Hello,

I wish you all the best for this new year. The 2023 performance started on Monday morning at 9.00 am, which means that we must move quickly to analyse the 2022 results, draw the necessary lessons and position ourselves for the next 12 months.

The 2022 analysis

Monocle ends 2022 at -1.92%. (A share).

It's better than many of our competitors, but it's still red - and we don't like red.

Our equity portfolio performed -2.5%..

With an average gross exposure of 35%, this amounts to a performance of -7% on a 100 basis.

Compared to the main equity indices: Europe (Stoxx50 -12%, Stoxx600 -13%) and US (SP500 -19%; Nasdaq -33%), this is good. Of all the equities we have treated over the year, 45% are positive, 40% neutral and 15% negative. This is a good result, especially with markets falling. But the problem is that of the few lines that are losing, two (Meta and Intel) are costing us too much.

Our bond portfolio costs us 4%.

The loss comes mainly from SAS, the Scandinavian airline bond (now at 1.6% of the fund). The stock has no liquidity (about one trade per month, the last one for about EUR 10,000). So in our opinion the price reflects more the lack of liquidity than the real value of the paper. But in any case the impact on 2022 performance is indisputable.

On the rest of the bond portfolio, we have been saying for years that the microscopic returns do not compensate for the risk. So we had nothing at the beginning of the year.

As interest rates rose, we added a few lines (12 to be precise) which now represent 16% of the fund with an average yield of around 8%.

Our covers earn us +7%..

We spent the year 2021 saying that we were in a bubble and that we were taking the necessary precautions. They have proved useful.

Lessons to be learned

The first lesson comes not from finance but from poker.

I don't play it, but there are important similarities between this game and our job. Indeed, as it is the case when you start a game, our performance at the end of the year depends on the same two parameters:

1) The quality of the decisions taken.

2) Luck or chance, call it what you will.

On point 1, we can be wrong.

On point 2, we have no control.

So it is essential to "Thinking in Bets"réfléchir en parisas former world poker champion Annie Duke writes. She explains in her book that even if you have a very strong hand, the probability that the player opposite you has a superior hand is small but not zero. And that if you bet your car every time in such cases, you will eventually walk home. This is what mathematician - fund manager Ed Thorp calls: "the ruin of the punter".

For what lies ahead, I imagine you will find it so simple that you will wonder why these reflections are not already much more widely used.

The reason is that the application of game theories to finance is not obvious.

Having done a lot of research on the subject, holding too many positions because of strong convictions has been the main reason for massive setbacks for many star managers.

To give two examples, the first : Janus funds, which had been excellent during the internet bubble, after having suffered during the year 2000, take two massive bets on ... AOL and ENRON (both stocks will be liquidated in the following months).

The second on credit: Martin Whitman was the go-to expert on high yield for 20 years. In 2008, at the age of 80, he took massive positions in insurers. The resulting loss cost him almost all of his outperformance over the past ten years.

So the first lesson we'll learn is is that we will structure our portfolio so that the worst idea of the year does not cost us more than -2%..

I will be here to do the accounts in early January 2024.

The second lesson concerns bonds.

Having also spent quite a few hours on the subject, I think that it is ultimately a more dangerous asset class than equities.

I imagine that this comment may shock you.

But let me explain: with bonds, the disproportion between limited gains if you are right and large losses if you are wrong makes it a game where, in the long run, you only win something if you have very few cases that go wrong.

In order to have very few files that go wrong, you should only touch files of good quality. But there are too many people on these, and they are only professionals.

They leave few opportunities on the table.

If you take on riskier files, sooner or later your file will go into restructuring. We have done a few such operations. Some of them went well (Steinhoff, DIA), others more badly (SAS).

Today we have a very small line (0.20% of the fund) in an Orpea bond bought post scandal - very cheap (at 21% of par). So we are in the creditor group discussions during the restructuring phase.

I give you my conclusion:

1) It is terribly long and complex.

2) We have little control over the final outcome, which depends on a set of factors that are too random (the will of the State, the role of the insolvency administrator, the appetite of the markets for refinancing etc.).

The second problem is liquidity.

Bonds are not traded on regulated markets and there are fewer participants. So there is less liquidity. So as soon as something goes wrong, it's much harder to get out. You can't "vote with your money" as the other guy said. You are much more subject to it. Especially when the bond starts to go into the red, the price drops can be much faster and sharper than for a stock.

This does not necessarily reflect the evolution of the intrinsic value of the paper, but directly impacts your performance.

I then took the problem in the other direction:

What major investors do we have in bonds?

Warren Buffett made very little use of it.

Bill Gross, the founder of PIMCO who was nicknamed the "bond king" in the 1990s, explains in his latest book that his strategy for beating the bond index was to replicate it and then add decorrelated strategies around it to create alpha (outperformance if you like).

And furthermore, in his latest interviews, he himself says "is it the man who makes the time or the time that makes the man?" referring to the fact that rates have gone from 15% to 0% throughout his career, putting the wind at his back permanently.

I looked carefully : I can't find any investors who have made a lot of money in bonds over the long term. This "heads I gain 3%, tails I lose 50%" thing prevents you from doing it. If you look at European high yield bond funds, 2022 alone has brought their 5-year performance down to almost zero. Five years of analysing, selecting, buying, selling to get zero.

Therefore, the second lesson we learn is is that we want to reduce our bond portfolio.

Today we have to have a minimum of 51% in bonds. We will reduce this threshold. This will require a change in the prospectus and will therefore take several months. You will be informed as the process unfolds.

I keep in mind that Monocle is a heritage fund - and a major part of my wealth is in it - so we will continue to manage the fund in that spirit. But with fewer obligations.

The year ahead

Our vision for 2023 will be the same as in previous years: it will be complicated.

There are several reasons for this :

1. Valuations remain high. Even though there was a significant correction last year, many stocks remain expensive. On a 30,000-foot view, the Shiller PE is still well above its long-term average. At 300 feet, many Nasdaq companies are still valued at ten or twenty times their sales and still unprofitable.
2. On inflation, there are too many possible scenarios to bet on just one. In the "big picture", I note that Larry Summers and Paul Krugman, who are not often of the same opinion, say that with such a tight labour market, we cannot be reassured about inflation. For this tension to ease, we need a recession.
3. Expectations for 2023 results have been greatly reduced. Will they surprise on the upside or the downside? There is nothing obvious on this question. I do note, however, that we saw growth rates drop significantly in 2022 when it was full employment. What will happen to demand when the recession that the FED wants (see above) arrives?
4. The global context remains extremely difficult: war and pandemic continue; geopolitical tensions are increasing and the effects of some problems seen in 2022 will only be felt this year. For example, the lack of fertiliser last year will only be seen this year in cereal production.

Consequently, I think that this context does not favour maximum risk-taking. It therefore seems to me that it is better to look for "quantitative" rather than "qualitative" cases. In the "quantitative" case, you generally make less money, but more safely.

And as always, you know that at Monocle, we are available and reachable - so don't hesitate to call us with any questions.

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Market and portfolio focus

Behaviour:

Regarding the fund's performance in December, you will find most of the information in the Factsheet attached to this post (see below). The fund posted a stable performance in December in falling markets (-9% on the Nasdaq 100 and -6% on the SP 500) - mainly due to the resilience of our equity positions and the positive contribution of hedging.

Lines:

Pershing Square (1% of fund) We have invested 1% of the portfolio in the shares of William Ackman's listed hedge fund: this is a philosophy and a quality of management that we like and on which we benefit from a 35% discount between the listed share price and the net asset value of the fund.

Pfizer (from 7% to 2% of the fund) The company remains attractive in our view (especially given the momentum of covid - to which we remain exposed in particular through Biontech) but the limited upside potential and the complacency that the market has shown in recent weeks make the stock riskier in our view.

See you soon,

Charles