Jeff Auxier Fourth Quarter Commentary
Hedge funds tanked even more, dropping 5.38% on average based on Barclay’s Hedge Fund Index.
This wide disparity in results illustrates how we strive to harness the long-term power of compounding by materially outperforming our peers in down markets rather than chasing hot stocks during upswings. The payoff? Since inception in 1999, the Fund has cumulatively gained 113.49%, convincingly lapping the S&P’s corresponding 12.48% return ninefold. On an annualized basis, the Fund since inception has been six times more rewarding than the market, returning 6.27% versus the S&P’s 0.95%. It’s worth noting that tenures of today’s stock fund managers average less than five years. By comparison, the Fund’s sole manager since 1999 also pilots many separately managed client accounts dating back to the early 1980s.
Market Commentary Europe’s sovereign debt contagion dominated last year’s headlines and depressed large bank stocks overseas and stateside (where the KBW Bank Index tumbled 23.19% in 2011). As economies in Europe slumped, those of China and other major exporters to the region sputtered, contributing to a sharp correction in commodity prices. Most major stock markets around the globe suffered losses for the year. So-called defensive stocks (e.g., healthcare, food and beverages) with high and increasing cash dividends tended to fare better than the more cyclical and credit-dependent stocks. Many European banks mistakenly perceived the risk in Euro-zone government debt and failed to provide an ample capital cushion on their balance sheets. The painful deleveraging and restructuring process that continues in 2012 could produce not only a recession but also a generational buying opportunity among the European Union’s battered blue-chip stocks. We are highly energized to capitalize on such bargains when they materialize.
U.S. Government bonds enjoyed strong gains last year as their yields continued to shrink. But one could argue that they present similar risks to those witnessed in Europe. Widely held perception that U.S. Government debt is comparatively safe can be questioned when you factor in such pitfalls as loss of purchasing power, interest-rate volatility and solvency. With governments eager to print money and defer fiscal restructuring, the risk appears much too high for the potential reward. To protect assets in today’s competitive global economy, it is more important than ever to focus on fundamentals and allocate portfolios based on price, value and margin of safety. Popular mutual fund mantras like “buy, hold and forget” are dangerous as well as hackneyed. The bankruptcy of Eastman Kodak, a former member of the elite “Nifty Fifty” in the 1970s, illustrates how advances in technology can rapidly undermine seemingly fortress business franchises.
How Our Portfolio Is Positioned
Natural gas prices recently dropped to a 10-year low—under $3 per Mcf (one thousand cubic feet). The ability to extract both oil and natural gas from previously underutilized shale formations should lead to lower energy costs for the next few years. As we observed last year, the commodity boom was more overextended (115 months in duration as of mid-2011) than both the ill-fated housing and technology bubbles. As prices stay high, blistering advances in technology make it possible to flood the market for just about any commodity, product or service. Gluts of supply can pose a major threat to the portfolio and are more prevalent in periods, like today, of easy money policies. China, for example, has been a voracious consumer of commodities. As that economy slows, prices should continue to return to levels closer to the marginal cost of production. Many of the companies in the Fund should benefit as these price pressures abate, leading to a widening of profit margins and potential P/E1 multiple expansion. The good news: dividend payout ratios among U.S. stocks remain historically low and should rise as investors demand increased cash payments over stock buybacks.
Incessantly negative headlines out of Europe often obscure the powerful and upbeat trend of emerging market urbanization. Food marketing in Asia, for example, is being revolutionized by rapid growth in personal income, which since 1998 has risen three to four times faster than in the U.S. and Europe. Wages in China are estimated to double in the next five years. This surge boosts demand for Western goods and distribution platforms that also supply local products to those aspiring customers in growing urban centers. We focus on companies that excel in selling quality products (especially lowticket necessities), executing on the details and positioning the Fund to profit from these long-term fundamental trends.
In developed countries, soaring levels of total public and private debt (exceeding 300% of GDP in the U.S.) ensure that investors can’t count on a strong economy or stock market to bail out poor investment selections. Recoveries following balance sheet recessions historically are much more susceptible to outside shocks. As a result, the Fund has carried more cash than normal both as a precaution and as a source of funds to make exceptional purchases when the time is right. Great individual buys, when prices are compelling, are critical to produce market-beating returns. This past quarter we were able to take advantage of such bargain prices in Molson Coors, Medco Health, and Hospira. All three are topnotch businesses that we have tracked for years, waiting for the sudden but surmountable stumbles that create rock-bottom entry points.
Periods of economic uncertainty favor an experienced investment manager who can draw on three decades of individual security analysis. We are excited when we can utilize that experience to add value in a meaningful way to your life’s savings.
Your trust and support is appreciated.