Ori Eyal’s Emerging Value Capital Management letter to partners and shareholders for the month and year ended December 31, 2015.
Emerging Value Capital Management 2015 Annual Letter
Dear Partners and Shareholders,
For 2015, Emerging Value Capital Management fund returned an estimated +3.7% net to investors. Stock markets worldwide were down with the All Country World Index (ACWI) and the HFRI Equity Hedge Index down -2.4% and -0.8% respectively.
Since inception (10/15/2008), Emerging Value Capital Management Fund returned an estimated +105.2% (netto investors). During this same time period the MSCI All Country World Index (ACWI) and the HFRI Equity Hedge Index returned approximately +83.0% and +43.2% respectively.
Emerging Value Capital Management - 2015 Performance Overview:
Emerging Value Capital Management Fund significantly outperformed its benchmarks in 2015 despite our conservative positioning, less than market exposure, cash, and short positions.
The five key elements leading to this outperformance were:
- Our investment focus on the US, Israel and Korea.
- Our avoidance of the commodities and energy sectors.
- Our short oil position.
- Our gradual shift towards investing in higher quality value companies.
- Our deep fundamental research and analysis of every investment.
We think all five of these decisions were more than vindicated in 2015 and all five remain valid for 2016.
Towards the end of 2015 (and into 2016), the markets became concerned that the price of oil had fallen too much which led to steep declines for many stocks. Despite having little direct exposure to oil, gas, or commodities, we did get hit as some of our investments suffered due to indirect exposure. For example, our basket of US banks declined due to write downs that these banks will have to take from loans made to companies in the oil & gas sectors.
We think market worries over low energy prices are misplaced. Low energy prices are a gift to the world which consumes about 95 million barrels of oil every day, mostly for transportation and industrial uses. Eighteen months ago, the world was paying over $100 for each of those barrels of oil. That’s a cost of about $10B every single day. This $10B was a real cost that each of us had to pay at the pump and through higher prices for every good and service (since every good and service requires some energy input to produce).
With oil prices now around $30 per barrel, the world is paying just $3B every day for its oil needs. Compared to 18 months ago, that’s a direct saving of $7 billion every single day! This massive cost saving will take time to fully trickle down into consumers pockets, but it will do so in time and it works as a powerful global economic stimulus.
Like all economic disruption, these changes are causing some temporary pain, particularly to companies with direct and indirect exposure to the oil & gas sectors. However, over the longer term, low oil & gas prices are an economic blessing.
Emerging Value Capital Management - Finding Value Around the World:
Both Israel and South Korea performed very well economically in 2015 during a year were practically every other country in the world (except the US) suffered. The expanding wars in the Middle East and North Africa, the collapse of commodity and energy prices, the massive refugee immigration into Europe, China’s slowdown, and Russian and Chinese belligerence left few countries and economies unhurt.
The secret to the success of Israel, South Korea (and, largely, the US) is their focus on technological innovation. In our view, the age of energy has ended and the age of technological innovation has begun. With technology comprising an ever growing portion of the economy, with more and more “old economy” sectors getting technologically disrupted and with the end of the commodity and energy super cycles, economic success in the future will be based on the ability to innovate and stay ahead of the advancing technological curve. Israel, South Korea, and the US are the best positioned countries to do so.
We wish to specifically highlight Israel’s excellent performance in 2015. Israel is located in the most volatile and dangerous region in the world and is surrounded by imploding countries and many enemies from within and without. Yet Israel had the best performing currency for 2015 (excluding BitCoin). It also has the highest fertility rate among all OECD countries. Israel achieved 2.3% GDP growth for 2015, continuing a multi-year string of good GDP growth numbers.
As a global fund with a fairly wide investment mandate, we are able to invest in almost any country in the world. This large menu of potential investment destinations provides us with a competitive advantage (compared to geographically constrained investors), as long as we carefully pick and choose where we ultimately do invest. Not surprisingly, the majority of our capital is currently invested in the US, Israel, and South Korea.
Emerging Value Capital Management - Fund Exposure Levels:
Fund Exposure by Geography
Top 10 longs and shorts
In the next section, we will go into greater detail on many of these positions. For now, however, we think it is interesting to point out that our top 10 longs make up over half of our long exposure. As of month end, we were 90% long and 5% short. Our overall net exposure level of 85% reflects the large number of compelling bargains we are finding in global stock markets.
Emerging Value Capital Management's main contributors in 2015:
Strong positive returns were generated in 2015 by most of our investments in Korea, Israel, and from our short oil ETF. In contrast, we struggled in 2015 to make money from our investments in the US.
Isras is a leading real-estate company in Israel. It develops and owns quality residential, commercial, industrial and office real-estate assets. The company assets and development projects are spread throughout Israel with most enjoying high demand and low vacancy rates. Isras is reasonably leveraged and has been taking advantage of the very low interest rate environment to refinance, thus reducing interest costs and extending debt maturities.
Until two years ago, Isras was focused on extensive asset development and therefore re-invested all cash flows and did not pay dividends to shareholders. This resulted in the company being underfollowed and mostly neglected by investors that often view real-estate holding companies as proxies for bonds. We invested in Isras right after management announced a new dividend policy where they will pay out an annual dividend equal to 35% of FFO (about 3% dividend yield).
Isras’s book value is about 1.5B ILS. Book value understates true economic value for several reasons. First, Isras values its yielding assets at 8%-9% cap rates which are above market rates. Second, Isras owns land assets recorded at low historical purchase costs which have not yet been marked up on its books. Third, Isras has tax loss assets that are not on