Night Watch Investment Management LP experienced a strong third quarter in 2025, with a net appreciation of 4.28%. This contributed to an impressive year-to-date performance of 25.88%, building on the momentum from the first half of the year. Key contributors to this success included Haypp, Western Digital Corp, Distribution Solutions Group (DSGR), and AAR (AIR). While some previous strong performers like GOGO (GOGO) and Marex (MRX) saw declines in Q3, the firm maintains confidence in their underlying business fundamentals.
Night Watch Investment Management focuses on a global value strategy, distinguished by several core principles. The firm prioritizes value companies that possess a clear catalyst for re-rating, such as industry tailwinds or company-specific events like earnings improvements or leadership changes. A significant emphasis is placed on identifying companies where management holds substantial ownership, aligning their interests with shareholders to drive share price performance. Furthermore, to provide unique diversification, Night Watch seeks portfolio holdings that offer minimal overlap with typical wealth management portfolios.
The US stock market witnessed a notable resurgence after a volatile start to the year, with small-cap stocks performing exceptionally well in the third quarter. This surge was primarily driven by weaker-than-expected US jobs data, which fueled expectations for the Federal Reserve to continue its interest rate cutting cycle initiated in 2024. However, Night Watch Investment Management notes a pattern of short-lived rallies following similar events in 2023 and 2024, as market attention eventually shifts back to corporate earnings. The firm observes that corporate earnings, apart from a few growth areas like AI, continue to fall short of expectations.
The firm expresses concern regarding increasing government intervention in corporate America, citing instances such as the nationalization of a portion of Intel and the imposition of export taxes on Nvidia's sales to China. Such protectionist measures, including tariffs and visa restrictions, are seen as exerting pressure on corporate profit margins and dampening business confidence in the short term. In the long run, these actions are believed to hinder innovation and foster an uncompetitive workforce. Consequently, Night Watch Investment Management holds an increasingly negative outlook on the US economy, believing that current market valuations do not yet reflect these underlying issues.
Recognizing the evolving economic landscape, Night Watch Investment Management is actively broadening its investment horizons beyond the US. The firm is increasingly exploring opportunities in other global markets to generate returns. Europe, despite a slow recovery from five years of economic challenges, is also viewed with increased caution due to a fragile economy and the rapid appreciation of the Euro against the US dollar, which poses a near-term headwind for its export-driven economy. Therefore, the firm aims to reduce its exposure to both the volatile European economy and the unpredictable regulatory environment in the US.
To mitigate these risks, Night Watch Investment Management is shifting its focus towards less cyclical industries, such as healthcare and food production, where it has recently added new positions. The firm also continues to bolster its existing portfolio holdings that benefit from multi-year tailwinds, including companies involved in airplane maintenance like AAR. Concurrently, the firm's allocation to Asia remains stable, with a recent initial investment in a Japanese company, marking a strategic expansion into new geographic markets.
Night Watch Investment Management has re-established a position in Brookdale Senior Living (BKD), driven by the robust long-term prospects for senior living facilities (SLF). The firm notes that the impending aging of the baby boomer generation will significantly boost demand for SLF services. Despite a period of overbuilding in 2017 and subsequent challenges from the Covid-19 pandemic and nursing shortages, construction of new facilities has largely halted, leading to a multi-decade low in new supply at a time when demand is set to increase. The firm's renewed confidence in Brookdale stems from a recent change in management, initiated by an activist shareholder, which has led to a rapid improvement in occupancy rates, aligning with industry peers.
In the technology sector, the firm has initiated two new positions in companies poised to benefit from AI-related spending. Western Digital Corp (WDC) has become a pure-play hard disk drive (HDD) company after divesting its Sandisk subsidiary. The HDD industry is now largely a duopoly, with WDC and Seagate actively managing supply in response to rapidly growing demand for storage capacity, driven by data center investments. Night Watch Investment Management believes that while AI infrastructure spending may be cyclical, the positive impact on WDC's earnings was initially underestimated by the market, making it an attractive outlier.
The firm has fully divested its energy positions in Valaris Limited (VAL), Tidewater Inc. (TDW), and Noble Corporation plc (NE). While previously holding a positive outlook on the offshore energy infrastructure cycle, which bottomed in 2021, the firm did not anticipate the pause in offshore spending that began in 2024. Night Watch Investment Management now expects a resumption of spending no earlier than 2027. The current valuations of companies like Noble Energy, trading at approximately 10 times free cash flow, are no longer deemed sufficiently attractive, especially given an 8% cost of debt and the limited lifespan of their assets. Overall, the firm incurred a modest loss of 2.67% on these energy positions, marking it as the only significant detractor from performance since inception.
Night Watch Investment Management has long sought investment opportunities in Japan that meet its stringent criteria, particularly concerning management teams incentivized to prioritize shareholder value. Recent corporate governance reforms by the Tokyo Stock Exchange have prompted significant changes in Japanese companies, making the market more appealing. In the third quarter, the firm initiated a position in Integral KK (5842 JP), a private equity fund manager. Integral’s business model, similar to that of global private equity giants, involves raising capital to acquire, improve, and eventually exit Japanese companies, generating fees for its shareholders.
Integral recently launched its fifth flagship fund, which raised double the capital of its predecessor, leading to a 135% increase in Assets Under Management and a material boost in profitability. President Mr. Yamamoto anticipates raising a sixth fund double the size of the fifth within two years. Furthermore, successful private equity firms often leverage their track record to launch funds in other asset classes, such as real estate or private credit, offering additional growth avenues. Japanese private equity enjoys several advantages, including lower acquisition multiples and greater opportunities for operational improvement. Integral stands out as the only Japanese manager capable of raising significant capital, despite Japanese pension funds allocating a relatively small portion of their assets to private equity compared to the US.
Integral co-invests in its funds and some portfolio holdings, with roughly half of its current market capitalization covered by the value of these investments. The firm's IPO prospectus suggests a conservative valuation approach for these investments, with an average EBITDA multiple in the 5-6x range. Night Watch Investment Management believes that greater transparency regarding this valuation could significantly boost Integral's market multiple. The management team is accessible and committed to transparency, exemplified by a five-year lockup on their shares post-IPO, which is seen as unusually shareholder-friendly. This commitment, coupled with a potential push for more detailed valuation disclosures, could lead to a higher market valuation.
Beyond long-term growth, a near-term catalyst for Integral is the rumored IPO of Tekscend Photomask in Q4 2025, at an estimated valuation of $300 billion. Integral holds a 50% stake in Tekscend through its Fund IV, acquired for an estimated 10-20 billion JPY in 2022, potentially valuing its current stake at $150 billion. A successful IPO would generate a substantial windfall for Integral's limited partners and a significant performance fee for Integral itself, likely encouraging reinvestment in future funds. Night Watch Investment Management's prior success with private equity managers in the US and Europe reinforces its excitement about Integral’s growth prospects, particularly given the unique advantages of the Japanese market.
Night Watch Investment Management is growing increasingly cautious about US equities, citing a deteriorating US economy and heightened speculative activity. The firm remains committed to its disciplined investment process, refusing to invest in any company where the current valuation cannot be justified by near-term free cash flow generation. While aiming for a fully invested portfolio, the firm currently holds approximately 3.5% in cash, having recently taken profits from several positions. The team is proactively shifting its research focus to opportunities outside the US, with a planned investment trip to Hong Kong in November to identify new investment ideas.