With the VIX (proxy for market volatility) at its lowest level since 2007, it is not surprising that investors’ tolerance for risk appears to be growing, as evidenced by the continued strength in global equities and most other financial instruments. In a fascinating study conducted by John Coates, a research fellow at Cambridge, linking risk taking to physical responses to stress, it was shown that when market volatility is high, cortisol (the “stress hormone”) levels increase, causing investor appetite for risk to decline. Conversely, when levels of market volatility are low, cortisol levels remain largely unaffected, resulting in a greater willingness on the part of investors to take on risk. One could argue that the complete transparency of central bank monetary policy around the globe, particularly in the United States, has caused the release of “one of the most powerful potential brakes on excessive risk taking in stocks.”† Whether or not we have reached bubble territory is subject to debate, but investors should be cognizant that, if risk is indeed largely predicated on the price one pays for a security, it is no time for complacency. As you well know, we are not about to make forecasts because in our mind, we are not sure from an investment standpoint that they are much better than random guesses. We think of ourselves as being in the business of chasing value, not performance, and we do know that we have to pay, on average, a whole lot more for a dollar of value today. Our experience has taught us that if we keep looking, and exercise some patience, opportunities will turn up.
* The Adviser has contractually agreed to waive its investment advisory fee and/or to reimburse expenses of the Global Value Fund II — Currency Unhedged to the extent necessary to maintain the total annual fund operating expenses (excluding fees and expenses from investments in other investment companies, brokerage, interest, taxes and extraordinary expenses) at no more than 1.37%. This arrangement will continue through December 31, 2014. The Global Value Fund II – Currency Unhedged has agreed, during the two-year period following any waiver or reimbursement by the Adviser, to repay such amount to the extent that after giving effect to such repayment the Fund’s adjusted total annual fund operating expenses would not exceed 1.37% on an annualized basis. The performance data shown above would be lower had fees and expenses not been waived and/or reimbursed.
§ The Value Fund’s and Worldwide High Dividend Yield Value Fund’s performance data shown above would have been lower had certain fees and expenses not been waived from December 8, 1993 through March 31, 1999 (for the Value Fund) and from September 5, 2007 through December 31, 2013 (for the Worldwide High Dividend Yield Value Fund).
The Funds do not impose any front-end or deferred sales charges. However, the Global Value Fund, Global Value Fund II – Currency Unhedged and Worldwide High Dividend Yield Value Fund impose a 2% redemption fee on redemption proceeds for redemptions or exchanges made within 60 days of purchase. Performance data does not reflect the deduction of the redemption fee, and, if reflected, the redemption fee would reduce the performance data quoted for periods of 60 days or less. The expense ratios shown above reflect the inclusion of acquired fund fees and expenses (i.e., the fees and expenses attributable to investing cash balances in money market funds) and may differ from those shown in the Funds' financial statements. Please note that the individual companies discussed herein represent holdings in our Funds, but are not necessarily held in all four of our Funds. Please refer to footnotes on page 12 for the Funds’ respective holdings in each of these companies.
As you can see from the above chart, the Tweedy, Browne Funds have continued to fare well from a performance standpoint despite carrying above average levels of cash reserves. The Funds were up from 3.3% to as much as 5% during the second quarter. The Worldwide High Dividend Yield Value Fund and our two international funds modestly trailed their benchmarks while the Value Fund modestly outperformed its benchmark.
Returns for the quarter were largely derived from strong results in our oil & gas, financial, pharmaceutical, and consumer staples holdings. Royal Dutch (RDS) and Total (TOT) turned in solid performances as these companies have signaled their desire to focus on efficiencies and moderate capital expenditures in an effort to increase profitability and return more cash to shareholders over time. Oil service providers such as Halliburton also produced strong results as did Devon Energy. Banco Santander (Brasil) (BSBR), our lone Brazilian holding, together with Provident Financial and Zurich Insurance Group led a solidly performing financial group. Novartis (NVS) and Johnson & Johnson (JNJ), two of our big three pharma holdings, continued their advance, and Nestlé became a portfolio leader again with a strong second quarter return. On the other side of the teeter-totter, our industrial and chemical holdings turned in lackluster results with companies such as ABB, Akzo Nobel, Vallourec and Siemens, among others, finishing in negative territory.
With equity markets gaining strength during the quarter, portfolio activity remained quite modest. In general, recent new positions in the Fund portfolios have been in companies that operate directly in the emerging markets or companies that derive their sales and profits from activities in those markets. This has included new holdings in Chile and Hong Kong. We also added one new Canadian small capitalization company to Global Value Fund II – Currency Unhedged. We have suppressed the names of all of these companies for the time being as we build positions in these stocks. We added to our positions in Standard Chartered Bank (LSE:STAN), TNT Express (XAMS:TNTE) and Vallourec (XPAR:VK), among others, and reduced our positions in certain holdings, including NGK Sparkplug, Fukuda Denshi, Daetwyler, Henkel and Provident Financial. We also sold our remaining shares in Publigroupe, Hi-Lex and Sysco during the quarter. In terms of portfolio characteristics, valuations were on the march during the quarter.
At quarter end, the weighted average price/earnings ratios of the top twenty-five holdings in our Funds ranged from 14.45 to 15.38 times 2014 estimated earnings. The cyclically adjusted price earnings ratio known as the Shiller P/E, which compares the current value of the S&P 500 to the average inflation-adjusted annual earnings of the S&P 500 over the last ten years, was 26.15 as of July 15. The weighted average annual dividend yield on the top twenty-five holdings in our Funds ranged from 2.8% to 3.8%. The number of holdings in our Funds as of quarter end ranged from 105 in the Global Value Fund to 38 in the Worldwide High Dividend Yield Value Fund, while cash reserves ranged from approximately 11.7% to 25.7% in all four Funds. (Please note that the range of weighted average dividend yields shown above is not representative of a Fund's yield, nor does it represent a Fund's performance. The figures solely represent the range of the average weighted dividend yield of the top twenty-five common stocks held in each of the Fund's portfolios. Please refer to the 30-day Standardized Yields in the previous performance chart for each of the Fund's yields.)
We continue to do our best to manage flows into our Funds in this challenging environment. We have established governors in all four Funds which restrict the amount a single investor or financial advisor can invest on a given day: $4 million for the two Global Value Funds and $7 million for the Value Fund and Worldwide High Dividend Yield Value Fund, respectively. Current levels of cash provide more than adequate “dry powder” to take advantage of new opportunities. While we are flattered by the growing interest in our Funds, if cash reserves continue to grow, particularly in our two Global Value Funds, we may have to take additional action to limit new inflows of cash. Thank you for investing with us and for your continued confidence.
Tweedy, Browne Company LLC
William H. Browne
Thomas H. Shrager
John D. Spears
Robert Q. Wyckoff, Jr.
Dated: July 2014