First Eagle Investment Management Annual Letter To Shareholder Letters 2014
Dear Fellow Shareholders, At First Eagle, we remain committed to protecting and preserving our shareholders’ purchasing power over time. Irrespective of short-term market events, swings in investor confidence or the pressure to follow a new market paradigm, our first priority is unwavering: to provide prudent stewardship of the assets you have placed in our care.
Since I last wrote to you in April, U.S. equity markets have remained strong, amidst continuing signs of an economic recovery. The U.S. dollar reached its highest levels in four years versus a basket of global currencies. Conversely, growth estimates have been reduced outside the U.S., leading to mixed market performance. In particular, European countries such as France and Italy have yet to find their footing while China shows signs of a slowdown. Adding to the uncertainty, we have seen a rise in geopolitical tensions, with a standoff in the Ukraine and increased instability in the Middle East. Yet asset prices and the appetite for risk remained relatively strong.
The MSCI World Index rose 8.7% in the 12 months ending October 31, 2014. In the U.S., the S&P 500 Index increased 17.3%. In Europe, the German DAX Index rose 3.2% but the French CAC 40 Index fell 3.7% during the period, reflecting the divergent health of these two economies. The Nikkei 225 Index increased 14.6% during the twelve month period. Dollar-linked commodity prices also suffered, as crude oil fell 16.4% to $81 a barrel, and the price of gold fell 11.3% to $1,173 an ounce as of October 31st. Over the twelve month period, the U.S. dollar strengthened 14.2% against the Japanese yen and the dollar strengthened 8.5% against the Euro.
During the same period, the Barclay’s U.S. Aggregate Bond Index returned 4.1% while the Barclay’s U.S. High Yield Corporate Index returned 5.8%. High yield spreads ended October at 430 basis points. Despite some intermittent volatility throughout the twelve month period, spreads are generally unchanged from their 436 basis point level a year ago.
While numerous signs point to a continued strengthening of the U.S. economy, we remain wary given the unresolved debt burdens at the Federal level. Another risk is weakening energy prices, which could slow the shale oil boom that has been a key driver of U.S. economic growth in recent quarters.
The strong rally by the U.S. dollar has led to soft performance for gold and other hard assets, but we hold firm in our conviction that gold may be a potential longterm hedge against extreme market events. At First Eagle, we always keep a watchful eye on what can go wrong, not only on what is going right. We will remain focused on delivering long-term absolute returns while also striving to avoid the permanent impairment of our clients’ capital.
Global Value Team
The Global Value team remains cautious in the face of ongoing concerns regarding overly permissive monetary and fiscal policies by central bankers. The Portfolio Managers, Matthew McLennan, Kimball Brooker, Matt Lamphier, Giorgio Caputo, Robert Hordon, Edward Meigs and Sean Slein, feel the unwinding of these policies creates a cloudy outlook for economic growth and debt servicing ability. The rebound in the U.S. economy this year masks longer term concerns our Portfolio Managers hold regarding the shortage in savings by Americans relative to investment, and the artificial demand created by fiscal stimulus.
Beyond the U.S., the absence of economic growth and high unemployment means the temptation persists for further rounds of stimulus. In the face of these persistent macroeconomic imbalances, the Global Value team continues to diligently seek what they perceive as a margin of safety in each investment. In the absence of sufficient bottom-up opportunities the funds continue to maintain some cash on the sidelines until appropriate opportunities come along at what they believe are the right prices.
High Yield Team
After rallying in the first half of 2014, the high yield market experienced some volatility in recent months. Portfolio Managers Edward Meigs and Sean Slein feel the Fund’s ongoing focus on credit risk rather than interest rate risk may stand investors in good stead over the long run. Corporate default rates remained low and we believe overall credit quality remains reasonable. We remain focused on investing in companies with strong balance sheets and a growth outlook robust enough to support their debt.
As of October 31st, we had allocated approximately 58% to single-B issues compared with about 29% allocated to double-B issues, which are historically longer maturity
and more sensitive to interest rates. This stands in contrast to an index allocation of 37% to single-B and 47% to double-B credits. We feel this allocation, along with the portfolio’s duration of 3.3 years, will help minimize our exposure to increases in interest rates. The duration of the portfolio is less than that of the Barclays Capital U.S. Corporate High Yield Index, which is 4.3 years.1
Fund of America Team
Portfolio Managers Harold Levy, David Cohen and Eric Stone continue to focus on their core competency: identifying corporate change that can potentially unlock shareholder value. While the U.S. stock market is more expensive today than it was two or three years ago, they continue to find interesting investment opportunities within the current market. Thank you for your continued confidence and support.
John P. Arnhold