Tweedy Browne Funds semi-annual report for the period ended September 30, 2015.
Slowing growth in China, the world’s second largest economy, coupled with uncertainty surrounding the prospective normalization of interest rates in the United States sent tremors through global equity markets over the last several months. After a rather short lived and furious correction in late August and early September, global equity markets regained their footing and, as we write, have taken back much of the ground they lost as summer came to an end.
For value investors such as ourselves, it remained business as usual through this turbulence, although we would admit to a certain counterintuitive satisfaction as equity markets began their long overdue retreat. After six and a half years of relatively smooth sailing, setting aside a brief hiccup in 2011, it had become quite a challenging environment for value investors. Bargains had become increasingly scarce and many of our existing holdings were trading at or near our estimates of their intrinsic value – consequently, we were selling and trimming back a number of those positions. As a result, cash reserves had increased and our returns were somewhat diluted while the bull markets and their associated benchmark indices raged on. We were able to take some advantage of the markets’ downside volatility in late summer. However, it did not last long enough, nor was it steep enough, for us to make significant headway in putting our cash reserves to work.
As we have explained in previous letters, 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 last year’s 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 long record. One thing we have in abundance at Tweedy Browne, given our long history and pedigree, are long, successful investment records. In the case of our mutual funds, those records have bested benchmark indices since their respective inceptions. However, those return streams have been lumpy, with multiple interim periods of underperformance like the one we are going through now. And yet this periodic underperformance has been part and parcel, in our case, of long-term, successful performance records.
Included below is a chart that we believe provides additional perspective on the Global Value Fund’s 22 plusyear investment record. It is in the form of a scatterplot, and examines 3-year rolling returns since inception for the Global Value Fund as compared to the MSCI EAFE Index (Hedged to US$) for different types of equity market environments. The chart illustrates that periods of relative outperformance for the Fund have tended to occur in “down” and more “normal” market environments, while periods of relative underperformance have tended to cluster in very “robust,” more speculative market environments, like the one we have been in over the last three years.
Out of 232 three-year measurement periods, the Global Value Fund outperformed the MSCI EAFE Index (Hedged to US$) 181 times, or in 78% of measured periods. Note: periods of relative outperformance have generally clustered in “down” and “normal” markets, while periods of underperformance have generally clustered in very “robust,” more speculative market environments.
The Fund’s average annual total returns for the 1-, 5- and 10-year periods ended September 30, 2015 were -5.76%, 7.20%, and 5.45%, respectively. The Fund’s Total Annual Fund Operating Expense Ratio as of March 31, 2015 was 1.37%. The performance shown, before and after taxes, represents past performance and is not a guarantee of future results. Investment return and the value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be higher or lower than the performance quoted. Please visit www.tweedy.com to obtain performance data that is current to the most recent month-end. The Fund does not impose any front-end or deferred sales charges. However, the Fund imposes a 2% redemption fee on redemption proceeds for redemptions or exchanges made less than 15 days after purchase. Performance data does not reflect the deduction of the redemption fee, and, if reflected, the redemption fee would reduce any performance data quoted for periods of 14 days or less.
As the above chart demonstrates, the underperformance of our value driven strategy in the Global Value Fund over the last several years would appear to be quite normal and to be expected in the later stages of a bull market, when equity valuations become untethered from underlying estimated intrinsic values. In fact, if we were “winning big” in this environment, it would certainly seem out of step with the pattern of our historical returns, and would no doubt prompt some questions.
Following this letter is a study we’ve recently published entitled “Different Perspectives on Investment Performance – Tweedy Browne Global Value Fund.” The study examines indepth the long-term return history of our flagship Fund, the Tweedy Browne Global Value Fund, since its inception in the summer of 1993. The study includes an analysis of rolling period results in different market environments, the variability of returns, down market performance, “peak-to-trough” declines and subsequent recovery, upside/downside capture ratios, and after-tax returns.
We hope it provides some additional perspective on what has been a long and successful, yet “lumpy” investment experience for Global Value Fund shareholders. Included in the study are several rolling period return charts that illustrate that, the longer the measurement period, the greater the consistency of outperformance of the Fund. We believe these charts provide interesting perspective about the returns of the Global Value Fund over long measurement periods. Since its inception on June 15, 1993, an initial investment of $100,000 in the Global Value Fund would be worth $739,293, as of September 30, 2015. By comparison, an investment on June 15, 1993 in the MSCI EAFE Index (Hedged to US$) would be worth $339,350.
While there are no guarantees, the study also suggests that this difficult slice of time will eventually pass, and we will once again have new opportunities. With the Federal Reserve’s back against the wall and the Chinese economy continuing to grind down, we suspect we have not seen the end of unsettled markets, and if the recent volatility persists, as we suspect it will, we feel we are well positioned to take meaningful advantage. In times like these, we are once again reminded of Ben Graham’s cautionary parable of “Mr. Market,” the obliging, but moody fellow who turns up every day at the shareholder’s door, offering to buy his shares at a price. Depending on his mood, that price could be absurdly high, perhaps about right, ridiculously low, or somewhere in between. As Warren Buffett has counseled:
Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom that you will find useful. If he shows up someday in a particularly foolish