Bretton Fund Shareholder Letter: Long CoachVW Staff
Bretton Fund’s letter to shareholders as of June 30, 2014?
Dear Fellow Shareholders:
The Bretton Fund’s net asset value per share (NAV) as of June 30, 2014, was $23.35. The total return for the fund for the second quarter was -1.48%. Over the same period of time, the total return for the S&P 500 Index was 5.23%, and the total return for the Wilshire 5000 Total Market Index was 4.86%. The total return for the fund for the first half of 2014 was -0.38%. Over the same period of time, the total return for the S&P 500 Index was 7.14%, and the total return for the Wilshire 5000 Total Market Index was 7.00%.
(A) Returns include change in share prices and, in each case, include reinvestment of any dividends and capital gain distributions. The inception date of the Bretton Fund was September 30, 2010.
(B) The S&P 500® is a broad, market-weighted average dominated by blue-chip stocks and is an unmanaged group of stocks whose composition is different from the Fund.
(C) The Wilshire 5000 Total Market Index is a market-capitalization-weighted index of the market value of all stocks actively traded in the United States.
Performance data quoted represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. All returns include change in share prices, reinvestment of any dividends, and capital gains distributions. Current performance may be lower or higher than the performance data quoted. Indices shown are broad-based, unmanaged indices commonly used to measure performance of US stocks. These indices do not incur expenses and are not available for investment. You may obtain performance data current to the most recent month-end by calling 800.231.2901. The fund’s expense ratio is 1.50%. An investment in the fund is subject to investment risks, including the possible loss of the principal amount invested. The fund’s principal underwriter is Rafferty Capital Markets, LLC.
Bretton Fund: Contributors to Performance
The largest impact to the fund’s performance in the second quarter was Coach Inc (NYSE:COH), which took 2.1% from returns as its stock dropped 31%. We discuss Coach in depth below.
Positive contributors to the fund’s performance in the quarter were Wells Fargo & Co (NYSE:WFC) and the railroads, which each added 1%.
The fund did not add any new investments this quarter, but did sell out of its remaining position in Apollo Education Group Inc (NASDAQ:APOL), the for-profit educator. We recognized a measly 1% gain over a three-and-a-half-year period, our worst realized investment to date.
When we first invested in Apollo, it looked like a growing company that was returning capital to shareholders and trading at a low price. The financial crisis created a large pool of unemployed and underemployed people who needed additional education to reenter the workforce, and Apollo’s online platform is an extremely cost-effective way of serving this market.
Apollo’s business model depends on government financing; its target market does not have the cash to pay upfront for tuition or the credit to borrow independently. Unfortunately, many recent alumni could not find new employment lucrative enough to repay their loans, and the Department of Education tightened loan availability in response. Additionally, competition got tougher as nonprofit and state schools got better at providing online degrees, whereas previously Apollo had by far a superior product.
Our low entry valuation and the intrinsic cash flow of the business allowed us to protect our principal, but each dollar invested in Apollo came at a dear opportunity cost. Not all the fund’s investments will be winners, and we hope to keep our losers and losses to a minimum.
Bretton Fund: Performance
Over the past year, the fund’s performance has lagged, courtesy of Coach and America’s Car-Mart, Inc. (NASDAQ:CRMT), resulting in the fund’s performance since inception to now trail the S&P 500. The performance of our stock portfolio has outperformed the S&P, but we have chosen to carry a significant amount of cash and accept that a consequence of this decision is drag in a frothy market. As most shareholders know, the fund’s goal is not to outperform an index in the short run; the goal of the fund is to compound and preserve wealth—a family office in a mutual fund—and we look to outperform the market over the long term. Since we do not know when markets will go up or down, we try to limit ourselves to investing in individual businesses at valuations we would feel comfortable holding regardless of overall market conditions. We have found fewer such opportunities over the past two years and therefore are not fully invested.
Bretton Fund: Coach
We look at our stock holdings as partial ownership of companies, not as abstract securities. In a typical day each one of our stocks will tick up or down a percent or two, but it is the rare company that is genuinely worth much more or less at 4:00pm than at 9:30am. We try not to let the noise of the trading floor distract us from the task of investing in good businesses at opportune prices.
That said, we are custodians of your capital, and it is incumbent on us to challenge our assumptions when the market’s assessment of a company begins to differ substantially from ours. We do our best to be right when the market is wrong, but we do not rule out the possibility of the reverse.
To date, our unrealized loss on Coach Inc (NYSE:COH) is -27%. It is by far our largest mark-to-market loss currently in the fund, and we would obviously all be better off had we waited on the investment. Sadly, we cannot go back in time to unwind that trade. We can, however, decide whether we wish to continue as partial owners of Coach or let someone else take it from here.
A bit about how we got here. Coach is a 70-year-old premium leather goods company based in New York. It primarily sells handbags for $200-$600, largely in the US but increasingly in places such as Japan and China. We invested in Coach because we saw a stable US market and rapid overseas growth, trading for what we took to be a price based solely on the stable US market. We were right about the overseas market—last quarter, sales abroad grew 20%—but completely wrong about the US market—last quarter, domestic sales fell 20%. It turns out that Coach had maintained its domestic revenue in the face of competition—most notably from Michael Kors Holdings Ltd (NYSE:KORS)—by leaning ever more heavily on online “flash” sales on its website and its outlet business. At some point the company needed to rein in these channels to avoid damaging the brand, and last quarter was that point.
Coach still is an iconic brand. Its product range remains largely perennial; it isn’t a fashion brand. Management has overhauled its stores, designs, advertising, and distribution strategy, and early reports are encouraging, if admittedly far too early to be meaningful.
Coach doesn’t need to regain its peak appeal in the US for our investment to work out if Coach can use its tremendous runway to build stores in Asia and Europe—both of which are markets where early Coach stores have done well—it should return to growth and deliver our target returns over time.
As always, thank you for investing.
Stephen J. Dodson
Bretton Capital Management