From Charles De Vaulx’s IVA International Fund Q3 letter
The IVA International Fund Class A (MUTF:IVIOX) account ended the quarter on September 30, 2013 with a return of 5.78% compared to the MSCI All Country World ex-U.S. Index (“Index”) return of 10.09%. This brings our year-to-date return to 11.69% versus the Index return of 10.04% for the same period.
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Charles De Vaulx on tepid economic growth
Global equity markets rose this quarter, propelled by elevated corporate profit margins, low interest rates, and quantitative easing despite tepid economic growth in many parts of the world and indications the Federal Reserve might begin to taper in the next few months. Our equity exposure was relatively unchanged over the quarter, 54.3% on September 30 versus 54.1% on June 30, while our cash exposure marginally rose to 28.3% at quarter-end from 27.3% last quarter. As value investors we must stay disciplined by always insisting on what we consider a sufficient “margin of safety” and selling (or trimming) a security once it approaches our intrinsic value estimate. We would rather own more cash than hold onto overpriced stocks that may, at some point, fall significantly in price. We never want to be in a position where performance could be badly hurt by a single name.
Year-to-date we are outperforming our benchmark despite being, on average, 55% invested in equities. This is due, in large part, to good stock picking as our equities averaged a return of 11.0% in the third quarter and 24.1% year-to-date versus the Index at 10.1% and 10.0%, respectively. Our equity exposure today consists primarily of what we view as quality stocks (strong balance sheets, non-capital intensive, good competitive positioning, well managed). The third quarter was marked by strong stock selection in consumer staples, technology, and France as well as good overall performance from stocks in the industrials sector. Our industrials and consumer staples stocks added the most to our return, collectively about 2.4%, due to solid returns from a few stocks in France and South Korea. Conversely, the only equity sectors to detract from our return were health care and holding company, together about -0.3%, as a Japanese holding in the health care sector and a Norwegian stock in the holding company sector dragged on the results, while these sectors added about 0.5% to the Index return. Geographically, our stocks in France and Japan contributed about 3.6% to our return versus the Index adding 2.0%. As mentioned above, performance and our overweight exposure to French stocks contributed meaningfully to our relative outperformance as our stocks in France averaged a gain of 18.3% versus the Index average return of 15.4%. A few countries that we have small allocations to detracted from our return this quarter. Collectively, Norway and Hong Kong detracted about -0.2% from our return. Our currency hedges as of September 30, 2013 were: 60.2% Japanese yen, 30.1% euro, 20.2% South Korean won, and 18.1% Australian dollar. Collectively they detracted -0.4% from our return as the euro strengthened versus the U.S. dollar.
Charles De Vaulx reduced exposure in Gold bullion
We reduced our exposure to gold bullion over the period, to 3.3% at quarter-end from 3.9% on June 30. We still view gold as a hedge against extreme outcomes, inflation or deflation, however, with our reduced equity exposure and increased cash levels, we took the opportunity to trim when gold reached around $1,400 an ounce in the midst of the crisis in Syria. Gold bullion averaged a return of 7.5% over the quarter and contributed 0.3% to our return.
We found a couple small opportunities in corporate bonds this quarter; however, our exposure remains mostly remnants of our investments from 2008/2009, which totaled 6.3% on September 30, up from 6.1% on June 30. They averaged a return of 5.7% over the quarter. We continue to own sovereign government bonds, mostly in Singapore that we view as non-U.S. dollar cash, which totaled 8.1% at quarter-end and averaged a return of 0.8% over the period. Collectively, fixed income added 0.4% to our return this quarter. Over the quarter, we increased our exposure to a top 10 holding (consumer staples, Switzerland) that we view as high quality and reasonably priced. We believe the company has a strong balance sheet, is well managed, and can sustain its high profit margins and thus compound its value over time. Increasing this exposure helped to offset some trimming in equities that we view as either fully valued or lower quality, particularly in Japan. Our Japanese equity exposure fell to 17.0% at quarter-end from 18.2% on June 30.
Charles De Vaulx on emerging markets stocks
While we initiated some small investments within emerging markets stocks this year, specifically in Brazil and China (through Hong Kong listed equities), we would like to see stock prices come down more in local currency terms. Additionally, we have some concerns about how much further economic growth in some emerging markets will decelerate as well as the direction of the Chinese economy. However, valuations are much more reasonable today than they were three years ago and we continue to look at these markets closely on a stock-by-stock basis. Our emerging market equity exposure totaled 11.4% at quarter-end. In conclusion, we think the investment environment today is difficult. We view most equities as fully priced, yet we believe they are the “best house in a bad neighborhood” compared to other asset classes. We continue to be focused on individual stock picking and absolute returns by in vesting in what we think are quality businesses that can compound their value over time. As value investors, we always insist on a “margin of safety” and our flexibility to hold cash is a great tool in an environment like this. While our portfolio today is as cautiously positioned as ever, at the right price we will be ready to pounce!