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Holly LaFon
Holly LaFon
Articles (8313) 

Tweedy Browne Fund 3rd Quarter Letter

Neither Hurricane Irma’s 185 mile per hour winds nor North Korea’s threats of nuclear retaliation were enough to shake investor conviction during the quarter

October 17, 2017 | About:

Neither Hurricane Irma’s 185 mile per hour winds nor North Korea’s threats of nuclear retaliation were enough to shake investor conviction during the quarter. Global equity markets continued their advance unabated, shrugging off a host of worries, not the least of which were increasingly high valuations, near term prospects for higher interest rates and coordinated tightening by central banks, a rising terrorism threat level, numerous natural disasters, and escalating geopolitical tensions. Such has been the enduring strength of what is now the second longest bull market in modern financial history.

All four of our Funds made financial progress during the quarter but trailed their respective benchmarks. Year-to-date, all four Funds have produced double digit returns of between 11.53% and 16.97%. In terms of relative returns, the Worldwide High Dividend Yield Value Fund has been the best performer producing a year-to-date return of 16.74% net of fees versus 16.01% for the MSCI World Index and 14.15% for the MSCI World High Dividend Yield Index. These strong Fund results were achieved in spite of their carrying a healthy dollup of cash reserves.

In terms of portfolio attribution for the 3rd quarter, some of our more economically sensitive companies, including those in the technology, energy, industrial and materials categories, led returns for the quarter. This included standout performers such as Baidu (Chinese search engine company), Royal Dutch, Total, Safran, and Antofagasta, among others. In contrast, most of our automobile, media, and tobacco stocks declined in price during the quarter. This included weakness in our Korean auto companies, Hyundai Motor and Kia; media holdings, such as Mediaset España and the Daily Mail; and tobacco stocks, British American Tobacco and Philip Morris. In addition, Provident Financial faced a substantial decline in part due to recent changes to their business model. Returns in the Worldwide High Dividend Yield Value Fund were led by companies such as Michelin, Diageo, Royal Dutch, Novartis, Cisco and Verizon, while Nestlé, GlaxoSmithKline, and G4S were under price pressure.

In light of the market’s continued advance, portfolio activity was once again quite modest during the quarter. However, there were a few new positions established in two small cap Korean companies, and in the U.S.-based auto parts retailer, AutoZone (NYSE:AZO), which was purchased in the Value Fund. We were presented with a pricing opportunity in AutoZone, in part, due to what we believe was an unreasonable fear that Amazon (NASDAQ:AMZN) might disrupt the market for retail auto parts. We believe such dis-intermediation is unlikely, given drivers’ needs for urgent repair and technical assistance. At purchase, AutoZone was trading at roughly 12 times estimated earnings, and had a strong historical record of intelligent capital allocation and an attractive value compound. In addition, it has historically produced high returns on invested capital, has a strong balance sheet, and, in our view, has a long runway of potential future growth. We also added to a few pre-existing Fund positions including Hang Lung, the Chinese high-end mall operator; and Lookers, a UK-based auto dealership business. We sold or pared back the Funds’ remaining shares in Hong Kong Shanghai Hotels and Provident Financial (which was a long standing position in the Global Value Fund, and a more recent acquisition in Global Value Fund II), and pared back positions in British American Tobacco, among others.

Overall turnover for the quarter was low as it has been year to date. As we approach year-end and begin to think about prospective taxable gains and income in our Funds, we are pleased to report that, based on current estimates, distributions should be quite modest. For shareholders who are interested in more information regarding estimated distributions, we have a more detailed analysis on our website at www.tweedy.com.

In terms of portfolio positioning, the Funds remain well diversified by issue, industry, and country. While all four Funds have more of a larger capitalization orientation today, which has been the case for many years now, they remain multi-capitalization investment vehicles, and we have added several smaller and medium capitalization issues to the Fund portfolios of late. The Funds continue to be largely focused on investment opportunities in developed markets and the more developed of the emerging markets. More meaningful positions in the emerging markets today include Baidu (NASDAQ:BIDU); two Korean auto companies, Kia and Hyundai Motor, together with their associated parts distributor, Hyundai Mobis; LG Corp, the Korean conglomerate; Antofagasta, the Chilean-based copper mining company; Bangkok Bank, the large Thai bank; and Embotelladora Andina, the Chilean Coca-Cola bottler. Together these companies and a few other minor positions represent approximately 10% of total assets in Global Value, 10% of Global Value II, 8% of Value, and 1% of Worldwide High Dividend Yield.

All four Funds have fairly significant exposure to Europe, where most market observers expect earnings growth to be robust in the year ahead. It has been a popular refrain of late in the financial press that European equities are cheap; however, in our view, this is at best only relatively true. We have found that European equities for the most part have full valuations. On a simple price/earnings ratio basis, we recently took a look at U.S. and European comparisons and found that on trailing 12 month earnings, both U.S. equities, as measured by the S&P 500, and European equities, as measured by the MSCI Europe Index1, were trading at about 21X. It is only when one looks at prices in relation to prospective earnings that Europe appears to be relatively more attractive. For example, on estimated 2017 earnings, the European index trades at 16X versus 19X for the U.S. On an absolute basis, these multiples appear high to us, and do not cause us to “tremble with greed.”

From a valuation perspective, bargains continue to remain elusive. Our quantitative-based value screens continue to reveal the fewest number of qualifying securities in a decade. That said, we are comfortable with what the Funds own, and currently carry cash reserves in all four Funds that should provide meaningful ballast should equity markets become turbulent in the weeks and months ahead. As of quarter end, the top 25 holdings in each of the four Funds had weighted average price/earnings ratios on estimated 2017 earnings of between 16.4X (Worldwide High Dividend Yield Value Fund) and 19.9X (Value Fund), and paid dividend yields between 2.5% (Value Fund) and 3.8% (Worldwide High Dividend Yield Value Fund). (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 yields of the top twenty-five common stocks held in the Funds’ portfolios. Please refer to the 30-day standardized yields in the performance chart on page 1 for each of the Fund’s yields.) Each Fund also carried cash reserves constituting between 11.0% and 16.9% of total portfolio assets.

It would be easy to put together an even longer laundry list of concerns than those cited at the beginning of this report. However, valuation remains our focus; and on that front, in our view, “margins of safety” are very difficult to come by in equity securities of even marginal quality, increasing near term risks for investors. With the VIX2 at record lows, short term interest rates still hovering near zero to negative in many parts of the world, and a growing consensus that the prospects for near-term recession are seemingly remote, many market participants continue to throw caution to the wind. We would advise against such sentiment. While we sleep well at night with the current structure of our Fund portfolios and the businesses the Funds own, confident that as a group they rest on a firm foundation of intrinsic value, we are also cognizant that near-term price risk is elevated today. At a minimum, equity investors at current price levels will have to temper their expectations regarding future returns.

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.

Managing Directors

Dated: October 16, 2017

Please note that the individual companies discussed herein were held in one or more of our Funds during the quarter ended September 30, 2017, but were not necessarily held in all four of our Funds. Please refer to the footnotes on pages 13 and 14 for each Fund’s respective holdings in each of these companies as of September 30, 2017.

  1. The MSCI Europe Index is designed to represent the performance of large and mid-cap equities across 15 developed countries in Europe.
  2. The Chicago Board Options Exchange Volatility Index (or “VIX”) is a measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices.

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