Why does our fund performance differ from other Motley Fool services? Nate Weisshaar explains.

Each month we answer questions from our audience of readers and shareholders. We enjoy doing it, and would love to answer any questions you might have. Please write to [email protected] and let us know what's on your mind! Here are our reader questions for February:

(Please note, when we mention Motley Fool "services," we're alluding to those of our sister publishing company.)

1) I cannot understand how MF has picked so many outstanding companies, many that I have purchased, while your mutual fund continues to flounder for the last two years…..I have cut my level of investment in the fund by half, considering abandoning completely. What gives?

This is a great question. And like most great questions, the answer is a little complex. I’ll try my best to explain.

All of our portfolio managers are long-time Fools, so our collective investing philosophy is quite similar to what you might hear from other Motley Fool investors. 

We recognize we are very poor market timers, and instead look to invest in great companies for the long term. We like to think of ourselves more as business owners than investors.

While we believe that this approach to investing can result in long-term market-beating returns, there are periods when it will underperform the market. This occasional underperformance is partly a result of our investing style.

If you look at our portfolios (here and here), you’ll probably see many names that you recognize as outstanding Foolish companies. Those companies have done very well for us in general.

We build our portfolios by looking to own the best companies, so we don’t pay much attention to benchmark allocation. We don’t worry about or how the S&P 500 (the usual proxy for “the market”) is exposed to various sectors. This means we will often have far more exposure to, say, consumer discretionary stocks than the broader market.

The last couple of years our underexposure to the energy and utility sectors has hurt us, but we’re not overly concerned about that. We think it is difficult to find high quality companies in these industries for a number of reasons. The energy sector is cyclical and has a history of questionable capital allocation. Utilities, meanwhile, require a lot of money and very high leverage to support their plants and infrastructure. In fact, very few utilities generate enough cash flow to cover their dividend distributions.

Of course, we’re not pleased to be trailing the market ever, but we expect it will happen from time to time. In addition, it’s important to remember that shareholder returns are a reflection of when they invest with us. Each of our investors will have different returns, especially if they’ve only been invested for a short period of time.

The only things we can control are our investment processes. We have a lot of confidence in our methods, but we’re constantly working to refine and improve them in order to ensure our shareholders have the best chance of superior returns. After all, if we’re not making the best investing decisions with your money, why are you paying us?

We think we’re pretty smart, but we know (and have significant others who reassure us) we are fallible. We’re never going to get it 100% correct; we’ll make bad investments and we’ll miss winners. This is probably the only thing we know with 100% certainty.

Wait. There’s one other thing – we’re 100% certain managing our shareholders’ money is a weighty and humbling honor, and we strive to do our best for them each and every day.

So how do we live up to this charge despite our shortcomings?

Our goal is to invest your money in the great companies of tomorrow, to be right more than we’re wrong, and to put more money behind our winners than we do our inevitable losers. To achieve this goal we’ve developed a disciplined system of vetting for all of our ideas.

We regularly gather our team around our conference table and hold our ideas to the flames. What makes this company great? Is that greatness sustainable? Where are its weaknesses? How will we know when to sell? When should we buy more? What kinds of made-up metrics does management use in its presentations? How much stock does management own? Have they been selling recently? What types of behavior are rewarded by the compensation plan? How large a position in our portfolio does this idea deserve?

Putting our ideas through this gauntlet not only means everyone on the team has at least passing knowledge about everything we own, but allows each company to be examined from multiple angles with less familiar eyes (it is human nature to become attached to things you’ve spent a meaningful amount of time associating with – including investments – and humans hate to kill their darlings).

In this spirit, our most disappointing investments this past year were Inifinera and Under Armour.

In the case of Infinera, a company that makes vital components for high speed transmission of data, we believe we may have overestimated two things: the strength of the company’s sales force, and the ability of company management to absorb an important acquisition. These aren’t fatal missteps, but it definitely frustrates us. However, we think Infinera’s technological strength remains. We’re hoping to see a recovery in the coming year.

We appreciate management’s candor, but we’re concerned by the departure of the CFO and the company’s continued struggles to improve operating efficiency. We still believe, however, Under Armour’s brand strength is intact, which is very important to the thesis. There are no easy answers here, so stay tuned.

We can’t promise our funds will deliver market-beating returns across every measured time frame, but we believe our process will allow us to discover great companies we want to own for the next several years (or decades). We also believe this process and our long-term mentality helps us as we strive to deliver market-beating returns over our target rolling 3-year period – and beyond.

2) Why sell Chuy's? Industry specific or company specific?

For those keeping score, we initiated an R&D position in Chuy’s in the Great America fund this past summer (for more on this, check out our discussion back in September), and we exited the position in October.

Our exit was perhaps for a combination of company- and industry-related reasons.

There are hundreds and thousands of competitors for diners’ dollars in the restaurant industry. In the same way, investment ideas are constantly competing for your investing dollars, and we have the daunting challenge of making a judgment call on which of the thousands of public companies are worth your money.

Considering our existing exposure to consumer discretionary spending – and the restaurant industry specifically, with names including Texas Roadhouse and Panera Bread – we just couldn’t see a clear reason Chuy’s was one of the best places for your money.

3) Can you explain why a company like Alphabet would buy back stock? What does that mean for the investor?

I recently came across an article on Bloomberg.com that addressed this very question. How convenient!

Mainly, the reason Alphabet is buying back shares is to demonstrate a level of capital discipline. This new attitude toward responsible spending arrived in 2015 with CFO Ruth Porat, who was previously an investment banker and CFO at Morgan Stanley.

This is also why the company restructured itself into Google and Other Bets under the Alphabet umbrella. By separating audacious (and unprofitable) research projects such as autonomous vehicles, Google Fiber, Loons, and whatever else may be going on in Mountain View from the cash-generating machine that is Google’s ad business, it became far easier for investors to understand the underlying value of the company.

So essentially, the folks at Google are buying back shares to show Wall Street that they’re grown-ups. It can be debated whether this is a good thing, but the market has liked it so far. 


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