Dear partners,
Throughout the more than five years since the Fund was launched, our portfolio had no component of either the S&P 500 index or of the ACWI (ACWI) in our portfolio.
In letters and presentations, I repeatedly mentioned that they are not benchmarks, and our portfolio has no similarity to any well-known index. So why compare its performance to such ETFs at the table below?
ACWI and SPY are ETFs that track the performance of the MSCI All-Country World and the S&P 500 indexes, respectively.
Well, it has to be compared to something. It could be compared to bitcoin or gold (more on that later), and it would make just as little sense. The above-mentioned ETFs are low-cost, easy to invest alternatives that anyone could buy to have exposure to equities – at least we are talking about the same asset class.
Arguably, the marked-to-market returns of a concentrated (mostly) equities fund such as ours is non-recurring by its own nature. Even by these standards, the 42% annualized returns (net of all fees and expenses) obtained over the last 25 months (i.e., 2023 year-end to January 2026) were considerably more atypical than anything I could hope for. Luck has played a big part in it.
By the same logic, the drawdown of -32% from October 2021 to October 2022 was just as atypical. Neither of these outcomes was substantiated by similar underlying economic development of the companies invested – which are usually much smoother.
What is recurring is your steadfast trust and commitment through both good and bad times. I am grateful for that.
When to sell
I have frequently been asked about how I make the decision to sell. Plenty of famous investors / fund managers developed a whole philosophy around it. That the stocks of great companies should be kept longer even if they seem a little overpriced. That selling is an acknowledgement that buying it the first time was a mistake – implying that any buying decision should have a forever holding period in mind. Well, Warren Buffett famously argued that his favorite holding period is forever.
I try not to overthink it.
In the end, it all comes down to opportunity cost 1 : the right time to sell is when there are better opportunities 2. That simple argument unfolds into:
a) why initiate a 20th position when I can just increase my second highest conviction position (assuming I am fully invested in the first one)?
b) if I realize a mistake was made in my appraisal of value, that also means there are better opportunities than to stay invested, and
c) just because I think a stock is undervalued by 50% does not necessarily mean I should stay invested.
The point c is what I want to elaborate. The concept of price to value was discussed in the Fund’s very first Letter, in 2021; it continues to be the cornerstone of our investment philosophy. An usually overlooked point is: if the assessment of the value of a stock is initially 3x 3 its price, which then doubles, the stock price has *only* 50% upside left. In most cases, there should be more enticing opportunities around, and the position will be sold. So no, 3x market price is not a “target” price.
Above all, I have to be honest with my value appraisals. We have had investments where the estimated value of the investment went DOWN, but the stock went up anyway and we made money. As long as the discount is large enough, that should not come as a surprise.
The danger is in wearing pink glasses and thinking that the value is unchanged, while things turn out to be much worse than expected. That is bound to happen from time to time, since value depends on the future and its own intrinsic uncertainty.
Gladly, there have not been any significant cases in the past year. But it has happened before (e.g. I0G Plc and 26 Acquisition Corp (ADER) , the SPAC that was trying to buy a stake in the Okada Manila casino), and it will happen again. This is not a business of 100% hitting rate.
Gold
During the past few months the substantial increase in the price of gold and other precious metals has been frequently mentioned in the financial news.
I have very little to say about it. The Fund has never had any position in either precious metals-related companies or in the commodities themselves. For a very simple reason: I have no idea of their intrinsic value. If I cannot have a (even gross) estimate of its worth, how can I tell if buying at the price at which it is trading is a good investment?
My job is to buy assets at a much lower price than what I consider they are worth. And wait that someday the rest of the market will agree with me – at least partially.
One of the arguments for the increase in the price of precious metals is the (potential) debasement of not only the USD, but of all fiat currencies 4. On that, I can relate a little more, although I disagree on the best ways to protect against it.
Unsurprisingly, I prefer to take the side of Warren Buffett and focus on productive assets 5. If customers are willing to trade a piece of the proceeds they receive for their work for such goods and services, that production capacity is worth something – regardless if it is priced in Zimbabwean dollars, US dollars, or gold nuggets.
Braskem (BAK) Idesa
One of the new (bought over the last 6 months) positions of the Fund is a corporate bond of a defaulted company.
It is a petrochemical company in Mexico. It missed a USD 33 mm coupon payment in late November. The company is currently “engaged in discussions with representatives of a certain ad hoc group of bondholders” (you will understand the meaning of this sentence in a few paragraphs), and so far it seems to be developing poorly. It trades at about 60% of par value. The company barely broke even over the past 4 years, its controlling shareholder (Braskem NYSE: BAK) is in an even worse situation, and the industry is facing the deepest and longest downturn ever.
Looks as awful as possible.
But, let’s take a step back.
Simplistically, to produce polyolefins (think plastic), you either use as feedstock naphtha (think oil) or ethane (think gas). Ethane is a much more competitive feedstock: cheaper, and provides a better yield. Even at the trough of the cycle, ethane-based plants continue to make money. Most of them are based in the US and Middle East. Naphtha plants (including the Brazilian plants owned by the controlling shareholder Braskem) are burning cash at the moment, and plants are being idled or shut down in Europe, Japan and South Korea.
First, Braskem Idesa uses ethane. In fact, it is the only world-scale plant (1 mtpy) in Latin America that is ethane-based.
The problem is that Pemex – the Mexican government-owned oil & gas company – was never able to supply the amount of ethane that Braskem Idesa needs. So it never operated at full capacity. And to run a petrochemical plant at less than 75% utilization rate, you’d better shut it down because it will not be able to make any money.
The situation became so dire that at the end of 2020, Braskem Idesa implemented a “fast track” solution: bring ethane from the US… by truck! During most of this period the plant was able to run at 75% to 80% utilization rate, but with horrible economics.
The fast track was a stopgap while its import terminal was being built. After years of construction, Terminal Quimica Puerto Mexico (‘TQPM’) is finally up and running. So, since its ramp up in October, it is capable of operating at 100%, with ethane imported from the US by dedicated ships. In fact, the 2025 4th quarter production report already shows an utilization rate of more than 90%.
However, TQPM did not ramp up in time to generate cash, and the company defaulted on its coupon due on November 18.
It is a problem of liquidity, not solvency.
Who financed the construction of TQPM? Banco Inbursa, which is owned by Carlos Slim, who used to be the richest man in the world – and still is the richest man in Latin America. He is a minority shareholder (25%), and there are rumors that he is also a significant bondholder (the “certain ad hoc group of bondholders”). Why finance USD 500 mm (the cost of TQPM) and let the company go bust right afterwards? It makes no sense.
Its majority shareholder is Braskem, which owns 75% of the company. Being owned by both Odebrecht and Petrobras (PBR), the company was in the midst of the carwash scandal in Brazil in 2014 – which took its multibillion dollar toll in terms of fines. As a result of the carwash scandal, Odebrecht went bankrupt, and the banks received Braskem’s controlling shares as collateral. The banks put Braskem for sale since 2019 – it was almost bought by LyondellBasell (LYB) back then. But around the same time, the company suffered a huge environmental incident in its operations in Northeastern Brazil: a whole neighborhood sinking due to its salt mining. So, more multibillion dollar fines. A neverending horror, with uncapped potential liabilities… no willing buyer had the guts to buy the whole company. At the moment,
IG4, a private equity fund specialized in special situations / distressed companies, is in the process of acquiring control of Braskem.
Add to that the deepest and longest downturn of the petrochemical cycle ever, and Braskem is, well… not in a good shape. In theory it has no liquidity issues, but its bonds are nevertheless trading at less than 45% of par value. No wonder they decided not to capitalize Braskem Idesa in time for the payment of the coupon.
It is still unclear if the petrochemical cycle has reached an inflection point. The stock prices of the companies in this sector in China have recovered on average more than 30% in the past 6 months (the whopping 130% share price appreciation of Sanjiang Fine Chemicals was one of the main contributors to our recent performance). This could be the result of nothing more than a very light technical positioning or even a dead cat bounce; or the infinite wisdom 6 of the market is anticipating an improvement yet to be felt in the real world.
Any debt or corporate restructuring of Braskem Idesa will have to pass through Carlos Slim. In a simple refinancing, we will probably either win or lose a little money, given the current price (60% of par) of the bonds.
In fact, it should be noted that when the company missed the coupon payment, bond prices barely budged.
If we receive an equity kicker, the upside can be much larger, depending on the dilution of the equity holders.
Let’s consider what would usually be the worst case: the company declares Chapter 11. Equity goes to zero 7. Some funds may be forced to sell. Court battles, injunctions, undetermined time to a resolution. The restructuring may be a mess, and bond prices can go anywhere in the short term. And yet, I believe our upside can be significant in this case.
In this scenario, Carlos Slim will essentially gain control of the company, if he is indeed the largest bondholder.
At face value, its net debt sums USD 2bn (only two bonds, a very simple structure), which the market prices at USD 1.2bn. Braskem Idesa plant is less than 10 years old, and has just completed a major maintenance turnaround. Its replacement cost is over USD 4bn.
INEOS ONE, a greenfield plant being built in Antwerp, has a similar industrial design: an ethane cracker whose feedstock will be provided by ships 8. If we ask Jim Ratcliff, its owner and one of the UK’s richest, if he would be willing to buy the whole of Braskem Idesa for USD 3bn, I am sure he would jump at the opportunity – but I don’t think Slim would sell at such a low price.
The likelihood that I am underestimating its liquidity needs during this cycle downturn cannot be disregarded. New capital may be needed – and at the right price, could very well be provided. On the other hand, its recovery value seems well established and hard to argue against.
I think the bonds offer a great asymmetric opportunity. It will likely be a bumpy and potentially long ride; for long stretches of time there could be little visibility on the potential outcome. But the business, the cycle and its competitive positioning are well understood.
New positions
In a sense, Braskem Idesa illustrates a specific need. In aggregate, the positions that have been called “core” for the past two years are substantially up. Getting back to the point c) of the When to sell chapter, their remaining upside is smaller 9 than they used to be – by definition.
Rejoice! It is a good problem to have.
That leads to either accepting lower discounts of price to value (not on my watch!), or finding higher ones. In the past few months, a record-setting six new positions became part of our portfolio. Some of them are old friends in new clothes – such as the Jakarta-listed Indofood (INDFY), a subsidiary of the HK-listed First Pacific (FPAFY) -, some are brand new. Some are slowly being bought due to low liquidity.
A different shape, but designed to keep the same inner strength: on average, these new positions are being bought at (as always, entirely subjective and highly inaccurate) appraised values of more than 3x their current price.
Warren Buffett
At the age of 95, Warren Buffett finally left the helm of Berkshire Hathaway (BRK.B) to his anointed successors.
He has repeatedly said in the past that buying a controlling stake of Berkshire Hathaway was a mistake : it was a doomed textile company. The proceeds of decades of transformation into a money-making machine ended up being divided among all minority shareholders.
The whole financial community is glad it happened that way, though. Managing a listed company brought him to the limelight.
A couple of years ago I was asked by my goddaughter what my favourite book of all time was. The answer came naturally: the collection of all Berkshire Hathaway Letters to Shareholders since Warren Buffett took charge. Much more than the also duly incensed videos of Annual Meetings – which by its own nature rely on spontaneous answers -, the Letters are deeply well-thought through (and pristinely edited by Carol Loomis), filled with what he actually wants to leave to posterity. Whenever someone gets interested in financial markets and asks me where they should start, that is where I point them to.
It surprises no one that the Letter you are reading right now is inspired by his.
It has been 60 years of highly anticipated annual letters. This end of February felt emptier 10.
Best regards,Diego B. Milano
References
1 In other words, a never-ending urge to keep the opportunity cost as high as it can possibly be
2 I am not being original. Charlie Munger, Francisco Paramés and many others think the same way
3 At the risk of being repetitive: the objective is to buy assets at EXTREMELY low prices compared to their intrinsic value
4 Unless you are REALLY interested in this subject, you can skip clicking on the links
5 The comparison between gold vs all US croplands + 16 Exxon Mobils at the 2011 Letter is a classic
6 Beware of the irony
7 To be precise, not necessarily. But if there is any recovery value to equity in a Chapter 11, the bonds would be worth 100% of par. Since they trade at 60%, it would still be a good outcome
8 At a total investment cost of € 4bn, INEOS ONE will be larger, but will produce only market ethylene. Braskem Idesa is integrated into polyethylene. Their investment cost is probably similar.
9 Unsurprisingly, their value failed to increase by 42% a year
10 Greg Abel, the current CEO, is keeping the tradition alive; but it is an almost impossible act to follow
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Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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