Please refer to our disclaimers, which can be found in the footnote of this page and here.

Contents

• Contents
• Mission & Vision
• Our Foundations
• Investment Philosophy
• Defining Business Quality
• Investment Process
• Sourcing
• Research Process
• Valuation
• Portfolio Construction
• Risk Management
• Decision-Making
• Team
• Culture
• Kalakau Avenue as a Learning Organisation
• Track Record
• Terms and Alignment
• Common Questions
• Final Thoughts

Mission & Vision

Kalakau Avenue’s mission is to engage in the pursuit of investment excellence and life-long learning while maintaining the highest ethical standards

Kalakau Avenue, pronounced Cal-a-co, is the street I grew up on. The name was chosen as a tribute to the three investment firms that I have had the privilege of working for to date, all of which are also named after personally significant locations/streets. I am grateful for the opportunities afforded to me by these firms and for the backing their leaders have given me throughout my career and in this new venture. I have learned a great deal from these individuals, my former colleagues, and from various exceptional investment managers around the world. I cannot think of a better training ground.

The strategy employed at Kalakau Avenue was developed during my time at a family investment office with their support. A long-term direct investment strategy was a natural evolution of the family office’s research and focus on business quality. The strategy was first launched on 1 January 2019 with my personal capital and is now in its 5th year. The launch of Kalakau Avenue will be the first time the strategy has been expanded to 3rd party investors.

The vision is to create a small, high-calibre team focused on owning a concentrated portfolio of the highest quality companies over the very long-term. A truly long-term capital base is imperative to the mission. Kalakau Avenue will seek only a limited number of capital partners that can work together in two-way thought partnership to achieve the mission. We do not plan to actively market — our focus is on building an exceptional investment process, team, and portfolio and not on building a “business”. As portfolio manager, I invest the majority of my investable assets in the strategy and view the strategy as the best place to compound my own capital over the long-term.

Success for Kalakau Avenue will be achieving our mission. Exceptional risk-adjusted returns over the long-term will clearly be required but this is not something we can directly control. To achieve investment excellence, we must focus on what we can control, the constant improvement of all the things that help improve decision-making — philosophy, process, people, and culture. To succeed we must be perpetual students; a healthy individual and organisational learning culture is critical to achieving investment excellence and in making Kalakau Avenue a great place to work. We want to accomplish this while being great stewards of capital and great long-term partners. We undertake to always put our clients first, to act according to our word, to be transparent and honest with our partners, and to avoid making money in companies that we see as bad for the world.

Our Foundations

Our investment philosophy is founded at the intersection of our circle of competence, competitive advantages, and passion. Our foundations are discussed more here.

“You don’t have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.” — Warren Buffett, 1996 Berkshire Hathaway Letter

Our circle of competence is rooted in the study of many industries and business models and the development of frameworks to assess why some business models might be more advantaged than others. We have developed insights regarding why some competitive advantages are durable or structural while others are more temporary in nature. Put simply, our circle of competence is assessing enduring business quality. We undertake never to stray from our circle, though as a learning organisation we expect our circle to grow slowly over time. We will only invest in companies we deem to be of the highest quality.

Our most important competitive advantage is our long-term capital base. This affords us a behavioural edge to invest in assets where we are confident that value will increase over the long-term even if we cannot predict the short-term path. It helps us avoid the pressure to produce short-term returns, which could lead to value-destructive behaviours such as focusing on multiple expansion, selling at the wrong time, excessive trading or risk-taking, or investing in businesses that do not match the strategy. Our second behavioural advantage is our strong culture of intellectual honesty, meritocracy, teamwork, commitment to organisational learning, and rationality. Our culture ultimately enhances investment decision-making, and it is an enduring advantage because culture is incredibly hard to replicate or change.

Passion is the fuel that sustains us and what makes us go the extra mile. Without passion, the work quickly becomes a job. We would become less innovative and think less critically. Our team must be passionate about investing, passionate about understanding business models, and passionate about learning.

Investment Philosophy

Built on our foundations, Kalakau Avenue's investment philosophy comprises 7 principles. Alongside our mission, these serve as our north-star not only for all investment decisions but also for all organisational decisions.

1. Risk is the likelihood of permanent capital loss: More simply, risk is the likelihood of losing money. We do not focus on price volatility though we do care about business volatility. We must also be conscious of the other risk faced — missing opportunities and not generating adequate returns (i.e. opportunity cost). Our investment approach tries to balance these risks with a focus primarily on the former.
2. Focus on the long-term: Repeatedly predicting short-term price movements in markets or individual securities is incredibly difficult and can lead to value-destructive behaviour. It is outside our circle of competence. Our long-term capital base, combined with our culture and rational decision-making process, affords us the advantage of focusing only on long-term value.
3. Highest-quality assets: If we are to focus on the very long-term, then we must assume our assets will face hard times at some unknown point. We need to ensure that our assets can survive the path, perhaps even become stronger as weaker competitors are impaired, and emerge with long-term value intact or even enhanced. This kind of durability exists only in the highest quality companies.
4. Deep research: To determine long-term fundamental value and to have conviction in our views during times of severe price movements, we need to understand the companies in the portfolio at a deep fundamental level, always from first principles, and always relying only on our own work.
5. Valuation focused: We seek to own assets at discounts to their fundamental value. It provides a “margin of safety” for when things go wrong. Valuation for us is more a risk mitigant than a return driver — we do not aim to predict multiple expansion, rather our returns will mostly come from the long-term compounding of intrinsic value.
6. Humble concentration: A concentrated portfolio is a must if we are to undertake deep research and build strong conviction with finite resources. However, we recognise that the world is unpredictable and that we will make mistakes. We are therefore mindful of our exposure to any single company, industry, or theme. A portfolio of 10-15 companies is a great balance between concentration of research efforts and diversification of risks.
7. Cash is the default investment: When attractive investment opportunities cannot be found, we will hold cash. However, we recognise cash is an inferior asset to hold over the long-term. We must work hard to find investments and may return capital to our partners when we cannot.

Defining Business Quality

One of the issues with “quality” is that it is impossible to define in an all-encompassing framework. There will always be idiosyncrasies and nuances with every business and industry that cannot be captured in a framework. That said, there are certain high-level characteristics that quality-businesses have in common, which enhance the durability of long-term value. We outline these in brief below but dive deeper in our Business Quality Framework.

1. Superior Value Propositions: Central to any business is the value it provides to its customers. If a company does not provide real value to its customers, then eventually they will find alternative solutions, even if the barriers-to-entry are strong.
2. Structural Competitive Advantages: Competitive advantages (“moats”) come in a variety of forms but only a few are sustainable over the long-term. The best competitive advantages continue to strengthen as the company scales. We want to own companies with assets that are irreplaceable. However, moats can also be abused — we are wary of management teams that use the company's privileged position to under-invest in the business to boost short-term profits or who become too extractive to their customers or suppliers. A healthy and sustainable value-chain is properly incentivised.
3. Attractive & Sustainable Economics: A high-quality company must offer a superior value proposition and defend its competitive position, all while maintaining attractive and sustainable economics in the long-term. We analyse the economics of a business from first principles, including the unit economics where appropriate, to gain a better appreciation of the long-term earnings power. We are comfortable investing in companies where the short-term accounting picture looks bleak when we have confidence in the long-term normalised earnings potential.
4. Attractive Growth Opportunities: We look for businesses that have long duration runways to re-invest into the existing business or into complementary lines of business at attractive returns. We typically own companies exposed to secular growth tailwinds that also have advantaged optionality to enter new markets or launch new products.
5. Strong & Aligned Management: No matter how good the business, management controls the cash flows and capital allocation, and can easily offset the value generated. We assess management based on integrity, execution, long-termism, capital allocation, and alignment.
6. Business Resilience: A key component of business quality is how a company is likely to perform during tough times. We want to own companies that can maintain sufficient cash flow and balance sheet flexibility during these times to fund its operations, to continue to invest in essential growth areas, and to potentially take advantage of weaker competitors. Few companies have this luxury.
7. ESG Considerations: Part of our mission is to maintain the highest ethical standards. We do not want to generate investment returns from businesses we deem unethical. Furthermore, businesses that are bad for the world are unlikely to be sustainable and therefore bring the business quality into question. Critically, we realise this is subjective, but the onus is on us to decide what we should and should not invest in and our investors should hold us accountable.

We do not start our search for quality by looking for high returns on invested capital, strong margins, market share etc. While high-quality companies have such desirable traits, these are “outputs” of the high-quality characteristics mentioned above rather than “defining characteristics”. Simply looking for these traits may run the risks of being too late, confusing an over-earning lower-quality business with a high-quality one, or missing the deterioration in the defining characteristics that led to these outcomes in the first place.

Companies that exhibit these characteristics are often well established in their markets. That said, we are comfortable investing in higher-growth, earlier-stage businesses if there is strong evidence that these traits are emerging and solidifying, and if there are compelling and proven unit economics, even if not yet profitable from an accounting perspective. However, given the additional risks involved, such businesses would typically have smaller position sizes.

Investment Process

You can read more on our investment process here.

Sourcing

Our ideas typically comprise companies exposed to big-picture secular themes around which we have built conviction and/or companies with business models that we are familiar with from prior analysis. Some of these include the transition to the public cloud, the expanding need for and use of data, the continued transition of commerce/advertising online, the increasing reliance on bandwidth and internet infrastructure, the diminishing use of physical cash in society, rising disposable income and consumption in China, and increasing access to global travel. We prioritise companies where we have preliminary indications of business quality and where we think our existing work might help maximise our return-on-effort. It is a bonus if we suspect the valuation will be attractive, but this is not imperative — we are happy doing our work and then being patient for future valuation opportunities.

Research Process

“I very frequently get the question: 'What's going to change in the next 10 years?' And that is a very interesting question; it's a very common one. I almost never get the question: 'What's not going to change in the next 10 years?' And I submit to you that that second question is actually the more important of the two because you can build a business strategy around the things that are stable in time.” — Jeff Bezos

Like most primary research processes, we seek to understand the core business model, the investment landscape, and competitive position. We use a range of resources including company materials, industry periodicals, academic journals, government publications, survey data, podcasts, books, and expert call transcripts. We source industry experts across the value-chain through personal networks and expert network firms but are careful to target the experts we need rather than simply relying on who is available. We take a first principles approach and prioritise the research process around the areas that are most impactful and in which we have lower conviction. However, all of this is simply “table stakes”.

What makes our process unique to Kalakau Avenue is the synthesis of this research into our business quality framework. We score all companies across this common framework to arrive at an overall business quality score that determines its cost of capital. This is not to make the process quantitative but rather to promote consistency of decision-making across the portfolio and over time.

In addition to our business quality framework, we attempt to understand why the business needs to exist and the few things that really matter. We narrow down the key risks and unknowns, including the regulatory environment, and try to understand their likelihood and impact.

All our research, investment frameworks, investment decisions, meeting notes, team priorities, and contacts etc are logged in our custom-built research management system in real time for easy access and recall. Our research management system is a key facilitator of shared learnings among the team and represents a key piece of our infrastructure.

Valuation

We see valuation first and foremost as a risk mitigant rather than a return driver. That is, we are not trying to capture the reversion of mispricing in the market. Our returns will mostly come from the long-term compounding of intrinsic value. We use a variety of methods to value our portfolio companies, all aimed at answering one question, “does a margin-of-safety exist?”.

In general, we model our companies to the point they are likely to stabilise (typically 5 years but this could be longer) and assess the IRR over a range of scenarios, always thinking probabilistically. We strive to build solid forecasts within each scenario and to understand the broad probability of each scenario. However, we also try hard to avoid false precision; valuation as a tool is a sledgehammer not a scalpel. We have more confidence in our views of the business quality — that is, the characteristics we see today that increase the odds of success no matter what the future holds.

We assign a valuation / risk-reward score by assessing the range of returns versus the cost of capital. Again, this is not to make the process quantitative but to help promote consistency and tracking of decision-making. If a company passes our quality filter but is too expensive or not more attractive, risk-adjusted, than the current portfolio then it simply goes on our investable list.

Portfolio Construction

Positions are sized based on conviction and risk-reward. Conviction is developed through our research and the risk-reward is determined with our valuation score, by comparing the range of potential returns versus the cost of capital. Further, sizing can never be decided in isolation from the rest of the portfolio, there is always a relative trade-off. We maintain a sizing framework that outlines suggested sizing ranges based on our quality and valuation scores. As before, the purpose of this framework is not to make the process quantitative and in any case, the framework is only a general guide. Rather, its purpose is to eliminate bias and inconsistency in our decision-making across the portfolio and over time.

The portfolio is adjusted only when there are very material changes in the risk-reward profiles. Positions are sold entirely if the investment is unlikely to compensate for the risks even over the long-term, if the quality thesis deteriorates or is proven wrong, or if the portfolio is fully invested and a competing idea takes precedence.

Once we find the assets we want to own, we avoid the need to feel productive through action. We are unlikely to add value from excessively trading around our positions. Rather, our focus is on assessing whether our investments remain good economic machines by regularly assessing the business performance (not the stock price performance) and any potential disruptive threats. Valuation is only a concern when the margin-of-safety is no longer adequate. We want to allow our investments time to compound over the long-term, maximising our return on effort.

Risk Management

Our primary risk-mitigant is the quality of the businesses we own. Conviction in the quality is built through our research process and business quality framework. This includes analysing and understanding the known unknowns. The business resilience of high-quality companies is what helps mitigate the unknown unknowns. Our second risk-mitigant is to own businesses with an appropriate margin-of-safety. Our final risk-mitigant is to maintain humility in concentration. Concentration is required in our strategy, but some diversification is also useful.

Decision-Making

As portfolio manager, I am the final decision-maker for our portfolio and investable list. All decisions are recorded in our research management system to ensure we capture our current mindset and thinking. This is critical if we are to analyse our decisions in the future and learn from our mistakes. Equally important is what we consider to be decisions. The action of buying or selling a stock might intuitively equate to a decision. However, we must also consider our more implicit decisions and make them explicit. For example, material changes in position size due to market movements are decisions equally as critical to the action of buying or selling.

Team

It may seem odd to refer to the team when I am the only employee of Kalakau Avenue. The reason for doing so is that I have a vision of what Kalakau Avenue will look like in time. Adopting this future in my current mindset helps me keep this vision front and centre. It is better to manage the firm for where it is going rather than where it is today. Further, the process to date has involved contributions from my former family office colleagues where I managed the process in a similar fashion to how I will manage the future Kalakau Avenue team.

Our organisation will always be lean. A small, high-calibre, highly focused, essentialist team can achieve a great deal. It can also be managed without hierarchy. Everyone can sit around the same table to debate investment ideas with strong intellectual honesty and the power of the idea superseding seniority.

Our small team will be built slowly as our budget allows. The initial hiring focus will be recruiting 1-2 smart, hungry, and humble investment analysts to help with research capacity. The key qualities I will be looking for include independence of thought, intellectual curiosity, obsessive and independent learners, humility, first-principles critical thinking, highly rational, team-players, and grit.

Our team will always be compensated on the collective portfolio to promote unity of mission and purpose. Contribution to our long-term mission will drive how one's share of compensation changes over time.

Culture

Culture is critical to achieving investment excellence. Investing is a tough business and the market will eventually uncover any weaknesses in our investment views. The power of ideas and thought must therefore be central in how we operate. Fostering the creation of brilliant ideas and investment thought leadership starts with a strong learning organisation culture, discussed more below. It is then put into practice through empowerment (with accountability) and teamwork. Investing is a human capital business; to get the most out of smart, talented people they need the freedom to explore and implement their talents while being given the appropriate resources, support, and mentorship. To allow these ideas to come to the forefront, we need strong intellectual honesty with a healthy collision of ideas — there is no room for politics or bureaucracy. To incentivise these efforts, we need a true meritocracy where people are rewarded for their contributions to the long-term investment excellence of the firm. Finally, we must strive for rationality in everything we do, making all implicit decisions explicit and removing biases and inconsistencies in our decision-making wherever possible.

Kalakau Avenue as a Learning Organisation

This component of culture deserves a special mention. Continuous improvement is critical to our mission of achieving investment excellence. A strong learning organisation culture starts with individuals. We can only hire people who are highly intellectually curious and obsessed with learning and self-betterment. We must also provide individuals the time, freedom, and support to learn, though individuals with a strong learning mindset always take accountability for their own learning. This individual learning culture is Level I. Level II is about capturing and sharing individual learnings to enable the team’s knowledge to compound faster than any individual. Level II requires strong team players who take the time to share their learnings with others, even if this is at the expense of their own immediate efficiency. Level III is the systematic capture of the team's learnings to implement, change, and improve process. Level III learners require strategic thinking with long-term vision. They inspire others and build coalitions for organisational change, rarely being satisfied with the status quo.

The use of technology is key in reducing collaborative learning friction — our centralised research management system is key here for all levels of organisational learning. However, while technology helps, the real driver is and always will be our culture.

Track Record

The strategy has been running since 1 January 2019. Through 30 June 2023, the portfolio has compounded at +16.7% annualised on a gross basis (vs. the MSCI ACWI at +11.4%), representing +5.3% annualised outperformance.

Returns Summary

Terms and Alignment

Second, we need to eat our own cooking and be fully aligned with our partners. As portfolio manager, I invest the majority of my personal investment assets in the strategy. If the fund loses money, I should too.

In addition, we have no lock on our clients’ capital and therefore the investment is highly liquid.

Common Questions

In launching Kalakau Avenue, three common questions arose:

• Why allocate to Kalakau Avenue when there are more established funds following a similar strategy; why not do something more differentiated?
• Why wouldn’t investors just do this themselves?
• Can you really outperform in well-covered stocks?

Why allocate to Kalakau Avenue when there are more established funds following a similar strategy; why not do something more differentiated? There are some great funds that invest in a concentrated way in high-quality companies with great long-term track records. In fact, some are investors that I have learned from and been inspired by throughout my career. The starting point for Kalakau Avenue’s strategy was not how it would resonate with allocators or whether it was differentiated versus established funds – I wasn’t building a product. Rather, it is the expression of my personal investment philosophy and how I want to invest and compound my own capital over the long-term. I simply wouldn’t be comfortable investing my capital in any other way. That said, while there are similarities with some more established funds, we have our own unique expression of what makes a high-quality company.

Why wouldn’t investors just do this themselves? In some cases, we do recommend that investors do this themselves. It removes the principal-agent issue and lowers the fee load. However, these are only secondary reasons to pursue a direct investment approach. The primary consideration is whether an organisation has a great investment and research process with solid long-term decision-making and governance foundations. Investing is hard work and there are no shortcuts.

Can you really outperform in well-covered stocks? Sources of alpha can be grouped into four broad buckets — informational, analytical, operational, and behavioural. It is true that the stocks we typically invest in are well-covered by research analysts. As such, it is unlikely that we can develop an informational edge. From an analytical standpoint, despite the information being available, many investors simply do not do the work or go the extra mile to understand something. However, there remains many smart, talented investors who do. While we back our analytical work, predicating our investment success on continuously outsmarting the market is unwise — great analytical work should be considered “table stakes”. We also don’t engage in operational value-creation initiatives seen in activist or private equity strategies. Therefore, the key source of value-add for us must be behavioural.

We have been very intentional in the design of our investment process, culture, and business operations to ensure our decision-making process is as long-term and as rational as possible. It starts with having like-minded and equally long-term capital partners. We then keep our expense base extremely low so that we are not dependent on raising capital to stay in business. This dependency would cause us to focus too much on short-term returns. Our investment process and culture are designed to preserve this long-term mindset and highlight irrationalities in our decision-making.

A key example is Meta Platforms. For years this was considered an “obviously high-quality” company. Then in 2018, the Cambridge Analytica issue made it the most hated stock that year. It quickly become a market-darling again until the market then panicked in early 2022 regarding Apple IDFA changes and TikTok. It is back to being a market-darling again, up almost 3x since the November 2022 lows. While we adjusted our view of long-term value for some of these events, the changes were dwarfed by the changes in the stock price. It shows that even in a well-known stock with widely available information, business quality is never “obvious”, and it is possible to generate outperformance in such stocks. It is easy to own “obvious” quality stocks when things are going well but it is harder to maintain conviction during tougher times.

Final Thoughts

The path to achieving our mission will require dedication and tenacity alongside disciplined process and decision-making. At the same time, it will be enriching and rewarding as we engage in our passions and develop deep and lasting partnerships with incredible people. I feel fortunate to be embarking on this journey.

Matthew Brown

Founder & Chief Investment Officer