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Excerpt Annual Letter 2023

“Those who do not remember the past are condemned to repeat it.” (Benjamin Graham)

The Nifty Fifty Bubble - a valuable lesson from the past

In the late 1960s and early 1970s, a phenomenon unfolded on Wall Street that became a defining lesson in the annals of investment history. The period gave rise to what was famously known as the "Nifty Fifty," a group of fifty stocks that were regarded as solid "buy and hold" investments. These companies, which included giants like Xerox, Polaroid, and IBM, were characterized by their strong growth prospects and market dominance. As such, they became the darlings of the investment world, with investors clamoring to own a piece of these seemingly invincible behemoths.

The fervor around the Nifty Fifty was fueled by a widespread belief in their infallibility. These stocks were often described as "one-decision" picks, where the only decision an investor needed to make was to buy. This mantra, coupled with the era's bullish sentiment, led to astronomical valuations. Price-to-earnings ratios soared, with some stocks trading at multiples far exceeding those of the broader market. It was a time marked by an unshakeable confidence in the enduring value of these companies, a sentiment that seemed to justify any price.

However, this euphoria was not to last. The early 1970s ushered in a harsh reality check as the bubble surrounding the Nifty Fifty burst. The very attributes that had made these stocks so appealing – their growth prospects and market dominance - were suddenly called into question as the economic landscape shifted. As the market corrected, the Nifty Fifty suffered devastating losses, and investors who had bought in at the peak, driven by the fear of missing out on what seemed like a surefire path to wealth, faced significant financial regret.

The tale of the Nifty Fifty serves as a stark reminder of the perils of chasing after investments driven by FOMO (fear of missing out), greed, naivety, and the assumption that past performance guarantees future success. It underscores the importance of a disciplined investment approach; one that is rooted in fundamental analysis and a clear understanding of valuation.

Passive Investing & Magnificent 7

Originally, passive investing strategies such as index funds and ETFs garnered popularity for their simplicity and cost-efficiency. However, in 2023, passive funds attracted US$244 billion in inflows while actively managed funds experienced US$258 billion in outflows. [1] The migration from active to passive investment strategies has evolved into a destabilizing structural phenomenon, with profound implications for the market and the broader financial system: the market skewed toward large index names and recent winners, forced selling by active managers, the efficiency of price discovery eroded, and heightened market volatility due to diminished meaningful liquidity. The increasing use of algorithms all trained to see the same thing is further exacerbating this trend. The best example of how the emerging dominance of passive capital is skewing the market may be a look at the MSCI World Index, a supposedly broad global benchmark for the world economy.

  1. The current composition of the MSCI World Index highlights an increasing division in global investment between the "west" and the “rest of the world”. With the United States now commanding a dominant 70% country weighting, followed distantly by Japan (6%), the United Kingdom (4%), France (3%), and Canada (3%), the index disproportionately favors Western and developed markets at the expense of non-Western and emerging markets, raising concerns about its inclusivity and diversity. Moreover, the rise of passive investing grants political power a tool for controlling capital flows. Those in control of index definitions can skew market dynamics in favor of their specific geopolitical or economic agendas.

  2. The MSCI World, NASDAQ, and the S&P 500 indices are now seeing an unprecedented level of concentration, where the top five companies - Microsoft, Apple, Amazon, Alphabet, and Facebook - collectively account for 20-25% of the indices' value. The market capitalization of the "Magnificent 7" (the top five + Tesla + NVIDIA) is a staggering US$13 trillion. This figure is roughly equivalent to the combined GDP of Japan, Germany, India, and the UK (i.e. the economic power of 1.7 billion people or 21% of world GDP) or three times the total annual tax collection of the U.S. The current extreme index concentration surpasses previous peaks observed during the Nifty Fifty bubble and the DotCom bubble, and it underscores the growing index dominance of a few tech giants.

  3. The weighting of energy in the MSCI World has dropped to a record low of 3%. Historically, energy commonly accounted for around 10-15% of the index, with peaks at around the 20% mark. In the index, energy was crowded out by the IT sector. This, even though reliable and affordable energy is the pillar of every developed society, and even though energy is the juice that powers cloud computing, cryptocurrencies, and artificial intelligence. The energy demand of data centers is growing by about 25% every year, doubling every three years. If Google integrated generative AI technology into every search, it would drain about 29 billion kilowatt-hours a year, according to calculations by Alex de Vries, a data scientist for the Dutch National Bank. That is as much electricity as Ireland consumes in a year. De Vries estimates that the entire AI sector will consume between 85 to 134 terawatt-hours annually by 2027, accounting for about 0.5% of global energy consumption. [2] That’s equivalent to the production of about 10-15x medium-sized nuclear power plants (or 40-60 coal plants, in the absence of newly built nuclear plants). Wind and solar are of little help, as data centers need reliable power around the clock. 

The inherent risk in market bubbles indicates the shift towards speculative behavior, driven by structural and psychological factors. This shift leads market participants to prioritize short-term price movements over fundamental valuations, often driven by a herd mentality and institutional reluctance to deviate from the norm. It’s a dangerous latter fool’s game.

For those committed to active management and fundamental analysis, however, the current market imbalances offer unique opportunities. By exploring undervalued segments, investors can find highly compelling opportunities, exploiting inefficiencies that passive investing overlooks.

Portfolio Adaptation and Evolution

During the Nifty Fifty Bubble in the late 1960s and early 1970s, Warren Buffett and Charlie Munger faced challenges in finding value, and they experienced significant paper losses with Benjamin Graham-style investments such as buying aging textile mills under book value. With growing assets under management, they lost their flexibility to trade in and out of stocks. In response, they shifted their strategy towards acquiring high-quality niche companies to hold long term. These investments included See’s Candies, Blue Chip Stamps, Wesco, National Indemnity, and Diversified Retailing. Warren and Charlie turned their investment partnerships into investment vehicles with permanent capital and took controlling stakes in companies, leveraging these businesses’ cash flows to purchase shares in each other. They also advised investors to focus on Berkshire Hathaway’s growth of book value, rather than its share price – a brilliant move that protected investors from falling prey to the market’s noise and volatility.

What Warren and Charlie accomplished with Berkshire Hathaway is an extremely powerful concept, yet it is rarely done, because it is exceptionally difficult to form a group of like-minded and aligned investors with enough capital to get a start. Over the last couple of years, my investment strategy has subtly yet significantly evolved in a very similar manner, mostly because I learned very similar lessons:


  1. With growing assets, it has become more difficult to trade in and out of positions swiftly. The real money is in the waiting, not the trading.

  2. The traditional strategy - of purchasing stocks at a 10x free cash flow multiple with the aim to sell at 20x down the road - is losing its allure with evolving market dynamics and rising interest rates.

  3. In times of crisis, the caliber and alignment of leadership is of paramount importance. Capable and aligned leaders seize opportunities to enhance market share amid adversity.

  4. Increasing iolite’s ownership stakes in businesses helps gain deeper insights and foster stronger relationships with management, thereby enhancing my conviction and steadfastness during periods of market turbulence.


[1] Source: Morningstar

[2] Scientific American

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