The Island Investing Blog

  • Thoughts from Recent Meetings With Our European Companies

    By Retz Reeves, CFA

    I certainly didn’t anticipate that disruption would be the theme of my March European trip, but it was – physical, political and technological disruption. Before going further, I wish to extend my condolences to the victims of the London attacks and Lucerne train derailment and to family of the first responder who gave his life in the former. My thanks to my Lucerne contact who added on a meeting in Zurich to see me.

    I thought that the political changes last year were going to cause serious disruption to our European investments, but outside of banks and employment companies, most of the managements with whom I met were not easily fazed. Many of those with sales in the U.S. already have matching production assets in the States, have work forces that have been around for generations and believe they can pass along any duties imposed on import components.

    In fact, if infrastructure spending picks up in the U.S. and taxes go down (although neither of these should be simply assumed), earnings power could actually increase in our companies. Most companies without London City exposure were also rather sanguine about Brexit, as they believed the weaker pound would have translational – not transactional – impacts. Concerns In Europe were higher regarding the outcome of the upcoming French elections. Although not expected at the moment, the election of a far-right or far-left candidate could put further strain on the euro.

    A Kantar Retail* presentation at the CAGE (Consumer Analyst Group of Europe) Conference I attended highlighted the disruptive forces of eCommerce. For instance, it is expected that 2018 e-commerce sales will reach over $2.24 billion and make up 15% of retail sales in the Americas, but only 1% in Eurasia and Africa. New technologies will impact shopping and search, supply chain replenishment and automation of product sales executed on computers, cell phones and new devices – either by old-fashioned typing, voice or automatically.

    At the CAGE Conference I also heard from companies about the evolution of robots, enabling them to work next to humans, as well as how new technologies are allowing storage of renewable energy and enabling its more efficient delivery. Regardless of industry, technology continues to alter the competitive landscape across numerous industries – and companies that adapt will likely thrive.

    Regardless of these disruptive forces, our international holdings in total have fared well to date this year.

    For the first quarter of 2017 our large cap Frigate Folio had was up 7.2%**, contributing to a return since inception on July 1, 2013 of 16.8%. The gross return*** of the S&P ADR benchmark was 6.4% and 15.4%, respectively, over the same time periods.

    Amid competition and concern over changing legislation, healthcare had a mixed but generally negative impact on performance in the first quarter, with generic company Teva being the biggest detractor. Energy company Technip FMC and Japanese auto manufacturer Nissan were also significant detractors. On the other hand, luxury companies, including Burberry and LVMH, were strong contributors to our performance, as were German companies SAP and Siemens and U.K. consumer company Unilever.

    Treasure Harbor, our international equity income portfolio, also generated good performance, increasing 8.2% for the first quarter of 2017 and up 1.57% since inception on November 1, 2013. The corresponding specialized benchmark**** was up 7.0% and down 4.7%; respectively, for the same time periods.

    Turning in slightly negative performance were Australia telecommunications company Telstra, U.K. utility SSE and the British shares of Royal Dutch Shell. Strong contributors included Brookfield Canadian Office Properties, Spanish companies Telefonica and Banco Santander, and Unilever.

    The small/mid-cap Yellow Tail Folio also posted strong performance, up 8.0% for the first quarter this year. This slightly lagged its VSS***** benchmark, which was up 9.2% during the same period. Since inception in November of 2014, however, Yellowtail has yielded a 25.8% return versus 3.64% for the benchmark. Yellowtail’s first quarter had rather eclectic detractors, including animal health provider Virbac, stationer Societe BIC and Spanish Ebro Foods. The equally eclectic outperformers were French long-term care provider Orpea, Swiss travel retailer Dufry and Japanese food manufacturer Nichirei.

    I still view both international currencies and stocks as attractive, but It appears that the disruption of all different types is bound to continue – it’s the world we live in, and it’s part of progress.

    We will strive to monitor and anticipate these sea changes, and incorporate them into our analysis when selecting our stocks and our portfolios.

    Please let Cale and myself know if you have any questions. In the meantime, thank you for investing along side of us.

    – Retz

    Notes:

    * Gildenberg, Bryan, “Ecommerce/Changing the Sales and Marketing Ecosystem,” Kantar Retail (WPP).
    ** All returns for benchmarks, indices and Folios are estimated and unaudited.
    *** Gross returns do not includes fees or taxes on international dividends and assume gross dividends are reinvested.
    **** 15% SPDR S&P Emerging Market Dividend ETF & 5% SPDR S&P International Dividend ETF
    **** Vanguard FTSE All-World ex-US Small-Cap ETF

    Posted by: Retz Reeves , For Investors
  • IIM International Portfolios – Investor Letter for Q4 2016

    Spreading out financial journals and newspapers, I began my literary diet and breakfast in the New Year. Yes, after a topsy-turvy year full of Brexit, terrorism, corruption and elections, I could still read and eat simultaneously; but the sector rotation, currency fluctuations and market volatility late in the year was upsetting my digestion a little bit. Adding insult to injury, I realized that it wasn’t cinnamon I had just sprinkled on my yogurt.

    The strengthening dollar eroded the U.S. dollar value of many international stocks in 2016, and their representative indices, generally underperformed U.S. equities but benefitted by a late year rally. The S&P ADR index returned a gross* 6.34% versus the net return of Frigate, our international ADR portfolio, of 4.45%**. Since inception on July 1, 2013 through 2016, the cumulative net return of Frigate has been 8.82% versus a gross return of 8.46% for the S&P 500 ADR index.

    In general, investors in pharmaceutical companies were concerned over pricing pressure and competition and this sector detracted from performance. Also some specific stock picks, such as the Swedish telecommunications equipment provider, Ericsson were laggards. On the other hand, energy and commodity companies had a positive influence on performance, as did technology companies Taiwan Semiconductor Manufacturing and SAP and industrial company Siemens.

    I made no position changes in Frigate in the midst of the year-end volatility. At the beginning of 2017, I am looking at adding to some of our most undervalued positions, especially pharmaceutical companies, while monitoring all of our holdings and looking for new opportunities. In fact, I have already set up meetings in Europe for March. In the meantime, Frigate has two positions under bid – agricultural company Syngenta and British communications company Sky.

    Treasure Harbor, our ADR portfolio focused on yield, also benefited from improving commodity prices and had a net return of 5.49% in 2016. This lagged its volatile specialized benchmark*** which was up 13.74%, although since inception on November 1, 2013 through 2016, Treasure Harbor was down 7.73% versus the benchmark return of a negative 10.95%. In 2016, healthcare had a slightly negative effect on performance, whereas telecommunication stocks had a mixed effect depending upon their location – European stocks underperformed and Canadian and Asian stocks outperformed. Indeed, in the final quarter, I trimmed outperforming New Zealand telecommunications Spark New Zealand, along with China Construction Bank. Taking advantage of post-election fears that seemed to spill over to companies exposed to Emerging Markets, I added to Spanish stocks Santander and Telefonica.

    Despite currency headwinds of almost 3%, Yellowtail, our international small- and mid- cap portfolio, outperformed our other International portfolios with a net return of approximately 6% in 2016, handily beating its VSS**** benchmark which was up 0.36% over the same time period. Since inception in November of 2014, Yellowtail has returned a positive 17% versus a negative 5% for its benchmark. Stock selection appeared to drive local currency performance. In Japan, Sawai Pharmaceutical and Casio Computer were detractors while food company Nicherei and Sumitomo Heavy Industries were strong performers. In Europe, poor performance of Hikma and Virbac, human and animal healthcare companies, respectively, were offset by such investments as appliance maker SEB, security firm Prosegur, business service company Ipsos and diagnostic company Biomerieux. Elsewhere in the world, Tiger Brands, an African consumer brands company, also helped performance.

    As 2017 starts, I am finding international stocks attractive: in general, they are trading at a discount to U.S. peers and the weaker local currencies enhance the competitiveness of their exports while making their share prices more affordable to the U.S. investor. So for those not invested internationally, I would suggest considering adding this “spice” to your portfolio. And for those wanting diversification beyond equities, we can also offer exposure to bonds, REITS and private equity utilizing Exchange Traded Funds (ETFs).

    It’s not the same as selecting specific companies as investments, but in my own case, accidentally adding a different spice – cayenne pepper as it turns out – to my cereal and yogurt had surprisingly good results. I hope that any investments you make this year yield a similar positive experience.

    Please write Cale or myself with further questions, and in the meantime, thank you for investing along side of us and Happy New Year.

    – Retz Reeves, CFA



    Notes:
    *Gross returns do not include fees or taxes on international dividends and assume gross dividends are reinvested.
    **All returns for benchmarks, indices and Folios are estimated and unaudited.
    ***15% SPDR S&P Emerging Market Dividend ETF; 85% S&P International Dividend ETF
    ****Vanguard FTSE All-World ex-US Small-Cap ETF

    Disclaimer: This post nor any of the material linked to herein in any way constitutes investment advice. Historical performance data above represents performance results as reported by the portfolio identified. Performance results are for illustration purposes only. Historical results are not indicative of future performance. Positive returns are not guaranteed. Individual results will vary depending on market conditions and timing of initial investment. Investing may cause capital loss. The publication of this performance data is in no way a solicitation or offer to sell securities or investment advisory services.

    Posted by: Retz Reeves , For Investors
  • Letter to Investors, December 2016

    Below is my recent letter to investors in the Tarpon Folio, originally sent out on December 18th. You can sign up to receive future letters here.

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    “It is the long-term investor, he who most promotes the public interest, who will in practice come in for most criticism. For it is in the essence of his behavior that he should be eccentric, unconventional and rash in the eyes of average opinion. If he is successful, that will only confirm the general belief in his rashness; and if in the short run he is unsuccessful, which is very likely, he will not receive much mercy. Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”

    – J.M. Keynes

    Dear Investors,

    From January 1 through November 30, 2016, net of all fees, the Tarpon Folio is up 91.8% compared to an increase of 9.8% in the S&P 500 over the same period.

    As of the market close last Friday, December 16, Tarpon is up more than 100% year-to-date, after fees, on an unaudited basis. So I am pleased to report that it appears that you will have doubled your money in Tarpon in 2016.

    Merry Christmas.

    Thank you for hanging in there after a tough 2015. We are succeeding unconventionally. And we are not done yet.

    We now have two ten-baggers in Tarpon. I have made no trades since August. And subsequent to that investor-only email I sent in early November, OPEC cut production, as expected, putting a floor under oil prices and formally closing out one of the most head-scratching chapters in the history of the oil market.

    My expectation, in short, is that oil will continue to grind higher in 2017. Global oil flows now look to be in deficit, while elevated oil stocks will be drained further by the recent OPEC/non-OPEC production cut agreement.

    I also believe the risk of sleepwalking into a supply crunch in either ’17 or ’18 remains uncomfortably high. That risk is due to several pro-cyclical idiosyncrasies of today’s oil market, the most notable of which is the inconsistent quality of global production and inventory data. IEA numbers in particular are, on occasion, confounding and irreconcilable, appearing to obscure or conflate trends in production and/or inventories which would otherwise be price-supportive for oil.

    I suspected it a year ago, and now unequivocally believe it: there are some strange things in that macro oil data – whether Gulf of Mexico oil production forecasts, OECD inventory stock revisions, or the obscuring of oil-versus-condensate storage levels here in the U.S. All of which makes the forward curve even less predictive of future oil prices than it already is.

    Get on it, 60 Minutes.

    In any case, our companies remain resilient, and our returns in Tarpon next year should be attractive enough that I believe my primary goal as your portfolio manager is to avoid doing anything that might cut the compounding process short.

    So let the record show that it’s in your best interest if I do a lot of fishing next year.

    But let’s not get cocky – nor forget the role good luck played for us this year. We’ll all be better off if we ratchet down our expectations for 2017.

    We found a glitch in The Matrix last year. It continues to be exploitable in a reasonably systematic way via the shares of deeply undervalued U.S. E&Ps – without using margin, derivatives or algorithms – although on occasion it does require some scotch. And we are not done taking advantage of it yet.

    As a reminder:

    Stock prices are not data. They are an opinion. To a value investor, they are an opinion about the future earnings power of a company. That there is a lot of data available to form an opinion about a company’s true value should not be confused with the idea that all opinions about stock prices are equally valid.

    The vast majority of the time, the market values companies correctly – or, at least, an investor should start by assuming the market is correct. But every so often, the market makes a grievous error that alert and patient investors can exploit. And for Tarpon, this has been of those times.

    Please understand that because of what we stand to gain the next few years, I will make no apologies for whatever short-term volatility may come as a result of continuing to hold our current Tarpon companies, at their current portfolio weights, for an indefinite period of time.

    We own good assets, bought at even better prices, which produce a critical product that many in the market don’t appear to realize may temporarily be in short supply in the not-too-distant future. The primacy of price over all else in the oil market has been nearly absolute. But it is also untenable. I continue to believe this is a perfect storm of cognitive biases, incentives, ambiguity and groupthink on Wall Street that we can take advantage of.

    And my job, essentially, is to not screw it up. So we are going to take every penny the market gives us in 2017.

    Right now, though, there is a worrisome oversupply of eggnog in Islamorada.

    And. I. Am. On. It.

    I’ll have more thoughts on Tarpon, OPEC, the new U.S. administration and the shale industry’s response to higher oil prices in a few months.

    In the meantime, Happy Holidays!

    Peace, love and cash flow.

    – Cale

    ______


    Sign up for these emails here.

    Read my original 82 page thesis on investing in U.S. E&Ps (exploration and production companies) here.


    Disclaimer: This post nor any of the material linked to herein in any way constitutes investment advice. Historical performance data above represents performance results as reported by the portfolio identified. Performance results are for illustration purposes only. Historical results are not indicative of future performance. Positive returns are not guaranteed. Individual results will vary depending on market conditions and timing of initial investment. Investing may cause capital loss. The S&P 500, used for comparison purposes, is significantly less volatile than the holdings of the funds listed. The performance data is net of all fees reflecting the deduction of advisory fees, brokerage commissions and any other client-paid expenses. The performance data includes the reinvestment of capital gains and dividends. The publication of this performance data is in no way a solicitation or offer to sell securities or investment advisory services.

    Posted by: Cale Smith , For Investors