Tweedy Browne Fund commentary for the second quarter ended June 30, 2015.
Concerns about Greece’s possible exit from the eurozone and a sharply correcting Chinese equity market appeared to drive global equity indices lower around quarter-end, forcing benchmark indices (in local currency) and in turn, our Funds’ returns into flat to marginally negative territory for the quarter. All sectors and most industry groups finished the quarter in the red. This increase in equity market volatility, which occurred during the quarter, continues as we write this update, and we are hopeful this portends pricing opportunities for our Funds in the weeks and months ahead.
On a positive note, our portfolios’ tobacco holdings, Imperial Tobacco and Philip Morris, demonstrated their defensive character by producing solid returns during the quarter, as did several of our banks, Wells Fargo, DBS Group and UOB. We also had a very nice return in TNT Express in our two international Funds, Global Value and Global Value II, after Federal Express announced that it would be acquiring the company. Just after first quarter end, Federal Express announced that it would be acquiring TNT Express, the Dutch parcel company, in an all cash offer of eight euros/share, or a 37% and 39% premium over our cost in the shares. As you will recall, we purchased TNT a couple of years back, after its previously proposed merger with UPS fell apart when European regulators failed to approve the deal, feeling it would be anti-competitive. We believe there should be no competitive issues with Federal Express this time, as its footprint in Europe is much smaller than that of UPS. Federal Express was able to use a strong currency (the US dollar), and extremely low-cost debt to secure a deal that we believe is attractive for all parties to the transaction.
Leading the decliners in the Tweedy Browne Funds’ portfolios during the quarter were several of the portfolios’ oil & gas, insurance, and pharmaceutical holdings, which included companies such as Royal Dutch, Total, Munich Re, Zurich Insurance, GlaxoSmithKline, and Novartis. One of our media holdings, Axel Springer, also was down for the quarter as were Hyundai Motor and Kia, our two recent Korean auto purchases.
With the increase in volatility during the quarter, we had an opportunity to add a few new positions to our Fund portfolios including Hyundai Motor, Kia, and a couple of Hong Kong-based smaller capitalization companies. We also added to various positions including GlaxoSmithKline, HSBC, Verizon and Standard Chartered Bank. Aside from the sale of a couple of smaller Japanese and Korean holdings and one New Zealand holding, there were few outright sales in the portfolios; however, we did trim back a few positions including Imperial Tobacco and Emerson Electric. Two of our more recent purchases, Hyundai Motor and Kia, belong to the same “chaebol” in South Korea, and both have demonstrated an ability to grow their intrinsic values at attractive rates over the longer term. They have become significantly more competitive against their Japanese rivals in recent years as quality and customer satisfaction ratings have risen at both companies. At purchase, both companies were trading at discounts to book value, less than 10X earnings and at substantial discounts to our estimates of their intrinsic values.
Looking forward, valuations remain high despite the recent bumpiness in global equity markets. As of June 30, 2015, the weighted average price/earnings ratios on the top 25 holdings in our Tweedy Browne Funds ranged from 15.5X to 17.6X 2015 estimated earnings, and the weighted average dividend yield ranged from 2.97% to 3.94%. Cash reserves remain somewhat elevated, more so in our two international funds, and as of June 30, 2015, totaled between 8.8% and 25.6% across our Funds. (Please note that the weighted average dividend yields shown above are not representative of the Funds’ yields, nor do they represent the Funds’ performance. The figures solely represent the average weighted dividend yields of the common stocks held in each of the Funds’ portfolios. Please refer to the 30-day Standardized Yields in the performance chart on Page 1 for each of the Fund's yields.)
Tweedy Browne Fund - Thoughts about recent underperformance
As you know, equity return streams are lumpy by their nature. We can identify companies that we believe are undervalued at purchase, but have no control as to when (or if) that value gets recognized in public markets. That recognition often occurs with a great deal of randomness. Therefore, in all investment records, there is an element of both luck and skill. As we mentioned in our semi-annual report, since a multitude of variables move stock prices around, particularly in the short run, it is virtually impossible to divine skill from luck without a large sample size, i.e., a very long record. As Michael Mauboussin, the noted investment strategist and behavioralist, pointed out in his book entitled The Success Equation:
In a game of poker, a lucky amateur may beat a pro in a few hands but the pro’s edge would become clear as they played more hands… only a small percentage of investors possess enough skill to offset fees. As a result, investing, especially over relatively short periods of time, is more a matter of luck than of skill.
One thing we have in abundance at Tweedy Browne, given our long history and pedigree, are long investment records, and those records have for the most part bested benchmark indices since their respective inceptions. This also holds true for all four of Tweedy Browne Funds, however, those return streams have been lumpy with multiple interim periods of underperformance. And yet this periodic underperformance has been part and parcel in our case of long term successful index-besting records.
Our most recent period of underperformance, for example, in the Global Value Fund began in 2013 and extends through today. In 2013, we produced an absolute return in excess of 19%, while carrying cash reserves of approximately 16%. As we have suggested to many clients, if at the end of 2012 we had offered them a guarantee of a 19% plus return for the coming year, while carrying some dry powder to protect on the downside, and provide optionality for new purchases at attractive prices, would they have accepted that deal?
We think we all know the answer to that question. The real impact of underperformance in the Global Value Fund has taken hold over the last 18 months, and the reason for the underperformance is largely our cash reserve position, an underweighting in Japanese equities, a modestly overweighted position in oil & gas related businesses, and the fact that we hedge our perceived foreign currency exposure, which means we have not been 100% nominally hedged during a period of significant US dollar strength.
Invariably, in our Funds, periods of strong relative performance have been followed by periods of weak relative results, which have been followed by periods of good results, and so on, resulting in a very good long term absolute and relative return experience. As we have recently explained to clients, we have seen a version of this movie several times in our decades here at Tweedy Browne. We underperformed in 1998 and 1999, as cash