Investing with (a) style: Dutch treasure hunter

Passion! Passion for the business, for the great investors. You will notice, Michael Gielkens has been firmly bitten by the microbe. This Dutchman who you can find on Twitter under the name @MichaelGielkens, has made his passion his profession and runs an investment boutique Trésor Capital. A vessel full of knowledge and very generous to share it! It provided a solid chunk of reading material, perfect for a cold weekend. Enjoy!

You caught my eye because of your posts on social media showing a great passion for investing and all things related. You are also a partner at an investment boutique Tresor Capital with a focus on compounders and family holdings. By way of introduction, can you share how the microbe got you and how you were able to turn your passion into your job?

First of all, thank you for the opportunity to contribute through this interview.

During the credit crisis, oddly enough, the investment flame started fanning, my father had company stock and employee stock options through his job, which I found interesting and I talked to him a lot about it. When I was studying business economics in 2010, a teacher pointed me to an investment club with (former) students, which caught my interest. At the same time, I delved more into the subject matter myself and soon came across the works of Warren Buffett, after which I was sold. After completing a master’s degree in Maastricht, I was asked by a member of the aforementioned investment club to join an asset manager as an analyst.

With three colleagues, I created a nice portfolio at a Luxembourg-based asset manager starting in 2016. As of January 1 of this year, together with these colleagues, I shaped the Dutch investment boutique Tresor Capital, where the jointly developed investment vision is propagated even more widely. We were also able to set up a nice partnership with two new, experienced and valued colleagues. Our focus is mainly on family holding companies and a few distinctive funds, supplemented with some specialties such as private equity.

A recurring question I often ask is how your style has evolved over the years. With your fund, you target the active, family-owned holding company doing recurring acquisitions. Was that your first personal style and what triggers shaped your trajectory?

From investment theory, it is preached that the stock market would always be fully efficient. It is argued that one cannot do better than the market, so then it is suggested to buy a passive index fund. Although for retail investors without underlying knowledge and/or time to do research, incremental investing in a world stock index is a great option to still be able to invest in stocks, something gnawed at me. According to the theory, the stock market is said to be efficient, with assumptions that investors would act rationally at all times and that all relevant information is known to all market participants. Under such assumptions, such a theory may indeed be tenable, but in practice there are daily examples of market inefficiencies and irrational behavior. At the individual stock level, this is often even more evident. The field of Behavioral Finance and the works of a Nobel laureate like Daniel Kahnemann have influenced my thinking in this sense. The works of Hans Rosling of the Gapminder foundation have also been an influence, he showed that the media often paints a much more pessimistic picture of the world than is justified from actual developments. So always do your own research.

So the fact that there are regular inefficiencies in the stock market, mostly overreactions due to emotion, presents great opportunities for active investors. Warren Buffett and his followers have shaped my investment philosophy in this sense. But classical value investing, as propagated by founder Benjamin Graham in “Security Analysis” and “The Intelligent Investor,” was harder for me to reconcile with a long-term philosophy. After all, according to classical doctrine, when an undervalued stock reaches its fair value, you should sell the stock and buy another position. For example, Buffett was a “cigar butt” investor in his younger years, buying extremely cheap stocks because there might be one last puff of the discarded cigar butt, and thus had a high portfolio rotation. The same influences that transformed Buffett into more of a quality investor with a long-term focus also had their effect on me. A well-known Buffett theorem is that it is better to buy a great company at a reasonable price than a reasonable company at a great price. Charlie Munger, in particular, was a defining factor in this, and his book “Poor Charlie’s Almanack” I highly recommend to everyone. By the way, it’s nice to mention that Graham made a substantial portion of his fortune with Geico, a “growth company” that totally failed to meet his own explanation of value investing.

Berkshire Hathaway, Buffett’s investment holding company, was a logical place to dig deeper. With a broad portfolio of listed and unlisted positions, Berkshire has managed to beat the U.S. S&P 500 index for decades. That was a great example for me, investing in a diversified portfolio but still being able to beat the stock market by acting rationally and seizing opportunities with both hands. That warranted further research, which led me to the works of Nassim Ben Taleb. In particular, the concepts of “antifragility” and “skin in the game” were crucial to understanding Berkshire’s success. Berkshire is not only crisis-proof, but even antifragile; the company actually gets stronger from a recession. Skin in the game means that there is a sizable ownership stake (ideally a multiple of the annual salary) within the board, SB and/or among the reference shareholder(s), so that not the short term but the long term prevails. These insiders are then connected to the success of the company with their own capital, and thus even better represent the interests of the shareholders, partly because they themselves belong to that group. For this I would like to refer to the white paper called “Skin in the game” on our website www.tresorcapital.nl.

Further research revealed that there are many more companies around the world, investment holding companies and serial acquirers (a.k.a. acquisition machines), that have the same characteristics. A family or group of insiders has a controlling interest and does not do crazy things, so there are, for example, solid capital structures and a clear vision of how capital should be allocated. So these companies have a heavy weight in our investment portfolio. By the way, we do not work with a fund, but through a discretionary management mandate.

I notice that you are a big fan and supporter of Buffett and his style. What do you bring to Tresor and where do you deviate from Buffett’s philosophy?

Despite becoming a quality investor, Buffett did always remain at heart a value investor. In the early years of an investment, the price you pay is critical to returns. However, I always keep a quote from Charlie Munger in the back of my mind: “In the long run, it is difficult for a stock to achieve a much better return than the company underlying it. If the company earns 6% return on its capital over 40 years and you hold it for those 40 years, you’re not going to deviate much from a 6% return, even if you originally bought it at a huge discount. Conversely, if a company earns 18% on its capital over 20 or 30 years, you end up with a nice return even if you pay an expensive-looking price.” That’s a philosophy we certainly subscribe to.

So valuation is relative. A company with a price-earnings ratio of 6 cannot necessarily be called cheap. What is the return on invested capital, what does the debt level look like, what are the growth prospects? These are important things to pay attention to, that is also certainly a similarity to Buffett’s style. By the way, we do try to optimize the risk-return ratio at all times by shaving off companies that are modestly discounted relative to their own history in favor of companies that are relatively discounted, but that’s more on a tactical level. We always try to stick to our strategic, long-term allocation.

One difference is that we do not hold so much large cash positions. Buffett has a substantial cash mountain of over USD 100 billion, but that is mainly the consequence of the size of the company. Since we invest with smaller amounts of capital, we can also invest in smaller companies. The “future Berkshire’s,” as it were. Another difference is that Buffett rarely invested in technology companies because it was outside his circle of competence. Berkshire bought a sizable position in Apple only after Buffett started considering it a consumer company. We invest in companies that do have exposure to technology. For example, an investment holding company may well have specific expertise, in which case we “hire” the management/family of the holding company to shape that piece of the portfolio, so to speak, by buying shares of that holding company on the stock market.

What is your benchmark within Tresor?

Our equity benchmark is the MSCI World All Country index, in euro with dividends reinvested. Since we invest globally, it makes sense that we also use a world index as our benchmark. What we do not do, however, is the so-called “index hugging.” Many parties deviate only minimally from their benchmark, trying to achieve a small outperformance and especially not doing much worse. In constructing our portfolio, we are completely agnostic of the world index. This has been a bit disappointing this year, as more than two-thirds of the world index is made up of U.S. companies, thus benefiting from a stronger dollar. Due to the huge flows of money toward passive investments, U.S. technology companies in particular have risen substantially in recent years, but high interest rates have actually put pressure on this segment. We remain convinced that a well-thought-out selection of companies should be able to beat the world index over an entire economic cycle.

You also often invest in holding companies with Tresor. Doesn’t that cumul of holdings in companies that have holdings become half an ETF over time? Can you have too many holdings in your portfolio?

The similarity of a holding company to an ETF is that costs are often relatively low. To cite the example of Berkshire Hathaway again, the head office employs 26 people, the entire organization employs 371,653. By having a decentralized corporate structure and trusting the subsidiaries and management teams (often acquired along with the acquisition of the company itself), there is no need to have an unwieldy, bureaucratic organization at the holding company level. In fact, the agility and flexibility at the holding company level makes these companies very dynamic.

The difference, however, is that with an ETF there is usually no active management or skin in the game. With a holding company, a family or group of enterprising insiders provides clear added value. An active selection, versus a passive ETF that merely tracks an index or basket of stocks. In addition, a holding is typically traded at an undervaluation, allowing you to buy the underlying portfolio at a discount. With an ETF, the price is a direct representation relative to the underlying holdings. This makes it possible, in addition to active management within the holding company itself, to optimize the risk-return ratio of a portfolio of holdings from time to time.

Of course, too much diversification can work against you at some point. If you have 100 stocks in your portfolio, it is impractical to track them consistently as an individual or small team. The same applies in that sense to a portfolio of more than 20 holdings. You’re going to get too diluted then I think. Therefore, it is good to ask yourself if the 21st idea is really better than number 20. The added value of any stock above 20 positions is quite small in terms of diversification, and especially if those 20 positions consist largely of holdings that already have inherently wide diversification. Continuous evaluation of the existing positions is obviously part of that.

You often interact with management, take the long view. I also feel a lot of passion for your participations. For example, you fiercely defend Sofina against the known shorter. Does that make you more forgiving in evaluating performance? What is a limit to selling anyway?

The selection in our portfolio is the result of thorough due diligence, interviews with management, the founders/family and Investor Relations, and visits to shareholder meetings. If you follow companies over several years and interact with them, you get a feel for the corporate culture, the way they operate and whether they actually deliver what they promise or say they do. It is striking how one-sided or ill-informed various journalists or analysts sometimes are in their reporting or analysis. Sofina’s shorter case and related reporting is a good example. Without wanting to repeat the specific case at length here, it has since become apparent that the short-seller’s arguments are based on loose sand. His allegations against Sofina, one of the most conservative holdings in terms of valuations of their holdings, were downright ridiculous. For example, he claimed that the corporate valuation of Byju’s on Sofina’s books was over EUR 10 billion higher than what this stake was actually on the books for. Media outlets that at first only expressed praise toward Sofina suddenly turned 180 degrees, which had a negative impact on the stock price. The company went from a premium to its intrinsic value, to a steep discount. Brederode has a stake in Sofina, its CEO recently said, “It remains a well-run holding company with a long-term perspective. The market was perhaps too euphoric on the boom side. Now it may be too pessimistic on the downside.” I gladly concur with that.

One reason for selling is when the investment case has changed dramatically. Also, if the reference shareholder, being the founder or family, sells a sizeable chunk of shares, that can be reason to reevaluate the case, because these insiders are closest to the fire. If value is destroyed, that is a clear boundary that can lead to a sale.

In a family holding company, we usually make sure that the best managers are appointed, whether they are members of the family or not. However, we are very alert to potential nepotism. Someone should not be appointed because they are a member of the family; someone must also be competent for the job. Families generally deal with this well, for example by requiring good education, training programs and external practical experience before a role within the family business is awarded. If that is not the case, however, it is a red flag and cause for sale.

Sometimes a sale is the result of a more attractive candidate presenting itself, for which cash must be released. Rather than a sale, reducing the weight of a position in the portfolio may be the result of optimizing the risk-return ratio, for example. Valuation can be a trigger for this, for example in a situation where the undervaluation of a position has increased significantly due to non-fundamental reasons. That recovery potential to a more normal discount can make an interesting contribution to additional returns.

You may notice that macroeconomic or geopolitical reasons for this are not named. We judge an investment case on its merits: does it add value and potentially contribute to longer-term returns? However, the corona pandemic outbreak was an exception. At the time, for example, we had positions in an American holding company that could finally start harvesting its hotel chain after years of investment, and a European holding company with a large international logistics and transport arm. At a time when you have no visibility at all regarding the severity and duration of lockdowns, suddenly the earnings model seems to be severely affected from such positions. Those were reasons to sell these positions. Buffett did the same with airlines, for example. Unwise in hindsight, but a prudent choice at the time given the circumstances. Another holding had a large mail and parcel division, which actually benefited substantially from digitalization as a result of covid. Investors, however, seemed to extrapolate the digitalization trend a little too far into the future; this holding company’s discount had shrunk sharply and its share price had more than doubled in one year. That was a reason to sell this position early in 2022.

As a professional, how do you deal with PE portfolios that are difficult to fathom within certain holdings?

This is where the importance of good due diligence once again comes to the fore. Things like skin in the game, track record in private equity returns, transparency and historical growth in intrinsic value are important parameters. Ultimately, you depend on the founding family and management to run the company properly, and to make investments that achieve attractive returns on invested capital. This is essentially true of all holding companies and actually applies as much as it does to holding companies with publicly traded positions. You entrust part of your investment portfolio to the expert management of the investment holding company. The fact that the major shareholders themselves have the bulk of their capital in the holding company provides confidence in this.

Of course, you do research the underlying managers. The holding companies with private equity portfolios are transparent about the parties to whom they have entrusted capital and about the largest managers in terms of committed capital, so you can see that they are dealing with good parties. This transparency has increased in recent years, which is also a good thing.

Furthermore, we also invest in private equity for clients who wish to do so, and then, for example, it is very gratifying to hear from this corner that they see a Sofina pass by several times among the most attractive and successful investment propositions. Track records of decades of outperformance of private equity portfolios mean that such holdings have more than earned the benefit of the doubt.

In current times, many investors are dropping out. How do you deal with that within your job? Do you try to change people’s minds? What are your arguments?

In our client meetings, our monthly report (available for free on our website) and our weekly newsletter, we try to encourage clients to keep the focus on the longer term. In the short term (less than two years), it is mainly sentiment and valuation that influence stock price movements, in the medium term (two to three years) it is the development of the economic cycle or the industry, in a term of more than three years the return on capital invested is decisive, and in the very long term corporate culture plays a crucial role.

We select only companies with rock-solid balance sheets and relatively little debt (often even a net cash position), strong market positions and sustainable competitive advantages in attractive niches (a moat) that have pricing power. So rising interest rates or high inflation have limited impact on these companies, but sometimes stock prices seem to reflect a completely different picture than fundamental reality. For example, companies are wrongly considered cyclical, or belong to a particular sector that is under pressure, resulting in selling pressure for all components of a particular subsector (this is where passive capital flows then play a role). In short: the stock price does not reflect reality. In the long run, it is not sentiment but fundamental reality that plays a decisive role. Graham said, “In the short run the stock market behaves like a voting machine, in the longer run like a scale.”

So we try to make our clients understand that the real risk, that of permanent capital loss, is minimized with our carefully chosen selection. Price fluctuations, volatility, only show the emotion, it is only a short-term mutation. We are there to unburden the client, so our main task is to help the client to look beyond the emotion of declining prices. In this respect, I think it is significant that the number of clients who have gone (partially) liquid can be counted on one hand. In the fourth quarter of 2018 and the first quarter of 2020, prices also fell sharply, which is one of the characteristics of financial markets. Only to then show a sharp recovery, with fundamentally strong companies pulling the cart. Therefore, the relationships that have already experienced these periods are already well able to accommodate the current turbulence.

Regardless of valuation, what do you think is the holding company that is best managed?

This is a more difficult question than it seems. After all, if a holding company is not well managed, it is not part of the portfolio either. That said, there are of course positive outliers to note. I think Berkshire should not go unmentioned, Buffett and Munger, but also Ajit Jain and Greg Abel are managers of exceptional quality and Berkshire is, I think, the epitome of an excellently managed, decentralized organization and corporate culture. Tom Gayner at Markel should also not go unmentioned; he and the Markel family have created an exceptional corporate culture. The thoroughness and sincerity he exudes and the things customers, employees and competitors say about him speak volumes.

Surely the standout as far as I am concerned is Constellation Software, a holding company that includes more than 1,000 decentralized niche software companies. Founder Mark Leonard has at times expressed sincere delight when he is convinced of a different point of view in a discussion. He is constantly learning and constantly improving himself. On a daily basis, he and his management team, commissioners and subsidiary executives examine how to improve, optimize and continue Constellation’s “runway” of highly profitable acquisitions. One interesting result of this is, among other things, that the company is spinning off “mini-Constellations,” subsidiaries that are themselves making acquisitions, and listing them separately on the stock exchange so that they retain their corporate identity and can make acquisitions under the existing corporate name. For example, Constellation absorbed Dutch company Topicus, and recently subsidiary Lumine, which will soon go public, also incorporated WideOrbit. Mark Leonard mentioned at that acquisition that he hopes his grandchildren will still own the stock 50 years from now, talk about a long-term horizon.

Constellation’s compensation structure is unique, especially in the software world. Whereas countless software companies dilute their shareholders with the virtually rampant issuance of employee stock options, Constellation employees are required to invest 75% of their bonus in Constellation shares on the stock market and hold them for a minimum of four years. This creates the ultimate form of skin in the game and a long-term focus. A look at the stock price shows that hundreds, if not thousands, of employees have now become millionaires by holding the shares. Something that to me is most indicative of the exceptional corporate culture is the fact that the absolute majority of those employees are still working for Constellation and still own the bulk of those shares. They may have long retired, but they still see a lot of opportunity and potential at Constellation, so that immediately makes me very bullish on this company.

By the way, I think it is no coincidence that there is a relationship between all three of these holdings. Larry Cunningham co-wrote a book with Buffett on corporate culture and is currently vice chairman of Constellation Software (and a shareholder of both holdings) and wrote very highly of the culture at Markel, Berkshire has an ownership interest in Markel, Markel in turn has an interest in Berkshire, in fact it is by far the largest position (and possibly in Constellation, but that is not public), and Gayner’s wife is a commissioner of and shareholder in Constellation. Like Berkshire and Markel, Constellation also holds a well-attended annual shareholder meeting where they answer numerous questions at length, the more complex and challenging, the better.

Another similarity is that Buffett, Gayner and Leonard all write detailed letters to shareholders. They clearly view the shareholder as a partner, unlike very many publicly traded companies, which view shareholder inquiries only as a burden. Through the shareholder letters, they inform their co-owners as equals about the most important developments in their organizations. In fact, we see this in the majority of holding companies, some even writing an extensive letter to shareholders on a quarterly basis.

Investing money from another is another thing than investing with your own money. Where does your personal style differ from that within Tresor. And how do you deal with the accompanying emotions?

Please refer to the previously cited white paper on our website https://tresorcapital.nl/wij-bieden/ called Skin in the game. “Eat your own cooking” is a well-known English saying, which we fully endorse. If we did not invest in the same investment opportunities for ourselves as we do for our clients, that would be remarkable to say the least. One nuance I do want to add is that each person’s private circumstances can result in different portfolio compositions. Surely each person may have a different emphasis to suit their personal situation. Generally speaking, however, it is safe to say that the same arguments that apply to a family holding company also apply to us personally: if our clients make a good return, we also make a good return privately, but if share prices are under pressure, our private portfolio is also under water. Besides the contractual and fiduciary responsibility to try to achieve the best possible return at the corresponding risk profile, our skin in the game gives us an additional commitment.

I deal with the emotions the same way as I advise clients. I like to take advantage of sharp declines, mostly overreactions, by buying in. So if fundamentals haven’t changed, and the stock price is down 20%, you can buy the same company on sale. It always amazes me that we all run to the stores when there is a sale, while in the stock market the opposite reaction occurs when prices fall. The teaching around “loss aversion” teaches us that a EUR 100 loss hurts more than twice as much as a EUR 100 gain on an investment. Then it is extra important to know your holdings inside out so that you have the conviction to hold them or even buy them when one has the opportunity to do so.

Thank you very much for your comprehensive answers