REPORT TO THE UNIT HOLDERS IN THE ASPIRING FUND FOR THE QUARTER ENDED THE 30TH SEPTEMBER 2008.
|
|
Aspiring
Fund |
|
NZX50 |
|
ASX ALL
ORDS
(NZ$) |
|
|
Month September 08 |
|
-7.16% |
|
-7.80% |
|
-13.80% |
|
| Quarter September 08 |
|
-3.52% |
|
-3.27% |
|
-17.20% |
|
|
Financial YTD (from 1/04/08) |
|
-0.60% |
|
-10.90% |
|
-16.60% |
|
|
Since PIE (1/10/07) |
|
-11.35% |
|
-27.60% |
|
-26.00% |
|
The Unit Price as at 1st October 2008 was 1.0567.
Our asset allocation at the end of the month was approximately:
|
New Zealand equities |
31.2% |
|
|
Australian equities |
9.6% |
|
|
Cash |
59.2% |
PERFORMANCE
The September month continued an extraordinary period in global financial markets, and the value of the fund felt the adverse effects.
The performance, particularly in light of our large cash weighting was very disappointing and requires some explanation.
The strength of the $NZ against the $A over September was a “mark to market” cost to the fund of 1.8%.We believe that, as a fund with an Australasian focus it is prudent, when holding large cash weightings, to spread this cash among both currencies unless there is in our view a strong reason for not doing so. At month end 50% of our cash was deposited in $A. We expect further aggressive rate cuts by the N.Z central bank will blunt the strength in the cross rate and intend to maintain this cash investment balance in the near term.
We saw some sharp falls in our largest remaining equity holdings, particularly on the last trading day of the month which followed the largest point fall on Wall Street in history. Methven fell 19% for the month, Michael Hill 20%, Cavotec 14% and Mainfreight 9.5%.Each is a sound company with solid long term growth prospects but these are extraordinary times with markets showing scant regard for such attributes.
Investors in the fund may rightly ask what the strategy is going forward to respond in the current environment. Firstly, it is very likely that we will continue to carry large cash holdings in the foreseeable future. Any new investments that we choose to make will be in large liquid companies where we regard prices as very overdone. Our recent buying of Telstra, Telecom and The Warehouse are examples of this.
The commentary below looks in more detail at the credit crisis and its effect on business and financial markets. We do not in any way underestimate the seriousness of these events. Before changing our strategy and beginning to invest our cash more aggressively we will need hard evidence that the credit markets are starting to function. The evidence for this will be declining credit spreads and banks again lending freely among themselves. This is a far greater problem for global banks than their Australasian counterparts. The big 4 Australasian banks all enjoy Standard & Poors credit ratings of AA putting them each in the top 25 banks in the world by credit rating. This is testament to their prudence which has been reinforced by the very effective regulatory oversight of both the RBA and RBNZ.
We acknowledge that this approach may mean that we miss the absolute bottom of markets, but capital preservation is a more important consideration than absolute market timing.
The end game here is plain too see; a once in a generation opportunity to buy very cheap assets. What we can’t be sure of is how long and circuitous the process of reaching that point will be, but the most important thing is to be in a position to take advantage when it occurs.
COMMENTARY
September saw a tsunami of negative events. Briefly:
- Lehmans filed for bankruptcy.
- The US government took control of AIG, Freddie Mac and Fannie Mae.
- Merrill Lynch sold itself to BankAmerica.
- Two large US banks (Washington Mutual and Wachovia) representing 8% of US deposits were folded into stronger banks.
- The UK's largest mortgage lender, HBOS, was shotgunned into a marriage with TSB Lloyds. Another lender, Bradley and Bingley, was nationalized.
- On mainland Europe lenders Fortis, Dexia and Hypo were all rescued.
- Governments in Ireland, Germany and Greece guaranteed depositors funds at banks.
Economically, the news was not a lot better (US car sales down 26% was probably the most disturbing), confirming the major economies of the world, including China, are slowing. This in turn, saw commodity prices fall sharply, dragging the Australian dollar with them.
Amongst this unprecedented gloom it was not surprising that global sharemarkets fell on average 11% even though much of the turmoil of September reflected problems already "noted" by sharemarkets to some degree.
Markets are now factoring in an enormous amount of fear, with it almost being de rigeur to draw parallels with the Great Depression of the 1930s. However, the actions of global governments and central banks this time around are diametrically opposed to those taken in the 1930s.
We talk more below about Warren Buffett but one of his better quotes is:
"We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful."
Or recently:
"cash combined with courage in a crisis is priceless."
Although in times of gloom it is easy to panic, there are undoubtedly opportunities developing. Distressed and even blue-chip corporate debt is one area of increasing value. As noted previously you can find companies in Australia trading at less than the cash they have in the bank. Globally, listed investment companies (in New Zealand companies such as GPG, Salvus and the Kingfish camp) are trading at unusually large discounts to the assets they own. It is possible to find good companies on PEs of less than five.
Whilst there are many companies who will suffer badly in the coming economic environment, there is also a significant number whose prices more than reflect the likely decline in their earnings from a deep recession.
At the moment our major concern remains the dislocation in credit markets. Since the receivership of Lehman Brothers the cost of interbank debt as measured by LIBOR has taken another leg up and the commercial paper market has shrunk further -- now down 30% in the last year. In simple language banks are paying higher rates for more limited funding (and passing these effects onto their clients) and even blue-chip corporate borrowers are suffering from similar influences. It is becoming increasingly difficult and costly for firms to roll over debt and this trend is only worsening.
The bailout plan passed by Congress over the weekend is aimed at adding some lubrication to gummed up financial markets. It is a start, but more will be needed in terms of recapitalising financial institutions.
With most of the chaos of September traceable back to the problems of credit markets we will remain hyper cautious until there is clear evidence that these markets are beginning to normalise.
Amongst the gloom in September we noted a number of positives. Firstly, central banks and governments in all parts of the world showed a willingness to do whatever it takes to sort out financial markets. This commitment is not trivial.
Central banks have acted in concert to inject liquidity, with there being a perceptible shift in the attitudes of the Europeans as to the need to fix financial markets rather than inflation.
To some extent the private sector has already begun shoring up the financial system, putting/pledging money into the strongest such as JP Morgan, Morgan Stanley, Goldman Sachs, Citigroup and GE. Global governments need to get involved in this area as well -- and they have started doing so. The rescues of Freddie Mac, Fannie Mae, Fortis, AIG, Hypo, Bradford and Bingley have all had some sort of Government hand.
European governments appear to have belatedly joined the US in recognising that they too will have a role in solidifying and recapitalising the banking system.
The next step for central banks is to drop interest rates, probably in a coordinated manner, in another move to help banks rebuild balance sheets. The NZ and Australian Reserve Banks have more room to move in than most.
If credit markets can be close to normalized and sharemarkets only have a recession to face, we believe much of the panic will dissipate and the value we can currently see will be worth buying, but there are a number of bridges to cross first. It is unknown what damage will be done to corporates and consumers and their confidence before the current credit market rationing and pricing is unwound.
In New Zealand economic data was mixed -- building consents for August were 43% less than the same month last year and retailers such as Hallensteins and Harvey Norman noted continued deterioration in trading.
But three different business confidence indicators suggested managers are starting to get more positive about the future and in particular their own outlook. We suspect the fall in the NZ dollar maybe the catalyst for such a view and indeed a decline in the currency has often been a forerunner to sustained periods of growth. Such confidence surveys are normally good indicators of future economic activity.
With the US economy contracting, this may be a false dawn, but tax cuts, falling interest rates and a reduction in oil/food prices gives hope that New Zealand is starting to find a bottom.
We have in previous correspondence talked about the option value of cash. The activities of Warren Buffett during September were a good example of this. He invested in Goldman Sachs and GE, both times taking preferred shares (ie they rank ahead of shareholders in times of distress) paying a coupon considerably higher than the companies’ dividends, plus he received extra warrants as a sweetener. There are many ways of looking at the deals he cut, but all lead to the same conclusion -- Buffett has used his cash at the right time to increase its value significantly.
Although Aspiring may not be offered the same sweet deals as Warren Buffett we believe the option value of our current cash holdings will be of much value at some stage in the future.
| Top 10 Holdings as at 30th September 2008 |
| Cash |
59.2% |
|
Mainfreight |
4.0% |
|
Methven |
3.7% |
|
Michael Hill |
3.5% |
|
Telecom |
2.8% |
|
Telstra |
2.5% |
|
Eservglobal |
2.5% |
| Cavotec |
2.3% |
|
Hellaby |
2.1% |
|
The Warehouse |
2.0% |