FPA International Value Fund webcast audio, transcript and slides for the second quarter ended June 30, 2016.
FPA International Value Fund 2Q16 Webcast Audio
FPA International Value Fund 2Q16 Webcast Transcript
Pierre Py: As always, we will start with performance. During the second quarter of the year, the Fund returned a negative 3.09% in U.S. currency, which compared to a negative 0.64% for the MSCI All-Country World Index. (01:55) Since the beginning of the year, however, the Fund has returned a positive 0.69% compared to a negative 1.02% for the Index. As in the first quarter, there was significant volatility during the period with stock prices having come down materially following several weeks of positive performance on the news that Britain had voted by referendum to leave the European Union on June 23rd. As always, we encourage shareholders to focus on returns over a multiyear period if not through a full market cycle rather than short-term performance; in particular, when short-term performance is impacted by big macro or political events such as the European referendum.
To this point, we would note that our FPA International Value Fund is appreciated by an annualized rate of 5.3% net of fees and expenses versus 3.77% for the Index since its inception on December 1st, 2011. Along with these performance numbers, it is worth noting that since inception, our cash exposure has averaged 30 to 35% and it has fluctuated from around 10% to more than 40% depending on the availability of suitable investment opportunities.
At the end of the period, the Fund was a little over 80% invested. While this is effectively unchanged from the reported figure at the end of the first quarter, there were significant fluctuations throughout the quarter. Prior to the results of the European referendum, the Fund’s cash exposure had increased to levels in excess of 25% as markets continued to rise and our portfolio holdings even more so. But following the results of the European referendum, we took advantage of depressed valuations to deploy more capital. And as a result, our cash exposure fell back to about 20% at the end of this second quarter.
(03:52) As mentioned, we prefer not to comment on short-term performance which we consider to be of little relevance to our long-term investment approach. Similarly, as bottom-up investors, we would prefer to refrain from commenting on microeconomic or capital markets developments. However, the historic decision by the British people to leave the European Union, known as Brexit, had a material impact on the Fund’s return in the quarter even though it happened on June 24th, less than a week before the end of the period and for reasons that need to be made clear.
To understand how sharp of an impact the Brexit vote had on absolute performance this quarter, it’s worth considering the following: By June 23rd, which was the day of the vote, the Fund had returned a positive 3.17% for the quarter versus 2.88% for the Index and had a year-to-date return of 7.2% versus 2.49% for the Index. Yet, by June 24th, one day after the results, the Fund had returned a negative 3.01% for the quarter versus a negative 3.34% for the Index. At that point the Fund’s year-to-date return was 0.78% versus a negative 3.71% for the Index. That’s how sharp of an impact the Brexit vote had on absolute performance this quarter.
Now, in terms of its impact on relative performance, the Fund actually held up better than the Index on the first day of trading that followed the results of the vote. But on that same day, as I noted earlier, we took advantage of the price valuations and made several investments which then cause the Fund to significantly underperform. On June 24th, as the markets panicked, we deployed 8% of the Fund’s asset, mostly in several U.K. small caps that I experienced price dislocations north of 20% on average. (06:01) These stocks sell by roughly another 20% on the next trading day, June 27th, when we invested another 3% of our assets. As a result, the Fund declined by close to 6% on that Monday, so on June 27th, almost 300 basis points worse than the Index. So by aggressively taking advantage of exceptional volatility, we effectively “gave up” in one day almost two-thirds of the Fund’s excess performance for the year. I would not on that front that at the same time as we put a significant amount of capital to work in these couple of days, I actually personally increased my investment in the Fund by more than 20%, my single-largest increase since the inception of the Fund back in December, 2011.
Now, in hindsight of course, I guess we should have waited another day. And, of course, I’m being factious here. But we can never predict how long a window of opportunity we are going to be dealing with. The discounts on that couple of days were such that it was clear what needed to be done and we didn’t think twice about the impact on the Fund’s short-term returns. This is precisely the type of situation that we long for and we were all too happy to take advantage of it. While others seem to be resorting to bookies and volatility forecast in order to position their portfolio for one outcome or the other in the months ahead of the referendum, we simply continued to research and value companies so as to be ready to move promptly if markets panicked. And when it happened, obviously we took advantage of it.
To be clear, we did not buy a variety of expensive names that came down a few percentage points on that day and have since bounced back to their previous levels. Rather, we invested in U.K. businesses where share prices fell as in one particular instance from $7.56 on June 23rd to $4.51 on June 27th, i.e., down 40% in s single day of trading on no new business-specific news. (08:06) In this case, it was a company we had actually long followed and valued. We knew the management and we knew the business to be of high quality, but we had found it unattractively priced up until then.
Now, this discipline can cause the Fund to underperform in the face of “market corrections” in the short run as we make aggressive investments in stocks that experience material dislocation while others hold up better. But this is a function of our unaltered focus on buying intrinsically cheap businesses rather than on manufacturing short-term paper returns. It also reflects growing valuation asymmetries in the markets between two types of companies in our view. One type is big and liquid companies often perceived as unlikely to negatively surprise that can be used to capture some marginal spread versus artificially-deflated interest rates. The other type is typically smaller, less predictable companies that tend to be overlooked and are fundamentally undervalued. With more capital pressed to adopt a similar approach and chasing the same names, share prices benefit which can make the trade look compelling in the short term. But longer term, however, it could translate into permanent capital destruction once focus is