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Mario Gabelli's 2012 Annual Letter
Posted by: Holly LaFon (IP Logged)
Date: April 30, 2013 10:46AM
Fellow Shareholders: Last year, in our 2011 annual report, we wrote to you that the U.S. equity market was one that seemed like walking through waist high mud. Lots of effort but…it didn't get very far.
2012 unfolded in a materially different way. The major U.S. equity indices were up 16% as measured by the Standard & Poor's 500 Index, 10.2% for the Dow Jones Industrials and a 17.7% gain by the NASDAQ Composite.
Our clients had a good year. The institutional/private wealth management portion of our business (GAMCO – GAMCO Asset Management Inc.) enjoyed a gross return of 16.9% and a net return of 16.3%.
This takes GAMCO's annualized returns from 1977 up to 16.7% gross and approximately 15.8% net. We ask anyone to find another asset management organization, unlevered and tax sensitive, and demonstrate how they matched or exceeded this return over a comparable period. Clearly, we can attribute our performance record to our Graham, Dodd, Murray (and now Greenwald) roadmap as well as a terrific stock market since we started the firm (ignoring 1977-81, '87, '90, '94, 2001-2002, 2008).
• Other ways to make money – The New New Mantra
Right now the new fad of dynamic trading (under the aegis of "risk on, risk off") is flourishing and reminds us of the "new flavors" of the past. We remember the nifty fifty of the 1970's and "one decision stocks"; portfolio insurance à la Leland, O'Brien and Rubenstein, which was discredited by the market crash of 1987; the tactical asset allocation portfolio dynamics that were developed and promoted by the Chicago crowd of which Gary Brinson was a part; the TMT bubble dynamics of the late '90s; and other various styles of momentum investing (risk on/risk off).
Many observers of the financial markets have proclaimed the death of the long term "buy/hold strategy". Well, not so fast - we continue to adhere to the philosophy of fundamental research by using our Private Market Value (PMV) with a Catalyst™ stock selection process. Our value based mutual funds had very low turnover in 2012 – and, for that matter, for longer periods as well. For example, our Asset fund had a turnover last year of 4%, the Small Cap fund a low 7%, and our Utility fund with 15%, just to highlight a few. Obviously, when you look through our fund offerings, those that are involved with merger and acquisition activity had significantly higher turnover, such as our ABC Fund which had a turnover of 256%, but that underscores its investment team's success at selecting "deals" that closed.
• So much for the past – but what next?
The U.S. economy, which represents about 22% of the $75 trillion of global nominal GDP, suffered many speed bumps in 2012. In addition to ongoing de-leveraging dynamics, we had a lingering but improving housing market, uncertainty over the U. S. election and fiscal cliff (were we going to patch – kick – fix again and again) and some bright spots, including low cost natural gas courtesy of the "shale revolution" and a resilient industrial sector.
On a global basis, the markets continue to be challenged by the credit, and economic and political headwinds of the European Union (22% of world GDP); continued constraints in China (12% of world GDP); and the lingering after effects of the deflation in Japan (8.5% of world GDP).
To the rescue: Federal Reserve Chairman Bernanke continued to pump significant amounts of liquidity into the financial system. These actions included:
– On January 25, 2012 the FOMC extended its forward rate guidance for an exceptionally low federal funds rate to "at least through late 2014".
– At the June 20th meeting the FOMC extended the program to lengthen the average maturity of its holdings of securities ("Operation Twist" initiated on September 21, 2011) from the end of June to the end of 2012.
– Following the September 13th meeting the FOMC initiated QE3 with the announced purchase of an additional $40 billion a month of agency mortgage backed securities (MBS) through the end of 2012, increasing the total monthly rate to $85 billion. The exceptionally low rate guidance was extended to "at least through mid-2015".
– At the final FOMC meeting for 2012 on December 12th, the committee launched QE4 with the statement that the Fed would start purchasing longer term U.S. Treasury securities at the rate of $45 billion a month in addition to the $40 billion of MBS. The FOMC also modified its forward rate guidance to a numerical threshold for employment from the previous date based time frame, stating that exceptionally low rates would remain appropriate "at least as long as the unemployment rate remains above 6½% ..."
By the end of the year elections had taken place in Russia (Putin was "re-elected") and China (the new guard of Xi Jinping and Li Keqiang, while officially not taking place until March 2013, were anointed by the Communist Party). Shinzo Abe was elected in Japan and has promised accelerated inflation while Mario Draghi became even more aggressive than Ben Bernanke in using the ECB's monetary tools at his disposal.
The stock market hesitated towards end of the year as investors reacted to uncertainty regarding another cliff (January 1st) and the probability that taxes would rise materially.
We expect that money which has earned significant returns in U.S. fixed income markets will start looking to the relative benefits of common stock ownership.
All in all, it was a very fruitful year for GAMCO clients and that has provided a great year for the shareholders of GBL.
• What about GBL?
We started the year with our stock at $43.49 per share and finished the year at slightly over $53.00 per share.
During the year, our shareholders benefited directly by:
– Dividends of $2.88 per share or $76.4 million consisting of a 25% increase of the regular quarterly dividend to $0.05 per share starting in our third quarter and special dividends of $0.25 per share in the second quarter, $0.25 per share in the third quarter and $2.20 per share in the fourth quarter.
– We initiated a Dutch tender within a range of $46 - $50 per share and repurchased 717,389 shares at $50 per share, or over 10.5% of our float, for $35.9 million. This was in addition to over 421,000 shares that we bought in the open market prior to that.
– We repurchased approximately $64 million face value of zeros that were issued in 2010 to shareholders. However, our business plan needs "tweaking" as we still need to:
– Find a suitable acquisition(s). However, Teton – a spinoff to our shareholders in March 2009 (14.93 shares of Teton Class B common stock for every 1,000 shares of GBL A or B shares owned) – was able to bring in a world class mid-cap equity asset management team that was seeded with $400 million.
– Increase the assets in the strategic value sleeve of our SICAV fund. Many seeds were planted, some have sprouted, but have yet to be harvested.
– Continue to evaluate the refinancing of $99 million of our May 2013 5½% debenture that is coming due.
– Get an individual turned around who recommended another fund product to his subscribers that has so far turned out to have weaker performance than our mutual fund which he recommended his followers liquidate. • Industry challenges - in no particular order
– Will new accounting standards lead to a stampede to "LDI" (Liability Driven Investing) for our defined benefit pension clients? As an equity firm – will we be challenged? What are the implications for management of pension assets?
– How about 12b-1 fees?
– What happens with active ETFs vs. Active Management?
– Why not invest more directly in the emerging markets?
– The Advisor channels have experienced many changes – Merrill Lynch is now part of Bank of America, Smith Barney is with Morgan Stanley, A.G. Edwards and Wachovia are now with Wells Fargo. What will happen to our friends and how they help their clients in this channel of distribution for our investment products? Will there be more consolidation in the channels of distribution?
– NTF Channels are demanding higher relationship fees.
– How about a recovery in the vitality of the hedge world and their attempt to "raid" our intellectual capital?
– What about acquisitions, lift outs, growth in Europe/Asia?
– What about the Flash Crash? A Tobin Tax? Flash Trading?
– Negative real interest rates and the destruction of savings.
– Increasing allocation of assets to money management firms that are "solution providers".
– The investment implications of "risk on/risk off", including "quant models" versus long term, buy and hold investing.
– Impact on the fund industry of the loose confederation of entities that manage funds organized to buy closed end funds and disrupt long term investment benefits for their owners through self serving pressure tactics.
– Taxes – up, down or stay the same at the federal, state and local levels?
– Scale economics related to increased regulation and costs associated with escalating compliance requirements.
– Changes to the structure of "money market" funds.
– Growth of "Private Equity", Venture Capital, and alternative investments.
• Yet to be done
Monetize our global research capabilities in the value area by launching mutual funds to capture our research skill sets in the small and mid cap area – stay tuned.
We want to again share with you our philosophy towards giving back – and announce a new partnership between you, our shareholders, and GAMCO Investors, Inc. to further the goal of charitable giving.
To help explain our thinking in this regard, we are going to highlight two commentaries, one from our own 2008 annual report and the second from Berkshire Hathaway's 2003 annual report.
• The first commentary is what we shared with you in the Chairman's Letter in our 2008 annual report in a section entitled "Giving Back". It explains our thinking:
"Each year, regardless of the economic climate, we strive to make the world a better place by contributing to those in need.
In 2008, many of us donated countless hours of our time and gave resources to causes that support education, the environment, that help to reduce poverty, and strive for human equality. We are fortunate to live in the wealthiest nation in the world and to have the capacity to support a wide range of institutions and charitable organizations. "The more you give, the more you receive".
Philanthropy is tied directly to the health of the overall economy. Historically, charitable giving declines in years in which the economy experiences a recession, or in years when the stock market suffers a significant decline. For example, in 1974, during a long recession (1973-1975), giving fell almost 10%. In addition, donations are dependent on the more fortunate, and as a result, charitable giving has become more top-heavy. In prior generations, 20% of donors gave 80% of funds to charities.
Today, the pool of donors has declined dramatically. Many nonprofits are faced with budgetary challenges because of sharply lower gifts coupled with sharply lower investment portfolios. It is therefore essential for us to maintain and to expand (where possible) our philanthropic efforts."
• The second commentary is one that was prepared by Berkshire Hathaway and given out as a July 3, 2003 news release. In it, they announced the conclusion of their successful twenty three year old shareholder contributions program: "Berkshire Hathaway has terminated its shareholder-designated contributions program, which has distributed approximately $197 million since it was begun in 1981. This program has allowed holders of Berkshire's A shares to designate a per-share sum for the company to contribute to as many as three charities, the only requirement being that the designee have 501(c)(3) status. The program thus allowed a wide variety of donations, some of them controversial but all outside the control of Berkshire.
In recent years, about 3,500 charities have been designated annually, with schools the favorite (about 800 different institutions have benefited), followed by more than 400 churches and synagogues. Some institutions were named by many shareholders. Last year, for example, ten shareholders directed funds to Creighton University and 20 named the University of Nebraska."
Something new, something old
We will continue in our internal "giving back" in 2013.
In addition, this year, we are going to follow Warren Buffett's initiative – which he undertook on behalf of Berkshire Hathaway from 1981-2003. We have asked our Board of Directors and they have agreed to contribute $0.25 per share for each registered shareholder who will then be able to designate this donation to a charity of their choice.
We will follow the same rules of participation that Berkshire Hathaway outlined in their annual report - To participate in our program, you must own Class A or B shares that are registered in the name of the actual owner, not the nominee name of a broker, bank or depository. Secondly, any donation request must be to an organization that is a 501(c)(3). Importantly, any requests received after August 31st will be ineligible. When you get the contribution form from us, return it promptly so - in the words of Buffett - "don't push it aside and forget."
We look forward to many years of partnering with you to give back.
Thank you for your continued confidence in GAMCO's future.
Mario J. Gabelli
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