Charles de Vaulx's IVA Funds Semi-Annual Update Call Transcript

Tara Hannigan: Thank you. Good afternoon, and welcome to the Semi-Annual IVA Funds Update Call. We thank you for joining us this afternoon. I'm Tara Hannigan, the Director of Mutual Fund Distribution. Our goals on this call are to update you on the funds and share our current investment thinking. Our portfolio managers, Charles De Vaulx and Chuck de Lardemelle, will give you prepared remarks explaining what they're seeing around the world today, and then we will open the call up to questions.

To update you on IVA as a firm as of August 31, 2016, we had approximately $18.5 billion in total assets under management with our two mutual funds comprising just over $12.3 billion of that total. Both funds do remain closed to new investors.

A quick note on performance. As of June 30, 2016, the IVA Worldwide Fund Class I returned -0.92% for the one-year period, while the MSCI All-Country World Index returned -3.73% over the same period. For the five-year period on an annualized basis, the IVA Worldwide Fund Class I returned 3.89% versus the MSCI All-Country World Index return of 5.38%. Since the Fund's October 1, 2008 inception, it has returned 8.56% on an annualized basis, while the MSCI All-Country World Index has returned 6.27% over the same period. As of June 30, 2016, the IVA International Fund (Trades, Portfolio) Class I has returned -2.72% for the one-year period, while the MSCI All-Country World ex-US Index has returned -10.24% over the same period. And for the five-year period on an annualized basis, the IVA International Fund (Trades, Portfolio) Class I returned 4.24% versus the MSCI All-Country World ex-US Index return of 0.10%. Since this Fund's October 1, 2008 inception, it's returned 8.44% on an annualized basis, while the MSCI All-Country World ex-US Index has returned 3.17% over the same time period. Year-to-date through Monday, September 12, 2016, the IVA Worldwide Fund Class I has returned 5.82% versus the MSCI All-Country World Index return of 5.73%. The IVA International Fund (Trades, Portfolio) Class I returned 4.49% versus the MSCI All-Country World ex-US Index return of 4.65%.

I will now hand the call over to Charles de Vaulx (Trades, Portfolio).

Charles de Vaulx (Trades, Portfolio): Thank you, Tara. Our last conference call was almost six months ago. A few things have changed, of course, since. Equities back then were down a little year-to-date. Today, several months after Brexit, and after the publication of six-month corporate profits that were down for several quarters in a row now, equity markets are up nicely year-to-date.

Meanwhile, value investing remains out of favor. Hedge funds are getting more and /more discredited, and the rise of passive investing continues unabated. Also unabated is the growing distrust of savers, endowments, pension funds, as well as insurance companies and banks that are being more and more squeezed thanks to ultra-low, and in some countries, negative interest rates.

As Angela Merkel from Germany said last week, though in a different context, "The world finds itself in critical condition, and there is no point in painting anything rosier than it is."

The topics I'd like to cover today are:

1. What has changed over the past six months?
2. A few thoughts on Brexit and the rise of populism.
3. Discuss why our portfolios remain so defensive, both in Worldwide and International.
4. Expand further on a topic that is dear to us- is value investing still relevant today?
5. I'll rehash once again why we do not believe that today's low rates would truly justify higher valuations, nor would they warrant accepting lower discounts.
6. I'll offer a few thoughts on the rise of passive investing and what the implications might be for active managers.
7. I'll have a quick update on DeVry on one hand and Astellas Pharma on the other.

What has changed over the past six months?

Now, we do not have much new to say today since our views have not changed much over the past few years, but also because we've had a chance recently to discuss some of those views, both in our recent Semi-Annual Report that came out late May, and in our interviews with Value Investors Insight as well as Barron's. If you have not had a chance to read any of those documents that I just mentioned, I would encourage you to do so. They are available on our website.

So, what has changed over the past six months? Well, among the positives, I would note that credit spreads, which had widened significantly during the fall and earlier this year, including in industries other than energy and mining, have contracted quite significantly. So, the “Nervous Nellies” that manage bond funds have concluded, rightly or wrongly, that we are not on the eve of major and widespread defaults. Also encouraging is that commodity markets, emerging market equities, emerging market bonds, and many emerging market currencies have bounced back.

In China, which has been and remains by far our biggest worry- the economy, foreign exchange reserves, and the Chinese stock markets appear to have stabilized as well, at least for the time being.

Brexit was clearly a surprise, but can be construed, we believe, either as a negative or a positive, long-term, so I'll discuss that in a few minutes.

Among the negatives, I'll mention that corporate earnings both in the US and outside the US are coming down, due to either:

- more competition

- more and more industries being disrupted

- low interest rates that are hurting many banks and insurance companies while enticing many other companies to increase their buyback programs, often incurring debt to do so, on the basis that, with 0% interest rates, most buybacks optically seem to be accretive on an earnings per share basis.

Also negative from a stock market standpoint, though probably a positive from a societal standpoint, is that antitrust authorities are finally getting tougher, whether recently nixing the Staples/Office Depot merger or the Halliburton/Baker Hughes one, and probably soon also nixing deals among healthcare insurance providers. Also, regulators and tax authorities seem to be cracking down on tax inversions, and now we've seen the recent EU case against Apple.

Another negative in the aftermath of Brexit was the reminder that the European banking system remains very fragile and under-capitalized in Italy and Germany in particular.

A few thoughts on Brexit and the rise of populism.

Based on the polls just before the referendum, Brexit was clearly a surprise. Our view is that Brexit does create a big uncertainty, but only on a long-term basis. Paradoxically, on a short-term basis, Brexit appears to have been a tempest in a teapot, almost a non-event. That is so in my opinion because it is impossible at this stage to handicap the odds of what might happen and what kind of an arrangement the UK and the EU will be able to come up with, i.e. will it be an agreement similar to the one between the EU and Switzerland, the EU and Norway, the EU and Canada, et cetera.

It's also encouraging that the conservatives have picked Mrs. Theresa May as the Prime Minister, considering that she appears at heart to be a pragmatist, not to mention that her personal preference was to vote for the Remain option. We at IVA, and before that at First Eagle and at SocGen, have always felt that the EU, and even more so the euro, was structurally unsound and had flawed constructs.

Mervyn King, former governor of the Bank of England, wrote a thoughtful essay recently for the New York Review of Books, where he lays out some of the same arguments we've been making for decades now, that the EU has pressed political union both too far and not far enough, that it has created half a political union with a single currency, yet without a collective fiscal policy. It has been a case of putting the cart before the horse, setting up a monetary union before a political union.

It appears at this moment that voters in Europe do not want a political union-the French, the Germans, and probably many others. And forcing such a political union today without a strong popular backing might test Europe's democracies to destruction. Mervyn King, and I would agree, believes that the UK cannot and should not guide the EU in solving its existential problem because it has already detached itself, in the past, that is, from the EU core. It chose not to join the single currency, nor did it participate in the Schengen Plan for borderless travel by retaining border controls and checks, though of course citizens from other EU countries have the right to live and work in Britain, and vice-versa. Thus, the UK is not, and isn't seen as, a full member of the club.

How then could it provide leadership?

The Brexit vote does create huge long-term uncertainty. The long-term consequences could be either very negative if this leads to the gradual disintegration of the EU, or conversely, very positive if it pushes the current leaders of Europe to return to the more gradualist and empirical approach of the founding fathers of the European economic community.

A lot has been written both in Europe and in the US about the rising tide of populism expressed in the popularity of a Marine Le Pen from the extreme right in France, or the somewhat surprising popularity of a Donald Trump in the US. In our view, those trends result from many fears (fears of terrorism, the refugee crisis, globalization, lack of job opportunities), but they also are probably a consequence of record-high levels of corporate profitability in the world, and the US in particular, as over the past 20 years so many of the goodies have accrued to the owners of capital, while real incomes and wages have gone nowhere.

Herbert Stein's law states that, "If something cannot go on forever, it will stop.” We do not believe that corporate profits, which have already started to decline, can stay that high forever, nor do we believe central banks may continue their policies that strike us as ineffectual, forever. Although we admit that they may try even more of those before trying something else.

Discuss why our portfolios remain so defensive, both in Worldwide and International.

For the same reasons we articulated recently in the Semi-Annual Report, dated March 31, 2016, which came out late May. To quote the semi-annual report, "The combination of nosebleed valuations, a well-advanced economic cycle in the US, and sustainably high profitability by many listed companies in the developed world, and extremely low manipulated interest rates in many countries are the main reason why we remain cautiously positioned, with roughly 55% in equities and 35% in cash in both funds" -- Chuck will give you more precise data in a few minutes -- "and with gold and high-yield bonds accounting for the remainder."

We believe policymakers are very misguided. The idea that the best policy response to poor economic performance is even higher levels of debt seems absurd. It strikes us that it is most corrosive for society and painful for savers to have governments punishing thrift and savings whilst encouraging governments to spend further beyond their means. We believe historians will look back on this era and will lament the huge damage made by central bankers.

In particular, for those of you that have access to the BCA, I would recommend reading the special report entitled, "The Case Against More Monetary Mischief", that their Chief Economist, Martin Barnes, wrote mid-August. I think the title speaks for itself.

Now, we have been able to do some buying during the second quarter either before and after Brexit. New names such as American Express, Raymond James, Tiffany in the US, but also Fanuc and Yokogawa Electric in Japan, and even smaller names like Euler Hermes and Jardine Lloyd Thompson in the International funds. And we've also been able, especially after Brexit, to add to a few existing positions. But, then again, we've also had to trim certain other positions, and even eliminate some altogether, for instance Symantec and Ingram Micro in Worldwide, Fimalac and Affichage in both Funds, all of these names having reached our intrinsic value estimates.

After Brexit, we added to our euro hedge that had come down to a negligible level. We went back up to 25% hedged in Worldwide, 20% International, from 10% and 10% respectively, as the weakness of European banks, in Italy in particular, became evident again. We also added to our gold, now 6.5% in Worldwide, up from 5.8% late March, 7.7% in International, up from 6.6% late March, as it became apparent that the Fed and the ECB, not to mention the BOE and many other central banks, were more and more eager than ever to maintain ultra-low and even negative rates for longer. We still believe gold provides a good hedge against extreme outcomes, and in particular benefits from negative real interest rates. Gold may not be income-producing, but at least you do not have to pay to own gold except modest storage fees, and there is no counterparty risk.

Expand further on a topic that is dear to us- is value investing still relevant today?

Now, we have argued in the past that the challenges that value investing are facing today are significant:

- access to technology and information

- a more crowded and competitive field

- 20,000 or so Bloomberg terminals around the world

- Quantitative Easing and ultra-low interest rates jacking up the price of most financial assets

- many companies in the US implementing significant share buybacks that are artificially pushing up stock prices

- the impact of takeovers, leverage buyouts, activists

All of these factors are certainly making life more difficult for true value investors.

Yet, in spite of the challenges, some of which are hopefully just temporary, we believe that the time-tested approach of trying to realistically appraise businesses and insisting on a margin of safety1 still works very well indeed. We recently ran some numbers on the equity-only component of both our Worldwide Fund and our International Fund. These are performance numbers through June 30, 2016:

Past performance does not guarantee future results.

So, what these numbers suggest to me is that, yes, on one hand value investing has been difficult for us as ultra-low interest rates and high profit margins, along with our worries regarding macroeconomic imbalances in China or Europe, has made it difficult to find enough genuine bargains to be fully invested. And indeed, our cash has been very dilutive to our returns. Yet, when I look at the actual stocks that we've been willing to buy and hold, stocks that met our investment criteria and offered enough of a margin of safety, I'm impressed that stock picking and value investing still works. People who claim that value stocks have underperformed for many years now use, in my opinion, a flawed and overly simplistic definition of value stocks, i.e. it's all about low price to book, low price to earnings, and high dividend yield stocks.

Thanks to low interest rates and the resulting over-investment in energy, mining, steel, cement, automotive manufacturing, shipping, oil rigs, shopping malls, etc., the flaw with this simplistic approach is that book value oftentimes becomes meaningless, and the earnings in the P/E might be peak earnings. And the dividend and the dividend yield may not be sustainable. Think about all the large companies that have recently had to slash their dividends. We at IVA try to be a lot more eclectic in our value approach, putting a lot more emphasis on the qualitative aspects of the business, the pricing power, the strength of the moat, etc., rather than relying strictly on low price to book, low P/E, et cetera.

And in fact, with more and more industries being disrupted (think about retail with e-commerce, software with the cloud, media with streaming and cord-cutting, et cetera), at a time of still very high corporate profit margins, typically the stocks that have fallen the most and appear to be cheap based on low multiple of earnings or book are just value traps, as their businesses are getting more and more competed away.

Another thing that still works, and seems to be working more than ever for us, is favoring companies with significant insider ownership, whether in the US, Japan, Europe, or elsewhere. Eating your own cooking does wonders in terms of incentivizing companies to take a longer-term approach, use safer capital structures, and ultimately generate great returns for shareholders. So, yes, value investing is still very relevant today, but not at all the formulaic, low price to book, low P/E type. Ben Graham talked about the margin of safety as being a discount to what a rational buyer would pay in cash for 100% of the business. We like to stick to that definition and not take shortcuts, such as low price to book or low price to earnings.

I'll rehash once again why we do not believe that today's low rates would truly justify higher valuations, nor would they warrant accepting lower discounts.

Let's go back to that theme. We wrote a newsletter about it in December of 2015. Basic math would suggest that, if the value of a business, and by extension of a stock, is the present value of the discounted cash flows to be generated by that business, it would stand to reason that the use of a lower discount rate would result in a higher valuation for that business. So, it would appear that lower interest rates would lead to lower discount rates that would then lead to higher valuations. We believe that such a conclusion today would be way too hasty.

The discount rate is the sum of a risk-free rate plus an equity risk premium. Today, risk-free rates indeed are very low. I believe the 10-year US government bond yields around 1.6%, and the Japanese bonds yield zero. But then, the question becomes why are risk-free rates so low? Are they artificially manipulated? In other words, maybe those rates would be a lot higher without central bank manipulation. Or, if indeed these rates deserve to be as low as they are, are they not perhaps symptomatic of a world economy with huge imbalances and possibly major deflationary forces at play that will result in earnings that are at a high level today contracting significantly in the future?

The Japanese case over the past 25 years has been interesting. Interest rates have typically stayed below 1%, yet it would have been foolish to pay 20-25 years ago 100 times earnings, the inverse of 1%, as low rates were in fact signaling that earnings would be deflated away. Also, let's not forget that equities are very long duration assets. If the risk-free rate were to go back up to 5% from 1.6% today in the US, in a few years from now the de-rating of stocks would probably be very, very severe.

Now, on one hand, I'm willing to consider the risk-free rate today is a lot lower than it used to be 8-15 years ago. Yet, I would argue that, with so many industries being disrupted today, at a time when corporate profit margins are high, that this spells trouble for corporate earnings in the next 10 years. So, I would argue that the equity with risk premium today in the face of those industries being disrupted and all those macroeconomic imbalances, ought to be a lot higher than before. Therefore, while 8, 15, 20 years ago we believed that for most stocks we should be shooting for an 8% type return2, we believe that today, and despite lower rates, we should still be looking for those kinds of returns in light of all the risks out there.

I'll offer a few thoughts on the rise of passive investing and what the implications might be for active managers.

An article in the FT yesterday made the point that passive investing now accounts for a third of assets under management, up, according to them, from 25% just three years ago. So, the rise has been phenomenal, and we're talking about very vast amounts now.

In a recent issue of Institutional Investor, Paul Smith, the President and CEO of the CFA Institute, wrote a good article, "Active Voice," about the changes in our industry. Paul Smith did not mince words, and rightly so, "Active managers do need to take a hard look in the mirror and reevaluate where and how they can add value. The best managers are those with a goals-oriented approach that is focused on long-term objectives.” And then, I think the conclusion is spot-on, "Active managers need to reinvent themselves. They need to focus on investment returns and not on growth of assets under management. They need to experiment with portfolios that are not constrained and charge less. And above all, the word ‘benchmark’ needs to be removed from the active manager's lexicon."

At the recent Morningstar conference held in Chicago a few months ago, Dennis Lynch, who runs the Morgan Stanley Institutional Growth Fund, made the following observation, that only 15% of active managers are persistent market leaders. And then he added, "The managers that tend to outperform have certain characteristics in common. They tend to be longer-term in nature, not traders; they are willing to be different to the benchmarks; most importantly, they also tend to have a lot of skin in the game." We could not agree more.

So, again, we believe that, on the active side, active managers to survive will have to be more similar to what we've been all along. In other words, they will have to think of themselves as being in the investment management business as opposed to the asset gathering business. They also will have to define goals that are unrelated to the benchmark. The promise many active managers made all along was that they would outperform their benchmark both in up markets, but also in down markets, almost quarter after quarter, which if you think about it was an absurd and impossible promise to fulfill. But, more importantly, those goals, meeting the benchmark or beating the benchmark, may actually not be the goals that most clients actually have.

For many clients, we believe investing goals are actually asymmetrical. You only need to be rich once. “Why risk what you have and need for what you don't have and don't need?” to quote Warren Buffet. And so, beating a benchmark should not be the primary investment goal compared to, say, a goal of preserving wealth in real terms.

On the topic of us being different and with very differentiated objectives, we recently published a newsletter, "A History of Winning by Not Losing," that illustrates so well for both of our Funds how minimizing drawdowns has helped achieve significant outperformance with less risk. I invite those of you to look at this recent newsletter.

So, we would agree that many active managers will shrink, and those that will be left will hopefully coexist nicely and complement certain passive strategies.

Now, I'd be remiss not to warn against the pitfalls at times of passive investing. Again, as I alluded to, delivering benchmark returns may not coincide with the goals of most clients. Some of the strategies, including the S&P 500, may be way too volatile for many clients. I remember that, as recently as from September of 2007 to March of 2009, the S&P was down 53%. That's a whopping decline, and I'm not sure many clients are able to tolerate that kind of downturn.

At times also, investing in market cap-weighted indices, such as the S&P 500 or the MSCI World, can be idiotic as happens when, after a huge run on a sector, one industry ends up accounting for a disproportionate percentage of that index. Energy ended up accounting for 30% of the S&P in 1980. TMT stocks represented 35% of many indices, including the S&P in 2000, and then financials in late 2007 ended up accounting for a huge portion of indices, both in the US and outside the US. And then, conversely, some of the smaller, more specialized ETFs may still be untested as of today as regards to their liquidity when something becomes out of favor and investors try to liquidate out of those vehicles.

I'll have a quick update on DeVry on one hand and Astellas Pharma on the other.

A quick word on DeVry (DV, Financial). In the Barron's article that came out mid-July, we mentioned that we have recently put someone from our firm, Michael Malafronte, our Managing Partner, on the Board of DeVry. That came about as we started to question over the past year or so the company's capital allocation moves, seemingly paying up for several acquisitions on one hand while not increasing its dividend, nor implementing significant share buybacks at prices that seems very attractive on the other hand. Whilst it is new for IVA to put someone on the Board of a company its Funds are invested in, it is not new for us at IVA, nor in our former life at First Eagle or SocGen Funds, to react when we believe it is appropriate and in the best interests of our clients.

Regarding Astellas (TSE:4503, Financial), which we've dubbed the anti-Valeant, all I want to mention is that, since the Barron's interview, and as the Value Investors Insight interviews came out, of note is that the valuation ascribed to Medivation has gone up as Pfizer has decided to pay up and outbid Sanofi for Medivation. And as a result of that, we feel more comfortable than ever that Astellas remains significantly undervalued today, although it has already done so well for us over many years now.

Let me now pass it over to Chuck for his comments.

Chuck de Lardemelle: I will now describe briefly how our mutual funds are positioned as of Monday, September 12, 2016, and make some brief remarks on the investment landscape.

Currently, our overall equity exposure is roughly 53% in Worldwide and 55% in International. Our fixed income exposure is 3% in Worldwide and 4% in International. Our gold bullion exposure is over 6% in Worldwide and over 7% in International. Our cash levels invested in short-term commercial paper of our choosing are 37% in Worldwide and 33% in International.

In terms of geographic exposure to equities, for the Worldwide Fund approximately 23% of the Fund is invested in US equities, 12% in European equities, and 18% in Asian equities. As for the International fund, approximately 35% of the Fund is invested in Asian and Australian equities (with Japan being 14% of the fund, Hong Kong and China collectively 5%) and 19% in European equities.

Finally, our Japanese yen exposure is roughly 25% hedged in Worldwide, 35% in International, while our euro exposure is approximately 25% hedged in Worldwide and 20% in International. These hedges include our fixed income exposure.

Investment opportunities are few and far between these days, in our opinion. Valuations remain heavily distorted by aggressive manipulation of long-term interest rates by large central banks around the world. However, the MSCI World Index has been flattish now for more than two years; underneath the surface, there has been some volatility recently around the Brexit vote. This has allowed us in the last few months to take advantage of a few opportunities in Japan, particularly in industrials and pharmaceuticals, as well as in financials in the US.

The banking system, in our opinion, in the US is now very well capitalized, if not over-capitalized. The normalized profitability and return on equity of these reformed financial institutions is likely to settle well below levels reached before the great financial crisis; but given appropriate discounts to book value, we're happy to own a few US financial companies.

I would contrast the US banking system to the Eurozone banks- Brexit reminded investors that government bonds denominated in euros may carry political risk, re-denomination risk, and/or solvency risks. Therefore, a large issue lies at the heart of the European banking system: government bonds denominated in euros carry default risk and are not a zero risk asset. For that reason, as we are always trying to protect capital, we are staying away from Eurozone banks no matter how cheap they may appear versus book value.

Not only do we remain cautiously positioned, the overwhelming majority of our investments carry little debt. Let me give you a brief overview of some of our largest equity positions.

In the top 10 holdings for both Funds, you'll find Astellas Pharma, a Japanese pharmaceutical company, which stands out for the quality of its drug pipeline, the strength of its balance sheet, and the flawless capital allocation skills of its management. We also note that Pfizer is offering $14 million for Medivation. Medivation is a joint venture with Astellas with one blockbuster cancer drug,

Xtandi. Astellas is entitled to 50% of profits on Xtandi in the US as well as 100% of profits on Xtandi outside the US.

We believe that Xtandi and the net cash at Astellas accounts for all of the market value of Astellas today, while Xtandi is only 40% of Astellas profits. In other words, if Pfizer is paying a fair price, we're getting 60% of Astellas' drugs for free, as well as Astellas' pipeline for free. Of course, it is always possible that Pfizer is wildly over-paying. The truth likely lies in the middle. The main risk to Astellas, in our opinion, is a negative development on Xtandi or regulation of drug prices in the US. Astellas accounts for more than 4% of assets in both mutual funds and still offers an attractive discount to intrinsic value, in our opinion.

Moving on to another large position, Samsung Electronics (XKRX:000830, Financial) is up substantially from its lows this year, and therefore not as attractive as it used to be. However, the balance sheet is pristine, the company sells not too far from tangible book value, and we believe the semiconductor franchise is highly profitable and solid. As for the telecom handset franchise, well, I'm sure you'll remember Motorola, Nokia, Siemens, SAGEM, or Sony Ericsson handset businesses? Yes, they all went out of business.

So, what do we see there? Why should it be different for Samsung Electronics? Well, SmartPhones today are computers; capital employed in the business is very low. Basically, Samsung simply assembles the mini-computers. It's a business model akin to the Dell business model, not to a Nokia. The industry has consolidated; through its scale, Samsung is able to achieve buying power and a low-cost position; and through the advanced manufacturing of display components and semiconductors, Samsung has an edge in innovation. We anticipate this business may remain profitable in the future, with single-digit operating margin being sustainable despite heavy Chinese competition. Capital allocation and governance have been issues in the past for the Samsung Group. There are encouraging signs on both fronts. Time will tell.

Next, Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) still sells at a discount to our estimate of its intrinsic value. We believe Buffett and his successors are likely to be able to compound at a reasonable pace, particularly due to the ability to buy listed or unlisted companies in their entirety. A few looming technological innovations, though may be tough for some of Berkshire's businesses: driverless cars would negatively impact insurance subsidiary Geico, while driverless trucks would be a large negative for the railroad business, Burlington Northern. If battery technology continues to improve, at some point the storage of electricity will make renewable energy a lot more competitive against traditional utilities, a risk for Berkshire Hathaway Energy.

This conglomerate, however, is well equipped to deal with obsolescence: after all, Berkshire is quite unique in its ability to take cash flow from mature or declining business A to invest successfully in a totally unrelated business B. Hopefully the lack of red tape, the investment culture, the candor, and the ethics on display at Berkshire will survive both Warren and Charlie.

In closing, while margin debt to GDP in the US is near record highs, and while some long-dated government bonds show negative yields in Switzerland, Germany, or Japan, a first in financial history, we continue to hunt for good businesses selling at reasonable prices with balance sheets able to withstand some tough times.

Because of our strong bias towards preservation of capital, we would expect to outperform benchmarks in bear markets or difficult markets, and underperform in strong bull markets are towards the end of a long, old bull market. We do not pay attention to benchmark performance over a month, a quarter, or a year. Over the long-term however, we aim to deliver attractive absolute returns and hopefully do as well or better than these equity benchmarks.

All of us at IVA are extremely grateful for your continued support.

Question: I'd like to ask you both, since you used the expression "interest rate manipulation by central banks," whether you might think that central banks are actually trying to fulfill their mandates, the double-one in the US and the single-one in Europe. I'm not quite sure what you think they're trying to do, I mean, why you call it manipulation if they're actually trying to stimulate their economies. Might there not be a possibility of secular stagnation, which would keep them from raising rates?

Charles de Vaulx (Trades, Portfolio): In the piece by Martin Barnes about Monetary Mischief, Martin Barnes makes the point that the underlying core inflation rate is probably around 1.7% right now in the US, so we're very close to the 2% target that the Fed has. And the labor condition has improved. The unemployment rate has come down.

Now, of course, I know about the thesis whereby the labor participation rate keeps declining, that the true unemployment rate is probably a lot higher than the reported one. But, on one hand I think we comprehend the kinds of steps that the Fed took late 2008, early 2009. Now that the US banks are well capitalized, now that the US economy is muddling through, I just question why the Fed is punishing savers as much as it is. And there seems to be a lot of unintended consequences stemming from those very low interest rates.

And also, the fact that the Fed models seem to have been totally flawed, what they expected in terms of economic growth due to recovering home prices, recovering equity prices. Again, I think they give the impression that they just don't know what they're doing. I don't know, Chuck, if you have additional thoughts.

Chuck de Lardemelle: In our opinion, the goal of these policies was to lower the ratio of total debt to GDP. In 2009 there was too much debt, and that prompted the crisis. The fear at the time obviously was to fall into a 1929 type of deflationary situation.

If we look at where we are today, the goal has not been met: total debt to GDP globally has gone up, mostly due to emerging markets ramping up debt.

The problem I see here is that, if you look at most large banking systems around the world, Japan, Europe, US, most banks today trade now substantially below book value. At that point, bankers have no incentive to lend anymore. Their incentive is actually to shrink their loan books and to buy back stock, and to get paid on a tangible book per share. So, it's clearly not working in that sense, and I think that's a key reason why printing so much has not created inflation so far. It's that the banks are not lending. And without bank lending growth, it's going to be very difficult to get inflation.

I think definitely negative interest rates send the wrong signal to CEOs who may be unwilling to increase CapEx when the environment is so "upside­down." For savers, negative interest rates actually prompt them to save more, because retirees are not getting income anymore on their savings. And for those who have not retired yet, to see a zero percent interest rate makes your computation of how much you might need for the 20 or 30 years that you're going to be retired fairly easy, and people figure out I don't have enough on the side. And so I'm not sure that lower interest rates are pushing people to spend more.

And finally, it keeps zombie companies alive. I think that's very clear in Italy. I think that's very clear in Japan, that if you don't have a restructuring process, a bankruptcy process that works well, the zombie companies are kept alive, banks are not in a situation, are not healthy, not in a situation to lend, and that doesn't help, either. And so, central bankers are starting to realize the negative implications of all this money printing. Now, if we were to look at financial history in the US, if you were to look at 10-year treasuries on average, now, there has been some volatility around that, but on average, long-term interest rates were two points above inflation historically. Using Charles' inflation number, 1.7%, you should be at 3.7% on a 10-year government bond yield, and we're at 1.7%.

So, hence, all these manipulations, they've just kept asset prices going up. The total debt to global GDP has gone up. So, I think from that, we can infer that QE is not working. Do we have alternatives? Well, that's a difficult question.

Question: Well, that addresses short rates. The markets seem to think, by the pricing of the 10-year and 30-year, that we're not going to have substantial growth for quite some time. So, that's not manipulation. That's a market reaction.

Chuck de Lardemelle: Well, I am not sure that's the case. The fact that you have central banks buying long-term bonds, in some cases in Europe corporate bonds, is definitely manipulation of long-term interest rates. And in cases where the European or the Japanese central banks have intervened on the long-term end of the curve, there was clearly some front-running by market participants. That's where we see some manipulation.

Question: You mentioned at the beginning of the call that you have initiated or increased your position in Tiffany. We've seen many iconic consumer brand names collapsing recently. And I was wondering if this is a space where we could see IVA adding more positions.

And piggybacking on that question, I wanted to get your thoughts on whether we are seeing an inflection point in a consumer cycle in Asia.

Charles De Vaulx: Well, luxury products companies have come down a lot in price for several reasons, one of which is that the Chinese buyers of those goods accounted for a big portion of these companies' businesses, and a lot of their Chinese business has come down considerably. You've seen what's happened with the luxury watches, for instance.

Because these store prices have come down a lot, because some of these companies have strong balance sheets, we are taking a look, and we've taken a stake in Tiffany. We have a very small, modest position in Richemont. So, yes, some of these brands are unique and irreplaceable. At the same time, since we are still very worried about China and whether there will be a hard landing, it becomes very difficult to estimate what normalized earnings may be. Also, I mentioned briefly the rising tide of populism, and we worry that if the wealth inequality stops growing, it may be a headwind for some of those companies. Chuck, do you have comments?

Chuck de Lardemelle: I fully agree with what you said, Charles. In both cases, though the companies have strong balance sheets, we are not sure whether watches at Richemont, which account for maybe about 50% of profits, were a complete fad or if we're just going through an inventory adjustment. For Tiffany (TIF, Financial), there are questions around how much damage was done to the brand with the millennials, with all the cheaper silver stuff that was sold in the past. We believe they made the right decision in curtailing that offering. It used to be extremely profitable for Tiffany, and they chose to protect the brand and sell a lot less of these $150 silver pieces.

So, there are a number of questions about the long-term earnings power of these businesses and whether just looking at the last five years might give you the wrong impression as to what the earnings power might be. Having said all this, they've come down enough that we're comfortable having small positions in both, and if they were to fall from here, potentially we might add to these positions. But, they are far from being no-brainers, and I think one of the keys was mentioned by Charles, which is both businesses have benefited substantially from not only emerging markets, but also growing income inequalities. And those two forces may abate going forward.

Question: You hold Emerson Electric. It's always acquired a lot of companies over the years. Do you think it could be anything like a Valeant, who acquired a lot of companies over the years, or have some characteristics like that?

Chuck de Lardemelle: No, not at all. Emerson (EMR, Financial) has a very strong track record of making smart acquisitions, spending some Research and Development. Now, over the last few years, they've diversified into a business that they are now trying to spin off and making a number of acquisitions in uninterruptible power supplies/electronics. That vertical, if you will, has not worked out at all for Emerson, and they are going back to basics and spinning off or selling that division. The balance sheet is extremely strong, which is absolutely not the case of a Valeant.

Emerson is in no position to hike prices and gouge clients. It's a very strong industrial company that is extremely well managed from an operational point of view, that has a strong balance sheet, and has not been able to hike prices substantially. However, again, over the last few years, they've gathered a collection of companies in one segment and those acquisitions turned out to be a mistake. And that's what provided us with an opportunity to get into Emerson. And they recognized their mistake and are now trying to correct it. So, in no way, shape, or form is it similar to a Valeant, in our opinion.

Question: What percent of the company do you think they're spinning off? I knew they were spinning it off, and that's what made me wonder. If they're so good at it, then all of a sudden they've made a mistake.

Chuck de Lardemelle: Yes, and I think we clearly recognized that when we made the investment, and that's why the share price was offering some discount. And the fact that they were recognizing their mistake and cleaning up the company by spinning off that division and selling a few other industrial divisions as well, that made Emerson attractive to us. It's not a huge share, but it's not negligible. I'd say 10%, 15% of their value is in that business and those that they are trying to sell.

Question: Hi, Charles and Chuck, thanks for the call. Could you elaborate a little bit on your worries about China?

Charles de Vaulx (Trades, Portfolio): The worries are similar to the worries we've had over the last 30 years about any country, region, industry, where we see a major credit bubble. In our experience, it never ends well, including in countries like China, which because they have trade surpluses, have not necessarily needed to borrow from foreigners. If you think about Japan in the 1980s, the individuals were saving a lot of money. The country never borrowed. The corporations that borrowed money didn't have to borrow from foreigners. And yet, the bubble burst late 1989, and it's been quite difficult for several decades now. So, we think that China is going through the same.

I think six month or nine month ago, I recall seeing a McKenzie study and it was striking that the debt levels had to grow faster and faster in China for them to generate an economic growth that was going lower and lower. So, the fact that you need more and more debt to generate less and less GDP is worrisome. Also, except for the past year, year and a half, where the Chinese currency has come down at least against the US dollar, and maybe more recently against the yen, over the past six, seven, eight years, the Chinese currency has appreciated versus many other currencies while their labor costs have gone up. So, it seems that their competitive position today is not as good as it was six, seven, eight years ago.

And it also seems to us that their attempt at transitioning from an economy that is based on capital formation and more towards being a consumer-based economy, a service economy, they seem to be struggling to meet those goals.

Chuck de Lardemelle: I would add that the trade surplus in China has collapsed and is only now 3% of GDP. And this is with commodities, which is a major import, perhaps somewhat depressed at these levels. The ratio of EBIT to interest for listed companies is now at or below one, for 15%, of loans outstanding, and that's with an economy supposedly still growing at 6%. So, if it were to slow down to 3% or 4%, it's likely that EBIT to interest would become a problem for a large portion of corporates in China. The return on capital employed of a lot of those state-owned companies has collapsed over the last 10 years and is now getting to levels that do not allow for these companies to service their debt.

From that, we infer that China, as Charles mentioned, is a lot less competitive than it used to be. And on top of that, you add the fact that labor costs in China are still going up at around 7% a year. And so, with a peg, or quasi-peg to the dollar, having your cost of labor going up 7% a year when you are, in a number of cases, barely profitable, that's going to be a very tough equation to square. And the only way you could do that is by becoming a lot more productive. That means a lot more machinery. But, to have productivity to go up very substantially for a long time is quite difficult.

So, all this together, plus the obvious signs, as Charles mentioned, about credit growth over the years, leads us to be quite cautious on China. Now, it's a problem that's been well flagged contrary to what happened in 1998 in Southeast Asia, Thailand, Korea, Indonesia, and those pegs breaking. And Asian equities, if you look at Hong Kong, Singapore, look on the surface low, at least on a price to book basis for Hong Kong, but the books are extremely flattered by the fact that they revalue real estate every year, and they use 2% cap rates on rents that are very peakish.

But again, in 1998, they used similar techniques, and at the time property companies were selling very close to book. Today, markets are much more aware of the issues that China is facing, and so you see those property companies in Hong Kong selling at 40% discounts to stated book value, which to us is much closer to fair value.

So, a lot of this has already been recognized, but Charles and I have the view that, in terms of having seen previous credit booms, the one in China is massive. It's opaque. And when credit bubbles burst, usually it's tremendously painful. So, that's why we continue to be worried about China and the consequences of the credit bubble in China bursting at some point.

Question: Thank you. I have two questions. The percentages that you hedge in Japanese yen and euros, is it specific to some companies? Why is it, like, 25%? That's the first question. And the second, can you go back to the risk premium and give me a bit more details on where you think it should be, what has it been historically?

Charles de Vaulx (Trades, Portfolio): Regarding the question on the hedge, your question is a great one. Yes, we do try to factor in the kinds of companies we may or may not own in, for example, Japan for the yen or Europe for the euro. If you look today at the Worldwide Fund, for instance, more than half of our exposure to Japan is through Astellas Pharma, which Chuck and I have discussed. Now, a large part of Astellas Pharma's earnings come from outside Japan, and to a large extent, a large chunk of the company's intrinsic value is conceptually denominated in currencies other than the yen.

So, if you look at our Japanese exposure in the Worldwide, half of that exposure we don't feel a need to hedge because we feel we have a natural built-in hedge through Astellas Pharma. Or likewise, if we own many export-oriented type companies in Japan, that would naturally, everything else being equal, benefit from a weaker yen. So, yes, that's a big factor that we take into consideration.

Now, regarding the equity risk premium, I think I've mentioned the number of 8%. Incidentally, I threw out some numbers of the performance of the equity only component of both our Worldwide and International Funds. And it's interesting to see that for 3 years, 5 years and since inception in both Funds we achieved more than 8%, and I've made the point that 8, 15, 20 years ago, for most businesses, most stocks, we would buy them cheap enough to expect an 8% per annum type return. And I made the point that, today, notwithstanding low interest rates, we would insist on trying to make the same kind of returns.

Interestingly enough, one of our analysts, Gabe Farajollah, shared with me some quotes from the past from Warren Buffett (Trades, Portfolio), where he and Charlie Munger (Trades, Portfolio) were asked about what kind of return expectations or discount rates they use. And Buffett was adamant that he, whether bond rates were 1% or 6%, that he felt for most equities that he wanted at least 10%. And he even said 10% in real terms. And by that I assume he meant after inflation.

So, again, on one hand today, the risk-free rates are very low, but then again, 1.) they may be signaling many economic problems ahead of us and 2.) many businesses (think about Walmart, Disney, Viacom, the asset management industry- Franklin Templeton and so forth) are being disrupted at a time when corporate profit margins are high. This is probably signaling that many companies' earnings will be under severe pressure in the next five, 10 years. And the way, as an investor, you deal with that uncertainty and that risk is by, we think, insisting on enough of a return.

Now, if for a business such as Nestle, which is not cyclical, which is maybe more predictable (although you always run the risk of private labels and other risks) we may be comfortable only getting a 5%, 6%, 6.5% return. Other businesses, including in emerging markets, we may need a 10%, 11%, 12%. But, I think, on average, 8% is a good number.

And of course, when we look at businesses, we try to understand whether those companies have pricing power. Pricing power is a beautiful thing. Pricing power allows companies to cope with deflationary environments, and then, conversely, pricing power enables some companies to cope as well as they can with inflationary environments. One of Warren Buffett (Trades, Portfolio)’s genius was, back in the 1970s during the stagflationary years, to identify certain businesses (advertising, newspaper publishing at the time) which were not capital-intensive, that showed an ability to raise prices along with inflation, and these particular businesses offered a way to protect oneself against inflation.

And of course, we pay a lot of attention to the balance sheet of the companies. We like to buy them “safe and cheap”, to use Marty Whitman's words. And with many companies today not having necessarily pristine balance sheets,

sometimes the only way we can get “safe and cheap” is by going one notch higher in the capital structure, buying high-yield bonds. Earlier this year we had a chance to buy bonds of Joy Global, of Rowan, and a few others. And typically we will ask for an 8%-plus return on the basis that we view 8%-plus as an equity type return.

Question: I know you're a bottom-up stock picker, but was curious. I noticed in your March Annual Report you didn't have any Canadian companies, they're primarily resource. And as a subset of that, would you ever look at, for example, the fertilizer companies right now that seem to be fairly cheap, like Agrium or Potash? Or I've seen some managers buy Deere in the US. Was curious what you thought about the agricultural segment.

Charles de Vaulx (Trades, Portfolio): Yes. Well, Deere (DE, Financial) is a much finer business. They are world-class. It's much more oligopolistic. The returns of capital over a full cycle dwarf I believe what they are with other fertilizer companies. Yes, the answer is that we've looked at both. There's a clear price at which we would love to own Deere. But, in the fertilizer space, and understand there's a proposed merger going on, we have found it difficult to find one company that truly has much lower costs than the other. In a commodity business, if you can find a company that structurally has much lower cost than another, it helps assure you that they will be a survivor if and when commodity prices are low, and then the company may in fact capitalize during times of low prices to maybe increase its market share position.

So, we have not been able to identify, at least yet, a fertilizer company that really stands out in terms of quality and being lower cost than others.

Thank you so much for your questions and for your interest.

Important Disclosures:

Mutual fund investing involves risks including possible loss of principal. There are risks associated with investing in funds that invest in securities of foreign countries, such as erratic market conditions, economic and political instability and fluctuations in currency exchange rates. Value-based investments are subject to the risk that the broad market may not recognize their intrinsic value. An investor should read and consider the fund’s investment objectives, risks, charges and expenses carefully before investing. This and other important information are detailed in our prospectus and summary prospectus, which can be obtained by calling 1-866-941-4482 or visiting www.ivafunds.com. Please read the prospectus and summary prospectus carefully before you invest. The IVA Funds are offered by IVA Funds Distributors, LLC.

Past performance does not guarantee future results. The performance data quoted represents past performance and current returns may be lower or higher. Returns are shown net of fees and expenses and assume reinvestment of dividends and other income. The investment return and principal value will fluctuate so that an investor’s shares, when redeemed may be worth more or less than the original cost. To obtain performance information current to the most recent month-end, please call 1-866-941-4482.

As of the most recent prospectus, the expense ratios for the funds are as follows: IVA Worldwide Fund: 1.25% (A shares), 1.00% (I shares); IVA International Fund (Trades, Portfolio): 1.25% (A Shares), 1.00% (I shares). Maximum sales charge for the A shares is 5.00%.

As of August 31, 2016, the IVA Worldwide Fund’s top 10 holdings were: Gold Bullion (6.4%); Astellas Pharma, Inc. (4.4%); Berkshire Hathaway, Inc. Class A, Class B (4.1%); Samsung Electronics Co., Ltd. (4.1%); News Corporation Class A, Class B (2.5%); Nestle SA (2.4%); DeVry Education Group, Inc. (1.8%); Oracle Corporation (1.7%); MasterCard Incorporated Class A (1.3%); HSBC Holdings PLC (1.2%). As of August 31, 2016, the IVA International Fund (Trades, Portfolio)’s top 10 holdings were: Gold Bullion (7.6%); Samsung Electronics Co., Ltd. (4.7%); Astellas Pharma,

Inc. (4.4%); News Corporation Class A, Class B (3.0%); Nestle SA (2.7%); Alten SA (2.2%); Genting Malaysia Berhad (1.8%); HSBC Holdings PLC (1.7%); Hyundai Mobis Co., Ltd. (1.2%); Hongkong & Shanghai Hotels Ltd. (1.2%).

MSCI All Country World Index is an unmanaged index consisting of 46 country indices comprised of 23 developed and 23 emerging market country indices and is calculated with dividends reinvested after deduction of withholding tax. The Index is a trademark of MSCI Inc. and is not available for direct investment.

MSCI All Country World Index (ex-U.S.) is an unmanaged index consisting of 45 country indices comprised of 22 developed and 23 emerging market country indices and is calculated with dividends reinvested after deduction of withholding tax. The Index is a trademark of MSCI Inc. and is not available for direct investment.

The views expressed herein reflect those of the portfolio managers through September 13, 2016 and do not necessarily represent the views of IVA or any other person in the IVA organization. Any such views are subject to change at any time based upon market or other conditions and IVA disclaims any responsibility to update such views. These views may not be relied on as investment advice and, because investment decisions for an IVA fund are based on numerous factors, may not be relied on as an indication of trading intent on behalf of any IVA fund. The securities mentioned are not necessarily holdings invested in by the portfolio manager(s) or IVA. References to specific company securities should not be construed as recommendations or investment advice.

The IVA Worldwide Fund and the IVA International Fund (Trades, Portfolio) are closed to new investors.