We are often asked to discuss our investment philosophy as it relates to our expected long-term returns. Many people making investment decisions today at very large, sophisticated institutions believe that an investment is less risky if it has a smooth progression of returns month after month and year after year. We believe this type of thinking is pure folly. It is akin to thinking that you are free from hurricane risk by living in New York. Most people living there now have no recollection of past significant hurricanes. In fact, New York bares the brunt of a significant hurricane about twice a century and is considered the third most susceptible metropolitan area to hurricane damage after Miami and New Orleans. Real risk is determined by the prospects of the underlying securities that make up a portfolio, and it is magnified exponentially by the degree of leverage employed. Taking large, leveraged bets and thinking your investments are safe because historical volatility has been low is simply crazy.
At Cook & Bynum, we have earned significant outperformance over the last five years while owning a concentrated basket of outstanding businesses. During this period, we have held significant cash positions at various times of as much as 80% of assets while never having been materially leveraged. Our average cash position has been near 30% over this five-year period. We often talk to potential investors who do not understand this core philosophy on risk. We are reminded of how delighted we are to have such a wonderful group of partners that understand how to properly evaluate risk. We sleep well at night, as you should, knowing that the intrinsic value of our stable of businesses does not change because of how manic “Mr. Market” gets each day or each month. We will continue to mitigate risk and raise our long term returns by insisting upon a “margin of safety.”