The Nomad Investment Partnership, Nick Sleep and Qais Zakaria

Insights on discipline, long term thinking, patience, behavioral finance, investment mistakes, permanent holdings, growth and value, scale economies shared, great businesses, concentration, and more

Nick Sleep and Qais “Zak” Zakaria, two value-oriented analysts, teamed up in 2001 to form an investment fund.

Documenting their work over a 14-year period, they ended up delivering one of the strongest investment records known to date with annualized returns of 20.8% versus 6.5% for the broader market.

A dollar invested in their fund, the Nomad Investment Partnership, would have yielded $10.21 versus $2.17 for the index.

They collated all of their investor letters into one package and made them available here.

I recently read through them in their entirety.

Below are some of my key takeaways.

Put in the work, with discipline

Nick and Zak were keenly focused on their craft of analyzing and understanding businesses. They wanted a track record they could be proud of. They weren’t overly concerned with getting rich quick or scaling assets under management.

“Job one, two and three for your manager is investment performance, not asset gathering.”

“Partnership results have been achieved without leverage, shorting or financial derivatives of any kind, nor do we wish to employ such techniques.”

“For our part we have no interest in such get-rich-quick schemes, and prefer to make money the old-fashioned way, through thoroughly researched and thoughtful stock picking, with a bias toward portfolio concentration and very low levels of turnover."

“We do not trade around our holdings (the practice of trying to outwit short term share price changes and if it goes up, sell a bit; and if it goes down, buy a bit). However, we do expect, through our analysis, to have some influence over Nomad’s destination at the end of a sequence of years”

“To date, we have declined almost as many investment dollars as we have let in, a ratio that the industry does not track and a habit that the industry is not good at keeping. But even so, whilst we hope that the fund will grow over time, we are in no hurry to do so, and will endeavor to maintain the quality of the Partners with whom we will share results, bad and good.”

“Our goal is a track record to be proud of, we wish to accomplish something meaningful, and to do that we aim to earn returns, over time, on par with those investors we greatly admire (Ruane, Tweedy, Klarman, Whitman, Hawkins, Miller, Schloss, Berkowitz). In no way do we guarantee returns, but if we can approach their results then, over time, we will beat the index too.”

“We focus on what we control.”

Focus on the destination, not volatility or noise

“At Nomad we would rather results were more volatile year to year but maximized our rolling five-year outcome.”

“What is not recorded is the cost of the suboptimal outcomes that result from over-diversification which range from lack of investment work, high fees and, most dangerous of all, complacency which allows one to ignore the only real, long term risk, which is the risk of misanalysing a company’s destination.”

“There is no reason why business values and share prices should move hand in glove. You should expect that there will be a time when prices, and Nomad’s performance, significantly lags the performance of our underlying businesses. It is then that we will ask you to be contrarian and invest more.”

“Be that as it may, one effect of having one sixth of the Partnership invested in a volatile stock, such as Amazon, is that our results will also be more variable over the short term. Please bear that in mind in future performance. The volatility does not bother Zak and me one jot.”

“In the near term our results are likely to be as bad as they may be good, but we are confident that in the long run they will prove satisfactory”

“Nomad is about destinations, not smooth routes (no kidding!), and we will have bad years again in the future.”

Think long term

“We own the only permanent capital in a company’s capital structure – everything else in the company, management, assets, board, employees can change but our equity can still be there!”

“Information, like food, has a sell by date, after all, next quarter’s earnings are worthless after next quarter. And it is for this reason that the information that Zak and I weigh most heavily in thinking about a firm is that which has the longest shelf life, with the highest weighting going to information that is almost axiomatic: it is, in our opinion, the most valuable information.”

Patience as a competitive advantage

“One of Nomad’s key competitive advantages will be the aggregate patience of its Partners. We are genuinely investing for the long-term, in undervalued firms run by management teams who may be making decisions, the fruits of which may not be apparent for several years to come. Our preference is to be measured over a rolling five-year basis; consistent with time it takes for many large capital allocation decisions to bear fruit and the average period that we expect to own an investment.”

“In a small investment partnership that I run we make people sign a form saying they understand that the fund is not suitable for those with time frames less than five years. No one else does that. We make them do it by the way, to try and put the investment in a different psychic space than other savings they may have. And to avoid the pressures of social proof and jealousy/envy I mentioned earlier. Incidentally we have average holding periods well over five years as judged by recent results.”

“Output maximisation looks efficient at least in the short term, but that is not the same as being long term optimal. The flaw to putting money to work immediately, for instance, is to presume that all relevant opportunity sets are available immediately.”

“What is the probability that say, over the next ten years, a good portion of these “super high-quality thinkers” will be priced at 50c? Our betting is that the odds are reasonable. Even though prices are generally high, the trick is to do the work today, so that we are ready.”

“Where is today’s anti-bubble? Perhaps in large high quality growth businesses that appear cheaper to us than for many years. It is for this reason that Nomad’s largest holdings are dominated by traditional growth stocks”

“Try hard to keep a healthy indifference to results achieved (certainly no extrapolation of annual results please) and maintain a patient temperament.”

Understand human behaviors

“One key to success is a high degree of awareness of the factors that distort judgement.”

“Bill Miller argued that there are three competitive advantages in investing: informational (I know a meaningful fact nobody else does); analytical (I have cut up the public information to arrive at a superior conclusion) and psychological (that is to say, behavioural). … The most enduring advantages are psychological. And the trick here is to first understand them. And then train yourself out of them!”

“Psychologists (McClure, Laibson, Loewenstein and Cohen 2004) have found that the brain perceives immediate rewards differently to deferred rewards because two different parts of the brain are involved. … the more stressed we are, the more we value short-term outcomes!”

“What you are trying to do as an investor is exploit the fact that fewer things will happen than can happen.”

“The public stock markets have many tens of thousands of potential investments, and the price of each of those changes almost constantly. … It is very easy, therefore, to feel unhappy about one’s investments. Indeed, on any one day, month, year it is highly likely, indeed statistically almost certain, that one’s chosen combination of investments will lag alternatives – there will always be someone who did better.”

Focus on the process versus outcome

“There are times when it is easy to feel good about investing, and there are times when it is much harder. The emotions usually go with outputs. After Nomad’s share price tripled, it was easy to feel that God was in heaven but, as prices decline, spirits sag. We would counsel you to think about the inputs to investing rather than the outputs. It is in times like these that the hard psychological and analytical work is done and the partnership is filled with future capital gains: this is our input.”

“Distinguishing features of probabilistic players include a focus on process versus outcome (I hope I have done some of that today), a constant search for favourable odds and an understanding of the role of time.”

“It is still amazing to me that everyone assesses a fund manager on his output, not his process.”

Learn from mistakes

“Investment mistakes are inevitable and indeed to some extent desirable, and we have no interest in hiding them from you.”

“We all make mistakes. What is often more important is how one responds.”

“There is a philosophical argument that a mistake is only a mistake if you call it so, otherwise it is a learning opportunity.”

“In investment terms, once lessons have been learnt, mistakes can be put on a price earnings ratio of one and the resultant, conditioned, good behaviour on a ratio of more than one. In other words, mistakes become net present value positive.”

The real mistakes

“The biggest error an investor can make is the sale of a Walmart or a Microsoft in the early stages of the company’s growth. Mathematically, this error is far greater than the equivalent sum invested in a firm that goes bankrupt. The industry tends to gloss over this fact, perhaps because opportunity costs go unrecorded in performance records.”

“So ,for example, the biggest mistake an investor can make is to sell a stock that goes on to rise ten -old! ‘ not from owning something into bankruptcy. But that’s what everyone thinks, at least judging by the questions we get from clients. Only last week we got questions about our holding in Northwest Airlines rather than the sale of Apple earlier this year. But selling Apple has cost us more. People look at actual costs, not opportunity costs, and what did we say about over-weighing the vivid evidence?”

“We take no comfort from the fact that not seeing success is a perennial investment mistake” “In the early 1970s a then, and still today, large successful fund management company analysed its portfolio and discovered that their sale of IBM thirty years earlier had been a huge error of omission. If they had instead kept their IBM shares for the last thirty years, that stake alone would have been larger than total funds under management. No doubt they all agreed to learn from that particular mistake and, as so often happens, went back to their desks and got on with life as before, as if nothing had happened. It is fun to note that, at about the same time, they also made the decision to sell their stake in Wal-Mart, which, thirty years later, would be worth more than their then-to-be funds under management! In terms of dollars of opportunity lost, it is likely to be the biggest single error this firm will make.”

From cigar butt investing to nearly permanent holdings

Nick and Zak's backgrounds as value analysts were pivotal to getting Nomad started. However, they came to realize that great businesses can deliver more value, more consistently over time.

They started with looking for and buying businesses at steep discounts:

“We are looking for businesses trading at around half of their real business value, companies run by owner-oriented management and employing capital allocation strategies consistent with long term shareholder wealth creation.”

“We are prepared for this and are recycling shares that have performed well (in aggregate the portfolio is valued at around 65c on the dollar of intrinsic value, up from 50 cents in December) into new fifty-cent dollars.”

Which then shifted to a longer-term focus on great companies at reasonable prices:

“The trick, it seems to us, if one is to be a successful long-term investor, is to recognize the sources of enduring business success, get in early and own enough to make a difference.”

“There are, broadly, two ways to behave as an investor. First, buy something cheap in anticipation of a rise in price, sell at a profit, and repeat. Almost everybody does this to some extent. And for some fund managers it requires, depending upon the number of shares in a portfolio and the time they are held, perhaps many hundred decisions a year. Alternatively, the second way to invest is to buy shares in a great business at a reasonable price and let the business grow. This appears to require just one decision (to buy the shares) but, in reality, it requires daily decisions not to sell the shares as well!”

“It would be tempting for Zak and me to do high-fives, claim victory, sell our winners and move on to new investments but, we think, that course of action would be fraught with re-investment risk. Be prepared, therefore, for portfolio turnover to be particularly low for a few years”

“If our firms can successfully grow, and we can resist the temptation to fiddle, then we can meaningfully reduce the reinvestment risk embedded in lots of share buying and selling.”

“Nomad is overwhelmingly invested in businesses of great character.”

“Today we have a portfolio of exceptional, iconoclastic businesses that we could own for many years.”

“If we had our time again, we would hope not to be seduced by their (apparent) mathematical cheapness but weigh more heavily their DNA, if you like. One of the things we have learnt over the last few years is that our most profitable insights have come from recognizing the deep reality of some businesses, not from being more contrarian than everyone else. Old habits die hard but, even so, Zak and I are finally attending classes in C.B.A., Cigar Butts Anonymous!”

“We can do better with the compounding businesses these days – and they are much less stressful.”

And the importance of inaction:

“Regardless of how it may appear, Zak and I are drifting toward inactivity, at least as judged by our industry.”

“One common psychological trap that agents may fall into is that clients expect action, or to be more accurate, fund managers expect their clients to expect action! The investor Seth Klarman was once challenged on whether Buffett’s track record was statistically significant as he traded so little? To which Klarman answered that each day Buffett chose not to do anything was a decision taken too. It is quite possible that we may not change the companies in which we have invested very much over the next few years. Indeed, that is our preference. Zak and I expect that we have built a portfolio not just for the recovery out of recession but for many years after that too.”

“Whilst a lack of buying and selling may look from the outside that we are not doing anything (a Sleep at the wheel, as it were…groan!), the decision not to change the portfolio is an active decision and our research continues as ever. Indeed, we find many great businesses available at what seem sensible prices, but, in our opinion, they do not compare favorably with what we already own, and so we move on, constantly comparing what we have with the alternatives, but often, as far as the portfolio is concerned, doing nothing.” 

“The research continues but, as far as purchase or sale transactions in Nomad are concerned, we are inactive. Inactive except, perhaps, for the observation, seldom made, that the decision not to do something is still an active decision; it is just that the accountants don’t capture it. We have, broadly, the businesses we want in Nomad and see little advantage to fiddling.”

“Our portfolio inaction continues and we are delighted to report that purchase and sale transactions have all but ground to a halt. Our expectation is that this is a considerable source of value added! At the time of our initial investments in Nomad’s investee businesses, the firms were, on average, around fifteen years old.”

“We had what we needed, just a few superb businesses and we were unlikely to sell any of those to fund the purchase of another cigar butt, Philippine cement company, were we?”

Growth and value

“Our definition is that a business is worth the free cash flow that it can be expected to generate between now and judgment day, discounted back at a reasonable rate. Period. Growth is therefore inherently part of the value judgment, not a separate discipline.”

“The wide use of valuation heuristics in the industry is quite bizarre.”

Scale economies shared

“There are very few business models where growth begets growth. Scale economics turns size into an asset. Companies that follow this path are at a huge advantage.”

““Scale Economics Shared operations are quite different. As the firm grows in size, scale savings are given back to the customer in the form of lower prices. The customer then reciprocates by purchasing more goods., which provides greater scale for the retailer who passes on the new savings as well. Yippee. This is why firms such as Costco enjoy sales per foot of retailing space four times greater than run-of-the-mill supermarkets. ‘Scale economics shared’ incentivises customer reciprocation, and customer reciprocation is a super-factor in business performance”

“How might corporate success be predictable? There are some clues in the world around us. Zak and I observe several business models that work in the long run, and scale economics shared is one of these, witness Ryanair, Wal-Mart, Geico, Southeast Airlines, Tesco, Nebraska Furniture Mart, Direct Line et al. And that is why companies that share scale with the customer such as Carpetright, Costco, Berkshire Hathaway, Amazon and AirAsia make up around sixty percent of the Partnership. It works because it turns size, normally an anchor to growth and returns, into an asset.”

“Air Asia is an example of scale-economics shared, which like Amazon, Costco, Carpetright and elements of other businesses in the portfolio (Geico, Nebraska Furniture Mart) have come to dominate Nomad (around 45% of the portfolio).”

“Amazon and Costco do not advertise (no shouting here); Berkshire Hathaway and Games Workshop do not provide earnings guidance (popular with baying fund managers and stockbrokers); Amazon, Costco, AirAsia, Carpetright, and parts of Berkshire give back margin to the customer, ”

Traits of great businesses

“There are only two reasons companies behave well. Because they want to, and because they have to. Our preference is to invest in those that want to.”

“Nomad’s businesses, to generalise, are run by their founders and the businesses are blessed with cultures that see part of their identity in low operating costs.”

“A business ought to be able to self-fund its own growth, and if the opportunity set is large, then the return on capital needs to be suitably high. Second, barriers to entry should increase with size; that way a company’s moat is widened as the firm grows”

“Our firms have also invested during the downturn: … There are two reasons that our firms have zigged whilst businesses as a whole have zagged. First, Nomad’s firms, by and large, have advantages not enjoyed by the incumbent competition and so have not been subject to the same economic imperatives. Second, their cultures are focused on the customer experience, not on the competition or the profit and loss statement. Our firms tend to chase the vision, not the money.”

“After all, why grow if returns are going to be poor? However, surprisingly few companies have the strength to just sit it out, or shrink, as the pressure to grow is often overwhelming.”

“Indeed, an interlocking, self-reinforcing network of small actions may be more successful than one big thing.  … Think of it as a business’ culture.”

“We are always on the lookout for companies with corporate character that are pursuing strategies designed to create sustainable value. This is no mean feat, and we work hard reading annual reports and proxy statements and interviewing management trying to answer the questions: what are returns on incremental capital and the longevity of those returns, are management correctly incented to allocate capital appropriately, and what is discounted by prices?”

Portfolio traits & concentration

“Sam Walton did not make his money through diversifying his holdings. Nor did Gates, Carnegie, McMurtry, Rockefeller, Slim, Li Ka-shing or Buffett. Great businesses are not built that way. Indeed, the portfolios of these men were, more or less, one hundred percent in one company and they did not consider it risky!”

“We had four main choices: add to existing holdings, invest in new firms, invest in growth businesses, invest in cigar butts. Overwhelmingly we have preferred our existing businesses to the alternatives. Of course, such a conclusion will only make sense if the businesses in which we have invested have great prospects and the shares are cheap.”

“The Partnership has twenty investments but a noticeable concentration in ten, which make up around eighty percent of the portfolio, and for those with sharp eyes around thirty percent of the Partnership in one investment”

“The largest group making up over half the Partnership are, no drum roll required, scale-economics-shared; next comes discounts-to-replacement- cost-with-pricing-power (I warned you) at around fifteen percent; hated-agencies fifteen percent; super-high-quality-thinkers just under ten percent.” 

“One reason for this is that the fund is over-whelmingly (over eighty-five percent) invested in firms run by their founders or first-generation management. Just as interesting is that Zak and I did not plan for this! We have ended up with a portfolio of owner-managed businesses as a byproduct of our assessment of the quality of the people involved. In other words, these managers earned their way into the portfolio. We feel slightly foolish for not recognizing this trait in advance, but, of course, we would have a bias toward founder-managed businesses”

“Almost ninety percent of the portfolio is invested in firms run by founders or the largest shareholder, and their average investment in the firms they run is just over twenty percent of the shares outstanding. Fifty-five percent of portfolio companies are either repurchasing shares or have had meaningful insider buying.”

“Return on capital in the portfolio is extremely high, as are endemic growth rates. We estimate that around three-quarters of the portfolio is invested in growth businesses, which have the potential to compound for many years, and the balance in more cigar butt like investments (we just could not help it!).”

“Keeping it simple again: return on capital at Nomad’s firms is over twice that of competing businesses.”

“By the standards of the industry, we do not own very many shares (ten stocks account for over eighty percent of the Partnership) and we own them for long periods.”

“Zak and I run a single partnership that has long-term investments in the shares of, for all that matters, ten companies, all paid for with cash.”

Conclusion

Nick and Zak certainly seemed to have enjoyed their work, even through the most difficult of times.

With a supportive investor base, they were able to capitalize through challenging times, leveraging their key competitive advantage: patience.

They ultimately closed their fund to external investors in 2014, able to invest their own money and pursue other interests.

As of Spring 2021, they were on track for annualized returns of over 20% for over 20 years.

One of the most important takeaways isn’t made explicitly in the letters. Nick and Zak seem to be characters of high integrity. They were intrinsically motivated; they weren’t phased by external perceptions or concerns; and they didn’t chase money at any cost. They were thoughtful, rational, and ultimately successful. They truly believed in their work. Conviction and passion are important ingredients of success.

Towards the end of their letters, they begin to reflect more on life.

“It can be tempting to think that more money is the answer to problems but it strikes us that it is not the money you have, but the choices you make, that count.”

The letters themselves dive much deeper and have many more insights.

I thoroughly enjoyed reading them and encourage you to do so.

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Torre Financial is an independent investment advisory firm focused on emerging and established compounders.

Federico Torre
Torre Financial
federico@torrefinancial.com
https://torrefinancial.com

Disclaimer: This post and the information presented are intended for informational purposes only. The views expressed herein are the author’s alone and do not constitute an offer to sell, or a recommendation to purchase, or a solicitation of an offer to buy, any security, nor a recommendation for any investment product or service. While certain information contained herein has been obtained from sources believed to be reliable, neither the author nor any of his employers or their affiliates have independently verified this information, and its accuracy and completeness cannot be guaranteed. Accordingly, no representation or warranty, express or implied, is made as to, and no reliance should be placed on, the fairness, accuracy, timeliness or completeness of this information. The author and all employers and their affiliated persons assume no liability for this information and no obligation to update the information or analysis contained herein in the future.