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Aquamarine Fund Zurich March 12, 2013Dear PartnerInvestment ResultsIn 2012, Aquamarine Fund returned 27.8% net of all fees to investors, as compared to 16% for the S&PIndex. For those investors in were with me at the very beginning, each $1 that you originally invested intoAquamarine Fund is now worth over $4. If you had invested in one of the indices, you would havedoubled your money. This amounts to a 4.8% annual outperformance over the S&P Index.My results are reported to you net of all fees and expenses, and the numbers for the S&P includedividends in order to make it an apples-to-apples comparison.Choice of Index: S&P vs. MSCIOver the last year, I received a number of questions asking why I compare my performance to the S&P inthese reports rather than the MSCI World Index which covers a more global basket of stocks.The short answer is that I do not want to “index shop”, or even go anywhere near that slippery slope. Comparison: Aquamarine Fund vs. S&P vs. MSCI Total Return Annualized Aquamarine Fund 298.5% 9.5% MSCI World 39% 2.2% S&P 98.3% 4.3%As the above table shows, the MSCI World has underperformed the S&P and may well continue to do so.If you are the creator of indices, there is not much demand from the fund management industry for indicesthat outperform the current ones. But there are plenty of underperforming funds that would like a bettercomparison, and the index creation industry is happy to oblige.The S&P, along with the Dow Jones Industrial Average, is an index that has been prepared for more than100 years and serves as a reliable indicator of investment market performance.Assets Under Management, Subscriptions & Redemptions.SubscriptionsIn 2012 we received $3.47 million in new capital. Half of this was additional investments from existinginvestors, and half was from five new partners. Each one of these new partners is an individual or a familyinvesting their own money and whom I know personally.RedemptionsWe received redemption requests for $2.69 million. Of those redemption requests, four were completewithdrawals totaling $320,000. The balance was partial withdrawals by existing investors whichrepresented a minority of their overall investment.It gives me satisfaction to see my partners meet life goals as a result of the appreciation of their holdingsin Aquamarine Fund.
Aquamarine Fund Assets Under ManagementWe ended 2012 with $118 million in assets. This is sufficient to run Aquamarine Fund comfortably, whilealso giving plenty of trading flexibility. We have low portfolio turnover and therefore, are not encumberedby difficulties in executing trades. I am confident that I will be able to continue to operate in this modeuntil the assets reach $1 billion or more.The most important thing to you is and should be your own investment return. I give you these numbersbecause I would want to know them if I were in your shoes. It should give you a sense of howAquamarine Fund is doing as an enterprise and offer an insight into my state of mind.Net New CapitalSubscriptions net of redemptions for 2012 were $0.78 million, which is a slowdown relative to 2011,during which I received $3.9 million in net new capital.I cannot give a definitive explanation for this other than that we are not immune to the animal spirits of themarket. During 2009 and 2010, the S&P Index was up 20%. Aquamarine Fund by contrast had anoutperformance of 40% having returned +60% over those two years.In 2011 the S&P took a pause and Aquamarine Fund was slightly negative. This may well havesubconsciously dampened the ardor of some potential new partners.Analysis of Positions Exited in the Last Year.Japanese Basket of Ben Graham-style Net-NetsA Ben Graham style net-net is a company that is trading for less than liquidation value. In 2010, my globalscreens for these sorts types of net-nets were showing a very high proportion of Japanese small-caps. Thisled me to some further thinking about Japan. Contrary to reports of imminent demise, it was clear to methat Japan is still an economic powerhouse. It is still among a handful of countries that are able to borrowin their own currency, and its deep interconnection with the global economy was very evident during theslowdown in the automotive supply chain in the aftermath of the 2011 Tsunami.Moreover, the Nikkei index of Japanese stocks, after having peaked in 1989 at close to 40,000 Yen, wastrading at less than a quarter of that value.I started purchasing Japanese net-nets as a basket in March 2011, selecting companies that met thefollowing criteria: 1. Cash on the balance sheet, net of debt and all other liabilities, greater than the market capitalization. 2. Ratio of market capitalization to after-tax earning power in the single digits.I would argue that these criteria made the basket even better than a Ben Graham portfolio.In total, through the end of the third quarter of 2011, I had purchased shares in thirteen individualcompanies. Then I stopped purchasing Japanese net-nets because I was finding much better opportunitieselsewhere – where there was better value and a better catalyst.With the same alternative opportunities available in mid-2012, I started selling the basket to raise morecash for other purchases. By December 2012, I had substantially exited the basket.
Aquamarine Fund The returns on individual names in the basket range from -20% to +46% and the overall return includingdividends was approximately 16%. While this far exceeds the return available on risk-free assets, thebasket underperformed Aquamarine Fund over the same period. Indeed, had I not diverted new moneyaway from the Japanese basket, our return in 2012 would have been substantially lower than the 27.8%result.This is the first time that I have held a Ben Graham Geiger-counter to the market and ferretted out net-netswith real money and I can report that it works as well in practice as in theory.There are some limitations. The main one is that there seems to be a correlation between how well net-netswork and the efficiency of the market for corporate control. The United States has the deepest and mosteffective market for corporate control which makes it far less likely that ridiculously cheap stocks will sitaround for long. This means that when they are found, the return is likely to be good.Japan is not that way and taking an activist position in the Japanese basket was never an option that Iconsidered: The market capitalizations were too small. Moreover, using legal and other threats on anymanagement team is not my style and would have gone profoundly against the grain of Japanese culture.Here is another consideration. Constantly updating stock screens, seeking the cheapest stocks and thengetting trades executed across time zones creates a lot of “busy work”: Plenty of activity, and not muchinsight. Given that I could not read the annual reports in their original language, I could not gain a deeperunderstanding of specific companies and the knowledge gained is a sort of an investment-research dead-end.Harley Davidson and HeinekenAlso sold during 2012 were positions in Harley Davidson and Heineken. The shares of both thesecompanies were purchased around seven years ago and although we doubled our money in them, the timeit took to get that double resulted in a relatively low rate of compounding.Harley Davidson and Heineken are examples of GARP (growth at a reasonable price) investing. It is a lotof fun to own shares of companies like these. For example, Heineken’s promotion of the James Bond filmQuantum of Solace, starring Olga Kurylenko, enabled me to put up slides of Kruylenko at my partnershipmeetings as well as one of myself on a Harley Davidson motorcycle. Any investor – current or prospectivewill tend to raise their eyebrows approvingly at the mention of such familiar brands. It creates a commonpoint of interest and discussion, which feels really good for all concerned.Aquamarine Fund is, and should be about delivering investment returns, not about feeling good.The checklist item that these investments violated is one that asks, “does making this investment result insome non-monetary, or psychic gain which interferes with my ability to think clearly about the investmentreturn?”.Omaha in ZurichI hope that you are as gratified by these results as I am. They are a direct result of things that I havelearned since 2008:Although it took me a long time to figure it out, I have a much better sense of where and how to invest. Itis not about simply picking the best company, but about picking the best bet given the odds. HowardMarks would call this second level thinking, and as with many things investment related, it is easy todescribe but difficult to implement.
Aquamarine Fund Some things have made it easier. For starters, I no longer talk publicly about current ideas. This gives mea lot more freedom to invest in my best ideas, rather than getting tangled up with the complexconsiderations that arise from talking about them.One element of this is clarifying the difference between fundraising and investing. Much of the activitythat we see in the investment world has little to do with good investment practice and a lot to do withattracting attention and raising funds. I understand this far too well – because I have been there.My focus for the last three years has been on creating the right environment for good idea generation andthen executing well on those ideas. While I still have plenty of improvements to make, I am confident thatI am moving in the right direction.Many people of the value investing ilk have been nurtured on stories of Warren Buffett working out of hisbedroom and Walter Schloss out of a small room in the offices of Tweedy Browne next to Grand CentralStation. The image is one of a semi-recluse, reading through annual reports and placing a stock trade everynow and then by phone.This is not the whole picture. Certainly all successful investors do an enormous amount of reading,especially of original materials, throughout their lives. When they are not reading, successful investorswork on and tap into rich and deep social networks that they also use to source and evaluate investmentideas in tandem with original source material.Everyone builds on different networks. When he was younger, Warren Buffett made regular andextensive trips to New York City as well as Washington D.C. where he met a very diverse group ofpeople. Then he would return to Omaha to think through the ideas that he had heard. These days, he hasless need for that sort of travel, and most of the valuable insights that cannot be gained through reading areavailable to him through a phone call.In a similar fashion, when I knew fewer people I had to do more on the ground scuttlebutt research. Now,with a richer and denser network of relationships, much scuttlebutt can be replaced by conversations withwell placed and knowledgeable people.While the right meetings and conversations cannot replace source material, they can save time and makeall the difference between getting the right insight or not. Thus, although my pace of travel has not sloweddown much since I moved to Zurich, it is much more productive. In New York City, I spent more timetraveling to potential investors. By contrast, much of my current travel is focused towards developingrelationships – both within and beyond the narrow world of investing – that have had a substantial impactin my investment decision-making.Lastly, I believe that creating this new environment has vastly increased my ability to leave the portfolioalone and let time work its magic.Current Investment ClimateLike a number of other economic observers, I am a little aghast at the implementation of QuantitativeEasing around the world, and the prospects for inflation. That said, I have twice had the opportunity tomeet with Stanley Fisher, Governor of the Bank of Israel, and former thesis advisor of Ben Barnanke.Both times, I posed my fears of inflation to Fisher directly, and he was respectfully and thoughtfullydismissive in the way that perhaps only central bankers can be. Fisher was very confident in the ability ofcentral banks to take liquidity out of the markets when growth restarts in earnest, and before inflationtakes hold.
Aquamarine Fund My strong sense of his personality is that he is extremely sober and has no interest in taking policy actionsthat would favor his own popularity over the benefit of humanity.As they say, expect the best and prepare for the worst. With this in mind, I hope that he is right. Even so,all the investments I make take into account the likelihood of substantial inflation (mid to high singledigits) over the next decade.I think that investors in so-called risk free assets – especially government bonds – will do absolutelyterribly over the next decade, and that equity investors will do better. People who pick inflation-proofstocks will do best. I very much intend to be part of that group.I think that I have often underestimated the impact that low cost natural resources had on the industrialrevolution of the 19th century. Similarly, I suspect that much of the investment world underestimates theways in which low cost natural gas and oil from shale will invigorate the American economy.A big takeaway from reading Jared Diamond’s “Guns, Germs and Steel” is that geography really matters.Asia’s size and shape – spanning similar latitudes East-West, in contrast to Africa and the Americas whichspan North-South, probably made it inevitable that human civilization would develop in Asia. Similarly,Britain’s unique geography as an island off the coast of Europe gave it huge advantages before and duringthe colonial age. Looking forward, my sense is that the United States – with its vast spaces, abundantland, water and natural resources; with coasts facing Europe and China; a single market and politicalsystem; and now low cost energy – will make the 21st century an American century in spite of its manifestproblems as well as challenges from other regions.This is not to say that the rest of the world is not worth looking at, but only to say that I am not trying tobe fair in my allocation of capital when it comes to geography. My goal is to deliver the highest rate ofcompounding that I can, wherever that may be.Original, Management Fee Paying Share Class to be Closed.Right now – two share classes are available to investors.Original Share ClassThis charges the investors a 1% management fee and a 20% performance fee over a four percent hurdle. Itis redeemable after one year on 60 days notice.Zero Management Fee ClassThis share class replicates the Buffett partnerships. It charges zero management fees and 25% of theprofits above a 6% hurdle. It is redeemable only once every year on the anniversary of the originalinvestment, with 60 days notice.It is a better deal for investors, a better alignment of our interests and an arrangement that I much prefer.Not surprisingly, the percentage of investors who have this share class has gradually increased. Year End in 0 & 25 % share class Percentage of Total Assets 2007 0% 2008 3% 2009 4% 2010 6% 2011 13% 2012 16%
Aquamarine Fund With this in mind, my plan is to stop accepting new investors into the old, fee paying share class at the endof 2013, after which the only share class available to new investors will be the Buffett style share class.CISA: Swiss Collective Investment Schemes ActAs I write this, Switzerland is in the midst of enacting major changes to its regulatory regime for assetmanagers – a rubric that I fall under. The popular mood in Switzerland is that voters are stung andashamed by the various banking and financial scandals that have engulfed the Helvetic Confederation inrecent history. They demanded and received legislation that has taken Switzerland from having a lighttouch when it comes to financial regulation to careful and stringent regulation.FINMA, the industry regulatory body, is currently writing detailed rules that will implement thislegislation. The details are not yet finalized, but this heavy regulatory touch may be cumbersome to ourmode of operation.We will have plenty of time (two years) to comply with the new regulations. It is possible that we willhave to fully register as an asset manager. Another option under consideration would be to close the fundto new investors which would mean that in 2015, we would fully close Aquamarine Fund.In the Event of my Death or IncapacitationVarious investors and prospective investors have asked what would happen in the event of my death orincapacity – which is not well handled by the documents. Here is a statement of my policy that I willimplement over the coming months.Upon my death or incapacity, Aquamarine Fund would immediately open for redemption to all investorswho no longer wish to remain invested with Aquamarine Fund without me. I have asked a deeplyrespected friend and peer investor to oversee an orderly liquidation of the portfolio in order to meet thoseredemptions and he has agreed to perform that role.For those investors who wish to remain invested in the fund, that peer friend and investor would continueto operate the fund and facilitate an orderly incorporation of the remaining investors into his funds.I will be happy to have an in depth conversation with you about this if you choose.Our Value PropositionI continue to believe that Aquamarine Fund offers an extraordinary value to its investors. • Low/No Management Fees. It is not unheard of in the fund management industry for investors to be charged 2% or even 3-4% of their assets for the privilege of having their assets managed by some bank employee. At Aquamarine Fund, the maximum fixed fee that you would pay is 1%. • “We eat our own cooking.’ The vast majority of my net worth is invested in Aquamarine Fund and I have no material investments elsewhere. My success in life is entirely dependent on the success of this vehicle. It is an example of “put all your eggs in one basket and watch the basket”. • No leverage, No margin loans, No short positions, No complexity. I want to earn you a return by purchasing part ownership in businesses. In the past, banks have tried to entice me to engage in complex transactions and I had no trouble resisting. Businesses are the wealth creation engines of society, not derivatives.
Aquamarine Fund 2013 Annual MeetingsI plan to hold three annual meetings – in London, New York and Zurich as follows:Monday, October 7th at the Carlton Club in LondonThursday, October 10th at Zunfthaus zur Zimmerleuten in ZurichTuesday, October 15th at the Harvard Club in New YorkPlease email either Orly Hindi email@example.com or Lynda Brandtlbrandt@aquamarinefund.com if you are interested to attend.Thank YouPart of my learning over the past three years has been to discover that I have a phenomenal set of investorsso thank you for investing with me.In connection with this most people who invest with Aquamarine Fund came referred to me by existinginvestors such as yourself. If you know someone who you think would benefit from investing inAquamarine Fund, please don’t be shy.Please feel free to call me about referrals, or anything else via phone on +41 44 210 1900 or+1 212 716 1352 (yes, it rings in Zurich!) or via email at firstname.lastname@example.org.With warm regards,Guy SpierManaging Partner
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