from northern Europe.
I’ve harbored a belief that the Euro was doomed to fail from the start, and the cleaner the break the better. Unfortunately, much more pain will occur before the correct decision will be made. Remember this, though: This economic problem would be solved if Greece, Spain, Portugal, Italy, and all of the other European countries with troubled economies were able to control their own destiny and succeed or fail based on their own decisions.
The United States also continues to have significant problems. We can all agree that the economic crisis of a few years ago was much worse than typical downturns because of the extreme use of leverage, primarily in the real estate market. How ironic it is then, that the federal government’s solution to over-borrowing is to encourage borrowing. In addition to citizens drowning in debt, our federal government has now exponentially increased spending, thereby adding more debt that you and I will ultimately need to repay. This perverse logic inhibits proper deleveraging and retards a healthy recovery.
Hayek’s quote above referred to the profession of economics and was made when he accepted the Nobel Prize in 1974. Click here to read his speech. Today, as then, we can also apply this quote to politicians and policymakers, as well as Wall Street institutions.
I believe the way out of our problems is through the creativity and risk-taking of entrepreneurs. In the long term, I’m optimistic for this reason. Whether it’s someone like me, starting a money management firm in the grips of a global financial crisis, someone like Steve Jobs, launching innovative products during a battle with cancer, or someone like you, investing your money or time in ventures that would have never been dreamed up by a central planning committee, the entrepreneurial spirit of Americans will continue.
I launched The Hayek Fund on September 7, 2010 because I believed that innovative corporations, on average, perform better. I found those corporations by looking at which of them financially contributed to free market-oriented institutions. Those contributions indicate two things to me, both good: the corporation’s management respects free market policies and supports organizations that promote policies limiting the size and scope of government; and the corporations generate enough cash to give them the ability to make donations like this. My backtests showed that stocks of corporations like this significantly outperformed the overall markets. Given that, the performance over the past year is not surprising.
Portfolio holding Microsoft is often seen as a big, old stodgy technology company when compared to Google (which we also own) and Apple (no position). However, Microsoft continues to innovate with lesser known products. They also continue to generate a huge amount of cash and currently have more than $50 billion in cash and short term investments. If you back that cash out, shares currently trade at a multiple of less than 7 (as of 10/1). That’s extremely cheap.
I’ll close with another pertinent quote from Hayek’s Nobel Prize speech:
If man is not to do more harm than good in his efforts to improve the social order, he will have to learn that in this, as in all other fields where essential complexity of an organized kind prevails, he cannot acquire the full knowledge which would make mastery of the events possible. He will therefore have to use what knowledge he can achieve, not to shape the results as the craftsman shapes his handiwork, but rather to cultivate a growth by providing the appropriate environment, in the manner in which the gardener does this for his plants.
This humility is the approach I take as a portfolio manager. Thank you for your interest in The Hayek Fund.
