March 2017 | Quarterly Report

Snapshot

The Alluvium Global Fund (Fund) posted a net loss of 1.1% over the March quarter1.

A significant factor was the rising Australian dollar (AUD).

The longer term net returns of the Fund, as well as some alternatives are shown below:1,2,3,4

Figure 1: Value of AUD100,000 (net dividends reinvested)

Source: Interactive Brokers, Alluvium, Apex, Factset

Figure 2: Comparison of Net Returns (AUD)

Source: Interactive Brokers, Alluvium, Apex, Factset. Inception: 1 Jan 2015 (Annualised)

General Commentary

It is never pleasing to experience a quarter where our capital declines. Then again, if one expects consistent positive returns there are always cash products or Ponzi schemes to consider.

Due to the strengthening of the equity markets and the AUD (up around 5%) over the quarter, our quite sizeable cash position and our small AUD position were a drag on performance. In fact, our cash holding alone (due to it being almost exclusively denominated in foreign currencies) cost the Fund 1.3% in performance over the quarter2 .

We remain on the hunt for suitably priced investments – but our thresholds in relation to the quality we seek and the prices we are prepared to pay do at times lead us to hold high levels of cash. We will not compromise these parameters to be more substantially invested. Accordingly, in times like these the Fund may not participate to the same extent as others in broader market rallies. We are of the view that there is unseen risk in the broader market, and although we are not market timers our preparedness to hold cash in the absence of suitably priced investments makes absolute sense. And importantly, this also provides us with the opportunity to take advantage of any pullback in prices of quality businesses when “Mr Market” facilitates it – and we are confident that eventually he will.

“Cash is misunderstood by some, who do not appreciate the value of a cheap option on a better future entry.” – Steve Romnick

Performance Review

Figure 3: Top Contributors/Detractors

Source: Interactive Brokers, Alluvium, Factset

The good news is that to a large extent, what worked kept working! Wabash5   returned 30.8%6   and Transcontinental returned 10.8% over the quarter. We view both as decent businesses that remain reasonably priced. This is the ideal scenario – where the business fundamentals improve, and whilst the improving fundamentals are somewhat reflected by an increase in share price it is not beyond our parameters. We prefer to “buy and hold” rather than trade – it’s just so much simpler! Having said that, post the quarter’s end, as a result of cash inflows and implementing our rules, we have lightened up a little on our weightings towards both of these businesses.

Cooper Tire & Rubber also posted a solid return of 14.4% and Regis Resources (up 11.1%) has performed admirably since we purchased it in November. Hindsight suggests we were fortunate in the timing of acquiring our initial stake in Western Forest Products (in January) as it has rallied 17.3% since. Not ideal for us though – because despite its higher price it remains an attractive business for the Fund, so we have had to pay more as we added to our position.

The bad news though is what hasn’t worked in the recent past continued not to work. Our position in retailers (or businesses with substantial retail operations) again cost us dearly. When will we learn? Not yet, as an article which we intend to release shortly will explain. However, for now let’s simply acknowledge our disappointing experience of investing in the following businesses, both of which we sold prior to the end of the quarter:

  • Buckle, in which, after accounting for dividends (to help temper the pain), the Fund lost 5.2%; and
  • Vera Bradley, where there was no dividend paid – and in any case unless it was an almighty special it wouldn’t really help lessen the pain of the Fund’s 33.2% loss.

We are more accepting of the other detractors. American Railcar Industries (-9.3% over quarter) and Subaru (previously known as Fuji Industries, which fell 10.4% from the beginning of January until we sold the position in mid February for a gain of around 11.2% over four months), have both posted acceptable longer term performance. American Public Education, which we sold soon after quarter’s end (for a 13.3% gain over a holding period of a few months) was down 6.7% over the quarter.

Portfolio Profile

Figure 4: Diversification by Sector

Source: Alluvium, Factset

Figure 5: Diversification by Region

Source: Alluvium, Factset

Table 2: Fund Overview

Cash 20.0%
Top 15 holdings 61.2%
Number of holdings 27
Weighted Average Market Cap. (USD m) 10,577

Source: Alluvium, Factset

Table 3: Quality Metrics (weighted average)

Debt (% of EV)7 11.9%
Piotroski score8 7.2
Return on Invested Capital (5y average) 23.5%
Latest Return on Invested Capital 25.5%

Source: Alluvium, Factset

Table 4: Pricing Metrics (weighted average)

Enterprise level yield (EBIT/EV)7 12.8%
Earnings yield (NPAT/Mkt Cap)7 9.3%
Free cashflow yield (FCF/Mkt Cap)7 9.5%

Source: Alluvium, Factset

Table 5: Top 15 Holdings

Hawaiian Holdings 5.8%
Cooper Tire & Rubber 5.5%
Transcontinental 5.3%
Wabash National 5.1%
American Public Education 5.1%
Regis Resources 4.6%
Western Forest Products 4.0%
T-Gaia Corporation 3.9%
American Eagle Outfitters 3.8%
Japan Airlines 3.7%
American Railcar Industries 3.6%
Michelin 2.8%
Wal-Mart 2.7%
Toshiba Plant Systems & Services 2.7%
Lear Corporation 2.6%

Source: Alluvium, Factset

We have mentioned that we disposed of Buckle, Vera Bradley and Subaru. In addition, we sold LyondellBasell Industries and Delta Airlines and some smaller positions (Yuasa Trading, Ennis, Eastman Chemical). All were sold when, after updating our analysis on the release of new financial information, the businesses failed to meet our financial distress and/or quality rules. Our returns ranged from being immaterial (three months of wasted capital in the case of Ennis), to respectable (22.9% for Delta Airlines, 18.9% for LyondellBasell Industries and 17.6% for Eastman Chemical – each over a period of around four months), to what we view to be impressive (42.1% for Yuasa Trading over eight months or so).

On the buy side, we adopted a new position in Hawaiian Holdings, facilitated by the sale of Delta Airlines. For the two days prior to March quarter’s end, it temporary represented a larger position than ultimately desired as we were preparing for the known cash inflows to the Fund in April.

We have mentioned our purchase of Western Forest Products, a Canadian listed timber harvester. And perhaps we are a glutton for punishment. We have bought into another retailer, American Eagle Outfitters. We are also building positions in two other US listed companies – a wireless technology business and a chicken farmer.

We do like to highlight in each report the Fund’s composition compared to an index portfolio. We believe that if you pay for active management you deserve to get it. Based on our best estimates, of the Fund’s 27 positions, three are in the Index (with a combined weight of 0.40%). Therefore, our “active share” is over 99.6%. Although this may vary from time to time, we do not expect the Fund to ever meaningfully represent an index portfolio.

The Fund increased in size substantially on 1 April, as a result of our own additional investment as well as welcoming new investors. We thank the new investors for their trust and confidence in Alluvium. As Principals of Alluvium, we are honoured to accept the opportunity to manage your capital. Rest assured that the assets you have entrusted to Alluvium will be managed according to our high standard of ethics, with full transparency, no conflicting interests and with the same level of care and diligence as our own investments – they are, after all, in the same pool of assets.

Our quarterly updates are intended to be succinct. If you are interested in learning more, please simply send us an email. We’re always happy to meet and elaborate.

Best as always,

Stuart Pearce
Principal

Alexis Delloye
Principal

1 Apex Fund Services Limited (Apex).

2 Interactive Brokers, LLC (Interactive Brokers), Alluvium Asset Management Pty Ltd (Alluvium), Factset Research Systems, Inc. (Factset).

3 Comprises: (1) a separately managed account for the period 1 January 2015 to 6 June 2016 sourced from Interactive Brokers and reduced by an assumed administration fee of 0.45% and a base management fee of 0.90% (both inclusive of the net effect of GST), as calculated by Alluvium; and (2) the Alluvium Global Fund from 7 June 2016 sourced from Apex.

4 MSCI World Net Total Return Index (AUD, unhedged), (Index or MSCI World).

5 Company names have been abbreviated throughout this document in the interests of readability. Should readers wish for more detailed information, please feel free to contact Alluvium.

6 All returns are quoted in local currencies unless otherwise noted.

7 EV refers to Enterprise Value. Alluvium defines EV as the market value of a company’s equity plus the book value of its gross debt. EBIT refers to earnings before interest and tax. NPAT is net operating profit after tax. FCF means cash flow from operations less capital expenditure. Return on invested capital refers to EBIT as a percentage of the average capital invested in the business operations (as defined by Alluvium).

8 Piotroski score is a discrete score between 0 and 9 which reflects nine criteria used to determine the strength of a firm’s financial position.

Alluvium Asset Management Pty Ltd, ABN 69 143 914 390, Australian Financial Services License number 476067 (“Alluvium”), is the issuer of units in the Alluvium Global Fund and is solely responsible for the preparation of this document. The Alluvium Global Fund is an unregistered managed investment trust available to Wholesale Clients as defined under Section 761G of the Corporations Act 2001 (Cth). An Information Memorandum for the Alluvium Global Fund is available and can be obtained from our website. A person should obtain a copy of the Information Memorandum and should consider the Information Memorandum carefully before deciding whether to acquire, or to continue to hold, or making any other decision in respect of, the units in the Alluvium Global Fund. This document was prepared by Alluvium and does not contain any investment recommendation or investment advice. This document has been prepared without taking account of any person’s objectives, financial situation or needs. Therefore, before acting on any information contained within this document a person should consider the appropriateness of the information, having regard to their objectives, financial situation and needs. Neither Alluvium, nor its related entities, directors or officers guarantees the performance of, or the repayment of capital or income invested in, the Alluvium Global Fund.

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