Zeke Ashton’s Centaur Total Return Fund annual letter to shareholders for the year ended October 31, 2015.
Dear Centaur Total Return Fund Investors:
The Centaur Total Return Fund produced a return of ?0.87% for the year ending October 31, 2015. Our primary benchmark, the Dow Jones U.S. Select Dividend Total Return Index, experienced a gain of 2.03% for the same period, while the S&P 500® Total Return Index returned 5.20%.
For the trailing 5?year period ending October 31, 2015, the Fund has produced an annualized return of 7.92% versus the primary benchmark’s return of 14.11% annualized over the same period. The S&P 500® Total Return Index has returned 14.33% annualized for the five years.
For the trailing 10?year period ending October 31, 2015, the Fund has produced an annualized return of 9.00% versus the primary benchmark’s return of 6.73% annualized over the same period. The S&P 500® Total Return Index has returned 7.85% annualized for the ten years.
Since the Fund’s inception on March 16, 2005, the Fund has produced an annualized return of 8.77% versus the primary benchmark’s return of 6.72% annualized over the same period. The S&P 500® Total Return Index has returned 7.63% annualized for the ten years.
(For the Fund’s most up?to?date performance information, please see our web site at www.centaurmutualfunds.com.)
Centaur Total Return Fund – Thoughts on a Difficult Year
The Centaur Total Return Fund’s performance for the fiscal year 2015 was disappointing to us, though we believe that our investing process remains sound and that the decisions we made over the twelve months were on balance both reasonable and consistent with the Fund’s risk?conscious strategy. While we would like to have done better, our performance as a concentrated, value?oriented Fund in any given year will be highly dependent upon the performance of a handful of investments. In addition, while we believe our approach to value investing allows for considerable flexibility in its execution, we are and likely forever will be heavily influenced by the biases we hold as investors. These biases have been shaped by long experience over a wide range of market conditions and represent the sum total of the many lessons we have learned. In addition, our mental filters have been shaped by the study of various other well?known investors of all styles and their experiences over time. Unfortunately, our value?oriented style tends to be unhelpful in certain market conditions, and we believe that the market conditions since late 2013 have been especially unfriendly to an approach weighted heavily on assessments of company valuation and business risk rather than on factors such as revenue growth, stock price momentum, and the excitement of the narrative or “story” surrounding individual securities.
We have also learned that in the world of investing, experience is not always the advantage it would seem to be. Knowledge of how things generally turn out in the longer term based a study of history and personal experience can be highly detrimental to keeping up with a crowd in the shorter term that is not encumbered with any bias other than being fully invested and focused on what is working now.
Of course, it is also true that the future does not have to play out as it has in the past. As Warren Buffett once said, “If past history was all there was to the game, the richest people would be librarians.” Formerly great businesses can decline suddenly due to new technology or changing industry conditions. New businesses or entirely new industries can burst onto the scene with unpredictable speed, disrupting formerly entrenched players. Every few years it seems we encounter conditions that neither experience nor historical study could fully prepare us for. We witnessed the unprecedented technology bubble of the late 1990’s, the financial crisis of 2008?2009, and more recently, zero and even negative interest rates on government?issued debt accompanied by a widespread effort on the part of central bankers around the world to influence asset prices. Finally, it is simply the nature of the market to occasionally behave in ways that are not entirely rational, and this behavior can often last much longer than one might think. Markets are prone to bubbles, busts, fads, trends, and the occasional bout of random weirdness. One of the key lessons we’ve taken from our experience as investors is that one can never really know what kind of market you may encounter next. We accept that our value investing style isn’t likely to be the best approach for any given scenario, but we believe that a framework that allows for reasonable returns with acceptable risk over the widest possible variety of scenarios is preferable to an approach that relies on correctly forecasting what is coming around the corner.
So, what exactly do our investing biases look like? Below is a short sampling of the most important:
- As value investors, we believe that the price one pays for a security in relation to the underlying asset value, future cash flow profits, or value to a knowledgeable all?cash acquirer is critical to future returns. Consistently paying low prices relative to economic value shifts the odds in one’s favor and reduces risk over time. Buying securities with no regard for value may work at times, but offers little margin for error.
- We prefer slow?growth businesses with a history of consistent profitability to those that are showing rapid recent sales growth without demonstrated profitability.
- We prefer companies that maintain strong balance sheets, with excess cash and debt levels that can be easily repaid with a few years of cash flow to companies that make aggressive use of debt in an effort to grow profits rapidly. It has been our experience that excessive debt (almost always taken on during periods of optimism) is the single most common cause of permanent capital loss for investors.
- We generally prefer conservative, low?key management teams that have managed well over the long term and communicate candidly with shareholders to highly promotional management that appears unduly concerned about near term stock prices.
- We prefer management teams that are owner / operators and who own a considerable amount of stock to hired agents that are largely compensated with stock options.
- Our valuation methods are heavily focused on free cash flow (which we define as cash that can be returned to investors or reinvested in the business) to reported accounting earnings or other often?used proxies for profitability (such as Earnings Before Interest, Taxes, Depreciation and Amortization EBITDA).
- We prefer companies that demonstrate a consistent and rational approach to capital allocation (sustainable dividends, intelligent share repurchases, and prudent acquisitions done with cash) rather than companies that attempt to maintain unsustainably high dividends, buy back stock aggressively at elevated prices, and which utilize debt to fund acquisitions or buybacks in a manner that reduces future flexibility or increases risk to shareholders.
- We favor a relatively concentrated portfolio of 20?30 securities, with our top ten ideas routinely comprising 40?50% of the portfolio’s value.
- We favor companies that pay meaningful dividends so long as they meet our other criteria.
- We look to sell covered calls on certain Fund holdings when we believe the prices received offer good value and where our valuation aligns well with the all?in stock price plus premium we would receive