This shareholder letter is part of the Bretton Fund 2023 Annual Report (pdf).

February 9, 2024

Dear Fellow Shareholders:

On October 17, 2022, a widely read Bloomberg headline declared, “Forecast for US Recession Within Year Hits 100%,” and the article calmly informed readers that “a US recession is effectively certain in the next 12 months.” The Federal Reserve was going to raise interest rates multiple times, which was going to hammer consumer spending, squeeze corporate profits, and trigger a recession—all necessary evils to slay inflation. Many stock market prognosticators predicted another down year.

When it comes to economic and stock market predictions, no one knows anything—and that’s perfectly fine. For the most part, we restrict our predictions to the micro. Will people keep buying discounted brand-name clothes at T.J. Maxx, or will they shift to fast fashion online retailers from China? Will consumers ditch their Visa cards for payment apps? Will corporate IT departments shift their computing to startups and away from Microsoft? These aren’t easy questions to answer, but they’re infinitely more manageable than “How much will the output of the entire US economy grow over the next 365 days, and what multiple will stock market investors in aggregate apply to the corporate earnings of publicly traded companies 365 days from now?” We’re okay saying we don’t know.

Returns as of December 31, 2023 (A)

4th Quarter1 Year3 Years5 Years10 YearsSince 9/30/10 Inception
Bretton Fund14.83%28.91%12.93%16.15%10.77%12.32%
S&P 500 Index (B)11.69%26.29%10.00%15.69%12.03%13.59%

Calendar Year Total Returns (A)

YearBretton FundS&P 500 Index
202328.91%26.29%
2022-12.56%-18.11%
202127.76%28.71%
20208.44%18.40%
201935.39%31.49%
2018-1.94%-4.38%
201718.19%21.83%
201610.68%11.96%
2015-6.59%1.38%
20149.79%13.69%
201326.53%32.39%
201215.66%16.00%
20117.90%2.11%
9/30/10 – 12/31/106.13%10.76%
Cumulative Since Inception366.12%441.02%

(A) 1 Year, 3 Years, 5 Years, 10 Years, and Since Inception returns include change in share prices and, in each case, include reinvestment of any dividends and capital gains distributions. The inception date of the Bretton Fund was September 30, 2010.

(B) The S&P 500® Index is a broad-based stock market index based on the market capitalizations of 500 leading companies publicly traded in the US stock market, as determined by Standard & Poor’s, and captures approximately 80% coverage of available market capitalization.

Performance data quoted represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted. You may obtain performance data current to the most recent month-end at here or by calling 800.231.2901.

All returns include change in share prices, reinvestment of any dividends, and capital gains distributions. The index shown is a broad-based, unmanaged index commonly used to measure performance of US stocks. The index does not incur expenses and is not available for investment. The fund’s expense ratio is 1.35%.The fund’s principal underwriter is Arbor Court Capital, LLC.

4th Quarter
In the fourth quarter, the main contributors to performance were Dream Finders Homes adding 2.1%, Ross Stores 1.2%, and American Express 1.2%. There were no major detractors.

Contributors to Performance for 2023
For the full year, the largest contributor to performance was also Dream Finders, which added 4.7% to performance despite starting the year as only a 1.7% position in the fund. At the end of 2022, it was a given that higher mortgage rates would decimate the housing market, and the values of home builders reflected that sentiment, especially smaller ones like Dream Finders, which traded for only three times earnings at year-end.

Our near-term view on the housing market wasn’t all that different, but we knew the market would turn at some point and we’d be rewarded for holding through uncomfortable times. The market for new homes turned out to be quite resilient, and the stock quadrupled during the year. Our other home builder, NVR, added 2.3%.

Tech led the market down in 2022, and it led it on the way back up in 2023. Alphabet, Google’s parent company, added 4.2% and Microsoft added 2.5%.

The only detractor for the year was Revvity (formerly PerkinElmer), which took off 0.3% from the fund.

Taxes
The fund did not make any tax distributions in 2023.

Portfolio

Security% of Net Assets
Alphabet, Inc.9.64%
The Progressive Corporation6.38%
AutoZone, Inc.6.20%
NVR, Inc.5.80%
Microsoft Corporation5.79%
Ross Stores, Inc.5.77%
Dream Finders Homes, Inc.5.31%
The TJX Companies, Inc.5.29%
American Express Co.5.19%
Bank of America Corp.5.09%
S&P Global, Inc.4.92%
Mastercard, Inc.4.80%
Visa, Inc.4.78%
JPMorgan Chase & Co.4.69%
UnitedHealth Group Incorporated4.55%
Union Pacific Corp.4.52%
Moody's Corporation3.89%
Berkshire Hathaway, Inc.3.21%
Revvity, Inc.1.44%
Armanino Foods of Distinction, Inc.1.41%
Cash*1.37%

*Cash represents cash equivalents less liabilities in excess of other assets.

Financials
As we’ve written before, one of the lasting, and tragic, behavior changes brought on by the pandemic is reckless driving. There are lots of theories as to why, but we think the shift away from commutes and their traffic jams to driving on emptier roads around people’s homes at irregular hours has led to faster speeding and more severe crashes. Americans’ addiction to mobile phone use has not helped either. Progressive was one of the first insurers to identify this shift—we think their data is the best in the industry—and raised rates before their competitors did. Despite raising rates by over 30% the past two years, Progressive still grew customers by 10%, quite a bit in a low-growth industry. Progressive’s core earnings from insurance operations increased 53%, and the stock returned 23%.

American Express’s stock had a strong year, returning 29%, as the big recession many investors were expecting to result in cardholder delinquencies never materialized. The company recently set ambitious, long-term goals of 10% revenue growth and mid-teens earnings per share growth, and while those numbers may be a touch optimistic, the investment will continue to do quite well if they even get close. Earnings per share increased 14% last year.

It was a little less than a year ago that the spike in interest rates caused the failure of multiple banks, most notably Silicon Valley Bank and First Republic. Those banks had tied up too much of their newly acquired deposits into long-term bonds, which decrease in value when interest rates rise and can then be a problem when depositors want their money back. Our two bank investments, JPMorgan and Bank of America, were the beneficiaries of these small banks’ struggles. In a banking crisis, depositors tend to favor safe banks. JPMorgan increased earnings per share 34%, and the stock returned 31%. Bank of America only managed a 7% increase in earnings per share; it, too, had tied up a significant, though manageable, amount of its liquidity into long-term bonds, dampening earnings. The stock returned 5%.

Rating agencies S&P Global and Moody’s both had terrible years in 2022 when bond issuance dropped from higher rates, but rebounded as issuance ticked back up. S&P Global’s stock returned 33%, and Moody’s returned 41%. We estimate earnings per share increased 24% and 22%, respectively.

Technology
Microsoft and Alphabet returned 58% and 59%, respectively. Corporate tech and advertising spending accelerated after a weak 2022, but it was mostly a change in investor enthusiasm for the space that drove those returns. Investors are optimistic about artificial intelligence and increasingly see AI as a good thing for Microsoft and Google. We agree. Microsoft’s earnings per share increased 12%, and Alphabet’s, which benefited from a much better advertising environment, increased 27%.

Like clockwork, people keep spending more on their debit and credit cards. Visa and Mastercard increased earnings per share by 17% and 15%, while their stocks returned 26% and 23%, respectively. Customers and merchants have a growing variety of ways to make payments—Zelle, Venmo, Bitcoin, Affirm, etc.—but nothing has yet to displace the coverage, speed, fraud protection, and rewards that cards offer.

Consumer
Having focused on retail customers for decades, AutoZone expanded a number of years ago into serving repair shops, and it’s gone swimmingly. They’ve already taken 4% of the market and continue to take more. They’re also planning to expand faster in Mexico and Brazil, having dabbled in both countries for over a decade. These markets have large bases of older vehicles served by a highly fragmented group of informal distributors and stores, a great opportunity for AutoZone. Earnings per share increased 13%, and the stock returned 5%.

As we wrote last year, Ross Stores and TJX struggled when inflation was at its worst. Costs rose faster than they could push price increases through to their cost-conscious shoppers. Inflation eased, and revenue and margins are back up. We estimate Ross and TJX increased earnings per share by 22% and 26%; their stocks returned 21% and 20%.

Our home builders—NVR and Dream Finders—continued their tradition of consistent operating performance and volatile share prices, with NVR increasing 52% and Dream Finders increasing 310%.

The older and more established of the two, NVR, delivered 20,662 houses in 2023. It delivered 22,732 in 2022, 21,540 in 2021, and 19,766 in Covid-impacted 2020. Looking at the rhythm of operations, you would be hard-pressed to notice much difference. The share price, however, went from $5,900 at the beginning of 2022, to $3,700 that June, before climbing back over $7,000 at the end of 2023. The share price movement had good reason: mortgage interest rates nearly tripled from their fiat currency–era lows in January 2021 to the end of 2023, although they are still lower than almost any point in the 1990s. We continue to believe that the nation has dramatically under-built housing for decades, and the principal competitor to new houses is used houses, which are owned by people who have low mortgage rates and would face a major penalty if they were to sell and move.

Dream Finders is slightly more complicated, in that it is a young, rapidly growing business with a less-experienced team. It made a series of acquisitions between 2019 and 2021 to enter new markets more rapidly, and when interest rates suddenly shot upwards, it seemed to be in a somewhat precarious position. By the end of 2022, the stock was half of its IPO price. It then proceeded to roughly quadruple in 2023 when the sky didn’t fall. Although consciously emulating the land-light NVR model, Dream Finders doesn’t operate at the same level: it typically runs a much higher cancellation rate than NVR, branches out into adjacent areas such as active senior communities and custom house building, and uses related parties to secure land.

Our tiny manufacturer of frozen sauce and pasta, Armanino Foods of Distinction, sports a market capitalization of just $150 million, a sliver of Microsoft’s $3 trillion. Both are high-margin, high return-on-capital businesses that are growing nicely, but only one of these has delicious products that are quite satisfying to “research.” Armanino expanded its presence in grocery stores like Safeway and Albertsons with a broad line of pastas and sauces, in addition to its core market of cafeterias and restaurants. The stock returned 37%, and earnings per share increased an estimated 20%.

Industrials
Union Pacific struggled in 2023. Carloads, revenue, revenue per carload, operating income, earnings, free cash flow—everything went in the wrong direction. This was not too surprising; industrial production has been flat, and a new labor agreement dinged margins. A brief activist campaign resulted in the replacement of the CEO with former COO Jim Vena, and the narrative shift from “imminent recession” to “maybe the economy isn’t so bad” caused the stock to return 22%. Earnings per share declined 7%.

Berkshire Hathaway’s operating businesses performed moderately well. GEICO emerged from several years of struggles to make a positive contribution, and comparatively calm weather meant that Berkshire’s reinsurance segment performed well; this was partially offset by challenges at BNSF Railway (which had a similar experience to our Union Pacific) and Berkshire Hathaway Energy. Interest income increased thanks to higher rates, and the value of the equity portfolio increased along with the overall stock market. Berkshire’s shares increased 15%.

Healthcare
Stock market investors turned bearish on the healthcare sector in 2023, perhaps best encapsulated by the S&P Pharmaceuticals ETF now trading below its value on the eve of Covid. Our investments were not immune to this sentiment.

United Healthcare stock was flat for the year, ostensibly over concerns about its medical loss ratio (MLR) and slower enrollment growth in Medicare Advantage. The MLR is the portion of health insurance revenue spent on healthcare, and it came in at 85% versus analyst expectations of slightly higher than 84%. As concerns about Covid wane, subscribers are scheduling more procedures.

We take some comfort in a longer perspective. In 2019—the last full pre-Covid year—United Healthcare had 5.2 million Medicare Advantage members out of a nationwide Medicaid population of 60.2 million; this business had a fantastic year and earned $15.11/share. In 2023, United had 7.7 million Medicare Advantage members out of an estimated nationwide Medicaid population of 64.9 million, and it earned $25.12/share. In four years, it captured over half of the net additions to the Medicare program, adding the equivalent of the entire populations of Idaho and Wyoming to its subscriber base, and increased its earnings by 66%. Medicare actuaries expect the Medicare population to exceed 75 million by 2030, and we think United provides the best platform to serve these new customers.

Revvity—the former PerkinElmer, having sold the name along with its food and environmental testing businesses to a private equity firm earlier in the year—had a rough 2023. Headwinds in the pharmaceutical and biotech industries caused site closures and program cuts, and fewer researchers and fewer projects meant reduced demand for laboratory consumables. Adjusted earnings fell 35% from $6.92 to roughly $4.50, and the stock dropped 22%.

For the market and economy overall, we remain cautiously optimistic, but more importantly, short-term agnostic. Over the long run, we think the right collection of businesses at favorable prices will continue to produce good returns.

As always, thank you for investing.

Stephen Dodson            Raphael de Balmann
Portfolio Manager         Portfolio Manager