Please refer to our disclaimers, which can be found in the footnote of this page and here.
Contents
Performance
Performance for the 3Q 2023 was +1.9% net (vs. the MSCI ACWI at -3.4%). Alphabet and Charter Communications were the top contributors while Block and Snowflake were the top detractors. There was very little trading during the quarter. We trimmed Alphabet as it grew too large in the portfolio and reallocated to Salesforce. We also added modestly to Block and Alibaba. Post quarter end, we trimmed Alphabet and Meta Platforms for valuation and portfolio construction reasons, and cash built up to around 11% (prior to the most recent sell off). At the time of writing, portfolio companies Alphabet, Meta Platforms, Microsoft, and Charter Communications have reported 3Q 2023 earnings. The Microsoft results showed continued momentum in cloud as well as some positive surprises in margins across the board. It remains to be seen whether the margin boost is sustainable as the company will reinvest aggressively. Alphabet sold off circa ~10% post earnings as the market was disappointed with slowing cloud growth. However, core business performance was very solid and there remains a significant opportunity to improve efficiency. Meta Platforms had a solid report also, particularly with respect to cost control. A key negative was the signalling regarding increased spending in Reality Labs. Charter Communications disappointed on broadband subscriber growth versus market consensus and sold off in post-market trading. Our base case broadband growth was already muted versus consensus. In all, it has been a volatile earnings season so far, and in each case, our view of long-term value changed only marginally relative to the subsequent market movements. We have deployed some capital in this weakness and cash now stands at circa 8%.
Longer-term, the portfolio has compounded +16.2% gross (+13.4% net) since inception (vs. the MSCI ACWI at +9.9%), representing +6.3% gross (+3.5% net) annualised outperformance.
Returns Summary
Discussion
Kalakau Avenue officially launched in the third quarter of 2023. Thank you to our founding investors – your mentorship and trust means a lot, and the business could not have launched without you.
Because the launch was close to quarter-end, deeper discussions of positions and performance will be saved for future letters. Instead, we discuss the key operational decisions taken in Kalakau Avenue’s launch.
The strategy at Kalakau Avenue was developed during my 8 years at a large, single-family investment office. It was developed with consideration as to how family offices could best utilise their key competitive advantage — ultra-long-term capital with minimal principal-agent issues. Few investment firms have this luxury. Most are highly dependent on external capital without the surety of capital. This naturally creates shorter-term pressures on performance. During my career as an allocator, I saw this manifest in various ways. Some examples included a focus on finding investments that would pay off in the short-term (requires timing the market which is hard to do), excessive trading, and excessive risk-taking to achieve an unrealistic return objective and justify high fees. The managers that best guarded against these pressures had some commonalities. They prioritised long-term investment performance ahead of business profit. Their motivations were driven more by investment excellence than making money. They had clearly articulated investment philosophies with disciplined investment processes to resist strategy creep towards a shorter-term focus. They often already had long track records with diversified client bases. This meant clients could more easily look past short-term performance and if not, the loss of any single client was not catastrophic to the manager’s business.
In launching Kalakau Avenue, it was apparent that it would be difficult to replicate the ultra-long-term capital base of a single-family office. Building the team and organisation set out in our founding letter requires an operating budget and that means raising external capital. We also did not have the luxury of an already-established 20-year track record. As such, we need to be very careful in the design of our investment approach and operations to guard against the shorter-term pressures that we will face. Our investment approach was discussed in our founding letter. From an operational perspective, there are two key ingredients. First, it means having like-minded and equally long-term capital partners. We are fortuitous in this respect with our founding investors. Second, it means keeping the expense base of our business low so that we are not dependent on raising capital to stay in business. In essence, the foundation of the business needs to be sustainable with just Kalakau Avenue’s capital such that we can emulate the ultra-long-term capital advantage of a much larger single-family office. As the business expands, we can reinvest earnings into the organisation to build the organisation slowly and deliberately.
Several key operational decisions we have taken support this construct:
Simplicity and Automation
Our investment approach and views on alignment dictate a single, concentrated portfolio that always represents our best expression of the assets we want to hold. We are not building an asset management business with a range of solutions for different clients. All our clients hold the same portfolio. A single portfolio of ~8-12 stocks is very simple to manage operationally, and less time spent on operations means more time available for investing. We maximise this simplicity by automating our operations as much as possible. For example, client reporting, fees, invoicing, etc are all fully automated.
Team
We have decided not to hire investment analysts or operational staff for now. As the business evolves, staff compensation will be the largest business expense by far. We will work slowly toward the vision set out in our founding letter as our budget grows. This is not without consequence. While the impact is mitigated by the simplicity and automation discussed above, a small team would increase our research capacity and introduce different, valuable views. There is a trade-off between this and the capital raising pressure that hiring a team upfront would introduce. A third option was to raise working capital to fund the team. However, while this sounds like an elegant solution, it introduces considerable misalignment for the clients. The working capital investor rightfully seeks a return on that capital, which can only come from fee revenue. This is not necessarily aligned with long-term returns and may introduce the short-term pressures we are seeking to avoid.
Fund Structure
We have eschewed the traditional fund structure for now. Most funds have a master-feeder structure whereby U.S. investors invest via a tax-transparent Delaware limited partnership and all others invest via a Cayman corporate. This set up exists to allow the pooling of capital into a single master fund, while offering investors the right vehicle for their specific tax and regulatory profile. However, this set up comes with considerable overhead given there are three entities, which means triple the administration, custody, audit, and director fees. It also imposes a considerable administration burden on the manager which takes time away from making investment decisions. The overhead is typically passed on to investors as fund expenses, creating a significant return-drag for clients in smaller scale emerging managers.
Some operators pool emerging managers into an umbrella master-feeder structure with segregated partitions. However, once on such a platform, it is very hard to exit, and it leaves the manager highly dependent on the operator and subject to their pricing power. In contrast, a separate account structure (i.e. each client has assets in their own name) can avoid these overhead issues while maintaining client-specific tax profiles. In the past, managing multiple portfolios across multiple custodians would mean significant operational complexity for the manager. This is, in part, why the master-feeder structure emerged.
Fortunately, for public market managers like us, there are now a range of global stock trading platforms that offer extremely efficient separate-account solutions. We have selected a leading global platform. Each client opens their own separate account (which is also the asset custodian) and appoints Kalakau Avenue as the account manager. The portfolio and order management system allows each account to be aggregated such that the manager effectively manages a single portfolio, in the same vein as the master-feeder structure. This is made possible by having all clients on the same platform with the same custodian and broker. This considerably reduces the overhead, to the benefit of clients, and significantly reduces the administration burden for the manager. There is no need for a fund administrator (there is no fund) or auditors (assets are in the client’s name so they receive reports direct from the broker platform). Further, custody and the order management system are free. Clients enjoy the additional benefits of controlling the assets directly (with segregation from the broker’s balance sheet), full transparency on positions, and daily liquidity. The drawback is the dependency on the broker platform and as such, we undertook considerable diligence on their business model, strategy, and balance sheet.
Overall, these operational decisions mean that Kalakau Avenue already has a sustainable business model. This gives us the luxury of focusing on investing, while resisting the shorter-term pressures that exist when there is a dependence on raising capital.
Matthew Brown
Founder & Chief Investment Officer