December 2017 | Half Year Report

Snapshot

The Alluvium Global Fund (Fund) posted a net return of 0.8% over the December quarter.1

The strategy has now built up a three year track record. Its annualised total return over that period is 12.1%. This is slightly higher than the return we expect to achieve over the longer term – which is not a surprising outcome given the very favourable equity environment during the last few years.

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

Figure 1: Value of AUD 100,000 (Net Dividends Reinvested)

Source: Interactive Brokers, Alluvium, Apex, Factset

Figure 2: Net Fund Returns Compared to Gross Index Returns (AUD)

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

General Commentary

The December quarter return is lower than the average quarterly return we would like to achieve when measured over the longer term. It is also significantly below than the Index return.

Whilst disappointing, we consider the Fund’s return was achieved with significantly less risk than that inherent in the broader global equity markets. Not only has the Fund held high levels of cash (averaging around 25%), it has also only held interests in financially strong companies (for example, those that carry little debt and have robust earnings) and which are priced at levels which make sense without the need to assume lofty earnings growth. This “comfortable” approach to investing is consistent with our philosophy and long term absolute return mindset.

Quarterly Performance Review

Figure 3: Top Contributors/Detractors

Source: Interactive Brokers, Alluvium, Factset

Mean reversion is alive and well. Four of the largest recent contributors had featured as significant detractors during the June and September quarters. American Eagle returned 31.5% over the quarter.5   Trading during the quarter proved fruitful here, but even more so in the case of Williams-Sonoma, where a large tranche we bought added far more value than its quarterly price increase of 3.7% would otherwise suggest. More on our trading in these names later. Hawaiian Holdings share price increased 6.1% over the quarter, but similarly – as we bought a large tranche (almost doubling our position) at a price 16% below the quarter end’s price – its contribution was significant. Welling Holding received an agreed takeover offer by its parent company, so even though it was a small position, the 43.7% increase in its share price resulted materially benefited returns. Unfortunately though, the Fund’s gain over its entire holding period (of around seven months) was a more muted 16%.

Unfortunately mean reversion, by its very nature, works both ways. Western Forest, which has been a significant contributor since we first purchased it fell by 8.2%, and Crawford partly reversed its 0.8% contribution over the June quarter by falling 19.6%. And one of our more recent acquisitions, JM (a Swedish home builder), has been a terrible investment to date – additional proof that we are not great market timers.

“In the short run the market is a voting machine but in the long run it is a weighing machine.” – Ben Graham

Portfolio Profile

Figure 4: Diversification by Sector

Source: Alluvium, Factset

Figure 5: Diversification by Region

Source: Alluvium, Factset

Table 1: Fund Overview

Cash 23.5%
Top 15 holdings 59.4%
Number of holdings 23
Weighted Average Market Cap. (USD m) 9,719

Source: Alluvium, Factset

Table 2: Quality Metrics (weighted average)

Debt (% of EV)6 23.5%
Piotroski score7 7.3
Return on Invested Capital (5y average) 26.3%
Latest Return on Invested Capital 28.7%

Source: Alluvium, Factset

Table 3: Pricing Metrics (weighted average)

Enterprise level yield (EBIT/EV)6 13.1%
Earnings yield (NPAT/Mkt Cap)6 10.1%
Free cashflow yield (FCF/Mkt Cap)6 11.1%

Source: Alluvium, Factset

Table 4: Top 15 Holdings

Transcontinental 5.2%
Hawaiian Holdings 5.2%
Belgian Post 4.7%
Williams-Sonoma 4.7%
Western Forest 4.3%
Gilead Sciences 4.2%
Haseko 4.2%
Lear Corp 4.0%
Michelin 3.9%
J.M. 3.5%
Magna 3.4%
Odelic 3.1%
American Eagle 3.1%
InterDigital 3.0%
Codan 2.9%

Source: Alluvium, Factset

During the quarter we completely sold seven positions, bought three new positions, and increased our investments in ten of the businesses we already held. This resulted in a concentrated portfolio that at quarter’s end comprised 23 positions and had a cash level of 23.5%. Five of the businesses we sold were only held for a short time. The returns ranged from -17.4% (for our small position in a small US listed supplier of baby bedding products) to 58.5% (for our small position in a Japanese listed software company). Most notably, we burnt a lot of capital with our investment in Goodyear (-11.4% over six months).

The longer term investments we sold included:

  • Wabash, where our returns ranged from 95.6% for the parcel acquired in November 2016 to a mere 4.2% for the more recent tranche acquired in April 2017 (the weighted average return was 38.1%). We faced an interesting dilemma with this sale. The timing of our updated analysis (which according to the rules deemed it a “sell”) almost exactly coincided with the one year holding period for the lowest cost base tranche. However, we judged the risk of holding an extra day to be too great so unfortunately investors will not benefit from the capital gains tax (“CGT”) concession. Whilst results are not prima-facie evidence of wise decisions, we do note Wabash fell 7.8% the next day; and
  • T-Gaia, where we applied our discretion to delay our selling for a few days post our updated analysis so unitholders would benefit from the CGT concession for at least a portion of the investment. In this instance, hindsight suggests we would have been better waiting longer – the share price has continued to rise.

In May we outlined our increased level of fundamental analysis for retail companies and we commented “We have refined our rules in relation to investments in retail businesses and with the newly “freed up” capacity we accumulated positions in two other US retailers in late March and April”. The retailers we bought were American Eagle and Williams-Sonoma. Initially these performed poorly (down 25.6% and 17.0% respectively at one stage), but in the face of these declining prices, we bought more. Now, largely as a result of that, these positions are showing signs of being fruitful investments. In fact, subsequently our diversification rules required us to trim both of these positions as their outperformance caused them to represent too larger part of the portfolio. This provides an interesting illustration of the way our rules can work. During November we increased our holdings in both only to sell down in part within two weeks. As a result, we realised an average 11.7% return for 0.5% of the Fund over seven days. If we managed to do that for 0.5% of the portfolio – and nothing for the remainder – repeatedly for five years, your $100 investment (if in a tax exempt account) would become $1.7 trillion. If only it were that easy…

“Compound interest is the eighth wonder of the world.” – Albert Einstein

Our three new positions are all Japanese companies. One is a gaming and media business, another manufactures and sells commercial kitchen equipment and the other supplies construction materials. All are small companies with market capitalisations of less than USD500m. Smaller Japanese positions have proved fruitful in the past – let’s hope that continues.

Our closing remarks – the mania continues, volatility remains low, Trump’s a “genius”, and we are envious of those canny investors that recognised Bitcoin’s inherent “value” at the start of the year. Thank you again for your interest and if you’d like to know more, please simply send us an email – we are always happy to discuss.

Don’t spend all those bitcoins at once,

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. Returns are based on price movements only and expressed in local currency. Should readers wish for more detailed information, please feel free to contact Alluvium.

6 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).

7 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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