This top-performing manager boasts mutual funds that are up 40% this year. Here’s how he crushes the market
Horizon Kinetics stood out in a brutal year for stocks — boasting several mutual funds that have returned more than 40%. On the list of best-performing equity mutual funds of 2022, four out of five are from this under-the-radar, New York City-based shop, according to Morningstar. The firm’s flagship Kinetics Paradigm Fund , with $1.2 billion in assets under management, rallied 40% this year, and racked up average annual gains of 9.7% over the past 15 years. James Davolos, a portfolio manager at Horizon Kinetics with an MBA from NYU business school, said his market-beating secret is to find “hard assets” like energy, land and precious metals that can benefit from inflation. For example, the Kinetics Paradigm Fund has a stake in Canadian energy name Tourmaline Oil , which is up 80% this year. A hard security offers “a tangible, finite inelastic demand asset. … It has a really strong demand profile through a full market cycle,” Davolos said. “When you do have an inflationary market, particularly one that is supply driven as well as, in this case, monetary based, these assets tend to perform best.” Investors have been grappling with the fastest inflation since the early 1980s, although the fever has finally shown some recent signs of breaking. Meanwhile, the Federal Reserve started its most aggressive tightening policy in 40 years in order to bring down high prices, which put massive pressure on risk assets, especially growth stocks with high valuations. The S & P 500 is down almost 19% this year, excluding reinvested dividends. Royalty companies Kinetics focuses on hard assets, but that doesn’t mean each candidate appears in a Kinetics’ portfolio. Davolos said he tends to avoid companies that require a lot of capital. For example, a gold mining company usually spends a lot of cash to develop its reserves. Instead of buying a miner, Kinetics favors precious metals royalty companies that collect a proportion of the revenues from the resources the miner develops. As a result, Kinetics has a big stake in precious metal royalty company Franco-Nevada . “We’re overlaying a quality business model on top of the hard asset exposure,” Davolos said. “All of these companies benefit from the underlying market…[and] they have much better business model and unit economics.” The Paradigm fund’s biggest position is in Texas Pacific Land , one of the largest owners of land in Texas. The company, which Kinetics has owned since 1995, has exposure to two types of hard assets — land as well as oil and gas royalties. “Raw, undeveloped land has actually been the most appreciating asset through hundreds of years of inflationary cycles,” Davolos said. “I think that’s also underappreciated as having close to a million acres of surface land, in addition to their mineral acres, which is just revenue from oil and gas production.” Kinetics also has a sizable position in Brookfield Asset Management . Much like the royalty model, the company earns a management fee and carried interest on managing properties, Davolos said. The Berkshire way At its core, Kinetics is a long-term value investor. But instead of using traditional value indicators like a price-to-earnings ratio, Davolos prefers companies that have a high asset value but are a “capital light” business. “You have high operating margins, and the business can scale, so that way, you actually see improving margins, even in a difficult environment, such as this year with rising inflation,” Davolos said. The manager revealed that when he first joined the firm more than 15 years ago, he was given a book by Benjamin Graham, widely known as the “father of value investing” and also a mentor of Warren Buffett. Davolos said Berkshire Hathaway’s value investing philosophy is ingrained in Kinetics’ DNA. “Ideally, we would love to use a Berkshire Hathaway type of approach where you buy a company well, and let it compound for you over many decades,” Davolos said. Kinetics’ massive outperformance does come with a lofty fee. The Paradigm fund and the Small-Cap Opportunities fund both charge 1.64% expense ratio. Morningstar called Kinetics’ fee a weakness and “a high hurdle to clear.”
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