Chuck Akre and the 2007 - 2008 Financial Crisis
On macro insights and bottoms-up investing
In October 2007, Chuck Akre’s Braddock Partners had just closed on its 14th year of operations. (You are likely familiar with Chuck from the eponymous Akre Focus Fund, which launched in August 2009.) While the partnership’s return had slightly lagged the S&P 500 through the first nine months of the year, the long-term track record was still an impressive one: as Akre noted at the start of the year in his January 2007 letter, Braddock had delivered an annualized return of roughly 21% to partners since its inception in October 1993, about ten points higher than the index. In that January letter, Akre reminded investors of the key attributes that he looked for in an investment:
“Because we are after returns which are substantially above average, we must look for those businesses which have ROE’s well above average… Our second area of focus is management. We are after managers who treat public shareholders as though they were partners, although it is unlikely they know them… We seek businesses which, because of their characteristics and the skill of their managers, have an opportunity to reinvest the excess profits in a manner that will continue to earn these above average returns… Even with all of this – the business model, the people model, and the reinvestment model – we are not yet entirely there. We also desire a modest valuation at the start – we like to say we are just not willing to pay too much. Having a modest valuation gives us some protection against uncertain investment and economic cycles, as we have no ability to predict either.”
Over the next few years, throughout the 2007 – 2008 global financial crisis, Akre would face the most difficult environment of his career. As I’ll discuss in today’s post, it would lead him to question how a long-term investor should deal with an inability to predict investment and economic cycles – a relevant question for us to ponder as we navigate our own investment journey.
As was his investment style, Akre’s portfolio at Braddock was highly concentrated heading into the financial crisis: as highlighted in his October 2006 letter, about 65% of the fund was allocated to six holdings, inclusive of 40% in the top two positions - Penn National Gaming and American Tower. He was well acquainted with these companies and their management teams, with two of the top three holdings having been in the Braddock portfolio for more than a decade. (For a stretch during the late 1980’s and early 1990’s, Akre had ~50% of his capital invested in a single company, International Speedway Corporation - “we made 10x - 20x our money on that business”.)
A major event was announced for a top holding, Penn National Gaming, in June 2007: Penn agreed to be acquired by two private equity firms for $67 per share in cash. As a result, the stock price rose ~20%, from the low-$50’s to the low-$60’s. As he wrote at that time, a decision to hold or sell PENN had not yet been made: “We continue to study the deal terms, and will follow the course of action that provides our partners with the best expected return.”
Beginning with Akre’s October 2007 partner letter, his commentary started to include a focus on broader economic events, with more frequent mention of topics like securitizations, CDO’s, and the housing market. That said, Akre reminded his partners that his goal in tracking these developments was ultimately in service of a bottoms-up investment approach. As he wrote, “My discussion of the risks to the economy only serves to highlight our excitement that a disruptive economic event may give us the opportunity to put capital to work in existing portfolio companies and new investments at bargain prices.”
By early 2008, those increasingly attractive investment opportunities were materializing: “we have seen some company valuations go from pricey to ridiculously cheap, hence we are very excited by the current environment”.
That said, Akre once again reiterated that predicting macro developments wasn’t his top focus or area of expertise: “We have no opinion on how the financial distress will sort itself out, and we remain very focused on individual opportunities. We remind ourselves often that predicting the direction of the market and the economy is not a discipline which has won us awards in the past, and that focusing on what is knowable – the likely experiences of certain types of businesses – is far more rewarding. That is our focus today.”
What happened subsequently is where the story gets interesting. The first major sign of trouble appeared in early 2008, following a significant and unexpected event that Akre later called “the canary in the coal mine”.