Bretton Fund letter to shareholders for the third quarter ended September 30, 2015
Dear Fellow Shareholders:
The Bretton Fund’s net asset value per share (NAV) as of September 30, 2015, was $23.59. The fund’s total return for the quarter was -8.67%, while the S&P 500 Index returned -6.44%.
Total Returns as of September 30, 2015
|3rd Quarter||1 Year (A)||Annualized
3 Years (A)
|Annualized 5 Years and
Since Inception (A)
|S&P 500 Index||-6.44%||-0.61%||12.40%||13.34%|
Performance data quoted represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted. You may obtain performance data current to the most recent month-end here or by calling 800.231.2901.
All returns include change in share prices, reinvestment of any dividends, and capital gains distributions. Indices shown are broad-based, unmanaged indices commonly used to measure performance of US stocks. These indices do not incur expenses and are not available for investment. The fund’s expense ratio is 1.50%.
Bretton Fund - Contributors to Performance
The fund’s performance was hurt this quarter by a number of investments: the Federal Reserve delayed its long-planned increase in interest rates, hurting the fund’s bank investments (Wells Fargo, JPMorgan Chase, and Bank of America) and affecting performance by -1.2%; broader industry concerns about healthcare companies hurt the stock price of Community Health Systems, a -1.2% impact on the fund; new holding HD Supply stock dropped—for reasons unclear other than general market/economic anxiety—a hit to the fund of -0.9%; fears about pay-TV “cord-cutting” affected the whole media sector, including our Discovery Communications holding, a -0.9% impact; and slower rail traffic, particularly coal, hurt our rail investments, an effect of -0.9%.
The bright spot for the fund this quarter was IPC Healthcare, which announced it will be acquired by a larger company in an adjacent sector, TeamHealth, for $80/share, versus our average cost of $42/share. This boosted the fund by 1.2%.
|Security||% of Net Assets|
|Wells Fargo & Company||8.3%|
|Ross Stores, Inc.||5.8%|
|American Express Co.||5.4%|
|Union Pacific Corp.||5.4%|
|Google, Inc. (Alphabet, Inc.)||4.7%|
|HD Supply Holdings, Inc.||4.3%|
|IPC Healthcare, Inc.||4.1%|
|Discovery Communications, Inc.||3.8%|
|Armanino Foods of Distinction, Inc.||3.3%|
|JPMorgan Chase & Co.||2.8%|
|Community Health Systems, Inc.||2.7%|
|Bank of America Corp.||2.6%|
|Whole Foods Market, Inc.||2.0%|
|The Gap, Inc.||1.4%|
|New Resource Bank||1.3%|
|T-Mobile US, Inc.||1.2%|
*Cash represents cash equivalents less liabilities in excess of other assets.
We exited four companies in the quarter: Norfolk Southern, Aflac, NexPoint, and HMS. We invested in Norfolk Southern along with our other two railroads, Union Pacific and CSX, at the fund’s inception in September 2010, and it generated an annualized return of 12.8%. The railroad sector has been under significant pressure from the decline in coal volume, with the eastern railroads more exposed to coal than the western ones. As western operator Union Pacific’s share price dropped during the year, becoming increasingly compelling, we reallocated our position in Norfolk Southern to Union Pacific. We also bought Aflac at the fund’s inception, exactly the wrong time (in hindsight) for a firm with 75% of its revenue in Japanese yen. While Aflac’s performance in Japan was fine and the earnings yield excellent, the company was no match for Abenomics, which devalued the currency by over 35%. Our annualized return on Aflac was 6.0%. NexPoint was a brief investment to take advantage of a spinoff; we did not intend to be long-term holders of a REIT, and were not. HMS was an even briefer investment, described more comprehensively below. Both had an immaterial impact on the fund.
The fund initiated five investments during the quarter: Google, HD Supply, Whole Foods Markets, Centene, and HMS.
Bretton Fund - Google
We have generally been averse to technology companies for a couple of reasons: 1) technology changes so rapidly that it’s hard to tell which company is going to be around and successful in the future, and 2) tech companies have a habit of treating their public shareholders as nuisances instead of as partners, often prioritizing cool deals over shareholder returns.
Like any technology firm, Google (which as of October 1 formally renamed itself Alphabet, Inc.) is only as good as its products. If someone invented a demonstrably better search engine tomorrow, she could well have half the market for search within a year or two. Nokia, MySpace, and Netscape are but three members of the large fraternity of firms that were leapfrogged. Clorox and Colgate can afford to be complacent; Google cannot. That said, Google’s long-held dominance in search and advertising has, if anything, grown stronger in recent years. What was once a static desktop URL that customers needed to visit is now an integrated suite of search engine, browser, mapping, and productivity applications available anywhere there is a screen. Its products are so fully ingrained in people’s lives that it would be difficult for a new entrant to displace Google. If Larry Page and Sergey Brin were young grad students at Stanford today trying to compete against a Google, we don’t think they’d stand much of a chance. They’d face a much tougher competitor than AltaVista.
Google’s product excellence has been obscured in recent years by a rather mixed financial discipline. Its forays into tangential products (e.g., Google Glass, a hoverboard prototype) may or may not pay off, but to date these investments haven’t been huge compared to how much it makes on its enormously profitable search and advertising business. The same can’t be said for its $12.5 billion acquisition of Motorola Mobility, which still seems to be in search of a rationale, and its attempted $6 billion acquisition of Groupon, saved only by the kindness of Groupon’s rejection. Management also missed a big opportunity to boost shareholder returns by using some of its excess cash to buy back its own shares at a fraction of today’s price. Even a highly profitable company isn’t worth much if management isn’t going to reinvest its cash well.
Google recently took two actions that give us hope that its back of house is catching up with the front of house. 1) It announced a restructuring that will separate the core search business from the self-styled “moon shots.” While changes in reporting do not themselves generate value, we suspect the first step to better discipline may be better measurement. 2) Google also hired former Morgan Stanley CFO Ruth Porat, esteemed for her ability to manage costs across a large organization. These changes give us confidence about Google’s desire to control costs and use its cash wisely. It’s an excellent business, and the stock is very reasonably priced.
Bretton Fund - HD Supply
HD Supply (HDS) is the former industrial distribution business of Home Depot. It comprises several businesses targeting products for maintenance, repair, and operations for different end markets. The facilities maintenance division, which represents the majority of HDS’s cash flow, serves multifamily and commercial buildings. Instead of each superintendent or maintenance crew going to Home Depot and Bed Bath & Beyond each morning, HDS will deliver things like HVAC parts, faucets, and coffee filters. The company has similar distribution businesses focused on municipal water systems, construction equipment, and residential interior goods like flooring and countertops.
Distributors typically suffer from one of two major ailments: low gross margins and weak free