Performance Report
This is an update of the portfolio as of October 31th 2011. The first part of the report (our first non–crisis report for a while :) ) is the usual iteration of facts. The second, wordier, part outlines my thoughts about the coming years and answers some questions that might be of interest.
Portfolio
Details of the overall portfolio (YTD) are as follows:
| Portfolio Return-actual | 4.3% |
| Portfolio January 1, 2011 | $149.7 million |
| Portfolio October 31, 2011 | $158.9 million |
| Investment earnings 2011 | $6.5 million |
| Investment Earnings 1981-2011 | $104.0 million |
We emphasize two things with the portfolio and they are of equal importance. We avoid major exposure to significant dangers (e.g. 2008-9 and the 2000-2 technology crash). The other thing we emphasize is to view things with a long-term perspective and, as you can see, our results since 1981 have been quite satisfactory AND not subject to extreme volatility. In industry parlance, we have excellen t risk adjusted returns.
The results since the year 2000 also illustrate both of the points described above. The market (S&P) record since the beginning of 2000 is as follows:
| March 2000 | 1503 |
|---|---|
| June 2011 | 1331 |
| October 2011 | 1285 |
We should factor in dividends but, even after that adjustment, it has been a lost decade for equity investors.
In the same period using an index where March 2000 = 100, our portfolio has performed in the following fashion:
| March 2000 | 100 |
|---|---|
| June 2011 | 300 |
| October 2011 | 310 |
In simple terms, $1 million invested in the S&P 500 Index would be worth, at best, $1 million today. In that time $1 million invested in our portfolio would be worth approximately $3.1 million.
The portfolio is currently invested in the following fashion:
Feb. 2, 2011 |
June 30, 2011 |
Oct 31, 2011 |
|
|---|---|---|---|
| Stock | 13% |
44% |
38% |
| - Shorts | (0) |
(-16%) |
(0%) |
| Net Stock | 13% |
28% |
38% |
| Oil | 0% |
5% |
1% |
| Real Estate | 0% |
0% |
0% |
| Gold | 5% |
6% |
7% |
| VR Bonds | 3% |
11% |
5% |
| Bonds | 0% |
0% |
0% |
| Distress/Hedge | 0% |
5% |
0% |
| Foreign Cash | 0% |
0% |
0% |
| Cash | 79% |
45% |
49% |
| TOTAL | 100% |
100% |
100% |
The portfolio is very active these days and this reflects the environment rather than any change in our fundamental value strategy. The chart doesn’t show the rapid increase in stocks between June and October 1st of this year when we were tempted by bargains in most sectors of the market. It also doesn’t show the savage market that accompanied that same period, which caused all of the attractive bargains. At the low point three weeks ago, the portfolio was down 5½% (and the market was, of course, down by a far greater amount). Since that time, we have experienced an equally savage upward movement and we have been a steady seller as the portfolio gained in value and as our targets were realized. We still own a core of excellent companies and we are very comfortable with their long term prognoses.
You can expect the volatility to continue (it is today :) ) and, while it is disturbing, it is also advantageous to us as we benefit from the irrational movements and herd mentality amongst lay investors but, more significantly, amongst professional investors.
Statistics 1981-2010
Details of the individual years are as follows:
| Year | Rate of Return | Year | Rate of Return |
|---|---|---|---|
| 1981 | 15% | 1996 | 15.5% |
| 1982 | 15.4% | 1997 | 6.9% |
| 1983 | 16.0% | 1998 | -4.5% |
| 1984 | 9.8% | 1999 | -2.3% |
| 1985 | 18.3% | 2000 | 15.3% |
| 1986 | 13.8% | 2001 | 18.4% |
| 1987 | 9.7% | 2002 | -0.6% |
| 1988 | 18.0% | 2003 | 25.2% |
| 1989 | 10.7% | 2004 | 9.9% |
| 1990 | 0.7% | 2005 | 8.7% |
| 1991 | 14.9% | 2006 | 11.7% |
| 1992 | 10.0% | 2007 | 6.2% |
| 1993 | 13.7% | 2008 | -5.1% |
| 1994 | 0.3% | 2009 | 14.3% |
| 1995 | 13.2% | 2010 | 10.2% |
| 30 Year Avg. | 10.3% |
Our compounded rate of return over the entire 30 year period was 10.3% p.a. Inflation over the period was compounded at 3.2% p.a. This produced a real rate of return of 7.1% p.a. Our financial planning summaries are based on achieving, in the long run, a real rate of return of 5% p.a. In the 30 year span, we had only four negative years with the largest decline of 5.1% occurring in 2008.
Our target rates of return may have seemed relatively modest but, in fact, the history of the last 100 years suggests that they are really quite difficult to attain over the longer term.
Top 10 Holdings
% of Portfolio |
Category | |
|---|---|---|
| Cash | 51.0 |
AAA Cash |
| Pfizer | 8.4 |
AA Stock |
| Hewlettt Packard | 8.3 |
A Stock |
| Microsoft | 8.3 |
AAA Stock |
| Barrick Gold | 6.3 |
A- Gold |
| Cisco | 6.2 |
A+ Stock |
| HSBC Preferred | 1.3 |
A VR Preferred |
| Vivendi | 1.3 |
BBB Foreign Stock |
| France Telecom | 1.3 |
A- Foreign Stock |
| SK Telecom | 1.0 |
A Foreign Stock |
| Total of Top 10 Holdings | 93.4 |
As you can see, the portfolio is very conservatively invested with over half the portfolio in cash and cash equivalents. All of the top 10 holdings are of high quality and, as you can see, make up the bulk (93.4%) of the portfolio. I should add that this can, and frequently does, change rapidly so I would caution the casual reader against assuming that owning these securities is a blueprint for a successful year ahead in the markets.
General Comments and Thoughts
I have done this in a question and answer format to address questions that I think are worth answering. Reading all of the following is only for those that are truly interested in the process and isn’t necessary if you are just interested in the details of your portfolio, which is adequately covered in the prior pages.
I apologize in advance if this is over detailed or includes too much technical jargon.
1. What are your views on the major investment alternatives in the coming months?
- Bonds remain, I believe, a very poor long-term investment. I simply cannot find anything attractive about lending to the Government, or anyone else for that matter, at rates in the 2–5% range for periods of 5 to 30 years. Although it has been a successful strategy for parts of this year, I am convinced it is akin to picking up nickels in front of a bulldozer i.e. it could be profitable in the short-term but sooner, or later, you will be flattened. A grade would be an F.
- Money market rates are, of course, artificially depressed and are close to zero. Completely useless as an investment alternative- (It should be noted that we are large cash holders, but we only use cash as a default when other opportunities aren’t available. Our large cash holdings are not a statement about the good value to be available when opportunities present themselves). :) As an investment, it is an F. As a default cash position, or a place to leave money for those uncertain about their investment skills, it deserves a higher grade (0% is always better than a negative return).
- I am, increasingly, looking favorably on residential real estate that meet certain criteria (i.e. that reflect a significant discount from their peak prices in 2006-7 and those that have motivated, and therefore flexible, sellers). I believe that, at the right price, that it is time to start looking for bargains if you, or a member of your family, is currently a renter and they can qualify for a mortgage in the sub 4% range. My enthusiasm does not extend to second homes or rental properties unless they are available at extraordinary prices. So for residential real estate that meets our criteria, I would assign a B+/A- grade.
- In the summer, I became more positive about a number of large dividend-paying blue chips that were priced well bellow any reasonable approximation of fair value. As stated elsewhere we have experienced extraordinary volatility in the past three months and our stock portfolio has changed dramatically as the world seems to be, increasingly, enamored of stock dividends after decades of neglect. As the enthusiasm has increased, we have sold into the rising market as we always feel uncomfortable when our ideas are widely accepted. J Luckily we still have a core of very high quality securities that haven’t yet caught the public fancy. A dwindling number of large blue chips are worthy of a B+/ A- grade. The market in general is a solid C. Dividend stocks were a few weeks ago a solid A, but as their popularity has increased, and their prices have risen, they are now a B.
- Gold: I have no clue about its future, but I do believe in always holding a small (5-7%) insurance position in gold as insurance against Armageddon. It is always a useful hedge and at this point we also have a disparity between bullion and gold mining stocks, which make the mining stocks decent investments in their own right. I own the large diversified miner Barrick, which I would rate as a B+/A- prospect. Bullion, I would consider a C.
2. The markets are increasingly volatile. How does this affect us?
For my part, volatility is welcome as it shows the increasingly irrational nature of the markets. It is a reflection of a number of modern tendencies and innovations – the growth of exchange-traded funds, the development of high frequency trading and the modern tendency towards hyperactivity driven by information overload. It creates a market which is, at least in the short-term, frequently quite dumb. As the market is where we buy and sell, I find it useful that our trading partner is prone to foolishness. So, from my point of view, I embrace the volatility but, equally, I understand that it can be stressful to see valuations fluctuate dramatically. Our portfolio volatility is quite muted, but it is still there and certainly can create anxiety if one has previously been used to certificates of deposit. Whenever you get concerned, please call or write. You can, equally, be sure that we will write an emergency report in the very unlikely event that something untoward is occurring with the portfolio.
3. Have events in recent years made you rethink your basic approach to investing? What about the spectacular failures of some well known value investors in the debacle of the last three years?
I certainly have reviewed the failures of some of the stars of the value community (Marty Whitman of Third Avenue, Warren Buffett, the folks at Longleaf and Oakmark, Bruce Berkowitz at Fairholme and the serial disasters of Bill Miller). Miller is easy to dismiss as his Legg Mason value trust was a value fund in name only. Warren Buffett always has a different time frame and I am inclined to give him a pass as he always manages his way out of difficult situations (and Berkshire Hathaway is much more of an operating company now and the investment side is of less importance to the whole). We all missed the technology debacle of 2000-2, but it was more difficult to understand where the others went wrong and how I managed to avoid the disasters of 2008-9.
I certainly don’t mean, incidentally, to over emphasize the failure of mainstream value investing in 2008 as that year was an equal opportunity disaster for most portfolio management.
The main conclusions I arrived at were that:
- Our portfolio can, and frequently does, hold large cash positions which mute volatility and reduce risk. Most mutual funds have real, or imagined, constraints on what they can do with their funds. Morningstar and fund consultants expect a fund to do what it is supposed to do in fair weather and foul i.e. be nearly fully invested in their specialty irrespective of valuations. I think this is like allowing the lunatics to run the asylum, but it is the standard and one that any manager has awareness of as they manage their portfolio. The old saying seems to apply that “It is wiser to fail conventionally than to succeed unconventionally”.
- I am very fortunate in that I work with clients, mostly of long standing, who make it much easier to succeed unconventionally :)
- I differ from the more well known value investors (specifically Buffett and Berkowitz) because I find modern bank balance sheets impossible to analyze and the potential risk to be far beyond my tolerances. This bias helped me mightily over the last decade. In some senses this places me closer to classic Graham value investing as I find it impossible to believe that any major bank in 2011 would meet Ben Graham’s margin of safety. There are other value investors that do follow a similar path, notably Seth Klarman of Baupost and Steve Romick of the FPA group, and they both navigated the last 15 treacherous years with aplomb.
Congratulations if you just navigated my ramblings! :) I am, indeed, very fortunate to have a group of clients who allow me the freedom to manage their funds without any of the constraints that impede so many people in the marketplace. I take the responsibility of managing your assets very seriously and, as you know, our personal assets are managed in an identical fashion i.e. we eat our own cooking.
Summary
I want to thank you for the trust you have placed in myself and, of course, in Nancy. The last 31 years have been full of challenges and we expect no less in the years ahead. We look forward to the challenge. We scour the markets of the world every day, on your behalf, searching for value with a significant margin of safety.