REPORT TO THE UNIT HOLDERS IN THE ASPIRING FUND FOR THE QUARTER ENDED THE 31/12/2007
PERFORMANCE
In the month of December in the Aspiring Fund returned 0.2% after fees and tax. The NZX50 Gross index returned -0.4% for the month.
Over the December quarter the Aspiring Fund returned 1% after fees and tax.
Aspiring's return of 1% after all costs for the quarter is obviously not a particularly grand number but in the circumstances it was, to borrow from our friends at Dominion Breweries, “hard earned”.
The NZX50 Gross index was down 5.3% for the quarter (and the gross index over estimates the actual after-tax return of the market by about 0.6% per quarter on average) while the Australian market fell 4.9% in New Zealand dollar terms.
Our performance over the quarter was assisted by the increasing of our cash holdings from 19% to 29%, and from the successful listing of NZ Farming Systems which we had held as a partly paid unlisted investment for some time.
Those unit holders who have their own direct investments in the market, or money with other fund managers, will appreciate what a testing time the market has had over the past quarter.
We should note that our returns for last month and the quarter were inflated somewhat by some unusual price movements at the end of the year (for example Michael Hill surged 10c in the last few trading days to close the year at $1.22). It seems inevitable that there will be some "mean reversion" in the January numbers.
For the year the Aspiring Fund returned 4.4% including all distributions. The New Zealand market as measured by the gross index fell 0.4% during this period and as noted previously the gross index over estimates the real after-tax return of the market by approximately 2.5% per annum. The poor performance of the New Zealand market in 2007 needs to be put into perspective. Over the previous five years returns as measured by the gross index had averaged 16% per annum.
INTRODUCTION OF THE PIE REGIME
The last quarter has been the first under the new "PIE " regime under which unit funds such as the Aspiring Fund are not taxed on capital gains. One consequence of this is that monthly returns will now be more volatile. For example, previously if we had gained or lost 3% in the capital value of our shares in a month the taxman would have taken/given 1% and we would have reported a 2% gain/loss. Now, the entire change in capital value flows through to the performance line.
Whilst such perceived increased volatility might sometimes make for a white knuckle ride when markets go through negative phases, it is worth remembering that the PIE regime will ultimately increase returns to unit holders.
Theoretically, the PIE regime should be a huge boost for the managed fund industry and, in turn, the entire New Zealand sharemarket. Unfortunately, the introduction of this new regime has corresponded with uncertain and negative times amongst global financial markets. Consequently, as yet there have been no behavioural changes from investors in terms of the logical move to place more money into tax efficient managed funds
COMMENTARY
Currently, it feels as if we are swimming against a strong tide, but the good news is that we kept our capital intact in the tricky last quarter of 2007 and that the universe of potential high-quality, well priced investments has improved.
As we start the new year markets remain equally challenging. The US market started the year on a very negative note, losing 5% in the first two weeks of the year. As we write Australian and New Zealand markets appear to have even worse sentiment than the US market even though our economies and credit markets are in much better shape. The New Zealand market is down 5% and Australia 6%.
The decline in the markets year-to-date is as much about fear as reality -- fear that prices will fall further (the momentum effect) and the more rational fear that economic conditions will in the future depress corporate profitability.
In the short run the major real (as opposed to sentiment) issue facing us is the extent to which the meltdown in the US subprime debt market spreads to the real economy and more importantly to the economies of New Zealand and Australia where most of our investee companies operate.
Without a doubt the turmoil in the US debt market is having second round effects in the real world where access to credit is tightening, home prices are falling (dramatically in some parts of the US), residential building industries are contracting and consumers have become more cautious. As the effects of falling wealth and rising unemployment bite we expect consumers in the US, NZ and probably Australia will become increasingly reluctant to spend.
In the US there is already evidence that the economy is in recession but how deep the recession will go is a moot point. The stimulatory effect of their lower currency and falling interest rates will provide some cushion in the US and may mean that their recession is neither deep nor long-lasting. Although many commentators have decried recent US government policy it should never be forgotten that the capitalist ethos of America has delivered far more wealth and growth than other regions of our world.
The doomsayers are getting a fair share of media time at the moment, but generally speaking in times of gloom things seldom turn out to be as bad as people fear, just as conversely in times of boom (the Internet bubble, for example) things are never as good as they seem.
There is also evidence that the subprime meltdown is having an effect on the availability of credit in other countries. In New Zealand we have seen one effect in terms of the mooted acquirer of Sky City Entertainment not being able to secure finance. Leveraged private equity concerns will not, for some time, be the players in the equity market that they have been over the past few years.
In New Zealand we have our own issues with the Reserve Bank keeping interest rates high which is underpinning an uncomfortably high currency and will ultimately squeeze a highly geared household sector. This, combined with rising wage and energy costs, is putting pressure on corporate profitability in many sectors, although there are few companies actually going into a tailspin.
Whilst falling consumer spending and other characteristics of economic slowdown will affect the profits of many companies there will always be pockets of stability and success, opening up opportunities when markets have broad-based declines.
Reading comments from experts out of the U. S. most people are expecting the overall market to fall in the first six months of the year -- we may be seeing a fair amount of this correction in the first month -- but interestingly many professional share investors are actually saying they already see far more attractively priced individual stocks than for some time.
In New Zealand many companies are still doing well. The decline in the share prices of companies such as Mainfreight, Cavotec, and Methven is probably a mystery to their management who see their entities enjoying much success.
Indeed, it has been very reassuring to see directors and management of many companies (Mainfreight, Methven and Hellaby come to mind) buying shares in the recent downturn. Such signs are not trivial.
We expect to see a number of companies, especially in Australia, initiate share buyback programmes in the coming months as boards take issue with the valuations currently being meted out by the sharemarket.
One trend in the New Zealand market of the past quarter has been a significant downward price movement in a number of mid and small capitalisation companies which has hit parts of our portfolio. This trend has also been evident in Australia and, indeed, has been prevalent there for the entire of 2007.
There seems to be a consensus view amongst many in financial markets that it is "safer" to be in large capitalisation companies, the safety coming from being able to exit if you want, even in markets where liquidity has decreased.
Whilst there is some merit to this approach, there is an alternate strategy of buying companies where the businesses are inherently safer in an economic downturn. This strategy has more appeal to us, especially when valuations become more compelling in a bloody market.
As a result of the downdraft in the market there are now a number of companies which we haven't previously owned appearing on our watch list as possible buying opportunities.
We will visit a number of these companies as their management return from holidays and conduct research on their prospects. We suspect there is still time on our side with many such investments, but opportunities are already presenting themselves when impatient sellers slavishly follow the "big cap" strategy and exit small and medium-sized companies.
So in summary, January will be an extremely challenging month, sentiment having turned negative in the face of rising evidence of US recession.
Currently, we are of a mind to keep our high cash position, but at some stage in the short to medium-term we believe there will be good moneymaking opportunities produced by the current fallout.
| Top Holdings as at 31 December |
| Cash |
29.0% |
| Mainfreight |
7.0% |
| Michael Hill |
6.0% |
| Cavotec |
5.0% |
| Wellington Drive |
5.0% |
| Ebos |
5.0% |
| Methven |
5.0% |
| NZ Farming Systems |
4.0% |
| Tower Australia |
4.0% |
| Hellabys |
3.0% |
| EservGlobal |
2.0% |