At the end of the year, my portfolio had risen in value by 15.9% vs a
total return for the index of 21%. I was unable to post the index returns
in the previous post because at that time I was on holiday and did not have
access to a Bloomberg.
As this blog is intended partly to be an archive for my own
thoughts at particular points in time, my discussion might seem a little “obvious”,
but when memories have faded in future years, I hope it might be interesting
(to me at least) to reflect on a particular point in time in the past:
So what of my portfolio portfolio performance? Well 15.9% seems
respectable vs my target long term return of 12%, but disappointing versus 21%.
What caused the under performance? Well first of all, the biggest two contributors
to global equity returns were Japan (c50% up this year) and the US (30%) and relative
to their weights, I was underexposed to both. In Japan, markets soared as
an unprecedented period of monetary expansion began, seemingly a last ditch
attempt to jolt the country out of its economically stagnant state. I’m
pretty sceptical that this will evolve will, given that complex economic
interventions rarely seem to work, and as I know very little of Japanese
companies, or Japan in general, I cannot feel regret at not being part of this
market. As for the US, well I obviously look to own the cheapest
companies I can, and for whatever reason I owned relatively fewer of the
Americans ones. So again, I can have no regrets. Finally, I note
the epic performance of the UK Small and Mid cap sector over the last couple of
years. This is obviously a response to the fact that credible and
sustainable growth appears to be emerging in the UK, and a long period of
stagnant profits, as Mid Cap UK delevered, restructured and reorganised.
At some point a lowering of investors’ required return had to happen, and
consequently share prices soared, as in much of the world. One of my big
priorities is to ensure that portfolio outperforms in a down year, and if I’m
going to underperfom in any year, it is likely going to be in years of
strong equity returns. Anyway, I shouldn’t beat myself up too
much. My portfolio is up strongly YTD, and I feel it is well balanced and
everything in it is trading below intrinsic value.
Last year was unique for my portfolio in that various life events
meant that I injected substantial cash sums into it at various points. As
I try and be a long term investor, albeit an opportunistic one, I resist
selling just to rebalance a portfolio or for any reason other than a share has
lost its cheapness. In addition, I have to think a great deal to manage
my mix of positions to minimise income and capital gains taxes. The
consequence of all this is my portfolio was fairly unbalanced throughout the
year, and rarely will it be again. This is not a valid excuse for the
fact that what probably hurt my performance the most was the poor perfomance of
my two biggest positions: Alternative Asset Opportunities (TLI) and Imtech.
On TLI probably underhandicapped the likelihood that management would yet again
admit that they have been using overly optimistic assumptions, and that stated
value could again fall. While this is frustrating, I still think TLI
serves it’s purpose of providing equity like returns over the long term,
with fixed income like volatility. I won’t lose permanent capital
with this asset and that, of course is rule number 1. In addition, the
NAV was hurt by the USD falling over the past several months. As my
attitude towards FX is that I have no idea where it’s going at any single
point the average return is zero, I think of this as “just one of those
things”. I think my biggest mistake of the past year was
Imtech. For a week or two, when the rights issue was announced, I forgot
to be conservative, and managed to convince myself that there is an opportunity
in all special situations, rather than just a few. Imtech is not a good
business, earning long term returns on capital that are not great, with thin
margins and poor growth prospects. Further, it was not cheap on an EV to
EBIT basis, and I failed to understand just how much the working capital could
swing (including intra year), and just how much the rights issue and company
reorganisation could cost. For some reason (greed) I made this my biggest
position. At one point it appeared as if I would suffer a disastrous
permanent loss of capital, but the stock has rallied at the start of 2014, and
I’ve managed to exit at not too much of a cost. Lessons learnt.
B&C Speakers has been by far my most successful position, up
over 120% in just over a year. In retrospect it was obvious. Family
business, high ROC, temporary problems, low P/E, high dividend, Italian so
macro issues. Stupidly I completley failed to buy any more at any point,
which means that that 120% has had relatively little effect on overall
performance. On reflection, this is my biggest mistake of the year.
On other stocks I’ve owned:
Veripos and Pulsion Medical have been both a blessing and a
curse. It seems that I was right on both of these companies being high
quality and undervalued businesses as they were both bought soon after my
buying them. This is what saved my year’s performance. They
both made me quick money, but the problem was that I would have liked to hold
them for a very very long time, as they could have both been good compounders
for me. I have been forced to recycle cash, which is never ideal.
Commerzbank appears to have been a good decision as things
stand. It’s up over 50%, and my judgement was sound, I think.
When a systematically important institution trades at less than 50% of tangible
book in a macro and better environment where things can only better and there
is apparently no risk of dilution, it really doesn’t matter if you don’t
know what will happen in the future – the thing is extremely likely to
double in 6 years, which is of course one of my basic test (that’s a 12%
annualised return). I shall continue to hold Commerzbank as it’s
still trading at a sizeable discount to book value, and momentum funds and
retail funds may only now be thinking about buying in.
Plaza and Dolphin: I believe I stated when I bought these that I
considered them a bit of a basket, and so far that basket has not performed
well. First, I clearly overestimated Plaza’s ability to realise
assets, and service debts, even if a fire in one of their Indian malls hurt
their performance. They have gone into administration, and are in the
process of a potential debt restructure, and right now I am significantly
underwater, so it’s just as well my position was extremely small.
Indeed, I am watching this closely for a potential future opportunity as it comes
out of administration.
New positions include Sastyle and Pennant International, H&T
and MS International:
Safecycle: I read about it in Investors Chronicle, which described
a high quality company with a seemingly unique business model, cash flow
generative, at the start of a new UK housing boom. I tried to look at the
annual reports and ... there aren’t any! It only listed a few
months ago and so there is a placing document which describes a small cap which
has a long term business (manufacturing and replacing windows and doors), with
a unique competitive advantage. As it manufactures of all of its
products, to order, it has extremely low working capital requirements, and is able
to undercut competitors prices. It has thus increased market share and
profits over several years, in a stagnant market. Think what it can do in
a booming market! And the market is booming. Trading at sub 11 *
earning ex cash, there’s only two reasons this is not cheap. First,
if I’ve made a terrible error somehow in my judgement. There is a
receivable on the balance sheet, which is a loan to one of the owner managers.
In an ideal world this wouldn’t be there, but I’m hoping some
market discipline will resolve it. I obviously feel this is a risk worth
taking, and it would be quite a stretch to imagine that something dodgy is
going on, at a time when the company is seeking institutional support.
Second, it’s not been noticed by the market yet. It took me
browsing the IC to see it, and it jumped around 6-7% after it appeared in the
IC. I think that once it starts appearing in screens, and the first
annual report comes out, it will re rate. The main risk with this one, I
think, is cyclicality. It subsidised Barclays to provide consumer
finance, and its profits are highly correlated with the economy. Also, it
has factory capacity for a 50% jump in orders which might come sooner rather
than later.
Pennant: I can’t remember if I’ve already discussed
this, but I believe it’s another off the radar high quality small cap,
with recurring revenues, that is priced for minimal growth. If new orders
continue to come in, it should rerate and grow.
H&T: Pawnbroker in the midst of a storm of industry over
capacity and a gold price that has fallen the most in 30 odd years. This
has caused competitors with a less balanced business model (Albemarle) a great
deal of pain, and industry consolidation is coming. It seems that H&T
has delevered successfully and not broken any covenants. From here, it
can play offence and reorganise its own business, cutting costs, and possibly acquire
new business elsewhere. I am nervous about what happens if gold continues
to fall, but I reckon other investors are terrified, and this might be priced
in. I also think I own the strongest player in the industry, so if there
are failures, H&T will not be one of them.
MS International: The company is run by owner managers who are
extremely conservative, holding nearly half the market cap in cash! It’s
a mini conglomerate with cyclical (perhaps fatal) issues in its defence
business. However, it trades at only 6.5 * depressed earning ex cash.
If it experiences a cyclical upturn, others will surely have to take notice
plus, of course, they might do something with their cash that creates
value. I don’t love this business – after all if the
management were great capital allocators they would have spent the cash in the
downturn. But I think it’s worth holding as I have a hunch good
things could happen in the next year or two.
Current environment: We are now in an environment where we appear
to be moving into a fully or valued phase for equities. Respected
investors like Baupost and Third Point are returning capital. Long only
equity hedge funds are the stars of finance: Children’s Investment Fund
was up over 50% in 2013, for example. Activist battles are
everywhere. The problem is, of course, is that equities are probably
still not that expensive when compared to financially repressed bonds. So
what does one do? I suppose I should not worry about “equities”
but should concentrate on finding 6 to 10 individually cheap and resilient
cheap businessses where downside risks are priced in. As they become
harder and harder to find, I should be careful to make sure that I am not
pushing myself lower and lower on the quality scale. Certainly, I own
some very small businesses but I remain confident that they are enduring
ones. And this is a quality companies need to have when the market is
rerating stocks, because I need to be comfortable sitting out the mark to
market falls, when they come. My skills and abilities as a portfolio
manager are completely unknown at this point, given that I’ve never
recorded my returns through a market downturn. However, I feel that I put
my money in the right places, and have a good temperament. Over time, I
think I should do well, and the question is “how well”? I
think 12% should be achievable and if I am capable of anything more this would
be absolutely fantastic and represent serious outperformance.
