July 24, 2019
Be curious, not judgmental.
- Walt Whitman
Dear Partner:
Arquitos returned -5.1% net of fees in the second quarter of 2019, bringing the year-to-date return to
0.1%. Our annualized net return since the April 10, 2012, launch is 19.7%. Before fees, Arquitos has
returned 437% cumulatively and 26.1% annually since our launch seven years and three months ago.
Please see page five for more detailed performance information.
We will be holding our annual meeting in New York City on Tuesday, September 17. Current investors
will be receiving invitations with additional details shortly. We will also have a limited number of seats
available for prospective investors. If you are a prospective investor and are interested in learning more,
please let my colleague, Jessica Greer, know.
A little more than 35 years ago, in 1984, Warren Buffett gave a famous speech entitled, “The
Superinvestors of Graham-and-Doddsville.” He highlighted nine funds that followed a value-investing
philosophy and that were led by managers he personally knew. Four of them had worked at Graham-
Newman, Ben Graham’s investment firm, from 1954-1956. Two were multi-manager pension funds that
Buffett directly influenced. This speech was a rebuttal of the efficient market hypothesis and was
presented at the 50th anniversary of the release of Ben Graham and David Dodd’s “Security Analysis.”
Buffett has never stopped advocating for active management for managers who apply value-oriented
principles even though he urges the average investor to simply invest in index funds. Why the apparent
contradiction? Two reasons: high fees from underperforming active managers eat into returns; and, he
has seen how unavoidable volatility in actively managed funds causes some emotional investors to add
and withdraw money at inopportune times.
To that second point, studies have universally shown that the performance of the average investor
significantly trails the instrument in which they are invested. The issue is poor decision-making
associated with subscriptions and withdrawals. The best advice that Buffett, or other active managers,
can give is for investors to buy and forget, whether it is an index fund or an actively managed fund.
Studies have shown that simply buying and forgetting saves investors about 5% per year in
performance.
Back to Buffett’s speech. There are several interesting takeaways from reading the speech today. The
managers from the nine funds cited had a similar philosophy but applied it in much different ways.
Walter Schloss and Tweedy, Browne were highly diversified, for example, whereas Charlie Munger was
15 East 67th Street, 6th Floor, New York, NY 10065 www.arquitos.com
2|P ag e
highly concentrated. Some of the investors used leverage; others did not at all. A few were focused on
small companies. Others, like Bill Ruane, preferred larger companies.
The shared philosophy was a bottom-up, fundamental approach. Each of the managers “search[ed] for
discrepancies between the value of a business and the price of small pieces of that business in the
market.” These managers were not chosen by Buffett at random and were not chosen after the fact.
There was no survivorship bias here.
Another interesting aspect is just how small some of these funds were even with the compounding from
their performance. For example, Walter Schloss in 1984 only had $45 million under management
despite returning 21.3% annually over 28 years. In today’s dollars, that $45 million is still only $111
million.
Most people know Charlie Munger as Warren Buffett’s 95-year-old sidekick at Berkshire Hathaway. He
managed one of the nine funds on this list. From 1962-1975 he returned 19.8% annually. When he
closed his fund in 1975, assets under management were only $12 million. That’s only $57 million in
today’s dollars.
Even Buffett himself only had $100 million in assets under management ($700 million in today’s dollars)
when he wound up his fund in 1969. This despite returning 29.5% annually with no down years.
Obviously, the hedge fund world is much, much different today than 5o years ago when these
performance records were made. However, there is a group of portfolio managers over the past 20
years who, like me, were inspired by the Buffett Partnership and other funds like Munger’s. We changed
careers to start a fund because we knew we could successfully apply these principles. It is interesting for
us to look back at those nine funds that Buffett highlighted and marvel at how different the
environment is, how our assets under management are not dissimilar, and how our performance stacks
up.
In many ways, Munger’s fund has proven to be similar to Arquitos. Like Arquitos, Munger’s partnership
was volatile, mostly in a positive way. He had four years where his gross returns were 50% or more.
Arquitos also has had four years where performance has been north of 50%. Munger had a few years
where he had losses of more than 30%.
Munger was highly concentrated. According to, “The Snowball,” by Alice Schroeder, Munger at one
point put the entire portfolio into one company, British Columbia Power, which was being taken over by
the Canadian government. In 1974, two holdings made up 84% of the portfolio.
Many people don’t know that Munger also took control of several public entities through his
partnership. He controlled Blue Chip Stamps, which was later folded into Berkshire Hathaway. He also
controlled, with Rick Guerin, a closed-end fund named New America Fund. Blue Chip Stamps made up
61% of Munger’s portfolio in 1974. Investors would be shocked at that level of concentration today.
3|P ag e
Close followers of Buffett and Munger know that Buffett’s partnership was also heavily concentrated
and, of course, he took control positions (sometimes in private companies) through his fund. This
includes allocating 25% of the fund to Berkshire Hathaway in 1967 and 40% of the fund to American
Express in the early 1960s.
I have received questions through the years about the unusual makeup of the Arquitos portfolio. We
have heavy concentration at times. We have a control position. We have, on occasion, invested in some
very small companies, and we have invested in “work-out” situations. In the context of today’s hedge
funds, most of which focus on asset gathering and not performance, this approach may seem strange or
unique. However, the approach I take through Arquitos fits in very well when you look at the activities
from the Buffett Partnership and the funds run by Charlie Munger, Rick Guerin, and others.
My experience is that the only way to generate high returns over time is through concentration and by
doing the activities that we do. Arquitos has always been highly concentrated, though not nearly to the
degree that Munger was. Since our beginnings in 2012, the top five holdings have typically made up 75%
of the fund. There have been times where, through appreciation, a holding has been as large as 40%.
Currently, our holding in MMA Capital makes up 39% of the fund (much of it through appreciation). This
is a position that I think can safely grow at 30% per year over the next five years.
We have seen some gains from MMA Capital being added to the Russell 3000 index. The stock continues
to trade below book value, though, and it has now transformed itself into a company that reliably
throws off a significant amount of free cash for its market cap. The index inclusion will eventually allow
it to reach fair value. In the meantime, we hope that management continues to buy back shares below
book value.
Our position in Enterprise Diversified makes up another 25%. This position has been the source of the
portfolio’s pain in the last 18 months. Long term, though, it has the potential to be our best-performing
company. I am unlikely to make additional allocations to the company through Arquitos, but I am so
confident in the future of Enterprise Diversified that I have personally been buying shares on the open
market when I have been eligible to do so. I have personally purchased shares at prices 15% higher than
today.
This concentrated approach is not for everyone. It does lead to volatility—mostly positive, but not
always. It can lead to periods of significant outperformance, like in 2016 and 2017. It can also lead to
periods of underperformance, like in the last 18 months. I will note that despite the recent poor
performance, we have still beaten the market by 23% over the last three years.
Being concentrated is the safest way to gain significant outperformance over time if we don’t use
margin leverage, which we don’t. But, in order for investors to enjoy those big years, they have to also
be able to endure down periods. An investment in Arquitos requires commitment. I asked that of each
4|P ag e
investor when they entered the portfolio. As a group, you have upheld that commitment with only a few
limited exceptions.
I regularly tell you to ignore your monthly statement, and I want to take this opportunity to reiterate
that. Following performance for that short amount of time only leads to unnecessary, heightened
emotions. Most recently, for example, we were up 7.2% in June after being down 7.7% in May. If you
follow your performance statement that closely, you may ascribe some sort of meaning to those
numbers. That would be a mistake. Nothing meaningful that would affect the long-term performance of
our companies occurred during those two months.
To further illustrate the meaninglessness of those monthly numbers, the fund has existed for 87
months. Performance has moved up or down by at least 5% in 34 of those months. That means a
meaningful performance move occurred nearly 40% of the time. Something meaningful enough to make
a buy or sell decision occurred with the operations of our holdings in only a handful of those months.
My commitment to one of our holdings, such as MMA Capital or Enterprise Diversified, is forged over
years. My opinion is unlikely to change based on one piece of news or a short-term operational issue.
I continue to see tremendous value in our holdings. Valuations continue to be cheap, and each of the
companies we own continue to transition into strong free cash-flow generating companies. Those
transitions bring new investors and more appropriate valuations over time. We have seen it occur
throughout the history of Arquitos and must remain patient as this process takes shape in our current
holdings.
Thank you again for your investment in Arquitos and for your commitment. I hope to see you in
September!
Best regards,
Steven L. Kiel
5|P ag e
Arquitos Performance Compared to the S&P 500
Arquitos (Gross) Arquitos (Net) S&P 500
2019 YTD 0.6% 0.1% 18.5%
2018 -30.6% -31.3% -4.4%
2017 80.8% 64.0% 21.8%
2016 65.4% 54.9% 12.0%
2015 -14.0% -14.8% 1.4%
2014 72.8% 57.8% 13.7%
2013 58.7% 46.6% 32.4%
2012* 9.0% 7.2% 4.9%
Cumulative 437.1% 269.1% 147.7%
Annualized 26.1% 19.7% 13.3%
*Founded April 10, 2012
Disclaimer
This letter is for informational purposes only and does not reflect all of the positions bought, sold, or held
by Arquitos Capital Offshore Master, Ltd. or its feeder funds, Arquitos Capital Partners, LP and Arquitos
Capital Offshore, Ltd. Any performance data is historical in nature and is not an indication of future
results. All investments involve risk, including the loss of principal. We disclaim any duty to provide
updates or changes to the information contained in this letter.
Performance returns presented above are for Arquitos Capital Partners, LP and reflect the fund’s total
return, net of fees and expenses, since its April 10, 2012 inception. They are net of the high water mark
and the 20% performance fee, applied after a 4% hurdle, as detailed in the confidential private offering
memorandum. Arquitos Capital Offshore, Ltd. was launched on March 1, 2018. Returns from Arquitos
Capital Offshore, Ltd. may differ slightly and are not presented here.
Performance returns for 2019 are estimated by our third-party administrator, pending the year-end
audit. Actual returns may differ from the returns presented. Positions reflected in this letter do not
represent all the positions held, purchased, or sold.
This letter in no way constitutes an offer or solicitation to buy an interest in Arquitos Capital Partners,
LP, Arquitos Capital Offshore, Ltd., or any of Arquitos Capital Management’s other funds or affiliates.
Such an offer may only be made pursuant to the delivery of an approved confidential private offering
memorandum to an investor.
