Investment markets fluctuate. We all know that they do, and today they are fluctuating at lightning speed. The advent of electronic trading, exchange-traded funds (ETFs), and retirement accounts that can be switched with a click or a call has led to an avalanche of trading. TD Ameritrade, a brokerage that caters to individual investors, has seen its average trading volume per account rise around 60% in the past 10 years. Other brokers have had similar results. This trading adds to the volatility of markets, which in turn increases investor anxiety. Emotions overwhelm rational thinking, herds of myopic and fearful investors are formed, and investment prices eventually become unhinged from their fundamentals. Wise investors understand these forces and put themselves in a position to be successful, even if doing so means accepting some short-term performance bumps along the way.
The Five Poisons of Investing
In past newsletters, I have discussed the five poisons of investing we must look out for, especially in times of heightened volatility. 1) Recency effect: Giving recent history more weight in a decision than it should get. 2) Endowment behavior: Our desire to hold onto something even if it is no longer useful or is unhealthy. Think habits of the mind, beliefs, etc. 3) Fear and inertia: Some people react fearfully to informa-tion overload or the possibility of a loss (e.g., sell everything NOW). Others just go into the fetal position, so to speak, and do nothing when they should be taking action. 4) Narrow investor’s universe: Limiting a portfolio’s holdings to just U.S. stocks or large “blue chips” can seem safer, but there is a downside to this behavior. Study after study show that expanding a portfolio’s holdings, adding global investments, bonds, resources, etc., actually reduces risk and improves consistency of performance. There is still volatility, but there is more likelihood of achieving a long-term investment goal. 5) Heuristics: Skewing the importance of certain information to a larger or lesser degree than warranted by the information. I will not add naiveté, but the quote to the left that I recently read by Edgar Degas comes to mind when I think of how people can fool themselves into thinking this investing stuff is easy.
FIM Group COO Matt Bohrer (my colleague for nearly 20 years) told me a story he heard recently from a fellow adviser who was trying to communicate to a group of investors the folly of ditching a long-term investment plan to do what many seem to be trying today: market trend following. These investors try to buy when it looks like there is momentum to the upside and sell when there seems to be momentum to the downside. They are enabled by invest-ment industry “technology advances” that allow for shifting the stock/bond/cash mix of entire portfolios with one click of a smartphone.
When these investors told the adviser how they were doing this with their mutual fund 401(k) retirement plans, the adviser asked them if they realized that the mutual fund “trades” they were putting in at eight in the morning didn’t actually do anything other than sit in an order pile to be executed at the end-of-day price (like all open-end mutual fund orders). The adviser got some sheepish looks and left the event wondering how many other investors are behaving this way.
My guess is that many similar types of investors who tried their hands at short-term market trend timing got bruised quite a bit in August as markets whipsawed. For example, look at the wild intra-day swings we had in the S&P 500 between August 24 and August 26 (Figure 1). Those waking up to the sharp drop in markets on Monday, August 24, might have put sell orders in first thing only to see markets rally sharply in their face through the lunch hour. Then, in a bid not to “miss out” on the rally under-way, these momentum chasers likely shifted to buying the market only to see momentum reverse back down to close near the lows of the day. Vowing to make up their losses the next day, they likely cheered the market opening rally, went “long and strong” only to see the rally fade fast and make new lows for yet another day. Then on Wednesday, perhaps thinking there was a pattern to exploit, they bought another market opening rally and then sold short the market as momentum picked up to the downside. Yet before they could recoup their losses from earlier in the week and cover their short positions for gains, the market surged higher, compounding their losses further!
Hopefully you get my point: speculation on day-to-day market momentum is a recipe for losing money. Investing is about management, and like anything in life, it takes work, education and experience to master. I agree with Degas that the more you know, the harder it can seem. A hallmark of FIM Group’s approach is to think like an informed, intelligent and wise businessperson would when making a thoughtful, long-term strategic investment decision. I would like to highlight a few things we see in the market today and how we “process that information.”
When It Rains It Pours (Emerging Markets Edition)
Emerging markets can’t catch a break of late. Generally speaking, their economies and their stock and bond markets have been savaged by changes in capital flows, economic uncertainty, political upheavals, banking stress, currency volatility and poor investor sentiment (being driven by fear). Emerging economies as a whole tend to have better long-term growth prospects than developed economies, but today, their stock markets sell at a 20%-30% valuation discount to developed markets (as proxied by the forward price/earnings and EV/EBITDA ratios of the MSCI Emerging Markets and Developed Markets Indices). Without a doubt, many of these emerging markets still face some near-term headwinds. U.S. dollar strength challenges the liquidity of countries from Russia to Brazil, and weak crude oil and metal prices have wreaked havoc on countries dependent on revenues from commodity produc-tion. While our direct portfolio exposure to emerging markets is limited, some of our holdings have seen their market values erode amid the emerging market selloff. We see real value in high-quality stocks and bonds that have been thrown out with the proverbial bathwater just because they have emerging market exposure.
One example holding along this theme, held in most of the portfolios we manage, is Atrium European Real Estate (Ticker: ATRBF). Atrium owns, develops and manages retail real estate with a focus on supermarket-anchored shop-ping centers in Central and Eastern Europe. Atrium pays a 7% cash dividend, sells for about a 25% discount to its book value and has great seasoned management. The company has a solid balance sheet but, oh yes, now the rub, it has seven properties in Russia that represent about 20% of its revenues. We believe that the Russian properties will continue to generate income (after all, even Russians eat), and that the book value of Atrium has already been sufficiently “written down” to reflect its underperforming Russian assets. We do NOT expect a miraculous V-shaped Russian economic recovery near-term as the country is not well run and it has a heavy dependence on oil and gas that could remain weak for some time. That said, we feel that Atrium has been overly punished for its exposure to Russia and that, at these prices, even if the Russian assets are marked down to zero, our shares would still be selling below book value. In the meantime, management is growing the business, rents have been rising on their non-Russian assets and Atrium has 12% of its assets in undevelop-ed land, which they can develop to generate even more income to investors. Despite the Russian malaise for over a year now, Atrium’s three-year dividend growth has been 18%.
A U.S. Recession?
There is considerable talk that China’s economic woes could drag the U.S. into a world recession. Could that happen? Sure it could. Recessions happen and then economies eventually get back to growth. As it stands today, prices in many bond and commodity markets (and the above-mentioned emerging stock markets) seem to already be pricing in the increasing risk of a
global economic downturn.
But amid the doom and gloom, America Inc., which accounts for roughly 25% of world GDP, is showing some positive trends. Our second-quarter GDP growth was a pretty solid 3.7%, our unemploy-ment rate is near 5% and the oil price drop has put more money in American pockets as we pay less to keep our cars full of gas and our homes at comfy temperatures. The strong U.S. dollar allows us to get more bang for our buck on imports, and when you look at big-ticket items, the trends seem to be pretty decent too. Car sales are hitting new records (I was born in Detroit, so I feel compelled by DNA to follow the auto industry – as “GM goes, so goes the [American] world”). Housing starts, while still well below long-term averages, are showing nice momentum, and the U.S. consumer is much better off than a few years ago (see Figures to the right). In short, it seems that at minimum, the U.S. economy is better positioned to deal with global recession should that be what comes our way. More optimistically, the U.S. may prove to be the global stabilizer as China transitions to a slower economic growth trajectory.
Y2K, the Fed and Bonds
Fears around what the Federal Reserve will do with interest rate policy at their September meeting have been a big topic this summer. Now we know what they did – very little (On September 17, the Fed announced it would keep short-term rates unchanged at zero).
We don’t know the future, but I’m fairly confident that going forward, people will borrow and pay back their borrowings like they have since lending was invented. Over my career, I have seen U.S. interest rates range 18% to zero. Our economy has a track record of chugging on and figures out a way to adjust to the changing price of money
as a matter of course.
In the meantime, though, financial media seems obsessed over and likely even contributing to irrational Y2K-like fears that a Fed shift away from its zero interest rate policy will wreak profound change on the economic landscape. This fear has trickled down to bond-land, where some investors have become afraid to own corporate, government and inflation-linked fixed-income investments. The Fed was created by Congress “to provide the nation with a safer, more flexible, and more stable monetary and financial system.” Smart people work at the Fed, they debate policy options with rigor, and they make decisions with a desire to minimize the risk of “screwing up.” Making the Fed out to be all-powerful economic agents is a meme that sells newspapers and gets Tea Party candidates elected. But the Fed is not the economy, nor is its action in setting interest rates and buying and selling bonds the economy.
We feel that the hyper-obsession with Fed policy and fears of where short-term rates will be set is overdone. It has also created a significant opportunity to own quality, solid interest income investments at price levels not seen for many years. This is great news for retirees and income-oriented investors as we can lock in significant, contractual income streams across a wide range of investments, including the floating rate investments we’ve been buying of late whose distribu-tions will actually increase should rates finally begin to move higher.
The Summer of Bargains
This has been one of the toughest periods of my career. Throughout our history, we have been early into trends, but not too early, and usually we avoid the big losses by using a “look at the downside twice – upside once” conser-vative, value-based approach. We have had periods like this in the past where everything bad seems to happen at once, and I’m sure we’ll have them again someday in the future. But our history shows that these tough periods are followed by good periods. I must say that I am very optimistic that our portfolios will eventually reflect the compelling value within them and that we will someday be saying to ourselves, “I wish we had more bargain-basement investments to pounce on like we had in the summer of 2015.” The reality is that markets, which are made up of people, driven by emotions, fear, greed, logic and such, tend not to be steady Eddie. More often, market participants lose sight of long-term financial plans, get suckered into “fad du jour” investment strategies, and turn to the crowd for comfort only to get burned. Our job as your money managers and financial advisers is to stay disciplined, thoughtful, savvy, patient and value-focused like we have throughout our long history, navigate you through the bumps along the way, and work together with you to successfully achieve your personal financial goals.
One of the big investment themes that my colleagues and I regularly explore is the mega global trend of health and wellness. Over the years, we’ve been involved with numerous companies riding this trend, including leaders in yoga goods (Gaiam), sports club facilities (Lifetime Fitness), fresh fruit production and distribution (Fyffes and Total Produce), and even massage chairs (OSIM), to name just a few. This month, I’d like to highlight another company benefiting from increasing consumer health consciousness around a beverage staple that most of us interact with on a daily basis: coffee.
Ten Peaks Coffee Company Inc. is a Canadian company our invest-ment team first purchased for select client accounts all the way back in 2008 after meeting management and hearing their vision for decaf-feinated coffee greatness. Ten Peaks owns two businesses based in British Columbia, the Swiss Water Decaffeinated Coffee Company Inc. and Seaforth Supply Chain Solutions Inc. The company is benefiting from the twin tailwinds of surging specialty coffee industry growth and increasing consumer demand for healthier food and beverage choices. One of those choices is the limitation of caffeine intake given the effects caffeine can have on the body. The central nervous system is stimulated by the intake of caffeine and can cause side effects such as insomnia, muscle tremors, heart palpitations, jitters, difficulty staying focused, heartburn, nervousness and – yikes – even irritability, amongst other signs of petulance.
For those who just want to enjoy a good cuppa joe without the caffeine buzz, the specialty coffee industry is rising to the challenge. These coffee aficionados are demanding decaffeinated coffee with enticing aromas and tantalizing flavors. They articulate their coffee taste in eloquent terms such as “bright citrus,” “captivating dried fig,” “caramel undertones” and “subtle fruit notes,” and they consider coffee a sensory experi-ence rather than just a commodity.
Raising the Quality Bar
Over the years, Ten Peaks has tweaked its proprietary Swiss Water decaffeination process to bring what these consumers now demand: a high-quality bean without the negative chemical baggage prevalent in mass market decafs. For the industry, such a combination has been a long time coming. Early on in the 20th century when decaffeinated coffee was first being made commercially available to consumers, the decaffeination process could be compared to a chemistry experiment. The result was usually a rather flavorless beverage, and for decades the coffee trade essentially sent only its second-rate beans to the decaffeination plants. Those subpar beans would further compromise the coffee flavor once the decaffeination process was performed. Bad beans, bad process, bad decaf.
Eventually, a new breed of “premium” decaf roasters emerged that focused extraordinary attention on acquiring and sourcing high-quality decaffeinated coffee beans and processing them in a more thoughtful manner. There is something like 1,000 compounds that contribute to the taste and aroma of coffee, and there is a huge difference between a good coffee bean and a not-so-good coffee bean. For example, the color of the bean is critical. Most decaffeinated, unroasted coffee beans are nearly brown in color rather than green. The brown coffee bean has less embedded moisture and responds erratically when heat is added during the roasting stage, further compromising the end product.
Double Decaf Latte, Hold the Methylene Chloride Please
Unlike the industry standard processes that use chemicals like methylene chloride or ethyl acetate to achieve decaffeination, the proprietary Swiss Water process from Ten Peaks uses only high-quality green coffee, water and carbon filters. This natural, chemical-free process, certified organic by the Organic Crop Improvement Association, also requires the precise control of multiple environmental factors, including temperature and humidity. The end result is 99.9% caffeine-free (buzz-free) joe with exceptional flavor.
Ten Peaks sells its Swiss Water decaffeinated green coffees to leading specialty roaster retailers, specialty coffee importers and commercial roasters. The company also owns and operates Seaforth Supply Chain Solutions Inc., which offers a complete array of green handling and storage services. These logistical services include devanning coffee received upon import, inspecting, weighing, sampling, storing, handling and readying green coffee for outbound shipments. Uniquely, the Seaforth warehouse has been certified organic by Ecocert Canada.
Since we first began buying Ten Peaks seven years ago, revenues have grown more than 150%. And while profits struggled during the early stages of the global economy recovery, over the last few years they have rebounded nicely. Management continues to execute on their business plan, gain market share and expand globally. The company recently raised a new round of equity capital (at more than two times the price we initially paid for our shares) to further its growth ambitions.
Funded for Growth
With the funds now in hand, Ten Peaks plans to finance capacity expansion at the current facility in Burnaby, B.C., and to fund the construction of a new facility which is expected to begin in 2016. This additional capacity should enable the company to further boost volumes at double-digit rates and keep pace with rapidly growing demand for premium quality decaf. This expected volume growth, coupled with limited competition and a knowledgeable, experienced management team, leaves us optimistic toward the future. We expect continued growth in revenue, cash flow and dividends from this buzz-free coffee producer for years to come and a boost in its market valuation as more investors take notice.
When we meet with new clients, we ask to review and scan their estate planning documents – wills, trusts, POAs, healthcare directives. The reason for this is to learn whether or not they have taken the time and energy to implement a plan, have signed and finalized the appropriate documents, and have expressed their wishes legally should incapacitation or death occur. Many clients implement these documents, but during the review/planning process, we learn things have changed, and these changes can cause major headaches and avoidable issues for those left in charge. Others have done no planning, claiming the intent is there and they’ll get around to it when they have the time. The following are the “essentials” to a less stressful, and hopefully easy transition when that day comes. And let me be clear: that day will come.
In order to determine what’s best for your specific situation, we advise you to seek the guidance of one of our Certified Financial Planners, in conjunction with a licensed attorney, who specializes in succession laws and drafting documents per your wishes. If you have not reviewed your documents in at least five years and/or you’ve had any significant changes (marriage, divorce, death, birth or adoption of a child, blended family), we suggest you pull them out, dust them off and spend the energy to review. It will take about 30-60 minutes and is well worth the time to make sure they still align with your wishes and goals.
Symphony International Holdings Ltd (Ticker: SYNNF,www.symphonyasia.com)
Share Price/Market Capitalization (09/16/15): US$.67/ US$354M
Company Description: London-listed investment company focused on a con--centrated portfolio of Asia Pacific healthcare, hospitality and lifestyle investments.
Investment Thesis: Symphony provides a high-quality portfolio of assets benefiting from positive long-term growth dynamics in the Asia Pacific region. The management team is top-notch and aligned with share-holders. We expect compelling total returns from a combination of value appreciation in the company’s under-lying investments, discount compression and a growing dividend.
Symphony is one of the oldest private equity firms in Asia having started back in 1981. It began as Schroder Ventures and then rebranded to Symphony in 2004 before listing as an investment company in 2007. This listed structure, in contrast to traditional private equity funds, allows management to take a long-term view and remain flexible to invest or divest without the influence of restricted life cycles. Symphony’s focus is squarely on the Asian consumer, and its portfolio features a range of investments in high-growth sectors, including healthcare, hospitality, lifestyle and branded real estate.
The company’s 11-person investment team is led by Anil Thadani, who has more than 30 years of investing experience in the region. Symphony’s team targets businesses with strong management, sustainable competitive advantages, and large enough markets to provide sufficient growth opportunities. Team members often serve on investee company boards to help with strategic and financial decision-making and, if necessary, even operational issues. Unlike traditional private equity funds that pay key employees via carried interest (a fixed percentage of profits), the Symphony team is compensated with a fee linked to the company’s net asset value and a stock option plan. We believe that this compensation structure better aligns the investment team’s interests with ours.
Using June 30 reported values for Symphony’s privately held investments and September 16 market prices for its publicly listed holdings, Symphony has net asset value (assets minus liabilities) of approximately $609M, or $1.15/share. Of this total, approximately 64% is made up of three listed stocks. The largest holding is in Thailand’s leading listed hospitality company Minor International (approximately 42% of Symphony’s net asset value). Minor owns or manages more than 100 hotels and 1,500 restaurants in the Asia Pacific region, and is also involved in contract manufacturing and consumer brand distribution. It consistently generates a mid- to high-teens return on equity and is expected to grow earnings at double-digit growth rates for years to come. The number-two holding, IHH Healthcare (approximately 13% of net asset value), is headquartered in Malaysia and is one of the largest listed healthcare providers in the world. IHH has more than 7,000 licensed hospital beds in 39 hospitals across 10 countries, with a significant pipeline of future growth opportunities. Parkway REIT (approximately 10% of net asset value) is a Singapore-listed real estate investment trust that owns healthcare income-generating property (mainly hospitals and nursing homes) in Singapore, Malaysia and Japan. Rounding out Symphony’s portfolio is an 11% allocation to cash and a 25% allocation to an eclectic mix of property developments and privately held companies.
At recent market prices, Symphony trades at a 40% discount to its net asset value and a 23% discount to its cash and publicly listed holdings. Given the quality of its underlying assets, we believe that return opportunities are very compelling from here. These returns will come from continued fundamental growth and value recognition in its public and private company holdings, successful sales/development returns from its real estate, and the eventual narrowing of its holding company discount. We also expect to continue receiving a mix of regular and special dividend payouts that yield us more than 4% annually on current cost.
Data Sources: Company Filings, Bloomberg
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