REPORT TO THE UNIT HOLDERS IN THE ASPIRING FUND FOR THE QUARTER ENDED 30 SEPTEMBER 2007
PERFORMANCE
In the month of September the Aspiring Fund returned 2.17% after fees and tax. The NZX 50 gross returned 3.6% untaxed for the month.
Over the September quarter the Aspiring Fund returned -0.38% after fees and tax.
Over the same period the NZX 50 gross gained 0.8%, the ASX All Ords 14%, whilst the MSCI World Index fell by 0.1% in local currency but rose by 4.8% in NZD terms, reflecting the lower $NZ.
Since inception in February 2006 the Aspiring Fund has returned 27.4% after tax and fees versus the NZX50’s return of 27.1% untaxed. The Fund’s pretax return of 47.6% for the period highlights the effect taxation has had on the Funds performance.
COMMENTARY
The above figures mask what was a truly extraordinary period for financial markets.
What had started as a problem in the so called sub-prime mortgage market in the U.S turned into a full scale credit squeeze which saw runs on some financial institutions and at its height threatened the orderly function of the financial system.
Equity markets reacted to all of this as was to be expected, and at one stage during August most were down some 10% from their position at the beginning of the quarter. Fear of widespread failure in the financial sector turned to more general concern about the ability of the global economy to withstand the secondary effects of the crisis, leading to further heavy selling.
Currency markets also behaved violently, with the $NZ losing 16% against the yen in one week in the middle of August as the so called carry trade was aggressively unwound.
In N.Z, the crisis saw a ‘flight to quality’ away from fringe financial organisations which resulted in a number of small finance companies going to the wall, and intense pressure on many others to maintain liquidity.
The reaction to all this by the major central banks was to inject billions of dollars of liquidity in the system, and on August 16th the U.S Federal Reserve took the unusual step of reducing the rate at which the banks can borrow from it, and at the same time warning that the downside risks to U.S growth had increased appreciably.
This action seemed to restore some confidence to the markets, which rallied strongly throughout the rest of August, and then when the Federal Reserve cut its Funds rate early in September this rally gathered further momentum and has continued since.
As we have stated on some occasions in the past, we have for some time felt uncertain as to value in equity markets, feeling that markets had become vulnerable to a major correction due to issues such as gathering inflationary pressures, higher bond yields and stretched valuations. We had, for some time, been reluctant and somewhat suspicious players in the game as we continued with difficultly to find pockets of value in both the N.Z and Australian markets.
We viewed the emerging credit crisis seriously and took the view that there was an increasing possibility that the so called ‘knock on’ effects could be material to the global economy, and therefore have an ongoing adverse impact on markets.
Accordingly, we moved at this time to further de-risk the fund by increasing its cash holdings, selling stocks that we felt were most vulnerable to the broader implications of the crisis. This included a number of our major holdings in Australia.
Hindsight has so far shown this to have been a mistaken view. The strength and duration of the rally in equities since mid August has been a surprise to many, including ourselves. In attempting to act prudently and preserve the value of the fund we have left some gains on the table, but that is the nature of investment markets and we will continue to be cautious investors.
OUTLOOK
The world remains awash with cash as the so called ‘baby boomers’, the richest generation ever, look for investment opportunities for their mounting savings. Further, the emergence of China and to a lesser extent India as major and fast growing economies has lessened the historical reliance on the U.S as the major source of global growth.
Against this, valuations are such that, as was shown in August, there is little tolerance for events from left field and we still view the future cautiously.
However, the fact that markets have emerged largely unscathed from the recent turmoil may well be a strong pointer to the short term outlook as this was truly a ‘cage rattling ‘event.
Despite the apparent lack of value, it is difficult to avoid the conclusion that investor liquidity and optimism will continue to hold sway and that markets may well be heading higher, and that, as happens in booms, over valuations may well just become more extreme.
A well known trader from a large Sydney broking firm, writing in his daily report, put in this way “This market is absolutely crazy, it’s almost like a swimmer who was taken by a shark and survived, and has decided to go back in for a dip. But that quick dip has become a big swim and they are feeling so confident that they have ventured far from shore”
PORTFOLIO
We made two significant additions to our major New Zealand holdings during the quarter.
EBOS is a company we have followed for years but always been nervous that the management were doing such a good job that the market was overpaying relative to the quality of the business itself. We share EBOS’ management’s view that the acquisition of Propharma and Healthcare Logistics is a company changing event and were delighted to be given the opportunity to participate in the capital raising which partially funded it.
We have also started to build a position in Hellaby Holdings. This company is also well-known to us but the share price has been trashed recently on the back of disappointing earnings and a slashed dividend. We have spent some time with the new management and are confident that they have the skill and commitment to materially improve the company’s operating performance in the next twelve months. Our view that it is currently cheap is clearly shared by the company’s management as we have observed that the new Managing Director, who had a big position in the stock before this result, has continued to buy along with 6 other individual insiders. Widespread insider buying is never a bad sign.
Another major holding, Mainfreight, acquired Target Logistics as a significant first step in a major expansion planned for its United States business. We know that Mainfreight conducted an exhaustive due diligence programme on this and we have complete confidence in the judgement of Mainfreight’s management and board. We expect this to be vindicated by the numbers over the next twelve months but acknowledge that the rest of the market seems to be waiting for those numbers before giving the transaction a tick.
As previously stated, the decision in August to sell some major holdings in Australian proved costly for the fund. We will progressively look to rebuild positions in Australia using a ‘bottom up’ approach utilising our new partner Roger Armstrong’s experience in this market along with his analytical skill.
As has been previously advised, Oct. 1st is a red letter day for the fund and the N.Z investment scene generally as the new tax regime comes into being. Over time, this will be of substantial benefit to investors in the fund.
However, because of the removal of the ‘smoothing effect’ of tax each month, the volatility of monthly performance will be greater than has been the case to date.
| Top Holdings as |
at 30 September |
| Cash |
19.0% |
| Mainfreight |
8.0% |
| Cavotec |
6.0% |
| Methven |
6.0% |
| Ebos |
6.0% |
| Michael Hill |
5.0% |
| Contact |
4.0% |
| Sky TV |
3.0% |
| Hellabys |
3.0% |
| Bravura |
2.0% |
NEW WEB SITE
During October we will introduce some additional functionality to our web site. Investors will receive a log in code and initial password. Each investors unit holding, current market value and historical information will be available on their personal page.