Charles De Vaulx: Valuations Now Attractive in China, BrazilVW Staff
Charles De Vaulx Q2 letter to shareholders.
The IVA Worldwide Fund Class A (NAV) (IVWAX) ended the quarter on June 30, 2013 with a return of 0.47% compared to the MSCI All Country World Index (“Index”) return of -0.42%. This brings our year-todate return to 6.67% versus the Index return of 6.05% for the same period.
It was a tale of two halves this quarter. Global equity markets rose until May 22 then primarily fell on indications that the Federal Reserve might scale back its bond buying program and end it by mid-2014, earlier than expected, if the U.S. economy continues to improve and the unemployment rate falls to 7%. The MSCI All Country World Index (Net) fell –6.02% from May 22, 2013 through June 30, 2013, while the IVA Worldwide Fund Class A (NAV) fell –2.58%, capturing only 43% of the downside. Our resiliency over this period was largely due to our multi-asset class approach, especially cash, which helps mitigate overall portfolio volatility and protects the portfolio on the downside. Despite the equity market selloff at the end of the quarter, which provided an opportunity to initiate or add to a few positions, many securities we own got closer to our intrinsic value estimate over the period and, as disciplined investors, we trimmed or exited these positions, thus raising cash. Our cash exposure rose to 28.4% on June 30 from 21.1% on March 31. Cash is a byproduct of manipulated interest rates, fully priced equity markets and our inability to find mispriced securities.
Because of good stock selection as well as minimal exposure to emerging markets and materials stocks, our equities averaged gains of 2.9% versus the Index at -0.4%. Our U.S. stocks added the most to our return, 1.2%, by averaging gains of 4.2% versus the Index average return of 2.6%. This was mainly attributed to good performance from our U.S. tech names as well as a few of our top positions. In addition, our Japanese equities performed well, averaging a return of 3.2% versus the Index at 4.4% in USD, and added 0.4% to our return. On the other hand, a few of our holdings in South Korea and Switzerland performed poorly and, collectively, they detracted about -0.2% from our return. On a relative basis, our minimal exposure to emerging markets benefited us this quarter as Brazil, South Korea, and China were among the worst performing countries in the Index. By sector, in addition to our technology stocks performing well, averaging gains of 5.4% versus the Index at 0.8%, our industrials stocks also outperformed with average gains of 7.8% versus the Index at -0.4%. Conversely, our consumer staples stocks underperformed those in the benchmark, averaging a return of –3.9% versus -2.1% respectively, and detracted -0.2% from our return. Financials was the only other equity sector to detract from our return.
Over the quarter, gold bullion averaged a return of -22.8%. During the quarter, gold suffered from rising interest rates and the announced roadmap to end quantitative easing by mid-2014. We view gold as a currency that central bankers cannot debase and we still believe it provides a good portfolio hedge in an inflationary or deflationary environment. Our allocation was 4.0% at quarter-end with no exposure to gold mining stocks. We recognize that gold has been behaving poorly given its increased correlation to equities and we have not trimmed or added to our bullion position during the quarter. When put in the context of the whole portfolio, with our decreased equity exposure and increased cash levels, we believe our gold position is appropriately sized. Since inception of the Fund, gold has played an important role in the portfolio and has created value for our shareholders.
A number of our corporate bonds were called this quarter as most of these are remnants of investments from 2008/2009 and since we aren’t finding any new opportunities, our corporate bond exposure declined to 7.8% at quarter-end, from 9.7% on March 31. The duration on our corporate bonds is only 2.5 to 3 years, so there is low interest rate risk. Over the period our corporate bonds averaged gains of 0.5%, while our sovereign bonds averaged a return of -1.8%, mostly due to a weakening Singapore dollar. Our sovereign government bond exposure was 6.4% on June 30.
Because of the Japanese equity market appreciation since November 2012, we sold a few holdings that reached what we believe is full valuation. We also reduced exposure to some less liquid investments and to a few companies that have not demonstrated an ability to allocate capital properly. Our Japanese equity exposure fell to 9.5% on June 30 from 10.5% on March 31. However, during the market correction in the latter half of the quarter, we were net buyers in Japan, and in many cases we added to existing positions that we trimmed earlier. We are happy to own more Japanese equities at the right price and we continue to favor stocks of mostly small and mid-cap local companies. In June, we increased our hedge against the Japanese yen to 47.3%, from 40.8% on March 31. Other currency hedges include: euro 39.3% and South Korean won 27.6%, and collectively our currency hedges added almost 0.2% to our return this quarter. Despite the rally over the past seven months, we believe the Japanese equity market still trades at attractive valuations and what we believe will make a difference over the long-term is better capital allocation among Japanese companies in addition to some structural reforms.
Since inception, the Fund has had minimal exposure to emerging markets. After several quarters of poor performance, valuations in emerging countries came down (as of June 2013, Brazil traded at 1.4x price/book value and China at 1.5x, compared to January 2010 when Brazil traded at 2.7x and China at 3.1x, Source: FactSet). We found a few new opportunities in China and Brazil this year, though we are proceeding cautiously on a stock-by-stock basis. Our position sizes remain small and at quarter-end our exposure was 0.6% in China and 0.5% in Brazil.
We found a few opportunities in U.S. stocks towards the end of the quarter. We initiated positions in two preferred stocks with attractive yields and increased our exposure to a technology holding (strong franchise, good capital allocator, less cyclical), now a top 10 position, in June after some volatility provided an opportunity to add at a lower price. However, this is being offset by the selling of holdings whose discount to our intrinsic value estimate narrowed substantially over the quarter. Our U.S. equity exposure fell to 25.1% at quarter-end, from 28.4% on March 31.
Overall, we are comfortable being underweight equities today (53.4% as of June 30) given valuations, which are partly a reflection of repeated liquidity injections by central bankers worldwide that won’t last forever. For the most part, we believe stocks in the U.S. are fully priced and the stocks we view as high quality in Europe remain expensive, while valuations are more reasonable in Japan and perhaps some emerging markets as well. As always, we remain focused on individual stock picking and look for companies with solid balance sheets, good management teams, strong moats, and pricing power. As longterm investors who attempt to deliver absolute returns to our clients, we will continue waiting patiently for the opportunity to buy securities that we view as undervalued.