Q3: 30.6% YTD, investing in businesses at war

Year	Return
2024	46.6%
2025 YTD	30.6%

Q3 was a negative returning quarter (the worst in a few years) resulting in 30.6% YTD. For the past few years as supply chains have been rattled, trade barriers have been erected, and economies have ebbed and flowed, we have taken refuge largely in vertical market software (VMS) serial acquirers. The reasoning was that they do not require strong economies and they are not sensitive to trade tensions. They grow through inorganic acquisitions and therefore may benefit from difficult macroeconomic conditions since acquirers might be able to acquire companies at lower valuations. However, one counter narrative that has reared its head this quarter, is the idea of AI being able to turn VMS into a commodity. To be clear, I don’t believe this is true and have written about this in the past. That said, markets are voting machines in the short run and time will tell whether we are right or not in the long run. 

There are many ways to make money in markets. One style of investing that has benefited as of late is in secular growth where tech companies have been spending tremendous amounts of capital to lay the foundation of AI going forward. Our portfolio has very little exposure to this investment theme and I’d like to share briefly about why not. As the total addressable market (TAM) for AI is undoubtedly large, there is a grand war unfolding as many fierce competitors see a prize at the end of the road. 

While a lot of teenagers did things like have a life, I spent a lot of my adolescent years playing video games. Growing up, I never had a bleeding edge computer like my classmates. Thankfully, one timeless video game, Starcraft, that I did end up playing ran on fairly modest hardware. At the time, I was just a kid pretending to command alien armies at war. But a lot of how I think about investing is very much shaped by thousands of those hours. Starcraft, war, business, and investing, are all games of choice with incomplete information. 

One of the biggest decisions a player or business makes is when to fight. In a business context, it is when to allocate capital to a product or service that has a comparable offering in the market. Most businesses are constantly at war, always fighting, as there are almost always competitive businesses fighting for customers. In a desperate war, it is a struggle where resources are mostly spent on neutralizing danger with no lasting benefit. It is the textile mill that must invest in superior manufacturing processes that the industry already has so as to have a competitive cost structure. It is the food delivery business subsidizing customer orders because the competition is subsidizing customer orders so they can be the app of choice on the customer’s iPhone. Today, perhaps it is the desperate capital spent on AI. When at war, resources are thrown down the drain for a short term benefit of staying alive. By comparison, we can observe many businesses where the fight is not desperate. The business might have a niche such that competitors would struggle to maintain a foothold. The business might be protected by regulatory barriers. And so on. In this world, a business can invest for the long term and can compound capital without constraints, etc. So the first question I ask investing in companies at war is: what is the nature of the war? 

The most important factor in deciding when to fight is the probability of whether a battle is winnable. After all, if a battle is not winnable, there is no point in the struggle. If we invert this fact, by definition, if there exists a war, it’s likely both sides think they can potentially win. Wars are nuanced, complicated, and full of surprises. Good investing is one that seeks a high reward to risk. Management teams live and breathe their industries. They think about them when they take showers at night. When they tuck in their kids. It tends to be very difficult for an investor to be as well versed as the management teams they invest in as they don’t have access to the same data, expertise, and time spent on a single problem. So if two opposing management teams think they can win, the bar for the amount of competence and ego an investor would have to have to decide on a winner is astronomically high. As I’ve read through numerous writeups by the sell side, buy side, and so on, it seems evident that that bar is very rarely met. Sun Tzu’s most famous quote is “the greatest victory is that which requires no battle”. It is simply easier to invest in businesses that clearly are not at war. However, if we must invest in businesses at war, the second question I typically ask is: is my level of competence comparable to that of a management team member or better? 

When I was younger, I got to work at some of the world’s best tech businesses. Microsoft, Amazon, Nvidia and the like. One thing I noticed was many of them engaged on some level with open source. At the time, this was counter intuitive for me as they were clearly the world leaders. I didn’t understand why they needed to engage with the rest of the world. As an example, many Microsoft Office products have native formats that are open source. And yet, despite them being open source, there’s not much in the way of other office software that can adequately render them the same way that Microsoft Office can. As it turns out, office software can add a near infinite number of features, rendering text et al. itself is quite complicated, and if another player were to attempt to implement the standard, Microsoft can just implement more features so as to outrun the competition. In theory, R&D capital would be spent just attempting to keep up with a dominant player that can more easily fund new feature development. Classically, this is exemplified by Microsoft’s “embrace, extend, and extinguish” philosophy. Thus, the third question I like to ask is: can a business force another to play a game it’s not comfortable playing?

"Korean War conflict, 1948–1953", from Te Ara – The Encyclopedia of New Zealand, URL: https://teara.govt.nz/en/interactive/34516/korean-war-conflict-1948-1953CC BY-NC 3.0 NZ.

I remember the gut reaction of seeing the battlefield maps of Russia’s initial invasion of Ukraine thinking “there’s no way they can come back”. In the earliest moments, it seemed Russia had pushed Ukrainian forces to the edge of defeat. And yet, as of the time of writing, Ukraine has stabilized. If you look at history, this dynamic is not uncommon. In the Korean war, communist forces were wildly successful in the beginning so as to have taken the vast majority of the Korean peninsula. Obviously, communist forces didn’t have the last word in Korea. At one point, it looked as if Lyft was doomed to lose to Uber. Uber had a more diversified revenue base (ie. Uber Eats), it had taken market share internationally, and Uber was ruthless in execution. And yet, today, Lyft has returned to some degree of growth, a turnaround of sorts. As wars are unpredictable, I necessitate an edge, ideally in the form of alternative data. This is especially important in B2C businesses where customers are fickle, effectiveness in marketing channels can swing wildly, and a single PR incident can make or break a business. The final question I ask is: do I have an edge in assessing how the war is going or going to go? 

There is a thrill investors get out of trying to solve hard investing puzzles. It’s what I love about investing as well! However, nobody gets additional points for investing in hard, complicated cases over easier ones. Although I think investing is a muscle and investors should probably still be attempting to solve hard problems so as to strengthen that muscle, betting real money is a different story. In addition to the checklist I use for most investments, for businesses at war, I’ve found the 4 questions above to be useful in avoiding being caught in the crosshairs of a difficult, unpredictable war that I have no business betting on.