Highlights

Nomad is an absolute return fund and reference here to an index is simply to place our performance, short term as it is, in context. We expect to beat the index handsomely over time, but only as a byproduct of our absolute return orientation.

Nomad’s orientation is genuinely long term, and more regular reports, daily, weekly, monthly or otherwise, are likely to be of little value to you, and may even be counterproductive for us.

When we evaluate potential investments, we are looking for businesses trading at around half of their real business value, companies run by owner-oriented management and employing capital allocation strategies consistent with long term shareholder wealth creation. Finding all three is rare, and that is why we think Nomad has a material advantage in being a global fund. We can look far and wide for candidates and simply are not required to invest in anything that does not fit.

Cash flow growth will likely be cyclically subdued in the near term and investors with a short-term time horizon, which appears to us to be the majority of professional investors, will have little to excite them. This is fine by us, because the outlook for the next five to ten years is very positive.

Whilst we are conscious that holding cash does not meet our long-term investment goals (to say little of earning our incentive fees) we are in no hurry to invest the money in companies that do not meet our criteria.

Imagine, he said, that you knew with 100% certainty of outcome, that on January 1st next year a company would come by some good fortune, perhaps a government contract or license award, which would result in the price of the share quickly rising tenfold. You and I would buy the shares today and wait. However, to the short-term investor the utility of this piece of information would be nought until after this year is ended.

This is momentum investing and is the mechanism by which expensive shares become very expensive, just as cheap shares may become very cheap. In the above example both sets of investors may even have privately agreed that the share in question was an outstanding investment, but only one would have bought. You can bank on us being the buyer.

The reason was that short term investors responded to the warning about next quarter’s profits and missed the long-term outlook. As Fred Schwed would say “pay no attention to this”. In effect the company had been punished by the markets for being sensible. It is this behaviour that gets us excited and sets up investment opportunities.

In aggregate we estimate our investments are currently priced by the market at 51% of their real worth, that is to say in our opinion we have bought dollar bills for 51 cents.

In this edition I thought we might discuss an investment you are likely to have read about in the press, Xerox Corporation, and an error in analysis, Monsanto Company, which we sold. That way you will be under no illusion about the fallibility of your manager.

One of Nomad’s key advantages will be the aggregate patience of its investor base. We are genuinely investing for the long term (few are!), in modestly valued firms run by management teams who may be making decisions the fruits of which may not be apparent for several years to come.

Investment mistakes are inevitable and indeed to some extent desirable, and we have no interest in hiding them from you (or in portfolio window dressing) - as they say, it is what it is.

Presumably somebody, somewhere had decided that the company now in administration was owned by Georgica and without checking, hurriedly sold their shares. Nervous investors tend to shoot first and ask questions later. As the saying goes, act in haste - repent at leisure.

We also feel that there are many undervalued investments available to us, to which we could put incremental capital to work. You can expect us to caution you when the opposite is true, and we find little available at reasonable prices. But for now, for those with a long-time horizon, we think it is a good time to be making investments.

This often works because there is normally a jewel at the heart of most companies that has often been used to fund new ventures or is taken for granted by impatient management. As the jewel becomes diluted by less successful projects aggregate performance declines and valuations atrophy or even fall.

One buyer recommended taking a higher gross margin than was usual (i.e., more than the usual 14% mark-up) as no one would know. Apparently Sinegal insisted on the standard mark up, arguing that if "I let you do it this time, you will do it again". The contract with the customer (very low prices) must not be broken.

In the near term our results are as likely to be bad as good, but we are confident that in the long run they will prove satisfactory. If Nomad is to have a competitive advantage over our peers this will come from the capital allocation skills of your manager and the patience of our investors.

That seems to have been the case, but for the record, and in case there is any misunderstanding, we do not have the faintest idea what share prices will do in the short term - nor do we think it is important for the long-term investor. All that we observed in the autumn was that barring a catastrophe, indeed in some cases perhaps even including a catastrophe, prices were so low that long-term success was almost inevitable.

A stoical disposition to short-term results is both the right way to think (never mark emotions to market) but it also prepares one for results that may be reasonable but are unlikely to be an extrapolation of the last two years.

We are always on the lookout for companies with corporate character that are pursuing strategies designed to create sustainable value. This is no mean feat, and we work hard reading annual reports and proxy statements and interviewing management trying to answer the questions: what are returns on incremental capital and the longevity of those returns, are management correctly incented to allocate capital appropriately, and what is discounted by prices?

Buying transitory outcomes (e.g., a manager with a one-year employment contract) with permanent capital is a duration mismatch a bond investor might understand, but short-term equity investors care little about, and so the dripping tap of share issuance is rarely turned off.

This belt and braces approach lowers short-term returns on capital, something the City would also frown upon, but builds the reputation of the firm in the long run. Value creation is often most sustainable when it is built slowly, and notably last year Weetabix became the largest selling breakfast cereal, overtaking Corn Flakes seventy years after the company’s foundation.

We have only one chance to grow Nomad to a reasonable size before it is closed, and the quality of investors when the doors are shut is of great importance to us. To date, we have declined almost as many investment dollars as we have let in, a ratio that the industry does not track and a habit that the industry is not good at keeping.

Our preferred route however is to be assessed on a compounded, multi-year basis for the reason that the only event we control is whether we are right, not when we are right. It is quite possible that our annual results will be inferior to the market for a period, but this will only convey information about the timing of outcomes, whilst saying little about the end result itself.

If we ever write to you asking for permission to invest in any of the above, sell your shares. And call us to sell ours. Nomad is not a hedge fund, it is an Investment Partnership, and the results below have been achieved without the investment Viagras that have become so popular with the get-rich-quick-crowd.

Several academic studies argue that mistakes hurt up to three times more than gains satisfy, a product of primordial environmental conditioning designed to prevent us from repeatedly eating poisonous food, apparently. For investors the implication of this asymmetry is great as it is often the favorable outcomes that drive performance more than losers destroy it. The Partnership’s investment in Stagecoach has in effect paid for the failure of Conseco six times over and yet it was Conseco that we wrote to you about first.

Our aim is to make investments at prices we consider to be fifty cents on the dollar of what a typical firm is worth. Capital allocation by investee companies must be consistent with value creation and, if this is the case, we expect that the real value of the business (the 100 cents value) could grow at around 10% per annum.

The prime determinants of outcome are price (sticking to 50 cents on the dollar) and capital allocation by management. The first is in our control, that is, it is in our control to be patient and wait for the right price. The second involves a subjective judgment about the quality of management, and an assessment about the sustainability of business returns in the long run. It is these factors that occupy almost all our time.

In no other sphere of capitalism can your property be seized in exchange for cents on the dollar (except compulsory purchase on the grounds of national interest). But fund managers, who in their private capacity would be insulted if someone offered less than their house was worth, happily sell shares in their professional capacity at discounted prices to smart buyers. And no one cries foul.

Job one, two and three for your manager is investment performance, not asset gathering. Few practice this approach. We work under the assumption that if performance is reasonable then the level of interest in what we are doing will increase and, if appropriate, the Partnership will grow in time. Common sense and simple maths dictate that it will be opportune if growth can be channeled to coincide with depressed prices, and not market tops.

In our opinion, the massive over-diversification that is commonplace in the industry has more to do with marketing, making the clients feel comfortable, and the smoothing of results than it does with investment excellence. At Nomad we would rather results were more volatile year to year but maximized our rolling five-year outcome. If you do not share this view, think long and hard about your investment in Nomad.

Parents will understand when I say that when children are born, they seem to bring their own love with them. However, stocks are not like children. The more stocks you own the less you care about each one individually. Attention paid to corporate governance, capital allocation, incentive compensation, accounting, and strategy has to be diluted as the number of stocks rises.

There are many companies that do the right thing when their backs are against the wall, and this list excludes those temporarily attending church. The anointed few are there because they have chosen to out-think their competition and allocate capital over many years with discipline to reinforce their firm’s competitive advantage.

What separates a corporate hero from a loon is an intellectually honest appraisal of business prospects and armed with that knowledge an appropriate allocation of discretionary resources. There are only two reasons companies behave well. Because they want to, and because they have to. Our preference is to invest in those that want to.

Over time, this offers the prospect that any business, indeed all businesses, will be meaningfully mispriced. Even the mighty Berkshire Hathaway with its stalwart long-term shareholder base was demonstrably half priced in early 2000. And Marathon bought shares (unfortunately pre-Nomad inception). It is just a matter of time. Those that chase high prices today, leave less gunpowder for the future.

If Nomad is to have a sustainable comparative advantage, this will come from the capital allocation skills of your manager and the patience of our Partners. In the latter we have started well, with no Partner turnover since we began and almost no enquires into performance despite the swings in general market prices. This is very unusual and a huge credit to our Partners and implies a similar long-term outlook. Only by looking further out than the short-term crowd can we expect to beat them.

We won’t end the debate here but, so that we all understand, our definition is that a business is worth the free cash flow that it can be expected to generate between now and judgment day, discounted back at a reasonable rate. Period. Growth is therefore inherently part of the value judgment, not a separate discipline.

Price to book, price to cash flow etc., cannot be an accurate substitute for the definition we provided above. The wide use of valuation heuristics in the industry is quite bizarre. Their informational value, leaving aside inaccuracy for a moment, can be limited if only because successful investing is a minority sport. Their survival can probably be attributed to intellectual laziness on the part of the investment professional, and spin on the part of the industry’s marketing departments.

So how does one avoid these mistakes? The answer lies in analyzing not the effects and outputs of a business, but, digging down to the underlying reality of the company, the engine of its success. That is, one must see an investment not as a static balance sheet but as an evolving, compounding machine.

In the office we have a white board on which we have listed the (very few) investment models that work and that we can understand. Costco is the best example we can find of one of them: scale efficiencies shared. Most companies pursue scale efficiencies, but few share them. It’s the sharing that makes the model so powerful. But in the center of the model is a paradox: the company grows through giving more back.

There is no reason why business values and share prices should move hand in glove. You should expect that there will be a time when prices, and Nomad’s performance, significantly lags the performance of our underlying businesses. It is then that we will ask you to be contrarian and invest more.

We struggle with a satisfactory system, but you should be under no illusion that Nomad’s returns, such as they are, are a product of its size alone. We look like a mouse but move like an elephant. It is not a good combination, but it is what it is.

Either fund management companies are investment companies or marketing companies. Not both. At Marathon we think we understand this conflict but even we struggle, and we make no claim to maximise both functions. The fact is that sales and size are the two main detractors of long-term performance, after inability.

Psychologists (McClure, Laibson, Loewenstein and Cohen 2004) have found that the brain perceives immediate rewards differently to deferred rewards because two different parts of the brain are involved. Immediate gains are perceived positively compared to larger deferred gains as the limbic (survival) system has the ability to over-ride the fronto-parietal (analytical) system. Interestingly, stress induces this over-ride, and of course, money induces stress. So, the more stressed we are, the more we value short-term outcomes!

Broadly Bill Miller argued that there are three competitive advantages in investing: informational (I know a meaningful fact nobody else does); analytical (I have cut up the public information to arrive at a superior conclusion) and psychological (that is to say, behavioural). Sustainable competitive advantages are usually a product of analytical and or psychological factors, and the overwhelming advantage with regard to Nomad is the patience of the investor base and the alignment of that disposition with the analytical and psychological traits of your manager.

To repeat: “what you are trying to do as an investor is exploit the fact that fewer things will happen than can happen”. That is exactly what we are trying to do. We spend a considerable portion of our waking hours thinking about how company behaviour can make the future more predictable and lower the risk of investment.

The robustness ratio is a framework we use to help think about the size of the moat around a company. It is the amount of money a customer saves compared to the amount earned by shareholders.

It does not happen in the investment industry where fees can be levied regardless of performance – that’s not much of a robustness ratio and does not take into account the asymmetry of the risks involved. You can’t lose money shopping at Costco, but you can investing. This would argue that robustness ratios need to be much higher in the investment industry than for normal businesses to compensate for the risks involved.

What is required is for people to behave in such a way that, in the words of Charlie Munger, one builds “a seamless web of deserved trust”. The operative word is “deserved”. The problem is that rules do not require people to think, and how are people to deserve trust if first they don’t think?

Today there is no Zen-like symmetry to stock prices; and there are few obvious pockets of undervaluation for the contrarian. A cheer all round then for Zimbabwe. The clients will hate it. Compliance will hate it. The consultants will hate it. Marketing will hate it. The size of the investment opportunity is tiny. It is not part of the benchmark. It is not even part of the Commonwealth. It’s perfect.

But as each idea came one at a time, with a lag in between, we were reluctant to open the Partnership for the sake of one new idea. We erred on the side of investment performance rather than maximising fund size. I know this is not how the industry thinks and behaves, but at Nomad we see our job as running an investment partnership first and commercial enterprise second.

What I am describing is one aspect of the principal agent conflict, that is, the interests of you, the principals, are different from ours, your manager, the agent. There are two ways to approach this situation: 1. maximise the conflict for the sake of maximising short-term agent revenues (standard industry practice), or 2. set about minimising the difference through behaving and thinking like principals. Zak and I have followed the second path.

No one has criticised the status quo. We are under no pressure to change anything. But I simply do not want to earn a “performance fee” if future returns are below 6% each year, that is not what we are about, and I want to be able to shave in peace in the morning!

He argued that investors often accept the risk of an occasional large loss for a steady small profit as the recurrence of the gains made them feel better. This occurred even when an opposite strategy, of steady small losses followed by a large gain, generated superior end results. Travelling comfortably dominates people’s thinking when they should be thinking about destinations.

And it is so unnecessary: as investors we own the only permanent capital in a company’s capital structure, everything else in the company: management, assets, board, employees, can change but, absent bankruptcy, our equity will still be there! Institutional investors have never really reconciled their ability to trade daily with the permanence of equity. Are they long-term or short-term?

It was put to us recently that we have a “told you so” portfolio (stocks which others will be dying to point out the idiocy thereof) and that pretty much sums it up. The task in hand is to find some more “everybody knows that’s a bad idea” stocks.

And even we have trouble getting these ideas adopted – there is a tendency for people to say, “thanks Nick, that behavioural finance stuff was really great”, but then they go back to their desks and carry on as they did before. Articulating this stuff is easy, internalising it is not. That’s the hard work.

It is far more important to us, and our existing partners, that we all see Nomad in the same light – we simply do not have the will or inclination to offer bespoke services, cater to a different crowd or to be particularly large.

The cost-reimbursement management fee means we do not need to open to put bread on the table. To date, we have turned U$1 into around U$2.70. Our aim is to turn this onto U$10 within a decade (approximately fifteen percent compound per annum) and we are somewhat indifferent as to how much money we carry with us during the process: For Zak and I, it is all about the destination.

Non-transitive dice offer two handy investment models: first, just as any dice can win for a while, so any superiority an investment process may have will only emerge with time, so patience is important. Second, the stock market posts prices every day, this is the equivalent of making your opponent chose his dice first.

Let’s be more blunt. There is an inconsistency between the multi-decade New Era-like prediction embedded in the share price, and the lack of will to see that prediction through. It is almost as if investors know it’s a lie.

And this is Nomad’s great strength. By looking out five years we do not have to invest in shorter-term phenomena in order to look good this year. And in our opinion that is at the heart of what is driving the frenzied trading in Phelps Dodge – the desire to look good this year, quarter, month, week, or just today.

Indeed, we don’t really see the new company as a business in the usual way: for example, we have asked our lawyers to structure the arrangement so that Zak and I could not sell Nomad to another fund manager – that way you will not wake up with someone else managing your money whilst your manager catches a plane to Hawaii! You can sack us, but we won’t sell you.

Philosophically our position is that the management fee should not be a profits centre (although a small surplus float is prudent). This is not a blank cheque: Zak and I will take a salary cut to run Nomad, and a total remuneration cut that questions our sanity, but as I have said, this is not a traditional business.

Even so, index relative funds are the industry norm because they sell. And they sell because the client does not trust their manager with the keys to the Ferrari. It is a ghastly Faustian pact.

A rational mind understands that it is the destination that is important, and if we have some skill in picking stocks (please, no answers on a post card!) then, whilst annual returns may bounce around, our destination will be some way ahead of the index.

For example, we have no idea where the market will end this year but given corporate strategies, capital allocation and starting valuations, I think we have some idea of how our companies will evolve over the next few years. In other words (at this point economics students may wish to cover their ears) the return from investing in shares can be both increased and de-risked by time.

It seems to us that most investors look at the accounting outputs of a company (the reported financial data) as a guide to near term price movements and play the market accordingly. As stated in the investment objective section of the Nomad prospectus our goal is to “pass custody (of your investment) over at the right price and to the right people”. That’s what investing is.

In short, the traders have many small ideas, and we have one big idea. Good luck to them. Picking up pennies in front of a juggernaut is just not how we behave.

I think Bezos would run a good investment fund: but that is the point, good investing and good business decisions are synonymous. Mr. Bezos does not control the timing of the payback, just as we do not control the timing of Nomad’s performance but, in our judgment, the ever widening of the moat surrounding Amazon largely determines whether our investment will be a success.

We shy away from more frequent reporting which risks say-something syndrome and at worst may provide a meaningless comfort blanket. Any psychological security you receive from us should be a product of our attempts to be more rational than the crowd.

Stock traders benefit from the same immediate feedback, but not so long-term investors who run the investment equivalent risk of continuing to eat the hemlock. The real world is messy, and moves in a messy sort of way, and means that long term investors probably have to work harder at intellectual honesty so as not to mis-analyse cause and effect.

But when this basic building block is combined with the scale efficiencies shared model (which increases the moat as the firm grows), customer centric orientation of the firm’s founder, as well as his healthy disdain for Wall Street, this combination makes us think that we may have a mouse that can turn into an elephant.

In previous Nomad letters we have argued that the biggest error an investor can make is the sale of a Wal-Mart or a Microsoft in the early stages of the company’s growth. Mathematically this error is far greater than the equivalent sum invested in a firm that goes bankrupt. The industry tends to gloss over this fact, perhaps because opportunity costs go unrecorded in performance records.

There is another way to construct a portfolio, which is to invert and start at a hundred percent weighting and work down! If fund managers did this, I am sure they would end up with completely different portfolios.

One reason for this is that the fund is over-whelmingly (over eighty-five percent) invested in firms run by their founders or first-generation management. Just as interesting is that Zak and I did not plan for this! We have ended up with a portfolio of owner-managed businesses as a by-product of our assessment of the quality of the people involved.

If the existing portfolio is to be successful then our results will come from the mismatch between the orientation of the founders and the mark to market mentality of the quarterly holding period investors that set the price of the companies on the stock market. This principal (founder) agent (trading oriented fund manager) conflict is the deep reality of the markets and probably the dominant characteristic of our careers.

As we have always said in the past, capital should only be raised in response to investment opportunity sets (to be slipped into the suggestion box of marketing-oriented fund management operations). Rightly or wrongly (and there is a perfectly rational case that we are wrong) we have an over-riding bias to keep our operation small.

This is particularly annoying as investing is, at its heart, a very simple discipline. Simple, perhaps, but not easy. And judging by my efforts, certainly hard to communicate. So why are letters more complicated than they need be? Probably because we feel a self-imposed pressure to say something, especially something new or (better and) impressive.

In our opinion, in dealing with mistakes the best state of mind is non-judgmental forgiveness. Parents will recognise that if their child thinks right, they will make mistakes, work it out for themselves and learn. They do not need to be judged or punished: instead, they need support, from themselves and others.

Companies often misclassify their mistakes in terms of outputs rather than inputs, and in so doing allow the original mistake to go unchecked. Psychologists call this denial, and we all do it to some extent.

What is not recorded is the cost of the suboptimal outcomes that result from over-diversification which range from lack of investment work, high fees and, most dangerous of all, complacency which allows one to ignore the only real, long term risk, which is the risk of misanalysing a company’s destination. Take for example the salami slicing of loans that are embedded in securitisation trusts. Diversification used in this way tries to turn ignorance into an asset.

Destination analysis is consciously central to how we analyse businesses these days. It helps us ask better questions and get to a firm’s DNA. What we learnt at Conseco may well have kept us out of the US banks last year, and what we learnt at Stagecoach has helped us continue to own Amazon.

If, for example, you think you are monitoring investment risk in monitoring the share prices of investee firms, then perhaps Nomad is not for you. In our opinion, transient, historic, stock price quotation volatility is not the same as investment risk. Indeed, quite the opposite.

As a younger man I separated investing from the rest of my life, as if they were different worlds. This is a false construct. Another mistake. What we learn from home-life helps us be better investors, and what we learn as investors helps us be better husbands and fathers. In the end, all reality has to respect all other reality.

Not since the Asian crisis do I think that Zak and I have been so “wrong” as measured by subsequent declines in share prices, so quickly after purchase as we have been in the last twelve months. We consider ourselves contrarian, value-based investors. Ordinarily what we are buying is hated and reasonable value. When investments go from hated and reasonable to despised and cheap something is normally up in the markets.

Investors can protect themselves from this risk by putting in their proportional share in any new capital raising. The problem comes when investors start to question the size of the capital raising. Perhaps the firm needs more than U$300m? Is the business really worth U$2bn? How can we know for sure? The doubt manifests itself in further share price declines and increases the dilution from not participating in a capital raising. Dilution risk comes from doubt about one’s original analysis.

In our opinion, what we are witnessing is the effect of a generation or two of the ascendancy of the marketing people and risk managers in the investment management function. The business model at many firms is not to make investments, to research and provide permanent capital; instead, the business model is to gather and retain assets. Fund managers at such organizations may have a strong financial incentive not to stick their neck out, and instead wrap themselves in a grey cocoon of rented stock portfolios.

The average holding period for the US stocks held in Nomad (excluding Berkshire Hathaway) is fifty-one days! That is approximately one twenty-fifth of the time that we expect to hold an investment. Those that set the current prices for our investments (the renters) cannot have an eye on long term value, and that, in a nutshell, is the investment case for Nomad.

It is not our system. The point of equity is that it is the only permanent capital in the balance sheet. It is there to weather storms, such as the current economic backdrop, and provide a stable base, and of course to earn the rewards of enterprise. This basic building block of society is broken when those with their hands on the permanent capital change their minds with their underwear. It is no coincidence perhaps that pass-the-parcel and musical chairs are children’s games.

The non-thought of those following orders never ceases to amaze. There are two routes to follow in investing: Drachten or Coventry. And we are following Drachten. The future is uncertain, nothing is perfect, and Zak and I may make huge mistakes. And it is because of this risk that Nomad will operate at its best.

There are times when it is easy to feel good about investing, and there are times when it is much harder. The emotions usually go with outputs. After Nomad’s share price tripled, it was easy to feel that God was in heaven but, as prices decline, spirits sag. We would counsel you to think about the inputs to investing rather than the outputs.

It is quite something to arrive at the end of a five-year period and for Nomad’s returns to be all but zero, and precious little better than the index to boot. This is a very interesting statistic. All that work and effort! Quite what are we doing with our lives, and with other people’s money? Please don’t answer that just yet!

One of the things this crisis reveals, at least in our opinion, is that there has been little give-in-the-system: that is to say, a lack of slack. Slack in time to think things through, or capital for investment for example. In a recent interview the author Nassim Taleb put it succinctly: “Capitalism does not teach slack, it teaches optimisation”.

Output maximisation looks efficient at least in the short term, but that is not the same as being long term optimal. The flaw to putting money to work immediately, for instance, is to presume that all relevant opportunity sets are available immediately. By accepting, say, a promoter’s promise of eight percent returns (six hundred basis points better than money on deposit), the investor denies himself the right to future opportunity sets which may be far better, like public equity circa 2008 and 2009, we would argue.

Notice, for example, how company spokesmen use words. To hide reality, the embarrassed use acceptable words to replace accurate words. This is how companies end up talking about “negative growth” rather than declines, and how bank investor relations spokespeople talk of “market turbulence”, when what they are referring to, we would suggest, is their own bad lending.

Capacity utilisation is also kept low by few investments, held for long periods. We have had the blessing of learning some big lessons early in life (there will be more). And we have worked out that, in any real sense, we do not know that much. In our opinion we have the right environment to think things through, think rationally, and come to meaningful long-term insights.

Scale economics shared operations are quite different. As the firm grows in size, scale savings are given back to the customer in the form of lower prices. The customer then reciprocates by purchasing more goods, which provides greater scale for the retailer who passes on the new savings as well. Yippee. This is why firms such as Costco enjoy sales per foot of retailing space four times greater than run-of-the-mill supermarkets.

The collector thought outside the box, rolled up his sleeves, did some proprietary analytical work, and found a contrarian investment opportunity with great growth potential that few of his peers recognised at the time, lucked into a low price, owned it forever and, in the end, it did not matter what price he paid particularly, as the growth in underlying value made his purchase one of the best investments of all time.

It is an interesting subconscious psychological tendency that truths are often spoken with a whispered voice whilst shaky suppositions are shouted for all to hear. It is not so much us that the shouters are convincing, as the need to convince themselves. We all shout to some extent, with agents usually shouting louder than principals: and that should tell us something.

So much commentary espouses certainty on a multitude of issues, and so little of what is said is, at least in our opinion, knowable. The absolute certainty in the voice of the proponent so often seeks to mask the weakness of the argument. If Zak and I spot this, we metaphorically tune out. In our opinion, just a few big things in life are knowable. And it is because just a few things are knowable that Nomad has just a few investments.

The church of diversification, in whose pews the professional fund management industry sits, proposes many holdings. They do this not because managers have so many insights, but so few! Diversity, in this context, is seen as insurance against any one idea being wrong. Like Darwin, we find ourselves disagreeing with the theocracy. We would propose that if knowledge is a source of value added, and few things can be known for sure, then it logically follows that owning more stocks does not lower risk but raises it!

However, this discount is applied to all stocks even those that, in the end, do not fail. The shares of great companies can therefore be cheap, in some cases, for decades.

In our opinion, the central engine of success at Wal- Mart was a thrift orientation fueling growth with the savings shared with the customer. The culture of the firm celebrated this orientation and reinforced the good behaviour. This is the deep reality of the business. This should have had the greatest weighting in the minds of long-term investors even if other things looked more important at the time.

What we are doing is investing at its most honest and most simple. But it is not easy. It is hard because one first has to reject industry dogma. The non-thought of received wisdom is shouted from the rooftops and it is safe and comfortable, glamorous, exciting even, being part of the crowd. The road less travelled is hard as there is lots of heavy lifting involved in the homework, although we happen to rather like the workout.

The investor Seth Klarman was once challenged on whether Buffett’s track record was statistically significant as he traded so little? To which Klarman answered that each day Buffett chose not to do anything was a decision taken too. It is quite possible that we may not change the companies in which we have invested very much over the next few years.

Even though it may be tempting to flatter oneself, it is the businesses we invest in that do almost all the heavy lifting in the wealth creating process. If Zak and I bring something to the investment party, and I may be stretching things a little here, it is to be more rational than other investors.

An odd pact may, therefore, develop between the immediate business imperatives of the salesforce-controlled mutual fund and, say, the consumer goods company with earnings to hit. Both parties will care for short term outputs and will take from the long-term to meet their needs. All parties will invariably be in denial that this is the case, at least to their clients but, we ask, how are the incentives aligned? We would argue that not only do companies get the investors they deserve, but investors also get the companies they deserve.

Our anti-locker room disposition was echoed by the founder of one of Nomad’s investee firms, who, in a private meeting, put it as follows: “if you want to be successful, and we do, then you have to be willing to be misunderstood, and do things that do not seem sensible to most people”.

Alternatively, the second way to invest is to buy shares in a great business at a reasonable price and let the business grow. This appears to require just one decision (to buy the shares) but, in reality, it requires daily decisions not to sell the shares as well! Almost no one does this, in part because it requires patience - and the locker room set does not do patience - but also because inactivity is the enemy of high fees.

Second, we have learned or, rather, come to appreciate, that the character of a firm - call it the ability to resist locker room temptation - is far more important than first we realised. This is an important insight. In the long run it may be all that matters.

Finally, great businesses have been “on sale” and were, in our opinion, the investment opportunity of the credit crisis period. When we wrote to you a year ago, we said, “It may not feel like it but for a long term investor this is the best of times not the worst...Take heart and look to the horizon.” Today we have a portfolio of exceptional, iconoclastic businesses that we could own for many years.

Nomad is also a very long term fund. We do not think it is suitable for those with time frames less than five years. We also do not think Nomad is suitable for investors overly conflicted with principal-agent issues. If you are at all uncomfortable, then Nomad is not for you.

There are, perhaps, few things finer than the pleasure of finding out something new. Discovery is one of the joys of life and, in our opinion, is one of the real thrills of the investment process. The cumulative learning that results leads to what Berkshire Hathaway Vice-Chairman Charlie Munger calls “worldly wisdom”.

Take Costco Wholesale: Costco’s advantage is its very low-cost base, but where does that come from? Not from low-cost land, or cheap wages or any one big thing but from a thousand daily decisions to save money where it need not be spent. This saving is then returned to customers in the form of lower prices, the customer reciprocates and purchases more goods and so begins a virtuous feedback loop.

Increasing the retail prices and justifying it on the basis that we are still “competitive” could lead to a rude awakening as it has with so many. Let us concentrate on how cheap we can bring things to the people, rather than how much the traffic will bear, and when the race is over Fed-Mart will be there”.

At the Welsh insurance company the penny dropped: firms that have a process to do many things a little better than their rivals may be less risky than firms that do one thing right because their future success is more predictable. They are simply harder to beat. And if they are harder to beat then they may be very valuable businesses indeed.

Certainly not the short-term investor, who will be indifferent as to whether Amazon, Asos or Air Asia will be the most valuable retailer/fashion e-tailer/airline in the world in ten years’ time. The institutional fund manager may be similarly indifferent. This collective professional myopia presents the true long-term investor with the spoils, but the mechanism for this wealth transfer from short-term holder to long-term investor is subtle.

The point is that the odds associated with any of these branches are not static but, in a hugely important way, they improve as one travels from branch to branch. Imagine the payoff in a game with these attributes? If investors recognise the inevitability of these improving odds they are also usually indifferent to them, perhaps viewing the eventual greatness of a business as simply outside their time horizon.

Nomad is about destinations, not smooth routes (no kidding!), and we will have bad years again in the future. Promise. To paraphrase the philosopher William James, the art of being wise is the art of knowing what to overlook. In that spirit, we would suggest you overlook Nomad’s short-term results. We do.

Whilst we love scale economics shared as a business model, it leads you down the wrong path if you run an investment partnership and are also trying to maximize investment returns! Absent a major swoon in the markets, the odds probably go up from here that our next move will be to return capital, rather than seek subscriptions.

There are two reasons that our firms have zigged whilst businesses as a whole have zagged. First, Nomad’s firms, by and large, have advantages not enjoyed by the incumbent competition and so have not been subject to the same economic imperatives. Second, their cultures are focused on the customer experience, not on the competition or the profit and loss statement. Our firms tend to chase the vision, not the money.

If we had our time again, we would hope not to be seduced by their (apparent) mathematical cheapness but weigh more heavily their DNA, if you like. One of the things we have learnt over the last few years is that our most profitable insights have come from recognizing the deep reality of some businesses, not from being more contrarian than everyone else.

Our inclination, whilst the businesses would appear to have so much ahead of them, is to leave well alone. It would be tempting for Zak and me to do high-fives, claim victory, sell our winners and move on to new investments but, we think, that course of action would be fraught with re-investment risk.

It is hard due to the human itch to be seen to be doing something, perhaps especially when paid a salary to be doing something. Whilst a lack of buying and selling may look from the outside that we are not doing anything (a Sleep at the wheel, as it were...groan!), the decision not to change the portfolio is an active decision and our research continues as ever.

It is so easy to screen out a good idea because of a bad association. As Charlie Munger quipped at a speech given at the same course a few years earlier “the human mind is a lot like the human egg”: once one sperm has entered then all the other sperm are locked out.

The process is more of a drift than epiphany. Our hunch is that the growth rate in online retailing is regulated, not by physical capacity, although that can be a limiting factor, but more by the rate at which our own incumbent habits and associations are replaced with more rational behaviour.

However, if the rate of growth in internet retailing is a product of attitude, rather than assets, then, the fact that a firm is quite large already does not necessarily tell you that its growth rate is set to slow. The widely held presumption that regression to the mean begins the moment the analyst picks up their pen, risks being wrong footed as a result.

Trust, once the cornerstone of the industry and derivation of words such as unit trust, investment trust, trustee and so on, has been all but lost. It is a great shame. The cynicism may be endemic, but it is no substitute for wisdom.

The spirit in which the industry conducts its affairs is not always mankind at its best, and sometimes it does not bring out the best in people. What is required, in our opinion, is the rebuilding of a web of deserved trust between participants. We hope that the Nomad model, with its patience, reciprocated trust, and calm, is a small step in the right direction. It is rather wonderful that it is also a financially profitable way to behave.

It is terribly, terribly simple, but it is not easy. It is not easy because there are so many distractions: news items, the soap opera of the stock market, macro-economic events, politics, currencies, interest rates, principal/agent temptations, regulation, compliance, administration and so on - this list is not exhaustive!

One trick that Zak and I use when sieving the data that passes over our desks is to ask the question: does any of this make a meaningful difference to the relationship our businesses have with their customers? This bond (or not!) between customers and companies is one of the most important factors in determining long-term business success.

Although Mr. Bezos does not mention it, one reason he prefers Amazon to be a large company with small margins is that if he shares the efficiency benefits that come with growth with his customers, he turns size, frequently an anchor on business performance, into an asset. In other words, the moat surrounding the firm deepens as the firm grows.

This is conjecture, of course, but we mention this to illustrate that the long-term risks our companies face are not those that dominate the newspapers and headlines today (credit crises, housing crises, budget crises, Euro crises and so on) but those events that could prevent them from reaching their potential. It is these risks that Zak and I try to identify and understand.

If everything you do needs to work on a three-year time horizon, then you’re competing against a lot of people. But if you are willing to invest on a seven-year time horizon, you’re now competing against a fraction of those people, because very few companies are willing to do that. Just by lengthening the time horizon, you can engage in endeavours that you could never otherwise pursue.

The uniqueness of Nomad’s ecosystem is the look-through consistency of approach of its participants, from Mr. Bezos and the good folks that run Nomad’s other businesses, to Zak and me and on to our investing partners. We are all choosing to see the world in the same way. It is very simple and, because it is the road-less-travelled, it is also very valuable, but it is not always easy.

Well...I suppose so...but then on the other hand it is fairly salutary to remember that perhaps the greatest naturalist that ever lived and had more effect on our thinking than anybody, Charles Darwin, only spent four years travelling and the rest of the time thinking.

When we study truly great businesses, we find that very often it has been simple human attributes that have led to their success: you feel differently drinking a Coke than a no brand cola or, you may feel differently towards a business that consistently undercuts the competition in price or, a delivery service that literally goes the extra mile and picks up returned items – and the reason you have these feelings, and the stimuli that produce them, have hardly changed in millennia.

The longevity of the model is not difficult to understand as Jeff Bezos pointed out “I can’t imagine that in ten years from now customers are going to say: I really love Amazon, but I wish their prices were a little higher” or Amazon was less convenient, or they had less selection.

Information, like food, has a sell by date, after all, next quarter’s earnings are worthless after next quarter. And it is for this reason that the information that Zak and I weigh most heavily in thinking about a firm is that which has the longest shelf life, with the highest weighting going to information that is almost axiomatic: it is, in our opinion, the most valuable information.

Our management fee was a philosophical decision for us. We thought that in managing the Partnership we had not added value per se, and so the management fee should meet the Partnership’s costs, but not be a source of profit. A by-product of this is that as the Partnership grows in size the management fee declines as a percentage of assets, and so the incremental dollar brings something to the party, as it were.

Zak and I do not like being open, and we are happy with our hermit-like state, minding our own business and getting the job done. Nomad is also of such a size that we may risk storing up problems for the future should we grow too large.

Inactive except, perhaps, for the observation, seldom made, that the decision not to do something is still an active decision; it is just that the accountants don’t capture it. We have, broadly, the businesses we want in Nomad and see little advantage to fiddling.

And so it should be. If you did not buy the companies you always wished you had owned when they were on fire sale over the last few years then, when exactly are you going to buy them?

In another sphere, the Olympic Team GB Cycling coach and Sky Tour de France Chief (now Sir) Dave Brailsford might refer to this type of behaviour as seeking “the aggregation of marginal gains”. Just as it leads to gold medals and yellow jerseys, its effect is that AirAsia, for example, is the lowest cost airline in the world. Good things follow when you care about the pennies.

However, Zak’s advice to his relatives is counter-intuitive: take prices down (he is a hard man to have on your board). The risk with super-normal profitability is that the profits are an incentive for a new competitor: far better, Zak argues, to earn less, but for a much longer time.

Zak’s family’s activity centre beat the competition because they understood the difference between good costs (nice staff, clean loos, good coffee) and bad costs (a whizzo new slide) and invested appropriately.

You only ever deal in round numbers these days. People don’t care about the pennies anymore, that’s why no one has got any money,” he told us.

It is important to Zak and me to be in an ecosystem that gives us the mental freedom to think rationally and avoid the psychological pitfalls that pepper the industry. Do not underestimate the important role you play in maintaining a healthy ecosystem.

We concentrated on the correct philosophical approach to incentives, and so the job was easy: the management fee should not be a profit centre as we do not create value through managing the Partnership per se (hence our break-even cost reimbursement management fee); the performance fee should respect the notion of the opportunity cost of capital (and long bonds had been six percent or so); and if we owned shares for long periods, then performance fees should be at risk for an extended period too.

It is not very important to us that a six percent hurdle has been well over ten percent in the recent past, and we would certainly never do anything to lower it.

And whilst conventional wisdom has, in our view, quite correctly drawn a Pavlovian link between financial incentives and behaviour, money is not the only reason that people behave the way they do. Those tasked with setting compensation arrangements may first wish to ask themselves, why do people climb mountains? After all, it is not for the financial rewards – there is more to life than that.

To the builder of flat pack furniture or the baker of cakes, the perceived value of the end product is influenced by the input of the consumer’s own efforts. In doing some work themselves the builder, or cook, puts a little bit of meaning, perhaps even a little bit of love, into the product.

In traditional capitalist thinking, Ariely surmised, we tend to have Adam Smith in mind, and the gains from subdividing pin manufacturing into twelve distinct steps. The efficiency embedded in this approach won the day over Karl Marx’s concerns about the estrangement felt by workers from becoming an anonymous cog in a larger process. The debate then, and ever since, has been the battle between efficiency and meaning.

These people derive meaning from the challenge, identity, creativity, ethos (this list is not exhaustive) of their work, and not from the incentive packages their compensation committees have devised for them. The point is that financial incentives may be necessary, but they may also not be sufficient in themselves to bring out the best in people.

Our portfolio inaction continues and we are delighted to report that purchase and sale transactions have all but ground to a halt. Our expectation is that this is a considerable source of value added!

Even so, in aggregate, the fund management function, evened out over all shareholder experiences, does not add value per se: it only shuffles wealth created elsewhere. As time goes by, the performance that you receive, as partners in Nomad, is the capitalisation of the success of the firms in which we have invested (minus our fees!). To be precise, the wealth you receive as partners came from the relationship our companies’ employees (using the company as a conduit) have with their customers.

At its heart, investing is simple, and to make it seem anything but, with the frequent repartition of short-lived facts and data points, may be a conceit. Indeed, it could be argued that a running commentary obfuscates a discussion of the things that really matter.

The public stock markets have many tens of thousands of potential investments, and the price of each of those changes almost constantly. The number of possible profit or loss combinations would make Schwartz’s hi-fi store look like a multiple-choice test. It is very easy, therefore, to feel unhappy about one’s investments. Indeed, on any one day, month, year it is highly likely, indeed statistically almost certain, that one’s chosen combination of investments will lag alternatives – there will always be someone who did better.

When we wrote the December 2013 letter, we did not know that it would be our last but, a few months later, the portfolio had been liquidated, funds returned to our partners and on we go. We did not like that final phase one bit: selling stakes built up over years felt wrong, the clients were grace itself but, even so, it is still an awkward conversation to take something away from someone, especially people that you like, and there was the administrative headaches of winding up an operation.

The pull was the prospect of independence and a new adventure, this time working out how to recycle the funds for others to benefit. We wound up at an age (mid 40s) when it forced us to build something new (you can’t sit on the beach forever) and, hopefully, we would live long enough to also see the consequences of our actions; we would have to eat our own cooking, as it were.

Many of the successful and wealthy people we know are a little mystified by what the money really means. Investors can think their way to success without seeming to work in the traditional sense and the payoff in capitalism from stock picking can be extraordinary. It is one thing for capital allocators to be rewarded for their efforts but, in our opinion, taking personal identity in everything above X-amount is not a route to building a better world.

If good investing is a minority sport, then good philanthropy is a minority sport for those that do minority sports. Our band could do with moving from the fringes of society to becoming the norm. We hope you will join us on the journey.