Hypothetical Growth of $10,000 invested since September 2011 (NAV at September 2011 was $9.71)
* A total return index is an index that measures the performance of a group of components by assuming that all cash distributions (dividends) are reinvested, in addition to tracking the components’ price movements
Portfolio Net Asset Value will be updated monthly at the end of the third week of each month.
As investors, it’s easy to get caught up in the hysteria and follow the herd. And yet, to earn a return that is excess of the market’s requires us to act against conventional wisdom. Markets are whimsical and it is my firm belief that it should never replace independent thought, especially when it comes to the critical process of capital allocation.
As we are a value based fund, we tend to invest in unloved and controversial companies that are trading at a depressed price compared to what we think they are conservatively worth. Many of these securities continue to trend downwards in price after our initial investment, and it is not uncommon for us to add to our purchases as prices continue to slide. This in turn may lead to us under performing the market in the short run. However, I must reiterate that the fund takes a long term view when it comes to common stocks, and seeks to invest in businesses that will continue to be profitable for many years to come.
As you may have noticed, we have significant positions in various financial institutions based in the United States. It’s interesting to note that many of these institutions are trading at a discount below tangible book value. Furthermore, many of these companies are trading at prices close to that of their bottom in 2009 – an interesting notion considering many of them are in a much better financial position than they were two years ago.
Let there be no mistake that these companies still face significant challenges in dealing with their legacy issues. However, we would like to point out that credit quality has generally improved, and charge-offs due to bad loans are showing a significant and steady decline. Furthermore, many of these financial institutions are far less leveraged, and far more cautious than before. We do not expect them to earn the outsized returns on equity they did in the preceding decade. However, we consider it reasonable for them to earn at least a 1% ROA (Return on Assets), or 10% ROE (Return on Equity) with 10x leverage going forward into the future.
With that, some of you may have realised that financial institutions in the EU are trading at historically depressed valuations. So why isn’t there an “opportunity” of the fund to allocate capital there? The answer is simple: leverage.
At the present time, we see little margin of safety with the banks so heavily leveraged. Make no mistake that the challenges faced by the European Union are indeed severe and deeply worrying. I have no extraordinary insight regarding the impending crisis. Suffice to say, it pays to be more cautious than usual when allocating capital.
Although the macro situation looks exceedingly grim, investors can take solace in an interesting phenomenon – high quality companies that are conservatively financed, and that possess long term track records of generating wealth for shareholders are on sale. We are confident that the companies we currently own in our portfolio were purchased at attractive valuations and will go on to do exceedingly well going forward into the future.