Please refer to our disclaimers, which can be found in the footnote of this page and here.
Performance for 2023 was +64.5% net (vs. the MSCI ACWI at +22.2%). Since inception, the portfolio has compounded at +18.8% gross / +16.0% net (vs. the MSCI ACWI at +11.7%), representing +7.0% gross (+4.2% net) annualised outperformance. Top contributors for 2023 include Salesforce, Alphabet, Meta Platforms, and Microsoft. The biggest detractor was Alibaba. During the 4th quarter October weakness, we increased our investments in Alphabet, Meta Platforms, and Okta. We also added Visa back into the portfolio based on relative valuation attractiveness. Later in the quarter, we reduced our investments in Meta Platforms, Microsoft, Block, and Snowflake for valuation reasons.
Returns Summary
Portfolio Statistics
This letter marks the 5-year anniversary of the strategy (although we have only managed external capital since September 2023). What an interesting 5 years to be investing — a global pandemic, a tech bubble, and the end of zero interest rates. We are proud of the performance generated throughout this challenging period on both an absolute and relative basis (see above). The 5-year mark is a good time to self-reflect, to read back through our decision log, and consider what we have done well and, more importantly, where we can improve.
The best decision we made throughout this time was to own great companies. Macro events are hard to predict and the impact on asset prices even harder. We try to own quality companies with a high degree of business resilience that can navigate through these unpredictable events. With some exceptions, we’ve done a good job here.
We are also happy with our valuation discipline. We were selling down our higher-growth companies in the 2021 tech-bubble. In some cases (e.g. Salesforce, Snowflake, MongoDB, and others), we were able to re-invest again after the bubble burst. In other cases (e.g. Block), we finished our underwriting but then waited several months for valuation to improve. We in no way predicted the bursting of the bubble, only that the long-term range of expected returns no longer compensated us for the risks we were assuming. With the benefit of hindsight, we should have sold much more in 2021. In the same vein, in late 2023 we made significant cuts to our positions in Microsoft, Meta Platforms, Block, and Snowflake, and we fully exited our MongoDB position earlier in the year (for the second time). These stocks may continue to rally but the forward expected returns justified the move. Our cash position built up over the year, reduced as we deployed into the October 2023 sell-off, and subsequently built up again, ending the year at circa 13%. We do not make top-down calls – our cash position is simply an outcome of the bottoms-up opportunities.
Finally, for the most part, we have made good sizing decisions. Position sizing is a function of quality (i.e. true business risk), valuation, and conviction. Our sizing has helped us capture gains in stocks where our conviction held steady and to avoid additional losses where we had underwriting mistakes and/or lower conviction, especially in our higher-growth names. That said, there are two notable disappointments in our sizing decisions. First, we mark ourselves down for not being more aggressive in Meta Platforms in late 2022. We had conviction and deployed more capital in mid-2022 (after selling some in late 2021), but our combination of quality, valuation, and conviction in late-2022 warranted a much larger position. Second, we increased the size of Twilio in 2022 and in hindsight, we had too great a size in a name where the business quality and our conviction had deteriorated.
On areas of improvement, in 2022 we re-deployed into some of our higher-growth companies as valuations retreated. We were too early in this decision. Inflation proved more persistent than our initial transitory view. While we do not make top-down macro calls, the long-term cost of capital and exit multiples for our companies needed adjustment to reflect the new long-term interest rate reality. This would have led to different valuation views. We now face the same decision going forward but in reverse. After realising our error, we increased our cost of capital and reduced certain exit multiples. This move already considered a future reduction in rates since we are underwriting the next 5-10 years, not the next 12 months. As such, we are comfortable with our current assumptions and make no attempt to time a potential rally if/when the Fed eases.
On stock-selection, our hit rate has been very solid overall. However, we have been wrong in Alibaba and Twilio. In Alibaba’s case, we underestimated Pinduoduo and were too sceptical of its ability to sustain its advertising and promotion spending. The impact has been market share-loss and margin reduction in Alibaba’s core business. In Twilio’s case, we overestimated the newer growth areas that had the potential to improve the overall business quality (Flex and Segment), while at the same time, the competitive lead in their core business (i.e. communications) narrowed more than expected. In addition, we underappreciated the execution risks in Twilio’s acquisition of Segment (acquisition risk has also been an issue in Block and Okta). Why then do we still own Alibaba and Twilio? The key reason is valuation relative to alternative homes for capital. Certainly, at some level of quality-deterioration we need to cut our losses and move on no matter the valuation. We wrestle the most with Twilio here. In contrast, despite the market share losses, we still view Alibaba as a high-quality company and, while our valuation has been revised down significantly, the share price has retreated much more.
While we do not judge our decisions on returns in the shorter-term, we are happy that our 5-year returns significantly exceeded our objective and the cost of capital for our companies. In fact, the portfolio has likely over-earned what we should expect given the high-quality nature of the businesses we own relative to the market.
We ended 2023 with Salesforce as our largest position. We first bought stock in June 2020 and at year-end, it represented 18% of the portfolio. As of 31 Dec 2023, the IRR for our investment over the 3.5-year holding period thus far is +29% and the annualised TSR over the same period is 13%. Key position changes throughout this time are shown in the chart below. Key moments of additions/disposals include trimming in Feb 2021, cutting meaningfully in Oct/Nov 2021, adding at various times in 2022, and trimming in Dec 2023. We do not try to generate returns by trading in and out of positions. Rather, these sizing changes are simply driven by the relative risk-rewards across the portfolio. We also do not claim success just yet – this will depend on what happens going forward.
Kalakau Avenue’s Salesforce Investment Journey