Rihard Jarc: We Invest In Platforms
By Rihard Jarc
Published:
What is your background?
I graduated from the Faculty of Economics in Ljubljana with a degree in Banking and Finance, and even as a student, I was drawn to the stock market. To explore my passion, I joined a club called Student Stock Exchange, where we organized events and hosted a stock simulation game to help other students learn about the stock exchange, and that is how it all started.
Later on, my first internship was with EY, one of the Big 4 audit & accounting firms, where I worked in the audit department. During my time there, I gained valuable skills in analyzing and understanding financial statements and understanding the inner workings. of different companies across various industries. Those skills are the foundation even today for me in analyzing the financial statements of public companies. After that, I decided audit was not for me and joined UniCredit in the investment department as an analyst, where I assisted the main asset managers. After a few years and after completing the portfolio manager exam, I became an asset manager for the bank's high-net-worth clients, managing their mandate portfolios.
Your career is very impressive. Despite your young age, you have already accomplished a lot - worked as a portfolio manager at UniCredit, co-founded a company called Autonanalytica d.o.o. and successfully sold it. Later on you have co-founded a company called typles. Tell us more about your previous career. How did you manage to sell the company? Did you use the money as a capital for investing in stocks?
After working for a few years in a bank, I had this unfulfilled desire in me. I wanted to run and start my own company. I wanted to try myself as an entrepreneur. I have always had a passion for technology, so that was my natural path. I founded two companies - Autoanalitica and Algoritmik - both of which I co-founded and served as CEO.
Autoanalitica is a data platform that ranks used cars. Algoritmik is an AI API-first company that focuses on document data extraction and classification using machine learning and AI algorithms. Our flagship product, Typless, has gained significant recognition and popularity. While running these companies, I learned valuable lessons about how it is inside a growing technology company and what is often unseen if you just look at the financial statements. Autoanalitica was acquired by one of our supplier companies and my co- founder, and Algoritmik was just recently sold to a public company that was previously a client and user of our product for several years. The capital gained from selling these companies mostly went into investing.
Since 2021 you have been working as a Chief Investment Officer at New Era Funds. How did you get the opportunity to work as CIO? Give us some details about the New Era Funds.
New Era Funds is a European alternative investment fund registered in Slovenia. It is a company I founded together with my co-founder, Gregor Kvas, back in 2021. Gregor and I have worked closely together already at UniCredit for several years. He was the Head of the Private Banking and Asset Management department at UniCredit, and we stayed in touch after I left the bank. In 2021, we decided to bring our idea of forming an asset management company to life.
In 2023, we welcomed the fund management company Alice run by Ana Brezigar to the ownership of New Era Funds. Ana brings valuable experience in regulatory frameworks and managing alternative investment funds. Together, we manage over 10M EUR of client funds, and we are excited about building on our vision for a successful future for New Era Funds.
Regarding our investment strategy. We seek to invest in growth companies that are developing or building innovative technology solutions and platforms that are changing the landscape of their industry and providing an ecosystem for new companies to emerge. We are agnostic to both country and industry, as we believe that every company will be viewed as a technology company soon. Without the right technology, companies won’t be able to compete in this very competitive environment. We prefer to invest in founder-led companies as we believe that the team and the vision of top management are essential to the long-term trajectory of the companies.
Our four pillars of investing are:
- innovation
- concentration
- clear-long term trends
- platform or platform-like qualities.
We believe in the power of concentration and the benefits it brings to our investment strategy. By concentrating on specific companies, we expose ourselves to risk on a company-specific level, which we believe drives most of our excess returns in the long run. Therefore, we do not limit how big or small of a position we can take in the fund.
We invest in companies operating in industries and sub-industries with established and clear long-term growth trends. Over the years, we have observed that the market frequently underestimates the long-term industry trends present in the market. These trends serve as a solid foundation for identifying valuable investment opportunities. Examples of these trends are e-commerce and social commerce, online advertising, fintech, cloud computing, AI and ML, SaaS, sharing economy, creator economy, automation and robotization, and many more.
We prefer to invest in platforms or platform-like companies for two primary reasons. Firstly, the market tends to undervalue these companies based solely on their current products or services and their revenue/profits. They often do not consider a platform's potential effects, such as the ability to add new products/services to the existing platform and cross-selling synergies between new and old products/services. Secondly, the success of a primary platform is crucial not only for the company running it but also for all the other businesses that have their business models dependent on the platform. This creates a dynamic where there are many other companies/stakeholders focused on the growth and long-term success of the primary platform. Examples of such platforms include iOS and Android App stores, cloud computing marketplaces, YouTube...
(New Era Fund team)
What is your investment strategy?
To add to the previous question about how my strategy has evolved over the years. When I started investing, I was strongly influenced by the Value investing approach from the Benjamin Graham book The Intelligent Investor. I was constantly on the lookout for “discounted” opportunities that had high intrinsic value, in my view, maybe even undervalued compared to Book value. I was very much focused only on the financials and the numbers.
However, over the course of my career, I have come to realize the importance of qualitative factors and the value of a growing business. A successful investment strategy must consider both worlds. While I still give a lot of weight to valuations and financial statements, I also carefully evaluate the business's growth potential and qualitative factors before investing. My entrepreneurial experience has also taught me that financials are just one aspect of a growing SaaS business. Other factors, such as the type of clients served, why they choose the product/service, and potential upsell opportunities, are just as critical.
To wrap it up, I also find it extremely important for fund managers to understand that they have a natural bias. The bias can be more inclined to be a bull or a bear, given your personality, but the bias you need to be aware of is also the bias of the age you live in. A fund manager that went through the 1920 and 1930 and one that was managing funds in the last 10 years have developed different subconscious patterns because of the period in which they managed and invested money. It is important to acknowledge these biases so that you can remain objective and efficient in all periods and situations. And this is important not just for fund managers but for any investor. If something worked in the past 10 years, it doesn't mean it will work for the next 10 and vice versa. Have a long-term mindset, as it gives you the edge over most other investors, but also always be open to learn and adapt.
Share with us more information about your portfolio. How concentrated is it? How many stocks do you have in your portfolio? Which sectors do you prefer? How much cash are you currently holding and why? What are the biggest positions? Do you also have some speculative positions? For how long do you usually hold a position? Do you only invest in stocks?
One of my fundamental principles in active investing is concentration. I strongly believe that the exposure to risk on a company-specific level is the primary driver of excess returns over the long run as a stock picker. As a result, in the New Era, we generally maintain a portfolio of only 10 to 15 carefully selected companies, mostly in the technology space.
Throughout 2022, we maintained varying levels of cash in our portfolio, ranging from a maximum of approximately 30% in Q1 to only 2% at the end of the year. Following a significant market rally in January 2023, we decided to significantly increase our cash position in February (currently at around 30%) as we continue to concentrate and allocate funds to only our highest conviction long-term names that are still attractive in valuation on our parameters.
Our largest holdings include Meta, Google, and Amazon. Additionally, we have positions in several smaller businesses, such as SoFi, Twilio & others, that we believe are, despite the macro uncertainties an attractive investment at the current levels given their valuations and the effects of the management teams to significantly affect the share prices via company specific actions even if the macro gets worse in this period.
As a strategy, we only invest directly in individual stocks. The holding period of one position is not limited, but the goal is to have companies in the portfolio that perform well over the long run.
What were the biggest/most significant changes in your portfolio this year?
We take a long-term view when initiating positions in companies. However, the fast-changing macro environment of the past year led to widespread rerating of stocks, particularly in the growth/technology sector. As a result, we made more significant changes to our portfolio than we normally would.
Towards the end of 2021, we completely sold out of 9 companies in our portfolio due to their high valuations, which we believed were unsustainable given the changing circumstances of monetary policy tightening. These were mainly smaller-cap companies that were not yet profitable and therefore represented a higher risk, with valuations more sensitive to potential interest rate hikes by the FED.
In Q4 of 2022, we focused even more on larger companies with stronger cash flows and those that were already generating profits. We plan to continue executing in this way in Q1 of 2023, given the sharp drops in stock prices of some big technology companies (50% or more in 2022) and their attractive risk/return profiles compared to smaller, less profitable names that could experience greater volatility.
At the end of 2022, some of the large tech companies had their valuations near the 2008 recession levels, as measured by the EV/EBITDA. In addition to their low valuations, we believe many of these companies have significant potential to cut costs and increase profits, even in the event of a recession and falling revenues.
What is your ROI since you joined the New Era Funds?
We began managing the New Era Core Fund in 2021, a year in which stock prices reached record highs. Since our inception on April 19, 2021, until February 16, 2023, we have delivered a negative return of -41.1%. However, the macro period has been one of the worst for our type of investments in the last 20 years. So it is often important to zoom out and showcase how our strategy performed during different periods. To illustrate this, I can take the performance of my own portfolio prior to the fund’s inception, which was managed using the same strategy and philosophy as in the New Era Core Fund.
As you can see from the past results, the strategy delivered above-average returns during periods of greater stability compared to general stock market indices. However, it is also more volatile in negative periods, as evidenced by our negative return in 2022 and 2018. The year-to-date performance at the fund (as of February 16, 2023) is a positive return of +25.7%.
What is the best performing stock in your portfolio currently?
If we look at the performance this year, the one that I would point out is probably Meta. It has grown a lot in the stock price this year, but also it’s the “best performing” for me because it is also my biggest position. To be as brief as possible on why I like the company, I would summarize it as an undervalued company in its importance to today’s world and its +3.5 billion people reach. But for more concrete reasons, I invite everyone to check my newsletter, where an extensive article is written on it. The timing of selling a position depends on fundamentals, so I can’t give you an exact number based on a stock price because I don’t know what the fundamental picture will look like then.
What is the worst performing stock in your portfolio currently?
The worst-performing stock this year in my portfolio is Google. Its underperformance can be attributed to the recent focus and hype around LLMs, particularly ChatGPT. However, I still find Google attractive for the following reasons:
1) Its valuation is compelling. Its EV/EBITDA is near 2008 levels. Even with a smaller EBITDA than their potential is at this point because of the Cloud unit losses, Other bets losses, and an over extensive employee count.
2) I believe in the long-term sustainability, resilience, and dominant position in Alphabet's three key business pillars: Search, YouTube, and Cloud.
3) I believe that Google's profitability will improve as it focuses on cost control, especially in light of the tech industry's ongoing "getting fit". This could lead to significant upside surprises for investors.
4) I view AI LLMs, not as a threat but as an opportunity for Google. With its strong distribution, vast data sources, and immense engineering talent pool, Google is well-positioned to benefit from the new AI cycle. This technology could potentially open up new markets for Google and even replace certain labor types. Having worked in the AI industry, I know the key thing about AI is data and computing, and Google has both at its disposal.
Where do you get your investment ideas?
I derive my investment ideas from reading, researching, and talking with other investors. When I find an interesting industry, I thoroughly analyze all the main players and companies in that space, including their market share and relationships. I pay close attention to both the industry leaders and the companies that are growing the fastest, even if they are not yet market leaders. I also like to review the most significant changes in the industry in the last 5-10 years. Whether it is a new technology advancement, a new big competitor entering the space, supply constraints, etc. I want to understand the current drivers of the industry before I can evaluate how companies are positioned for the future.
If I come across an interesting company in terms of its business and market position but is too expensive on a valuation basis, I add it to my "internal watchlist". Then, when it hits my desired valuation parameters, I reanalyze its fundamentals. If everything checks out, it becomes a candidate for addition to my portfolio.
While analyzing financials is a critical step in any investment process, I also place considerable weight on qualitative factors. I evaluate the company's product, its ability to upsell to existing users or clients, and how the adoption of new technologies could impact its cost structure. To gather qualitative data, I often review expert interviews with industry insiders or competitors, as well as feedback from former employees of the company I am analyzing. These sources provide valuable insights into the company's direction, challenges, and internal operations. Company financials tell the history, but as an investor, you also have to understand and look at the future, which won’t be seen in the numbers yet, and that is why a fundamental understanding of the product/service is essential.
Tell us your 2023 outlook
I think 2023 will be another hard-to-predict year because there are so many moving parts in the macro environment that play a decisive role in determining where economic growth and interest rates will be. But I think inflation is still the thing investors need to keep their focus on. I think the real crucial part of the inflation will be when the FED pauses in the first half of this year and what happens with commodity prices after that.
I think the other parts of inflation besides commodities & energy are in at least partial control of the FED and its monetary decisions, but I think commodity prices could be a problem once the FED reaches a realistic upper limit of 5-5.25% interest rate. If commodity prices would reaccelerate much higher at that point, it could present a risk to the equity market in case FED feels the need to stop those prices and again goes on an aggressive path of hikes, despite already being at that 5-5.5% interest rate range.
My base 2023 outlook right now is that inflation will continue to move in a downward direction. We will probably get to a 3%-4% annualized inflation rate fairly soon. At that point, if the FED “backs off” and isn’t overly focused on getting it to 2% in the short term, it could be a very positive 2nd half of 2023 for equity & bond prices. Even if inflation is higher and we have a FED that is not that aggressive with hikes and QT anymore, the setup, in that case, would still be good for equity markets.
Of course, a significant escalation of the war in Ukraine, with China's increased involvement, could change this outlook. In such a scenario, inflation could surge, and the Fed may be compelled to take extreme measures, leading to a major recession.
Which stock do you believe has the biggest potential in your portfolio and why?
This is a really tough question. Because I believe in all of the stocks in my portfolio and their potential. But if I understand the question right and we are strictly talking about the upside and disregarding the risk, I would say Sofi is one of those names that would be high in the rankings. Despite a tough macroeconomic environment, Sofi is continuing to execute well. In just the last quarter, they grew revenue by 60%. They added almost 500k new members in the quarter to a total of 5.2M, growing 51% YoY. They are just in the early stages of their product offering in their financial service segment. Their software segment is one of the leaders when it comes to backend infrastructure for other fintech players. They received their banking license in 2022, which is giving them the ability to have better margins and to be even more competitive on a product level. To add on that, the management team is really focused, led by Anthony Noto, who is a great CEO. A higher interest rate environment is also a tailwind for the business.
In addition, what I find really interesting is that Sofi currently trades at book value. So it’s being valued as a traditional bank even though it’s growing 60% YoY, adding almost 10% of its user base in one quarter in its financial service segment and has a growing software as a service business. To keep it brief for anyone interested more about the name again, you can check my article about Sofi in my newsletter.
You also write a great newsletter focusing on tech stocks. Tell us more about your newsletter Uncover Alpha.
The idea for Uncover Alpha came very spontaneously. In 2020 I started sharing my thoughts and opinions about investing and stocks on Twitter and began to reach a bigger and growing audience. After a few months, I found out that I had more to say/share than what was the character limit of Twitter. I decided to start a newsletter where I could share some of my analysis and summaries of companies, especially those I invest in. And that is how Uncover Alpha was born. Uncover Alpha is a newsletter for company-specific analysis and articles but also has articles that target an industry or a growing new industry as a whole and try to identify investment opportunities in it etc. One of the goals of Uncover Alpha was to publish summaries of analysis publicly so I could keep track and look back to them at later points in time and see how my thought process was right/wrong and learn from it to make me a better investor.
Since the early days, Uncover Alpha has organically grown a lot. Today we are just shy of reaching 10.000 subscribers, and it has become much bigger than I would have imagined. I enjoy writing the newsletter because it combines my two passions: investing and writing. I have always had a passion for investing, but I also have a passion for writing. My mother is a screen and book writer, and I got that part from her.
Uncover Alpha is an important project for me personally. First and foremost, I enjoy helping other investors out with their research. I also get a lot back from my readers as they often send me feedback on things that I might have missed in my analysis or their personal experience as a business person with the company or product. It is beneficial to my process. It is also personally rewarding when you get emails from readers that are young students and are learning about investing and really enjoy your articles and start building a passion for investing. I think we live in an era where investing knowledge is more decentralized than ever. I connect with so many great analysts & professional investors from all over the world that are not giving their opinion on Bloomberg or CNBC but are far better than the ones that are talking there daily.
Also, as a fund manager, I think it is really important to be connected to the world and read, share, and explore ideas from other smart investors worldwide and keep an open and curious mind. Besides being successful at my company as a fund manager, my personal goal is to empower many young people to start investing because it truly is the main source of economic freedom. And if you are young, the investing amounts do not have to be big because you have the long-term horizon on your side.
Who are the best investors you follow?/What investors do you admire most?
I don't strictly have one best "famous" investor. I do draw inspiration from a variety of investors. Some of the famous investors include Terry Smith, Stanley Druckenmiller, and Brad Gerstner from Altimeter Capital, among others. However, I've also formed valuable connections with lesser-known investors who share their insights through newsletters or on Twitter. I enjoy engaging with these investors and learning about their research, views, and investing concepts.
In terms of books, I started out like many investors with Benjamin Graham The Intelligent Investor. However, for my area of focus in investing, I found The Innovator's Dilemma to be one of the most insightful books I've read. In the investment industry, I find that domain knowledge is often very underappreciated, and too many investors rely only on financial knowledge, which I believe is not enough.
What is the biggest investment mistake you have made? And what did you learn from it?
I believe my biggest lesson learned from past mistakes is not to deploy cash too early. Now even if a company and its product are great and have a promising long-term story, I make sure to let the valuation reach a level where I feel very comfortable before investing/adding.
Another lesson that ties into the first one is to invest aggressively when a company's valuation and potential are a "screaming buy" according to my internal parameters. Instead of nibbling on small positions during these times, I take advantage of the opportunity and invest larger chunks. For example, when Meta hit the $90 mark, I added to my position, but I could have added even more based on my parameters. As Buffet puts it, "wait for the big fat pitch but then swing!".
(Meta forecast, profit margin and quarterly earnings)
Which sectors do you believe will outperform in 2023 and 2024?
I believe technology will outperform in 2023 and 2024, and that is because the valuation of the sector came down a lot in 2022, and the difference in valuation between an S&P 500 and Nasdaq is one of the narrowest in history. Even if a recession comes, technology companies have the most “fat to cut” from the zero interest rate era. This means they will be better able to handle the potential drawdown in profits because of internal cost-cutting than some companies from other sectors that are fully operational optimized for profit and don’t have much “excess fat” to cut costs.
In the second half of 2023 and 2024, I also see the potential for the commodity sector. As the Federal Reserve becomes less aggressive and recession fears subside, the demand for commodities may rise. Moreover, the deglobalization trend could make cheap commodities a thing of the past, driving up prices and benefiting companies in the sector. New entrants that could lower margins are also limited in a high-interest-rate world because a lot of the new projects are mostly funded via debt, which is now expensive.
Which stock(s) do you believe will double in 2023?
While I'm not expecting any of the stocks I follow to double in 2023, it's difficult to predict what the year's second half will bring. However, I believe there's a possibility that it could be one of the more lucrative periods for investors. In such a scenario, beaten-down stocks in our portfolio,such as Sofi and Twilio, could present themselves as potential candidates for significant gains or even doubling this year.
What do you believe will be the next black swan event in 2023?
A black swan event is typically an unexpected event that catches everyone off guard. However, at present, people seem to be focused on negative possibilities. As such, a significant event could be an escalation of the conflict in Ukraine, but that would not qualify as a "black swan" event. A true "black swan" event would be if inflation were to drop sharply unexpectedly, perhaps in the second half of the year when the housing lag on CPI is no longer in effect. Such an occurrence would be viewed positively for equities and the market in general. Although no one anticipates a return to near-zero interest rates in the short to mid-term, I wouldn't rule it out completely just yet.
What is the best stock for the long-term to buy?
In the long run, I believe stocks like Sofi, Block, and Airbnb are promising investments. However, I also see good risk/reward opportunities in larger companies such as Amazon, Google, and even Meta. These companies will emerge from this period as leaner entities, with fewer cash-burning moonshot projects and a reduced workforce. This could pleasantly surprise Wall Street in terms of its profitability under a lean operational structure. While Apple and Microsoft are already optimized operationally, I think Google, Amazon, and Meta are much more profitable but have been weighed down by excess workforce and numerous moonshot projects funded in the zero interest rate era. With the focus back on efficiency, these companies net-margins could expand, and their real core business profitability could become more apparent.
