In Part I, I discussed how Burgundy has navigated the storm in Europe by owning great companies with strong profits, regardless of the macroeconomic scenario. In Part II I will look at the importance of avoiding large losses – what we don’t do is just as important as what we do (and keeping the ship afloat is essential to getting our clients to their destination).
It’s very hard to compound capital if you incur large, permanent losses. If you lose 50% you need to make 100% to get your money back. A more tangible example is that within our 25-stock European portfolio, if I make 10% on 23 of the companies, but two go bankrupt, the portfolio return is only 1% – and if three go bankrupt the portfolio loses 3%. A batting average of 22 out of 25 is exceptional in investing, but not if the few mistakes are big ones.
Burgundy strives to avoid large, permanent losses by avoiding unnecessary risks. We don’t believe that we need to take more risk to get higher returns; in fact, we take as many risks off the table as possible, such as too much debt, too much complexity, low barriers to entry, bad management, businesses that are over-dependent upon the economic situation of a few potentially troubled countries, and paying too much for a stock with little margin of safety.
Another way we try to avoid large losses and minimize risks is to make sure that the portfolio is not over-reliant on a few potentially troubled countries. Our companies are headquartered in Europe but earn more of their profits outside of Europe. We estimate about 47% of profits are earned in Europe, 31% in North and South America, and 22% in the rest of the world. In addition, if you split out the higher-growth emerging markets from each of those regions, we estimate that it constitutes about 29% of the portfolio.
We do not currently own any companies that trade in Portugal, Ireland, Italy, Greece or Spain – the so-called PIIGS – or have large sales exposure to them. So we have limited risk of significant currency devaluation should a country like Greece go back to the Drachma. We estimate the sales exposure of our companies at well under 10%. But we should not be too quick to assume that sales are a disaster even in the troubled PIIGS countries because some of our companies are achieving resilient results even in these troubled places.
Avoiding large losses by avoiding unnecessary risks is an important reason for Burgundy’s European returns in the choppy waters of the last couple years.