Avenir Value Fund commentary for the third quarter ended September 30, 2016.
The Avenir Value Fund (the “Fund”) increased 13.5% in the September 2016 quarter, gained 13.1% in the calendar year-to-date and has returned 90.8%, net of fees and expenses, since the Fund’s inception in August 2011. By comparison, the ASX All Ordinaries increased 5.3% in the quarter, 6.9% year-to-date and 52.6% since Avenir Value Fund’s inception. The MSCI World Total Return index returned 7.5% for the quarter and 44.3% since Avenir Value Fund’s inception.
The quarter marked the 5-year anniversary of Avenir’s inception. During that time we have done some things very well and some things that we could have done better. We have worked continuously to refine our process as part of the never ending quest to reduce risk and improve performance. What has not changed during our five years, however, is our steadfast belief in the value of investing with a value oriented mindset.
Many people think of value investing as applying a mechanistic process of identifying statistically cheap stocks. This is overly simplistic and is a form of investing we do not practice. We align with the Seth Klarman view of the world, in which he describes value investing as:
“…a comprehensive investment philosophy that emphasises the need to perform in-depth fundamental analysis, pursue long-term investment results, limit risk, and avoid crowd psychology.”
Investing in this world has led us to companies with long term operating records and attractive business characteristics when they are offered at bargain prices. While this approach sounds relatively straightforward, practising it take enormous reserves of discipline, selectivity, patience and resilience in the face of a market continually telling you that you are wrong. You don’t get to buy something for much less than it is currently worth unless there is a lot of people telling you that it is not worth anything! Klarman, has summed it up nicely by noting “you don’t become a value investor for the group hugs”.
Sometimes, buying something at a discount, requires buying when it is declining in price as this is when it is most available. When the price starts to rise, sellers are scarce and there is a lot more competition from other buyers for the limited supply of stock. Equally, it is impossible to know when the bottom is and acting on an apparent bargain means, at some point, actually pulling the trigger and committing capital often when there is still uncertainty about the future.
To act in this manner and not be continually shaken out of positions and sell at precisely the wrong moment requires a high degree of conviction in those positions. One of the valuable lessons we have learnt over the past five years is the danger of reaching for conviction. There are many investment ideas in the public market that look interesting and reasonably worthy. There are far fewer that actually are.
Those investments in which we have done best have been those in which we developed a strong, research-driven conviction in the merits of the investment. In practice, this means both a willingness to commit capital, due to a firm belief that our downside is limited, and the willingness to be patient, borne from an equally strong belief that our upside is meaningful and worth waiting for. It is when the share price of something we own declines, or simply takes a long time to rise, that this conviction can be tested.
It is those situations in which we have reached for conviction that isn’t really there that have become problematic. A decline in price, without appropriate conviction, can lead an investor to become adrift and lose the resolve to stay the course exiting the position at the wrong time simply in order to stop the pain. Often, it can result in capitulation at the point of maximum pessimism, gifting a bargain buying opportunity to another investor who will reap the long-term benefits.
An important part of our continual process improvement has been to improve our selectivity. We have often felt that it is our selectivity that allows us to reduce risk and win in the market. It is by avoiding the temptation to reach for conviction that we will maintain this competitive advantage. It is the process of winnowing through the many ‘wannabe’ compelling investment ideas and acting only on the few truly compelling ideas we need to deliver worthwhile results over time. These ideas do not come in a steady progression but in fits and starts. Sometimes we find none and other times we find many. We have gotten better at staying calm and building cash in the former times and not hesitating to act repeatedly to allocate that cash in the latter.
This process has led to a current portfolio that is made up of robust, well managed, well capitalised and strongly growing companies that we believe has upside of over 70% to achieve our price targets. Each of those companies is delivering a high level of operational performance that is increasing the underlying value of those companies every day. We can’t tell when the market will agree with our view of value, but we can be sure that, unless the underlying circumstances for any of those companies changes adversely, or we uncover something with markedly better risk/return characteristics, that we will have the conviction to stay the course and allow ourselves the best opportunity to win.
During the quarter, Avenir was shortlisted for the best long/short global equity category in the HFM Awards Asia 2016.
Avenir Value Fund - Select Portfolio Updates
Our biggest winner for the quarter was El.En, an Italian based laser manufacturer, which we acquired 2 years ago. Despite the Italian market being down almost 20% over the last year, El.En increased 96% over the same period including rising 38% in the recent quarter. El.En has continued its strong run into October and, so far, we have made 200%+ on our investment in El.En.
At the time of investment, El.En fit nicely with one of our favoured investment ‘models’, being at a point of inflection not yet recognised by the market, as well as being a good quality company with a capable and economically aligned management team. El.En had cash equal to half the market capitalisation and was available for 5-times operating income with plenty of internal growth opportunities available. It participated in a consolidating industry giving plenty of scope for value added corporate activity as either an acquirer or target which we felt would ensure underlying value was identified before too long. El.En has continued to grow revenue, earnings and margins during our ownership which has resulted in the market repricing it from the bargain level at which we invested.
As the chart below highlights, we do not need a rising market in order for our investments to deliver strong results. In fact, the Italian market declined by 17% over the same period that our Italian holding increased by over 200%. The chart also highlights the difficulty in timing investments. Once the market decides a higher valuation