Charles De Vaulx: We worry About Massive Misallocation of Capital In China

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Charles De Vaulx: We worry About Massive Misallocation of Capital In China
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less than 60% invested in equities over this one year period, both Funds delivered solid absolute returns and kept close pace with their respective equity benchmark due to good stock picking.

Our Japanese equity exposure fell to 8.6% on September 30, 2013 from 12.1% on September 30, 2012 in the IVA Worldwide Fund and to 16.9% from 21.0%, respectively, in the IVA International Fund. Japanese equity markets have been rising since November 2012 when Shinzo Abe was reelected as Prime Minister with an agenda to pursue aggressive monetary policies to weaken the Japanese yen and engineer inflation. Over the period, we sold or reduced our exposure to a number of holdings (such as Temp Holdings Co., Ltd.).

In the IVA Worldwide Fund, our U.S. equity exposure fell to 24.1% at period end from 30.7% on September 30, 2012. We sold a few positions that we believe reached full valuation such as Applied Materials, Inc. and Texas Instruments Inc.

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Even though we were net sellers of equities over the year, primarily in the U.S. and Japan, we found a few opportunities in emerging market equities, specifically in Brazil and China (through Hong Kong listed equities) and we increased our exposure to a South Korean holding, E-Mart Co., Ltd. We also increased our exposure to a few holdings that we view as high quality yet reasonably priced such as Nestlé SA in Switzerland and Oracle Corp. in the U.S.

We still view gold as a hedge against extreme outcomes, inflation or deflation, and it also helps to protect against the effects of currency debasement. Over the period we sold our small allocation to gold mining stocks, therefore our exposure at period end consisted solely of gold bullion. As our equity exposure came down and cash levels increased, we reduced our gold exposure over the period to 3.3% in IVA Worldwide and 3.2% in IVA International on September 30, 2013, from 5.2% in IVA Worldwide and 5.1% in IVA International on September 30, 2012. Over the year our exposure to gold was one of the largest detractors from both Funds’ returns. It detracted -1.9% from the IVA Worldwide Fund return and -2.0% from the IVA International Fund return.

Within fixed income, a few of our corporate bonds were called over the period, predominantly in the U.S., as most of our exposure is comprised of remnants of our investments from 2008/2009. Our corporate bond exposure totaled 6.8% of the IVA Worldwide Fund as of September 30, 2013 compared to 9.2% on September 30, 2012, and in the IVA International Fund, our exposure totaled 6.2% versus 7.3%, respectively.

IVA Worldwide Fund

The IVA Worldwide Fund Class A, at net asset value, returned 14.02% over the one year period ending September 30, 2013 compared to the MSCI All Country World Index (Net) (the “Index”) return of 17.73% over the same period.

Because of good stock picking, particularly in the technology sector as well as the U.S. and France, our equities (ex-gold mining stocks) averaged a gain of 29.0% over the period versus the Index (ex-gold mining stocks) average return of 18.3%. By sector, our technology and industrials stocks contributed meaningfully to our return, adding 7.1%, due, in part, to solid gains from Bollore SA (XPAR:BOL) (industrials, France) and Temp Holdings Co., Ltd. (TSE:2181)(industrials, Japan). MasterCard Inc. Class ‘A’ (MA)(technology, U.S.) was also a key contributor to our return. There were no equity sectors that detracted from our return over the year, however, our significant underweight exposure to financials and health care stocks weighed on relative results. These two sectors added 7.4% to the Index return versus only 1.2% to the IVA Worldwide Fund return.

Geographically, our stocks in the U.S. and France added the most to our return, together 11.8% versus those in the Index adding 10.0%. We benefited from strong security selection in both countries (in particular our U.S. stocks averaged a return of 31.1% versus the Index at 19.2%) as well as overweight exposure to stocks in France. Berkshire Hathaway Inc. Class ‘A’, Class ‘B’ (BRK.A)(BRK.B)(holding company, U.S.) and The Washington Post Company Class ‘B’ (WPO)(consumer discretionary, U.S.) were among our top five contributors to return. All equity countries contributed positively to our return this period, however, our Japanese equities underperformed those in the benchmark as we own mostly local, non-exporting stocks.

Within fixed income, our corporate bonds averaged a gain of 11.3% due to good performance from our Wendel bonds, which were among our top five contributors to return as they collectively added 0.6%. Our sovereign bonds averaged a return of -1.9% over the period and detracted about -0.1% from our return.

Our forward foreign currency contracts, which are used to hedge currency risk, contributed about 0.6% to our return, mainly due to our Japanese yen hedge which averaged 40% of our total yen exposure over the year.

The largest individual detractors from our return this period included: gold bullion (gold), IAMGOLD Corporation (IAG)(gold mining), Benesse Holdings Inc. (OSE:9783)(consumer discretionary, Japan), Singapore government bonds (sovereign debt), Newcrest Mining Limited (ASX:NCM)(gold mining), and Devon Energy Corp. (energy, U.S.).

IVA International Fund

The IVA International Fund Class A, at net asset value, returned 14.09% over the one year period ending September 30, 2013 compared to the MSCI All Country World (ex-U.S.) Index (Net) (the “Index”) return of 16.48% over the same period.

Our equities (ex-gold mining stocks) averaged a return of 28.6% versus the Index (ex-gold mining stocks) average return of 17.5%. Security selection within the industrials sector was a significant plus, as these stocks collectively averaged a gain of 47.0% compared to the Index at 24.3%, and added 4.6% to our return. A number of the Fund’s top contributors to return were in this sector and included: Temp Holdings Co., Ltd. (industrials, Japan), Teleperformance SA (industrials, France), Bollore SA (industrials, France), and Financière de I’Odet SA (industrials, France). Because of our overweight exposure and strong performance, our consumer discretionary stocks added 3.7% to our return. All equity sectors contributed positively to our return over the period, however, our underweight exposure to the financials and health care sectors detracted from relative results as these two sectors added 7.4% to the Index return versus 1.4% to our return.

Our allocation to France provided the largest contribution to return, with our holdings averaging a return of 43.5% versus the Index average return of 32.0%, and added 6.5% to performance. This was led by good performance from a few industrials stocks mentioned above. Even though our Japanese equities underperformed those in the Index with an average return of 20.1% versus 31.5% respectively, as we own mostly local, non-exporting stocks, they still added 3.7% to our return in U.S. dollars. The only countries to detract from our return this period were India and Mexico, together almost -0.1%.

Within fixed income, our corporate bonds averaged a gain of 11.9% due to good performance from our Wendel bonds, which were among our top five contributors to return as they collectively added 0.5%. Our sovereign bonds averaged a return of -1.7% over the period and detracted about -0.2% from our return.

Our forward foreign currency contracts, which are used to hedge currency risk, contributed about 1.8% to our return, mainly due to our Japanese yen hedge which averaged 50% of our total yen exposure over the year.

The largest individual detractors from our return this period included: gold bullion (gold), IAMGOLD Corporation (gold mining), Benesse Holdings Inc. (consumer discretionary, Japan), Newcrest Mining Limited (gold mining), and Singapore government bonds (sovereign debt).

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