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 mood, you are free to ignore him or to take advantage of him, but it will be disastrous if you fall under his influence.
As your Fund manager, you can count on us to try to put Mr. Market’s anxiety into perspective, and behave rationally, so that we can capture for you some of the rewards that we believe will come in the future. We hope that, through our actions and words, we are able to do just that.
Tweedy Browne Funds – Stability of People and Process
We thought it might make sense, in addition to ruminating about our Funds and markets, to reflect upon the organization to which you have entrusted a portion of your hard-earned capital. We are rapidly approaching our 95th birthday as an investment organization grounded in a deeply rooted value oriented investment discipline that has proven its efficacy both empirically and in practice over the years. As we have said quite often, we remain deeply indebted to Messrs. Graham, Buffett, Munger and Schloss, our intellectual forebears, for having paved the way for multiple generations of Tweedy Browne employees. We are now fortunate to have a third generation of Brownes working at our firm.
While new investment products in the money management industry have multiplied and investor time horizons have shortened, we have remained dedicated to Graham’s simple but elegant proposition that there are in essence two prices for every share of stock: the price listed on the exchange on any given day, and the other price, the one that would accrue to investors if the entire company were
purchased outright in an arms-length negotiated transaction between a knowledgeable buyer and seller. Graham referred to this price as the intrinsic value of the business, and to his way of thinking, the essence of investment was to try to exploit discrepancies between these two prices – in other words, to try to take advantage of mis-pricings in public equity markets. To this day, judgments around these two prices form the basis for everything that we do at Tweedy Browne. Thank you, Ben.
Looking back, surviving intact for roughly 95 years is a rather remarkable feat for an investment organization, particularly in this day and age. We believe the key to this success has been our strict adherence to a highly efficacious investment approach and process, stewardship by successive generations of partners who have been willing to subsume their individual egos for the sake of the firm as a whole, and a healthy dollop of good luck. We have been incredibly fortunate in running our business, relying on a collaborative, team-oriented approach that we feel provides a better framework for investment decision-making than an approach based on any one individual’s investment acumen. It has become clear to us over time that the diversity of perspective that this structure provides often leads to unique insights, deeper understanding, and occasional breakthroughs in research, all necessary for high quality investment decisions. It has also become clear that maintaining a balance of personalities and skill sets is essential in preserving the interpersonal harmony necessary for long and successful careers at our firm. We feel we have been successful at creating a culture that fosters cooperation for the good of the firm with the result being that each individual is better for it.
Our Investment Committee today is comprised of our four long-serving Managing Directors, Will Browne, Tom Shrager, John Spears, and Bob Wyckoff, and three of our analysts, Roger de Bree, Frank Hawrylak, and Jay Hill, each of whom joined our Investment Committee within the last two years after many years of service to our firm. The four Managing Directors have worked together at Tweedy continuously for between 24 and 41 years, while the analysts on the Investment Committee have been on board for between 12 and 29 years. No Managing Director or past partner of Tweedy, Browne has ever left the firm to take another job. All of the members of our Investment Committee have ownership stakes in the firm, and have a significant portion of their net worth invested alongside clients in the various investment products that the firm offers. While none of us at the Managing Director level have any immediate plans for retirement, our clients should be able to take comfort in the fact that, given the skill sets of our Investment Committee analysts, the transition to new leadership when the day comes should once again be seamless.
The long tenure and dedication of personnel at Tweedy, Browne extends across virtually all departments. For example, the remaining five analysts who do not currently serve on our Investment Committee have been employed at Tweedy, Browne for between six and 28 years. The average time in service at Tweedy of traders on our trading desk is 20 years, and the eight members of our Client Services team have been at the firm for an average of 13 years. Jason Minard, who heads our Client Services department, Glenn Finn, our Chief Operations Officer, and Pat Rogers, our Chief Legal Counsel, are each in their 17th year at the firm; Jane Ciar, our Mutual Fund Coordinator, is in her 27th year; John Mullahey, the head of our computer department, is in his 28th year; and Mary Gaddist, our Librarian, is in her 36th year at Tweedy, Browne. We have also made it a practice that all department heads are responsible for grooming their potential successors, so that we have coverage in the event they get hit by the proverbial bus.
So while the near-term environment has been challenging for value investors such as ourselves, the longer-term results of the Funds continue to be strong. The management team that produced these long-term records is largely the same management team that is in place today. The investment approach and process have not changed, and we continue to hammer away at our business, day in and day out.
Tweedy Browne Funds – Performance Results
While the Tweedy Browne Funds and their respective benchmark indices finished the six months ended September 30 in the red, relative results for the Funds were mixed. Our two international Funds, the Tweedy Browne Global Value Fund and the Tweedy Browne Global Value Fund II – Currency Unhedged, bested their respective benchmark indices by a considerable margin, while our two global Funds, the Tweedy Browne Value Fund and the Tweedy Browne Worldwide High Dividend Yield Value Fund, trailed their respective benchmarks for the period. Near quarter-end, equity markets began to rebound, and as we write in October, they have regained much of the ground that was lost in August and early September, and the same holds true for the Tweedy, Browne Funds. Longer-term comparisons remain more favorable.
Presented below are the results of the Tweedy, Browne Funds for various periods through September 30, 2015, with comparisons to indices we consider relevant.
Tweedy Browne Funds – Our Fund Portfolios
Please note that individual companies discussed herein represent holdings in our Funds, but are not necessarily held in all four of our Funds. Refer to footnote 7 at the end of the letter for the individual weightings of these companies in the respective Funds.
While we welcomed the volatility of the last two quarters for the opportunities it often brings, our Funds did lose some ground on an absolute basis. While companies around the globe were negatively impacted by the markets’ decline, we gave up the most ground in our oil & gas and bank holdings. Oil prices were highly volatile over the last six months, and uncertainty surrounding China’s economy have cast a pall over commodities, Asian and emerging-market-related companies. Energy-related holdings such as Halliburton and oil & gas production companies such as Devon Energy, Total, and Royal Dutch were up and down as oil prices vacillated between $48 and $66 per barrel. We continue to believe that, given industry demand and cost considerations, oil prices are likely to move higher over the longer term, and, if that indeed bears out, we are well positioned in what we feel is a diversified and undervalued group of companies in the sector. We also have little doubt that our companies have the financial resources to weather this period of lower energy prices.
Prior to the recent correction, the only place where you could uncover fear in the markets was in emerging market countries and in commodity-related businesses, and that pretty much remains the case. We certainly witnessed this over the last six months in our Asian-related bank holdings. As you know from past letters, we have had long and successful investments in two Singapore banks, DBS Group and United Overseas Bank, both of which in our view are high quality, conservatively financed, and well-managed banking institutions that have significant growth prospects and currently pay us very attractive, 4% plus annual dividend yields. We have also made an investment (in multiple lot purchases over the last two years) in Standard Chartered Bank, a UK-headquartered but largely emerging-market-dependent bank that again in our view was conservatively financed by deposits well in excess of loans, and has, in our opinion, one of the best banking networks across Asia, the Middle East, Africa and other emerging markets. Unlike our other Asian bank holdings, Standard Chartered has incurred above average loan losses and recently replaced senior management and undertaken multiple steps to address what we consider to be “fixable” problems. While this process may, and usually does, take longer than expected, we are optimistic that the bank will be able to get through this difficult period, and ultimately emerge stronger and more profitable. As you can imagine, given the uncertainty around China’s future growth (as evidenced by the recent devaluation of the yuan), these bank investments have not been getting the votes from “Mr. Market” over the near term; however, over the longer term, China and other parts of Asia should, in our opinion, continue to grow at rates in excess of the growth rates found in most of the Western world, and we believe these banks should remain significant beneficiaries of that growth.
With markets in a state of flux, it was some of the more defensive components of our Fund portfolios that held up the best over the six months ended September 30, 2015. This includes food companies such as Nestlé, beverage companies such as Heineken, and tobacco holdings such as Imperial Tobacco, Philip Morris and British American Tobacco. We also had strong results in our more recent Korean auto company investments, Hyundai Motor and Kia; Safran, the French civil jet engine manufacturer; and in Google and MasterCard.
With price volatility on the rise, portfolio activity across our Funds also perked up, allowing us to work down the cash reserve positions somewhat in our Fund portfolios. We established new positions in the two Korean automobile companies mentioned above, Hyundai Motor and Kia, and added to our position in the company that supplies them with parts and maintenance, Hyundai Mobis. At purchase, Hyundai Motor, Kia, and Hyundai Mobis were all trading at discounts to book value and mid-single digit price/earnings ratios. The reputations of these companies in terms of product quality and customer satisfaction have risen dramatically over the last decade, but a strong Korean won and concerns about Chinese demand in the near term gave us a pricing opportunity during the summer.
We also established positions in MRC Global, a US-based but global producer of pipes, valves, and fittings largely for the oil and gas industry; Ebara, a medium-capitalization Japanese manufacturer of pumps, compressors, and incinerators; and IBM. All three of these companies at purchase were trading at significant discounts from our conservative estimates of their respective intrinsic values. In addition, we believe they are financially strong and have attractive prospects for future growth in intrinsic value. Moreover, in the case of IBM, it currently pays us an attractive dividend yield as we wait for value recognition in the market. On the sell side of our Fund portfolios, we did some modest tax loss selling in September, and trimmed a number of positions across all four Funds that were trading at, or marginally above, our estimates of their intrinsic value.
As we write, all four of our Fund portfolios remain highly diversified by issue, industry, and country; are composed of securities that, overall, trade at what we believe are reasonable valuations and that currently pay attractive dividend yields on average; and carry meaningful, but declining levels of cash reserves. Should global equity markets continue their advance, our Funds should participate; however, should we revisit the instability of August and early September, we believe we are well positioned to take meaningful advantage.
Re-Opening the Tweedy Browne Global Value Fund II – Currency Unhedged
In the summer of 2014, we closed our unhedged Global Value Fund II to new investors as the cash reserve position had grown to be greater than 25% of total portfolio assets, and flows into the Fund were growing at a rapid pace far in excess of our ability to put the new cash to work in undervalued securities. Today, cash reserves in the Fund represent approximately 15% of total assets, flows have subsided significantly, and the investment opportunity set, given the volatility of late, has improved somewhat, putting us in a position to re-open the Fund for new investments. Barring a substantial change in current market conditions or a resumption of rapid inflows near term, our intention is to re-open Global Value Fund II to new investors in the near future.
Tweedy Browne Funds – Looking Forward
Just five years from now, we will celebrate our 100th year of operation as an investment organization. This will be quite a landmark for our Firm, and as mentioned earlier, a rare occurrence in our industry. We have worked hard over the years to develop what is in essence a “recurring golf swing” in the investment business – one that we hope will allow for some consistency of results over the longer term. We believe the case study discussed above and appended hereto demonstrates some success in that regard for the Global Value Fund, but we remain humbled by the day-to-day vagaries of our capital markets, and how little control we ultimately have over our investment fortunes in the short run. The stocks we own don’t know that we own them, and therefore do not behave in ways that are always consistent with our near term interests. We can ferret out pockets of what we believe to be undervaluation in our markets and individual securities that offer clues to future investment opportunity, but we have no assurance as to when, or if, that value will be recognized by other market participants, or by an acquirer.
What we do know is that Graham’s “big idea” has empirically and practically worked over the long term, and we have done our best to hone an investment organization that can execute on Graham’s promise. One of our Managing Directors read a book this past summer called The Boys in the Boat, which is about the University of Washington crew team and their epic quest for Olympic Gold in the 2,000 meter, eight-oared crew race at the 1936 Berlin Olympics. It is a wonderful emotional and historic account of how eight young men, mostly from extraordinary hardscrabble backgrounds, came together for a remarkable and unexpected achievement. We were particularly struck by the author’s description of the benefits associated with a diverse crew, and what it took for them to find their “swing” on the water. We couldn’t help but think about our many years at Tweedy Browne and the crews that have made Tweedy what it is today:
Crew races are not won by clones. They are won by crews, and great crews are carefully balanced blends of both physical abilities and personality types. In physical terms, for instance, one rower’s arms might be longer than another’s, but the latter might have a stronger back than the former. Neither is necessarily a better or more valuable oarsman than the other; both the long arms and the strong back are assets to the boat. But if they are to row well together, each of these oarsmen must adjust to the needs and capabilities of the other. Each must be prepared to compromise something in the way of optimizing his stroke for the overall benefit of the boat – the shorter-armed man reaching a little farther, the longer-armed man foreshortening his reach just a bit – so that both men’s oars remain parallel and both blades enter and exit the water at precisely the same moment…
… Good crews are good blends of personalities: someone to lead the charge; someone to hold something in reserve; someone to pick a fight; someone to make peace; someone to think things through; someone to charge ahead without thinking. Somehow all this must mesh. That’s the steepest challenge. Even after the right mixture is found, each man or woman in the boat must recognize his or her place in the fabric of the crew, accept it, and accept the others as they are. It is an exquisite thing when it all comes together in just the right way. The intense bonding and the sense of exhilaration that results from it are what many oarsmen row for, far more than for trophies or accolades. But it takes young men or women of extraordinary character as well as extraordinary physical ability to pull it off.
– The Boys in the Boat by Daniel James Brown
Thank you for investing with us, and for your continued confidence.
TWEEDY BROWNE COMPANY LLC
William H. Browne
Thomas H. Shrager
John D. Spears
Robert Q. Wyckoff, Jr.
See full PDF below.