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Steven Romick: Quality Companies Underperformed
Posted by: GuruFocus (IP Logged)
Date: May 28, 2012 01:46PM
FPA Crescent’s long-term, conservative approach to protect and grow your money did exactly both this first quarter, but we did trail the stock market’s big move, which was generally fueled by companies more economically sensitive and leveraged than we currently prefer. FPA Crescent returned 6.6% in 2012’s first quarter; the S&P 500 returned 12.6%. Our Fund’s performance was influenced by a variety of factors:
Quality: Companies in the Crescent portfolio are, on average, of a higher quality than the companies currently pushing the stock indices higher. Firms with the greatest operational and/or financial leverage have the greatest “torque” in an improving economy, and it was these companies that drove performance in the first quarter. Although our companies, on average, underperformed in the most recent quarter, we prefer a more conservative course given our ongoing conviction that the global economy still faces significant headwinds and that markets will exhibit continued volatility.
Europe: Currently, 22% of our total portfolio, and 34% of our long equity exposure consists of European domiciled companies doing business globally. Broad European indices underperformed the U.S. stock market in the quarter – the S&P Europe 350 returned 7.8% measured in dollar terms – and, emulating the U.S., the best performing companies were on average the more cyclical.
High Yield: Just 3.4% of the portfolio at the quarter’s close was made up of high yield debt (with nothing in distressed debt), a weighting that’s far lower than our average. High Yield performed well in the quarter, with the most commonly cited High Yield index increasing 5.2%.1 With rates so low, companies are wisely offering new debt issues to buyers starving for yield. We generally avoid a market that’s saturated with reckless buyers and savvy sellers. Instead, we prefer a climate plagued by an absence of buyers and an abundance of forced sellers.
Long-Term Holdings: Our longer-term, non-equity investments should benefit the portfolio over time, but are unlikely to keep up with a big stock market rally over any short time frame, e.g., the investments in sub-prime mortgage whole loans and farm land.
Cash: The cash in our portfolio can’t compete with a market in melt-up mode, but having it socked away makes sure we have enough capital available to deploy at those times when the demand for risk assets is at a low ebb – a time when we can buy good businesses at bargain-basement prices.
As always, some stocks did better than others, and those that had the most impact on this quarter’s performance are listed in the table below.
Microsoft (MSFT) added more to our performance than the top five losers detracted from it. Tesco’s (TSCDY) share price has suffered lately because of weak sales over the Christmas holiday. We don’t expect a quick turnaround, but find solace in its attractive valuation, provided the company can hold serve in the UK, while continuing to expand internationally. We added to Tesco on weakness.
We also added to Canadian Natural Resources (CNQ) when its price sagged amid what we believe are temporary conditions: unanticipated downtime at a key mining operation and a delay in the narrowing of Canadian oil price differentials. The latter is thanks to a politicized debate over a proposed pipeline that would carry the company’s crude to the U.S. Gulf Coast.
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