Bretton Fund letter to shareholders for the month ended March 31, 2016.
Dear Fellow Shareholders:
The Bretton Fund’s net asset value per share (NAV) as of March 31, 2016, was $23.97. The fund’s total return for the quarter was -0.08%, while the S&P 500 Index returned 1.35%.
Total Returns as of March 31, 2016
All returns include change in share prices, reinvestment of any dividends, and capital gains distributions. Indices shown are broad-based, unmanaged indices commonly used to measure performance of US stocks. These indices do not incur expenses and are not available for investment. The fund’s expense ratio is 1.50%.
Bretton Fund – Contributors to Performance
The largest impact on performance during the quarter was our bank investments (Wells Fargo, Bank of America, and JPMorgan), which took 2.0% away from performance. Investors became less optimistic about the level of interest-rate increases the Federal Reserve will implement in 2016 given economic weakness and ultra-low rates outside the US. We think rates will rise eventually, and the values the banks present are highly compelling even with a slow rise in interest rates.
The largest positive contributor was paint manufacturer Valspar, which announced it was being acquired by its larger competitor Sherwin-Williams for between $105–$113 per share, compared to our average cost of $81.53. The performance impact to the fund was 1.5%. Carter’s stock price jumped in the quarter as it announced strong results, adding 0.9% to the fund.
*Cash represents cash equivalents less liabilities in excess of other assets.
The fund did not sell any securities in the quarter and made one new investment: Realogy Holdings.
Realogy has four housing-related businesses: a real estate agent franchising company, a network of its own real estate brokerages, a relocation service provider, and a title insurance company.
The largest and most important of these businesses is the Realogy Franchise Group (RFG), which licenses the use of many familiar agency names: Coldwell Banker, Better Homes and Gardens, Century 21, Sotheby’s International Realty, Corcoran, ERA, and ZipRealty. In exchange for the infrastructure and credibility of a recognized brand name, independent real estate agencies pay RFG a commission—roughly 4.5%—on each transaction. Since the buyer’s broker and the seller’s broker typically each receive 2.5% of the purchase price of a house, RFG receives as revenue 0.1125% (4.5% of 2.5%) of the purchase price of each house its franchised agents sell. It is a tiny fraction—but a tiny fraction of a very large number, for independent RFG agents were involved in $290 billion of transactions in 2015. Realogy also directly runs its own agencies, typically in coastal locations with more expensive real estate, and these brokers paid RFG a 6% royalty on their 2.5% commissions of the $165 billion of real estate they sold.
RFG commits to spending 12% of revenue on advertising, but apart from this, the costs of running the platform are essentially fixed. For each additional dollar of revenue, more than 80¢ falls to operating income. This makes the company especially sensitive to the pace and value of house sales. The US currently has about 124 million households, and 4.2% of these homes changed hands during 2015. We expect this ratio to creep up closer to 4.5% in the coming years, back to historical levels. The household formation rate, which had languished in the 0.6% range since the financial crisis, is finally rebounding toward the 1.0–1.5% rate that demographics would imply. And low interest rates and coastal zoning regulations continue to push house prices.
Realogy generated $2.98 of free cash flow per share in 2015. We think it has the potential to increase to $5 over the course of our investment horizon, and believe the opportunity is attractively priced at the current $36.
As always, thank you for investing.
Stephen Dodson ? ? Raphael de Balmann
Portfolio Manager Portfolio Manager