Thoughts on Client Concentration and Underlying Liquidity

July 7, 2014

“It is a common defect in man not to make any provision in the calm against the tempest”
– Niccolo Machiavelli

When we analyze a business, the most important question we must answer is, “what could go wrong?” One important risk we consider is customer concentration. Any business is vulnerable when it relies on a single customer for a large portion of its revenue. For example, MoneyGram relies on Wal-mart for about 30% of its sales. So Wal-mart’s announcement in April 2014 that it would offer a competing service was problematic for MoneyGram. MoneyGram’s stock declined 30% in one day.

Similarly, client concentration is a risk for investment managers. A redemption by a large investor can cause problems not only for the manager but for the other limited partners too. The risk is that the manager could be forced to sell investments at an inopportune time with negative consequences for the remaining limited partners.

In order to guard against this unfortunate fate at Ewing Morris & Co., we have established a number of defenses:

1. We focus on attracting stable, long-term investors. This is the most important safeguard we have as well as the most difficult to measure. In the future, the market value of the Partnership’s assets will inevitably decline because the prices, rather than quality, of our investments have become cheaper. We need limited partners that will understand the situation and will consider adding to their investment instead of redeeming. In return, it is our duty to communicate frequently and candidly.

2. We match our portfolio liquidity with the fund’s redemption terms. We regularly assess how long it would take to sell an investment based on the size of our investment and the stock’s recent trading volume. We make sure the Partnership’s investments are not over-weighted to stocks that could not be sold quickly in the event of a large redemption.

3. We closely monitor client concentration. Our largest outside investor accounts for 12% of the Partnership’s assets. Since inception our cash position has averaged 15% which gives us the ability to redeem our largest investor immediately with no impact to other limited partners.

4. A large portion of the Partnership’s assets belong to Ewing Morris & Co. shareholders and teammates. Currently 20% of the Partnership’s assets belong to Ewing Morris & Co. shareholders and teammates. This gives us the ability to hold our less liquid positions with internal capital. While the percentage of internal capital may decrease as the Partnership expands, Ewing Morris & Co. operating partners will continue to keep a very large portion of their net worth invested in the Partnership.

In periods of broad market declines liquidity can evaporate and even the most loyal limited partner could be forced to redeem to fulfill other financial commitments. However, constant vigilance combined with a sound plan to handle unforeseen redemptions should protect both Ewing Morris & Co. and, more importantly, our limited partners from the risks posed by client concentration and the underlying liquidity of our investments.

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