A decade of investments

Dear investors,

Ten years ago, on June 27, 2013, we formed an investment club called Arcádia, with initial capital of R$126,000. At the time, the goal was to join forces to better manage our stock market investments, since we all worked in investment banking and had insufficient free time for each of us to manage our investments separately.

The strategy worked. We began to see good results, increased our investments, and also received contributions from some friends and family. By the end of 2014, we had R$6 million under management, still tiny compared to investment funds. With the high return and some new contributions, by the end of 2018, we reached R$46 million in capital under management, enough for us to decide to found a professional management firm and transform the club into an investment fund. This is the story of how Ártica Asset Management came about and how Clube Arcádia became the current Ártica Long Term FIA, which celebrated its 10th anniversary last week.

We closed our first decade of investment with a cumulative return of 1,294% until 06/30/2023, corresponding to an average annual return of 30% per year.

Histórico do valor das cotas do Ártica Long Term FIA¹

In this letter, we'll share some of the experiences and lessons our manager learned along the way, which helped us solidify the investment philosophy we follow today.

Investment theses mature in a non-linear manner

Unipar

In 2013, Unipar's only asset was 50% of Carbocloro, a chlorine and soda manufacturer. That year, Unipar announced the purchase of the remaining 50% of Carbocloro, and the acquisition price caught our attention. The acquired asset was exactly the same as Unipar's existing one, but it paid approximately 25% more for the second half of Carbocloro than Unipar's stock market value. In other words, either Unipar had overpaid for the acquisition or its stock was undervalued. Therefore, we further analyzed the issue to estimate Carbocloro's true value and realized that Unipar, now the owner of 100% of Carbocloro, was worth at least twice its trading price.

In August 2014, we began buying Unipar shares. Six months later, the share price had fallen 25% (compared to the IBOV's 12% drop in the same period). Given the discomfort that a decline of this magnitude generates, especially in a newly acquired position with a good margin of safety, we conducted a detailed review of our thesis. The results of this review were counterintuitive.

Carbocloro's operations continued to perform very well, even better than our initial expectations. The drop in the share price seemed more related to macro factors (2015 was the year of the crisis related to Dilma Rousseff's impeachment) than to the company's performance. In this scenario, we decided to buy more shares.

Our belief in Unipar's value wasn't shared by the market for quite some time. The stock only began to rise at a more significant pace in the second half of 2017. In other words, we held the stock sideways for three years before seeing our thesis truly prove correct and Unipar's price rise rapidly the following year. We sold our entire position in 2019, after five years as shareholders. During this period, we received almost the same amount in dividends as we had paid for the shares, so the sale was practically pure profit and generated a return of around 20x the invested capital. The price expansion during our shareholder period is illustrated in the chart below.

UNIP6 Price History*

This case illustrates well that the market is far from perfectly pricing the value of listed companies. Unipar's price volatility during this period was much greater than the volatility of its operating results. Another lesson is the importance of patience. If we had become frustrated with the initial years of lack of significant appreciation and sold the position, we would have missed out on several million reais in profits for our investors. This investment case is detailed in more detail in our July 2020 letter.

After our sale, the stock traded sideways for about a year and a half and then rose again, surpassing R$ 100. Even with the 20x return on our investment in Unipar, we still feel some regret for not having bought back this stock, which we knew so well, and taken advantage of the second wave of appreciation. It's part of the fate of investors to ruminate over the extra return they could have earned if they had made a few different decisions throughout their lives.

Marcopolo

A more recent case study, still in our portfolio, illustrates the same point. In 2019, we began purchasing shares in Marcopolo, a leading bus body manufacturer in Brazil. In short, the rationale behind this thesis is that the Brazilian bus fleet is much older than the equilibrium age implied by the history of the last 25 years. Since bus replacements are technical decisions (when a bus begins to incur maintenance costs and cause excessive downtime due to mechanical problems, it's time to replace it), we expected a wave of higher sales volumes until the fleet's age returns to its normal level.

The path over the years was tortuous. The first few months after our purchases were positive, with the price rising to around 50%, until the pandemic hit, and the stock depreciated to 35% below our purchase price. We reviewed our accounts, and the penalty seemed excessive, so we purchased more Marcopolo shares.

To be honest, at the time we thought the pandemic would last less time (those who didn't think so, cast the first stone). For those who are curious, our view of the COVID crisis at the time is in April 2020 letter. In any case, the advantage of a thesis supported by the fact that the bus fleet is old is that the passage of time can only make it even older, so we increased investments in Marcopolo until we reached a position about 6x larger than the one we had before the pandemic.

Today, this investment has already proven quite profitable, as seen in the share price chart below. The thesis is described in more detail, including our rationale for increasing the position amid the pandemic, in October 2021 letter.

POMO4 Price History*

Good returns don't depend on buying and selling all the time.

Whirpool

Another successful investment case, albeit with a very different profile, was Whirlpool, the company that manufactures Brastemp, Consul, and Kitchen Aid appliances in Brazil. Despite the company's annual revenue of ~R$11 billion, it is rarely heard of in the Brazilian market because its shares are so illiquid (currently trading volume is ~R$40,000 per day). This lack of liquidity has historical reasons.

The B3-listed company is a subsidiary of Whilrpool Corp., a global leader in home appliances, listed on the New York Stock Exchange and with annual revenue of approximately USD 20 billion. The parent company attempted to delist its Brazilian subsidiary twice: first in 2000, which reduced the share's free float to 5%, and then in 2016, which further reduced the free float to the current 2%.

This was our first investment thesis. We purchased our first shares in 2013 and increased our position in the company over the years. During our second attempt to go private, we were already shareholders and organized a group of minority shareholders to negotiate what we believed to be a fair price for the offering. The price negotiation with company executives was unsuccessful, but we managed to prevent the company from going private at an unreasonably low price and maintained our portfolio investment.

Due to its lack of liquidity, the company is overlooked on the stock exchange, and we're unlikely to see significant increases in its share price. However, its business is excellent, with significant competitive advantages, and it generates excellent dividends. We've held the stock for 10 years, taking advantage of downturns to increase our investment over time, and today we have an internal rate of return of 14% per year since inception, even with the stock currently at a very low price.

WHRL4 Price History*

The scholarship also offers atypical opportunities

CEB

Buying shares in a good company at attractive prices and waiting for time to generate good returns is the most traditional investment formula, but not every opportunity falls into this category. In 2019, we were drawn to the case of Companhia Energética de Brasília (CEB), a state-owned company controlled by the Federal District government. At the time, the company's largest asset was an electricity distribution company (CEB-D), which was operating at a loss and at risk of losing its concession because electricity sector regulations require operators to maintain minimum financial health indicators. This was far from what we would classify as a "good company."

However, there were plans to privatize CEB-D, and if so, it could prove to be a valuable asset, as the Brazilian electricity sector has a history of successful privatizations of state-owned companies (Equatorial and Energisa, for example, have managed to generate enormous value for their shareholders by acquiring state-owned companies and making them more efficient). We decided to analyze the situation in detail.

In summary, we concluded that there were two very different scenarios for the future of a potential investment. If CEB-D were privatized, the likely return was around 150%. If privatization did not occur, the risk was that the company would lose approximately 50% of its then-current stock market value. In other words, if the probability of privatization was greater than 25%, the expected value of the investment was positive. We monitored the case until it appeared that the likelihood of privatization success was quite high, and we began purchasing CEB shares in November 2019.

As the thesis risk was significant, we started with a small investment and, as the privatization process became more certain, we continued to buy more until we had approximately 10% of the fund invested in CEB.

The privatization of CEB-D was completed in March 2021, at a higher acquisition price than we had considered. After that, the market still took a while to properly evaluate the share price. For months, CEB's stock market value was below the cash position it would have had after receiving the payment from the sale of CEB-D. Therefore, we maintained our investment for another year and sold it in 2022, with a cumulative return of 5x the invested capital. More details about this investment are described in our January 2021 letter.

CEBR6 Price History*

Not every thesis will be successful, it takes constant attention and flexibility to change your mind.

Restoque

Since not everything is rosy, we will tell you about our worst investment, which was in Restoque (currently changed its name to Veste), the clothing manufacturer and retailer that owns the brands Le Lis Blanc, Dudalina and some others.

The company had a troubled history after acquiring Dudalina from its founders, partly due to failed strategies and partly due to conflicts between its main shareholders. However, the stock seemed very cheap, the conflicts between the partners seemed resolved, and the business recovery plan presented by its executives was reasonable. We followed the company for some time and, after three consecutive quarters of improving indicators, we concluded that the recovery plan was beginning to bear fruit and this would be a turning point for the business. If the plan's implementation was successful, the potential for appreciation was enormous. We began buying shares in the middle of the third quarter of 2018.

In the following two quarters, operational indicators worsened again. Since operational restructurings are always complex, we gave the company and its executive team the benefit of the doubt and remained invested. After five quarters of poor results, we decided to liquidate our position in early 2020 and suffered a loss of approximately 30% of the amount invested.

LLIS3 Price History*

The only consolation is that the decision to exit was correct, because after we sold, the shares continued to fall to a fraction of their historical value. The company recently underwent a capital restructuring.

It was our first significant loss, and we make a point of remembering it from time to time, to contemplate the irrefutable proof that even carefully crafted theses can be completely wrong, and to keep alive the fear that makes us diligent and willing to change our minds.

The profile of the investor base is important for the fund's good performance

As you can see, even successful theses had their "exciting" periods. In these moments, the biggest risk an investor runs is despair, abandoning rationality and starting to make decisions based on psychological factors. In addition to the natural pressure generated by investment setbacks, fund managers are under an additional element of pressure: pressure from their investor base. In this regard, we feel privileged.

To date, our acquisition of new investors has been atypical. While most managers choose to make their investment funds available on brokerage platforms, which allow anyone to invest without much information beyond the fund's historical returns, we decided to keep Ártica Long Term FIA off these platforms and adopt practices that ensure greater alignment of expectations.

We explain to interested parties our strategy, the results it should generate, and what portion of their capital is appropriate for investing in this way. In short, we seek to maximize the fund's absolute return over long periods, longer than 5 years. We are subject to periods of volatility along the way (although Ártica LT's volatility is very similar to that of the IBOV itself), as we tend to take advantage of market stress to make purchases and are willing to wait several years to sell, as long as the investment thesis remains sound. Therefore, it is only appropriate to invest with us a portion of capital that can be left invested for a few years, ideally with term flexibility to be able to withdraw at a favorable market moment.

Although it seems like an obvious approach, few managers follow this path because it reduces fundraising and, therefore, the manager's own compensation (at least in the short term). However, we prefer to grow slowly and steadily rather than take shortcuts to attract investors with profiles incompatible with our investment style.

The great benefit is that today we have an extremely differentiated investor base that aligns with our philosophy. The best proof of this is comparing the evolution of Ártica LT's assets under management throughout the 2022 downturn with what happened to other equity funds. While most funds suffered waves of redemptions due to the months of decline, some losing more than half of their assets under management, we received a substantial volume of new contributions, which allowed us to take advantage of the depreciated prices and expand our investment portfolio. Furthermore, approximately 90% of our investors never made a withdrawal, even though they went through difficult times with us.

Having the support of our investors to do what we truly believe will yield the best long-term returns, even when it requires psychologically uncomfortable decisions, is a rare privilege. Therefore, we extend our sincere gratitude to everyone who has entrusted their capital to us over the years. We will continue striving every day to provide you with returns as good as we achieved in our first decade in the years to come.

*The prices shown in the graphs are adjusted for dividends, and any groupings or splits of shares during the period.

¹ O Ártica Long Term teve início em 27/06/2013 como “clube de investimentos” e, em 27/09/2019 foi transformado em “fundo de investimento em ações”.