It is my pleasure to welcome you to the Jafar Liquid Strategies LP (“JLS”) first annual letter. I’d like to start by saying that I am humbled by the magnitude of your support; your partnership is an honor that has made possible the very writing of this letter, along with the many accomplishments achieved in our first year. Please know that I am grateful to you and that my personal family balance sheet is alongside yours for the exciting journey ahead.
Our partnership’s long-term mandate is to grow real economic wealth with capital preservation as a primary consideration. Our investment strategy combines fundamental business economics with a diversified, liquid portfolio.
Conceptually, our fundamental research helps us identify long-term economic realities and whether to invest in them. If we can agree that the most important variables for determining an asset’s value are the trajectory and durability of its cash flows, then we must frame the shift of profit pools between economic winners and losers to optimize our capital allocation decisions. In practice, we evaluate many factors including, but not limited to, the following:
- End market growth and dynamics – determining whether an asset’s cash flows are cyclical, declining (structurally broken and decoupled from GDP growth), or structurally growing in scale (growth in excess of the GDP rate)
- Industry structure – the barriers to entry and competitive dynamics that ultimately determine pricing power and profitability
- Balance sheet strength – the amount of debt on a company or asset can impact how much it can invest to grow its business (a good thing) or, in extreme cases, increase the risk of bankruptcy (a bad thing)
After making our determinations about economic winners and losers, we construct a portfolio of long investments comprised of companies that we believe drive the majority of cash flow growth in the economy (structural winners) and short companies whose profits are declining regardless of market cycle (structural losers). Given our focus on capital preservation, some of our core portfolio construction considerations are:
- Diversification
- Since we are focused on the long-term, it’s important to recognize our journey is inherently a “marathon” rather than a “sprint”. Therefore, we try to position ourselves to always “have a seat at the table” and “live to fight another day”.
- We attempt to limit the potential negative impact of any single investment loss by sizing each investment generally between ~1-4% (at cost) of the portfolio.
- Humility in individual security underwriting
- We will make mistakes from time to time. To account for this reality, we analyze how much we can lose in the event we are wrong.
- To maintain intellectual honesty, we have specific operating performance targets for our companies. When a company’s reported results deviate significantly from our expectations, we evaluate whether to maintain or exit the investment and conduct a post-mortem review to understand and learn from our mistakes.
- Liquidity
- During times of market distress, the ability to convert to cash is very valuable and a significant strategic advantage. If we can agree that a distressed seller (i.e. needing to sell very quickly at a discount) is in the worst position, then being the buyer from the distressed seller is the best position. Therefore, we take explicit measures to try to always be in a position of liquidity and relative strength.
- The liquidity profile of our underlying investments allows us to convert to cash as quickly as within a day (weighted average ~$1.2 billion daily volume traded of each underlying investment)
Assuming our conclusions are correct, the potential for investment returns is quite significant. Of course, macroeconomic cycles may impact the timing of growth. It is my view, ironically, that downward economic cycles can ultimately benefit our long investments as their structural tailwinds allow them to outpace GDP through the cycle and their strong balance sheets (as described above along with their cash flow generation) allow them to survive and invest in their businesses – resulting in much stronger franchises exiting the cycle.
On the other hand, our short portfolio is comprised of companies that are currently facing declining cash flows. Furthermore, many have large debt balances and face a high risk of bankruptcy. Should a downward cycle occur, the weak positioning of our shorts only accelerates in our favor and many will not survive (the ones that do, likely in a much smaller form). Unsurprisingly, the companies that comprise our short portfolio are the “losers” in the profit-pool shifts described earlier.
Thank you for your consideration and support. I am blessed to do what I love and to do so in partnership with you. Please know that my personal family balance sheet is invested with yours and, to demonstrate my conviction in our long-term potential and alignment, I invested 100% of my 2019 fees back into JLS. Feel free to reach out anytime (my contact information is below).
Your partner and fiduciary,
Faris Jafar, Chief Executive Officer
Phone: (734) 678-8562