2024: 46.6%, taoism, the circle of extreme competence, whisky, cash, and future plans
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Returns in 2024 were 46.6%. In the same time period, the Nasdaq Composite returned 30.8%, SP500 returned 24%, MSCI World returned 19.2%.
In 2024, my family welcomed a new life into the world. At the time of writing, my son is just under 3 months old. As I work, he is in the back of my mind and I repeatedly tell myself that I hold his future in my hands. The most important people in a newborn’s life are their parents and I find that incredibly motivating. There is absolutely no way I am going to let him down.
2024 was a great year for us from a returns standpoint. In the US, valuations are quite stretched. Multiples have expanded to levels similar to 2021 and 2001. Everyone looks like a genius in a bull market. However, 2025 with a more ambiguous, volatile setup, could be a more challenging year.
On taoism and the circle of extreme competence
When I first met my wife, Janet, I started a company with her. To date, it’s the hardest thing I’ve ever done. By the time we had parted ways with it, I had been so burned out to the point where I couldn’t look at a computer screen without feeling an incredible feeling of dread. That experience catalyzed a multi-year deep dive into philosophy and religion. One of the philosophies that deeply resonated was taoism (the philosophy, not the religion). Taoism, at least the part that resonates, assumes that there is a natural way. For example, as an engineer, analytical work (ie. design, programming, etc.) to me is much more natural than work that requires emotion (ie. singing, dancing, etc.). For the past few months, I’ve been studying the alcohol and spirits industry. This is something I find easy as I have a WSET certification in spirits and at one point, studied whisky as seriously as I study companies. I loved every second of it. When I watch an expert on TV or read a professional analysts’ large, extensive reports, I find a large number of mistakes even if they are a so-called sector specialist. Likely they haven’t spent years studying distillation textbooks or spent the time/money to taste thousands of whiskies. You only get that kind of intensity for years if it’s something that you’re deeply interested in. By comparison, in recent memory, Aritzia, Lululemon and Estee Lauder were stocks that went “on sale”. I saw, first hand, a great deal of men speculate about the consumer trends of women, despite not being one themselves. Maybe these men are uniquely talented in understanding what women want. Certainly, many men would like to think that they are. But personally, as someone who has never been popular with women and who wakes up shocked he still has a wife, I do not have that kind of confidence!
Warren Buffett calls the area which matches an investor’s skill and expertise the circle of competence. That definition of competence is incredibly important. In my past career, I’ve interviewed hundreds of software engineers. I’d argue most engineers are not competent enough to charge for their time. The reason? Some might not be naturally wired to write software. But more common, I find, is that a lot of those engineers write software to make money rather than have a passion for software itself. When I was younger, I’d go to bed reading the Linux kernel source code because I loved it. It was natural to me. Nearly everyone I’ve met in software engineering who I’d characterize as competent has a love of the craft. If we tweak Buffett’s wording from “circle of competence” to “circle of extreme competence”, it seems self-evident that the word “extreme” is only achieved with a certain level of intensity. It’s probably possible to get to that level of intensity through sheer discipline and willpower. However, I find it easier to study something deeply fascinating.
By definition, the average return in markets is an index. Presumably, for an investor to beat the market there needs to be differentiation in process, intelligence, portfolio management, and so on. The problem with average in markets is that market participants include armies of brilliant people, PhDs, custom silicon, proprietary data sources, industry experts, all trying to compete and have an edge over each other. That is, the average in markets is a high bar. Certainly higher than in many other professions including software engineering. I’d argue, extreme competence is the only way to outperform in the long run. As investing is a marathon that spans many years, the only way I believe I can sustain that degree of intensity is to study subject matter that I find deeply fascinating.
Whisky
A few months ago, I had the privilege to meet the founder of my favourite whisky distillery, Anthony Wills. Anthony had the idea to start Kilchoman in 2001. Anthony is 69 as of the time of writing, but conceived of the idea when he was 45. 2001 was a challenging year for markets as there had been a telecom/tech bust. Scotch distilleries are difficult to start because whisky requires some experimentation to perfect a recipe and there’s time required to age that stock. A few years back, I did some of the math to start a distillery as I was fanatical about whisky at the time. The math didn’t make any sense. Anthony claims he jumped head first without doing the math. 24 years later, he won. His whisky is some of the most delicious whisky out there and the whisky I drank celebrating my son’s birth. I feel his story is emblematic of whisky being about more than just money. It’s his life’s work. Unfortunately, it appears many new distilleries are opening without doing the math.
Whisky is cyclical. On both sides of the pond, in both the US and Scotland, I have noticed an incredible increase of capacity in the form of new distilleries and retrofitting of existing distilleries. As a whisky drinker, this is an incredibly exciting time. As an investor however, I think there is pain to come. During the pandemic, there was not enough whisky to go around. Unfortunately, it is a tale as old as time. A shortage followed by glut. In the UK (of which, Scotland is a part of), public filings can be seen at Companies House UK. Many new and small distilleries are woefully undercapitalised and cash flow negative at a time when Scotch volumes are down. In the US, lower end whisky is seeing a dramatic change of fortunes as tequila and ready to drink (RTD) cocktails seem to be gaining market share. Furthermore, American whiskey (in the US, whisky is spelled with an “e”) inventory has reached incredible highs with nearly 13M barrels. On the high end of the spectrum, however, American whiskey seems to have a bright future. Sazarac’s Buffalo Trace Antique Collection (BTAC) and Pappy van Winkle whiskies are collections of hard to get and delicious whisky. From a whisky drinker’s standpoint, I’d argue Sazarac’s BTAC/Pappy whiskeys have inspired a kid-like enthusiasm for bourbon among Americans and has elevated the entire industry. They are part collector’s item and part drinking experience. In my opinion, some of them are really not any better than good, widely available bourbon. However, that scarcity and reverence has gotten people to pay attention. Many other distilleries have followed suit and just like with wine vintages, there are now “vintages” of American whiskeys. I say this without hyperbole, some of these annual releases have been the best things I have ever tasted in my life.
On both sides of the pond, I suspect there will be potential bankruptcies and acquisitions. In recent history, larger profile bankruptcies include Waterford (Ireland) and Mackmyre (Sweden). Personally, I find this profoundly sad as Waterford had a vision of putting the spotlight on terroir, viewing whisky through the lens of wine. It was most definitely an effort that required blood, sweat, and tears. Names like Diageo will likely be a benefactor, buying distilleries at a discount in the single malt/Scotch side of the world. On the American side of the world, I think companies with high exposure to the low end of the market will continue to see poor numbers as oversupply and changes in consumer behavior make for a difficult operating environment. To make an oversupply story even more bleak, a number of theories have emerged. Some investors hypothesize that Ozempic dampens the craving for alcohol. Recent polling has shown that something like 1 in 8 Americans have tried Ozempic. On January 3, 2024, US Surgeon General Vivek Murthy argued that alcohol and cancer have a direct link. In recent history, European spirits have been the geopolitically punching bag of both the US and China. In 2019, Trump slapped a 25% tariff on Scotch whisky. This past year (2024), China imposed a temporary tariff on European brandy (ie. cognac). I would not be surprised if this trend continued. Finally, it is also hypothesized that marijuana is a competing product, especially among Gen Z.
Despite all of these negative headlines, I think there are a few areas/names I find compelling. With such incredible fear and a great deal of negative stories floating around, there is already a fair amount of mispricing. That said, I have yet to make a bet and hope to do so in 2025.
Cash
The canon in value investing circles is to ignore the macro arguing it is unknowable. I disagree. I’d argue there are things within macro that are knowable and that the distinction should not be between macro and not macro. It should be between the knowable and unknowable. We know that the US is led by an increasingly isolationist president. We know he stands for a departure from the status quo. In his last presidency, President-elect Trump gave us two pitches we swung hard at: CNOOC and China Mobile. At the time both were high quality businesses with a gigantic margin of safety from a forced seller. By banning American ownership of these businesses, Trump presented some of the easiest investing opportunities of a lifetime.
Furthermore, while there is undoubtedly mispricing in markets, there does not seem to be very much within my circle of competence that I feel hits my hurdle rate. As an example, I’m a software engineer. The industry I know best is software. Unfortunately, software has mostly been bid to stratospheric valuations that I don't feel comfortable investing in. I have nibbled on companies on sale. However, as they are not industries I know inside and out, I cannot make them meaningful positions. They serve as a fire under me to expand my circle of competence.
That said, at the time of writing, US treasuries are offering mid 4% to 5% yield depending on duration. The SP500 has historically returned ~10% since 1957 representing something like a 5-5.5% spread. Furthermore, valuations are elevated to the point where Goldman Sachs predicts a 3% return over the next decade. Cash has the downside of opportunity cost as well as inflation risk and in the long run, will likely underperform most equity indices. However, given the potential volatility, high yields on US treasuries, elevated valuations, lack of opportunities within my circle of competence/hurdle rate, cash seems like a reasonable short term holding. As a result, going into 2025, my family has a relatively large cash position, certainly larger than I’d like to hold long term.
Future Plans
A few years ago, I lived with 5 other roommates in a flat in New York City, including my wife. There was one washroom which has led to some pretty funny situations and one ended friendship. I would like to stress how lucky I am to have my wife in my life who was willing to put up with my frugality. In the past, I have tried to start companies and as you're trying to be scrappy, I’ve tried to live on less than $1 USD/day. I am from Toronto, but have not paid for a ticket to go up Toronto’s most famous landmark: the CN Tower. The first time I bought the dream computer I really wanted (a mid range computer) was when I was 24. In most of my life I have attempted to save and squeeze value out of every penny in my life. A lot of it is because of my childhood. To me, capital represents safety and the ability to provide for my family. Allocating capital isn’t an activity that should be taken lightly.
I’ve had a number of friends/acquaintances ask me to invest on their behalf. I’m not quite ready to take on what I consider a very serious endeavor. At the moment, I have a lot going on. My son is just about to be 3 months old, I have a very sick close relative, and there are quite a few regulatory/legal questions an investor would need to answer if investing on behalf of others. So, for now, I hope these letters give some amount of value and I hope you have a wonderful 2025!
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