FPA International Value Fund webcast audio, transcript And slides for the fourth quarter ended December 31, 2015.
FPA International Value Fund 4Q15 Webcast Audio
FPA International Value Fund 4Q15 Webcast Transcript
Pierre Py: As always, we will start with performance over the quarter and, since this is the last quarter of the year, over the course of the entire year. Quite simply, the last quarter of the year was madness. During the past three months, FPA International Value Fund returned a negative 2.2% in U.S. dollar germs compared to a positive 3.2% in the MSCI All Country World Index, and that’s ex U.S. and on a net basis. This means we gave back close to 500 basis points of excess performance that we had accumulated by September 30th in these past three months and more than half of that in the last two weeks of the year alone.
This painful year end was primarily a function of intensified pressure on the share prices of some of our large and increasing holdings, which continue to experience challenging operating conditions and to suffer from deep negative market sentiments. These holdings include Countrywide and LSL, which have exposure to the volatile U.K. real estate market. They include Prada, which has exposure to the economic slowdown in China and the associated decline in Chinese demand for luxury goods. They include Fenner and ALS, which both have exposure to the deep prolonged down cycle in mining. They include Fugro, which has exposure to the sharp decline in oil prices, and Aggreko, which has exposure to weakness in energy and power and the more challenging economic environment in most of the emerging markets. As such, these are the very cheap stocks that our value discipline entices us to own even they clearly do not help short-term paper returns in the current environment. From that perspective, we would have been better off sticking with Alten, Assa Abloy, or Givaudan in the past few months.
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It’s not the first time that we’ve been face with this sort of situation though, and we think we know how it goes from here. We certainly understand the institutional imperative to play quote/unquote more favorable stocks, but we cannot force ourselves to continue owning, let alone buying, new companies however compelling their businesses might be when multiples and profit growth expectations continue to expand further as their share prices rise speculatively. These are the type holdings, assuming quality is there obviously, that we’re selling, not buying. As we do that and monetize those names, maintain a large cash position in the absence of compelling enough alternatives, and increase exposure to a few hard-hit companies, pressure on short-term performance intensifies.
With this painful final quarter, FPA International Value Fund ended the year down 6.3% in U.S. dollar terms versus 5.7% for the Index. And to add insult to injury, one additional day of trading, the first day of trading of the year, so January 4th, would have sufficed to turn 60 bips of underperformance for the year into close to 90 bips of over-performance for the year. And that is simply to highlight how volatile things can be and how misleading short-term, in particular short-term relative performance, can be. After a longterm approach, we look five years out when placing new trades, and thus we encourage shareholders to evaluate performance instead over a multiyear through-cycle period.
To that point, we would note that FPA International Value Fund has appreciated by an annualized 5.8% net and 7.2% gross since its launch on December 1st, 2011 versus 4.5% for the Index, notwithstanding that one first day of the year. This is with cash having averaged close do 35% and the strong currency headwinds we have been facing in the past couple of years. On that note, I would remind everyone that our approach to hedging only preserved dollars invested, and thus it does not allow us to safeguard upsides, nor does it allow us to capture any incremental returns that could be gained from movements and exchange rates.
On the topic of cash, I would also note that we ended the year below 20% of our assets in cash. This is a little underweight relative to what it should be, and it would have reverted towards the low to mid-20% after the year end. That said, cash does continue to come down as the weighted average discount to intrinsic value of our holdings continues to increase and as we see some opportunities coming our way.
For reference, historically cash has averaged close to 35%, and it has fluctuated along with the opportunity set from the low teens to in excess of 40%, which means it is coming back down towards historical lows. I do want to highlight, though, that this is more a function of the increased attractiveness of what we own rather than an overall improvement in the opportunity set, which speaks to the asymmetry in value opportunities in the current market environment that obviously you can see in the current positioning of the portfolio.
That’s what is most important in my mind—that we believe that we have constructed a portfolio of highly attractive value opportunities much like we had a few years ago. We started at the FPA International Value Fund’s inception with a heavily discounted portfolio, and now again… once again own a selection of attractively prices businesses, albeit quite different in nature, rather than winners at the tail-end of a cycle. Again what we’ve done at a very fundamental level is monetize holdings that had rich fair value and redeployed capital towards cheap stocks, and we remain believers that long term this is the way to create wealth.
And I think if you look at where we stand in the market today, the value discipline that we continue to follow seems warranted. While the prevailing views may be that market prices have come down in the past couple of years, we find that there has not been in fact much of a market correction. We think that this misperception may be a function of currency, as well as high dispersion in market prices progression during that period of time and of course not putting things in a long-term perspective.
First the rise of the U.S. dollar has more than offset the increase in price of international equities in the past two years, which in U.S. dollar terms means prices have actually come down. A euro-denominated asset delivering a 13% negative return in U.S. dollar terms actually is seeing a positive return of 10% in local currency in the past two years and from what we would argue was already an elevated price, meaning opportunities to invest at significant discounts to fair value in fact have not expanded significantly over the period despite the decline in the Index—in U.S. dollar terms, that is. Incidentally I would note that it does mean, however, that in the meantime the purchasing power of our U.S. dollar denominated cash has increased and now be used to buy cheap assets in depressed international currencies.
Secondly, while many of the companies that we track yet do not own or do not own anymore have seen continued increase in their share prices, specific geographies and sectors have experienced true price dislocations, causing the overall market to show weaker progression. But there are a few areas of the market where prices have fallen dramatically, thereby presenting value investors like ourselves with some opportunities, while there are many others where prices have simply continued to increase in the past two years, with individual stocks often getting even more overvalued, with continued expansion in both multiples and expectations of future operating growth. Now as I mentioned above, these troubled waters are where we see opportunities to invest.
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