One might think a more volatile environment would result in a larger spread between the top contributors and detractors to portfolio returns. Counter intuitively, the March quarter has the narrowest spread since inception.
We continued to build our position in Canfor Pulp5 (the Canadian pulp and paper products supplier) which returned 21.8%6 . We also bought a little more Lear Corp (the US automotive manufacturer which was up 4.8%) and we sold a small amount of Haneda Zenith (the Japanese engineering and construction provider which was up 2.0%). The contributions from Codan (an Australian electronic solutions provider which returned 17.5%) and the smaller contributions from the other positions (which returned around 5% on average) were achieved our preferred way – without trading.
The most successful investments often feel uncomfortable at the time of purchase. Connect Group (the British media distributor) is currently a small position (2.3% of the Fund). It has fallen 17.4% since we first bought it in mid-February. And yes indeed we felt uncomfortable. So what did we do? We bought more – so now we can feel more uncomfortable. It ended the quarter down 13.2% from our average purchase price. Bottom line: We are not market timers and our willingness to go against the herd (subject to our rules) – which often looks foolish in the short term – has not faded.
We sold both Crawford (the US insurance service provider which was down 0.9%) and Marvelous (a Japanese online gaming business which was down 7.3%) as they failed our financial strength rules. When the rule says sell, we sell – which in these instances proved wise as the share prices of these companies fell a further 7.3% and 2.2% respectively to quarter’s end. But let’s not be too happy with that ‘apparently’ correct decision. We chewed up 6.6% of the capital invested in Marvelous over four months and we are less proud of our 6.2% loss in Crawford because we tied up capital for around ten months in doing so.
Also in Japan we completely sold two smaller positions due to declining financial strength. The results: One was a poor investment (we lost 1.6% over four months) and the other only mediocre (5.5% gain over six months). Japanese businesses typically rank quite well on our criteria – we are usually ‘fully occupied’ (when applying our diversification rules). So, these divestments then opened up the possibility for us to increase (or initiate) our weighting in better ranked alternatives: Nichirin (which manufactures hoses mainly for automobiles), Haseko (a construction and engineering business), Odelic (which manufactures lighting equipment) and a small building company.
For the same reason of deteriorating financial strength, our rules required we sell Interdigital (the US technology developer/owner) and this resulted in a distasteful 11.8% loss after almost a year of detention. The proceeds were reinvested in new positions – Lyondellbasell (the US chemical producer) and Franklin (the US financial services provider).
The lessons learned from our investments in retail companies have been expensive, so we are pleased that the story for American Eagle (the US retailer) is much more palatable. Those prior painful experiences were the catalyst for us to revisit some elements of our process and introduce new rules – refer ‘We Don’t Break Rules, We Create New Ones!’. More on rule refinements later. We first bought American Eagle in late March/early April last year, and two months later (looking stupid) we ‘averaged down’ and bought more at a 20% lower price. But from its low in mid-August last year to the end of March, it returned a whopping 84.8% (of course, we were unable to capture all of this return – largely as a result of our rules based process). From our perspective, such a share price increase has two ramifications. Firstly, if not accompanied by improving business fundamentals, it becomes a less attractive investment and may breach our pricing rules. Secondly, it may breach our diversification rules (on a stand-alone basis or at the portfolio level). In this case both were reasons for our progressive selling leading to its complete divestment. We are not boasting though – as its price at quarter’s end was 15.3% higher than our average sell price and our holding period was shorter than ideal. But we prefer to lower our risk profile and leave some money on the table for someone else. We concur with Baron Rothschild’s view “I made my fortune by selling too early”. In fact this is one way to protect ourselves against permanent loss of capital.
Continuing with US retailers, we sold some Williams-Sonoma (which started in December) realising a 9.1% return (mostly dividends) on that portion of the Fund (around 1.4%), which we held just short of one year.
And for some more implications of our sector diversification rules let’s turn to the automobile industry. We repositioned the portfolio’s positions in this sector by selling Magna (we realised a pleasant gain of 13.0% over a holding period of around eight months), increased our position in Lear Corp, and established a position in Tenneco.
Back in Europe, we continued to accumulate shares in JM and we can assure you it felt as uncomfortable as the building of our position in Connect that we mentioned previously. The good news: it was not a detractor to the portfolio’s return this quarter. The bad news: it has a long way to go before it can be considered a successful investment. Patience is of the essence.
And finally, an interesting tale of emotions when it comes to Bpost (the Belgian postal operator). Declining in ranking due to price increases, we trimmed our position from 4.8% to 2.6% (in accordance with our rules) and realised an impressive return of 23.6% over ten months, but our selling was halted due to the imminent release of its results (again in accordance with our rules). Our updated analysis prescribed us to sell, but others had already done so – and massively! The price achieved was 28.6% lower than the former tranche and our overall gain was reduced to 8.7%. The sale of that tranche at a loss is another way we protect ourselves against permanent loss of capital.