The Swingbridge Recipe to Drive Long-Term Returns

Our job at the Swingbridge Public Equity LP (a concentrated portfolio pursuing a Private Equity / Venture Capital replacement investment strategy) is to drive long-term outperformance relative to the S&P 500. To achieve this, we need to construct a concentrated equity portfolio through the constant evaluation and investment in companies that are:

1. Aggressively pursuing growth via dedicated capital allocation plans (organic and inorganic)
2. Demonstrating a proven history of generating “value add” to the franchise via strong return profiles on capital and operational investments (as measured by returns on invested capital, or “ROIC”)
3. Trading at valuations that are attractive enough, through a longer-term lens, to generate strong upside-to-downside skew characteristics (e.g. consolidated portfolio skew of > 5x estimating upside return potential relative to downside risk exposure)
   
   

Simply put, this is not a passive, index-based investing strategy. On the contrary, in the aggregate, we believe that if we can invest in a small portfolio of category-leading companies that are: A) growing faster than the average company in the S&P 500; B) better allocators of capital than the average company in the S&P 500; and C) are priced more attractively than the aggregate S&P 500 valuation, we have a strong likelihood of achieving our objective over the long-term. Additionally, we increase our probability of success by targeting and monitoring investments in category leaders that seek to be winners in their respective industries. 

In recent years, however, investors have continued to seek the comfort of index investing and passive allocations. And for many investors, and for a variety of instances, that approach makes sense. However, when we look at the market construct today (as measured by the S&P 500 skew profile outlined below), we believe the opportunity to achieve excess long-term returns via a concentrated equity portfolio of equities with aggressive capital allocation plans and favorable skew profiles hasn’t been this attractive in a long time.

Following a highly volatile capital markets environment in 2022 and early 2023, and with news flow and geopolitical events seemingly getting louder by the day, investors have been engaged in a multi-quarter dance with a dynamic risk/reward tradeoff. This has ranged along the risk curve from the certainty and preservation of “nominal” capital offered by cash on one end to the potential but not guaranteed “real” capital appreciation from equities on the other end – both book-marking the theoretically “stable” yield profile of bonds. 

As of the end of April 2023, our estimate of the long-term skew for the S&P 500 index (measured as upside return potential of ~15% vs. downside risk exposure of ~24%) was just 0.62x with an equity risk premium slightly below 2.0% (and 10-year U.S. Treasuries yielding ~3.5%). While no one knows the future, these levels are consistent with mediocre long-term passive index returns. At the Swingbridge Public Equity LP, however, we look to continue to invest our portfolio with a long-term skew profile in excess of 5.0x, in hopes of positioning the Fund with a superior risk/reward profile relative to the 0.62x skew estimate of the S&P 500.

To add some context behind these estimates, at the market peak near 4,800 in the S&P 500 in Jan. 2022, our estimate of the long-term skew went negative, implying a rapidly deteriorating risk/reward profile. And then at the market lows near 3,500 in the S&P 500 in Oct. 2022, our estimate of the long-term skew was nearly 4.0x, implying a markedly improved risk/reward profile. This highlights the aforementioned dynamic dance that investors do with risk and reward, absent short-lived swings in underlying momentum, structure, and psychology.

When taking a long-term investment horizon approach, as we do, the short-lived swings matter less, and the recipe for success remains consistent. Pick category leaders that are successfully investing in growth with upside/downside skews that outpace that of the S&P 500.