“This is a nightmare, which will pass away with the morning. For the resources of nature and men’s devices are just as fertile and productive as they were. The rate of our progress towards solving the material problems of life is not less rapid. We are as capable as before of affording for everyone a high standard of life – high, I mean, compared with, say, twenty years ago – and will soon learn to afford a standard higher still. We were not previously deceived. But to-day we have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand. The result is that our possibilities of wealth may run to waste for a time – perhaps for a long time.”
The Great Slump of 1930 – John Maynard Keynes
FIM Group is an investment manager with a bias toward buying $2.00 of assets for $1.00. In today’s generally expensive market (see below), do risk-adjusted bargains even exist to be found? We believe the answer is yes, although the challenge is perhaps as great as it’s been in the last decade to uncover them. Structural and behavioral issues amid the markets we invest in certainly help our cause. For example, even in today’s information age, some companies remain off the radar for big institutional investors (like pension funds) until they reach a certain size or are included in the indexes by which so much money is benchmarked against. Because these stocks are not “worth” the coverage of brokerage analysts (who make money selling their research to the big institutional investors) or the inclusion into the stock indexes upon which today’s massive passively-managed products target, they may not be swept up by broader market manias. Another reason bargains exist is simply the short-sightedness of many investors today who don’t have the patience (or investment mandate) to invest through the near-term issues that even the highest quality companies must contend with. These issues can include regulatory changes, new competition, and a shift in customer preferences, among other things. More often than not, management teams facing these issues respond effectively, but with a lag. This can result in a temporary market over-reaction and yes, a bargain for those who can invest with more than a 90-day time horizon.
We will always believe that the price we pay for an investment matters. Oddly, this does not seem to be a philosophy shared by many market participants today who invest (or more accurately speculate) with little regard for price at all. In fact, what we see today are market participants increasingly attracted to 1) the lowest cost index funds (whose “managers” make decisions by index formula rather than price), 2) momentum strategies (aka stocks and funds that have recently appreciated), and 3) get-rich-quick, fad du jour schemes (like the mania today in crypto-currency Initial Coin Offerings). Put another way, these approaches are highly price-insensitive, and in my mind, warrant high levels of caution.
Today, stock and bond markets seem eerily calm despite extreme economic and geopolitical uncertainties around the globe, hypercompetitive forces, bloated debt levels and changing demographics. All of that uncertainty would be fine and dandy if we were not in this bizarre world where the earnings yield is 4% on the popular S&P 500. The earnings yield is simply the amount of a company’s earnings (net profits) divided by its stock market value. Generally, the higher the earnings yield, the more investors “get” for their money. The long-term mean historic earnings yield is 7.39%, and the median is 6.72% for the S&P 500. If we figure that 7% would be a reasonable earnings yield over time, then the S&P would need to drop 43% to get to that “historic average.” This math, of course, is vastly oversimplified. But for anyone who believes that “price matters,” the message is clearly “lookout, because this stock market ain’t cheap!”
Those in “La La Land” say that this time is different. And, yes, this time is different. Interest rates are very low. Government debts and deficits are high. The developed world’s population is “old,” and we have crazy people shooting missiles over Japan, and other crazy people saying that the price you pay for an investment doesn’t matter. Well, I might be crazy like a fox, but I would rather buy an investment that earns 10% than one that pays 4%.
All investing requires that we make judgements and take action (or inaction if appropriate) despite an unknown future. Finding good quality companies and investing in them with price sensi- tivity is mission-critical. So is structuring client accounts to handle individual liquidity needs and volatility tolerance. This allows perseverance and success through the inevitable cycles that roll through markets by avoiding the perma- nent losses that come from being a forced seller. I will not bore you with the details or methodology of a recent retirement study, because, really, it’s like a “Duh!” that is a commonsense kind of conclu- sion: People who got hurt bad in 2008/2009’s Great Financial Collapse market were the ones who sold their stock and corporate bonds to buy something considered “safe.” What the panicked sellers did, in fact, was lock in losses. Today, in 2017, we expect that there is a possibility of some significant volatility in the stock market. I have been through this before, and while experiencing that volatility is unsettling, it is really a necessary step to maintain some sanity in the markets. Every investment tends, over time, to get either far too expensive or far too cheap.
I don’t have a crystal ball but I do have decades of experience as does my terrific team. We’ve learned over these many years to be cautious with high priced market environments like the one we face today, at least in the U.S. That doesn’t mean we stop investing. Quite the contrary, when we can find good risk-adjusted bargains, we will happily own them in client accounts. Fortunately, we maintain a flexible investment mandate and robust client servicing structure that focuses on real client financial goals rather than tracking or beating the most popular U.S. stock indices. This allows us to invest outside of the most expensive parts of markets today and own a diverse mix of good quality holdings that still meet our margin of safety requirements. It also allows us to structure accounts that cater to your needs, especially the important areas of liquidity and volatility tolerance where proactive management can make a big difference through market cycles.
On September 7, 2017, Equifax, one of the three main credit reporting agencies, announced a massive data security breach that exposed vital personal identification data – including names, addresses, birth dates, and Social Security numbers on as many as 143 million consumers, roughly 55% of Americans age 18 and older.1
This data breach was especially egregious because the company reportedly first learned of the breach on July 29 and waited roughly six weeks before making it public (hackers first gained access between mid-May and July) and three senior Equifax executives reportedly sold shares of the company worth nearly $2 million before the breach was announced. Moreover, consumers don’t choose to do business or share their data with Equifax; rather, Equifax – along with TransUnion and Experian, the other two major credit reporting agencies – unilaterally monitors the financial health of consumers and supplies that data to potential lenders without a consumer’s approval or consent.2
Equifax has faced widespread criticism following its disclosure of the hack, both for the breach itself and for its response, particularly the website it established for consumers to check if they may have been affected. Both the FBI and Congress are investigating the breach.3 In the meantime, here are answers to questions you might have.
Equifax has set up a website, equifaxsecurity 2017.com, where consumers can check if they’ve been affected by the breach. Once on the site, click on the button “Potential Impact” at the bottom of the main page. You then need to click on “Check Potential Impact,” where you will be asked to provide your last name and the last six digits of your Social Security number – a request that was widely mocked on social media as being too intrusive when the standard request is for only the last four digits.
Equifax has stated that regardless of whether your information may have been affected, everyone has the option to sign up on the website for one free year of credit monitoring and identify theft protection. You can do so by clicking the “Enroll” button at the bottom of the screen. Note: Just clicking this button does not mean you’re actually enrolled, however. You must follow the instructions to go through an actual enrollment process with TrustedID Premier to officially enroll.
More wrath was directed at Equifax when some eagle-eyed observers noted that enrolling in the free year of credit protection with TrustedID Premier meant that consumers gave up the right to join any class-action lawsuit against the company and agreed to be bound by arbitration. But an Equifax spokesperson has since stated that the binding arbitration clause related only to the one year of free credit monitoring and not the breach itself; Equifax has since removed that language from its site.4
Equifax’s response to the data breach is to offer consumers one free year of credit file monitoring services through TrustedID Premier. This includes monitoring reports generated by Equifax, Experian, and TransUnion; the ability to lock and unlock Equifax credit reports with a credit freeze; identity theft insurance; and Social Security number monitoring.
Consumers who choose to enroll in this service will need to provide a valid email address and additional information to verify their identity. A few days after enrolling, consumers will receive an email with a link to activate TrustedID Premier. The enrollment period ends November 21. After the one free year is up, consumers will not be automatically charged or enrolled in further monitoring; they will need to sign up again if they so choose (some initial reports stated that consumers would be automatically reenrolled after the first year).5
It is always a good idea to monitor your own personal information and be on the lookout for identity theft.Here are specific additional steps you can take:
• Fraud alerts: Your first step should be to establish fraud alerts with the three major credit reporting agencies. This will alert you if someone tries to apply for credit in your name. You can also set up fraud alerts for your credit and debit cards.
• Credit freezes: A credit freeze will lock your credit files so that only companies you already do business with will have access to them. This means that if a thief shows up at a faraway bank and tries to apply for credit in your name using your address and Social Security number, the bank won’t be able to access your credit report. (However, a credit freeze won’t prevent a thief from making changes to your existing accounts.) Initially, consumers who tried to set up credit freezes with Equifax discovered they had to pay for it, but after a public thrashing Equifax announced that it would waive all fees for the next 30 days (starting September 12) for consumers who want to freeze their Equifax credit files.6 Before freezing your credit reports, though, it’s wise to check them first. Also keep in mind that if you want to apply for credit with a new financial institution in the future, or you are opening a new bank account, applying for a job, renting an apartment, or buying insurance, you will need to unlock or “thaw” the credit freeze.
• Credit reports: You can obtain a free copy of your credit report from each of the major credit agencies once every 12 months by requesting the reports at annualcreditreport.com or by calling toll-free 877-322-8228. Because the Equifax breach could have long-term consequences, it’s a good idea to start checking your report as part of your regular financial routine for the next few years.
• Bank and credit card statements: Review your financial statements regularly and look for any transaction that seems amiss. Take advantage of any alert features so that you are notified when suspicious activity is detected. Your vigilance is an essential tool in fighting identity theft.
Consumers with additional questions for Equifax can call the company’s dedicated call center at 866-447-7559. The call center is open seven days a week from 7 a.m. to 1 a.m. Eastern time. Equifax said it is experiencing high call volumes but is working diligently to respond to all consumers.7
1, 3-5, 7) The Wall Street Journal, September 8, 2017, September 10, 2017.
2) CNNMoney, September 8, 2017.
6) The New York Times, September 12, 2017.
Source: Broadridge Advisor Solutions
Share Price/Market Capitalization: $35.30/US$842m
Investment thesis: Associated trades at a significant discount to its adjusted book value. We expect this book value to grow over time as the company increases assets under management in its unique investment strategies. Additionally, we expect the discount to book value to narrow as the company deploys significant non-return-generating cash into more profitable opportunities.
Company description: Associated was spun off from famed investor Mario Gabelli’s GAMCO Investors in 2015. The idea with the spin was to take the cash and investment assets at GAMCO, which were receiv- ing little, if any, value in the market, and to create a new public company to make this value more transparent. Associated was listed with assets including cash, GAMCO funds and seed investments, GAMCO shares, and even a loan from GAMCO paying 4%. In addition to these assets, Associated also received two operating businesses. The first is an alternative asset management business currently focused on merger arbitrage strategies. These are strategies that aim to generate investor returns independent of the overall stock market return. Essentially, Associated’s investment managers buy the target companies of announced corporate mergers at discounts to the merger price and hold them through completion of the deal. The second operating business is Gabelli’s institutional investment research business, which does about $10 million per year in annual revenues.
More about the business model and the value we see: Associated makes money by charging fees for managed assets and research services while also benefiting from returns on its rich balance sheet. In its most recent financial update (the second quarter ending in June), the company reported healthy results. Assets under management, on which it earns both base and performance fees, were 18% higher than a year ago, to $1.4 billion. Research service fees were also modestly up, and the value of its balance sheet investments appreciated materially.
Associated should see a continued demand tailwind for its largely market-agnostic merger arbitrage investment strategies. Institutional investors are looking for alternatives to expensive stock and bond markets, and especially to those that can withstand potentially higher interest rates. With a long track record in the merger arbitrage space and decent performance in higher rate environments, Associated is well positioned to grow assets. Because the company’s business model is highly scalable (for example, the current investment team that manages $1.4b could manage double this amount with no further staffing increases), the backdrop for operating profit growth is also quite positive.
Perhaps equally important to moving the book value needle at Associated (if not more so) is management’s success in allocating the company’s balance sheet capital going forward. This capital includes more than $300 million in cash that is now earning close to zero. Management is already taking strides to put this excess cash to work, with announcements of a new investment fund (Gabelli Private Equity Partners) and board authorization of a new share buyback plan. Combined with better operating profit growth through growing assets under management, plus nonoperating profit growth via improved cash utilization, we believe that Associated’s book value can grow annually in the high single digits. As it does, we expect the discount to book to narrow, providing us with an additional source of return.
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