• Gus Crennan

Balmoral Fund 1Q19 Update

Hi everyone,

Thank you for your continued support for the Balmoral Fund.

I have good news. We have enjoyed another great quarter; following avoiding the worst of the selloff late last year we were well positioned for the recovery and the value of our investment portfolio has increased over 15% during the last three months.

1Q19 Update

From inception on Australia Day 2017 our Fund is now a little over 5.1% in front of global share markets after accounting for costs. This is a really strong result and reaffirms we are doing the right things and avoiding costly mistakes.

You may recall that at the end of December 2018 I mentioned capital markets were the most nervous I had seen for several years. That anxiety dissolved in global equity markets over January and by February equity sentiment had recovered and the value of the new investment assets we acquired opportunistically in November and December increased handsomely.

I strongly believe we will see more anxiety at some point this year. The old fears and concerns which rattled equity markets in November and December 2018, despite none of those risks being new, are all still there. BREXIT has certainly become more chaotic, but more broadly the geopolitical, economic cycle and ongoing unwinding cheap liquidity in market valuation risks remain.

Most importantly – the message global bond markets are sending us is one of extreme caution. Yields for the highest quality bonds have fallen to very low levels – for example 10 year US Government bond yields have fallen from 3.25% in November 2018 to nearly 2.4% at end March 2019 despite the US Federal Reserve holding the US cash rate at 2.5% in January and March 2019. Our AAA rated Australian Government is also benefiting from this and borrowing at very cheap interest rates. This fall in yields for safe bonds likely means very large amounts of money are chasing those very safe assets which in turn means very large institutional investors are cautious. Im not smarter, and have far less resources, than those big shops so think it’s prudent to pay attention to this message.

This is the conundrum then; fearful bond markets, and concurrent confident equity markets, cannot both be right. Smashing that collage of conflicting messages together my view is that the asymmetries are not strongly in our favour and it’s likely that some negative piece of news or data will startle a disorderly equity market retreat like what we saw last year. This is not an environment where we should have all our assets committed but rather an environment where we should be cautious.

I am not alone in thinking like this. “Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.” Mr Buffett, aside from his legendary investment skills, turns a wonderful phrase.

Over the last quarter I have opportunistically trimmed our invested positions back and by the end of March our Fund is back to 36.5% cash, which is a highly defensive position to be in. Said differently only two thirds of our Fund is currently invested with the rest not at risk of any equity market pullback and ready to go shopping for bargains with.

I respect that all our investment capital was hard won and I will always prioritize protecting it first as the strongest foundation to grow that capital over time.

The risk in such a defensive portfolio positioning is if equity markets rocket higher then only a portion of our assets will participate in that rising market – this risk is sometimes called ‘Fear Of Missing Out’ or FOMO. I believe retaining a third of our Fund in cash at this point is an acceptable risk given the 15% gains that portion of our invested capital has already made this year and my view that we will be able to invest that capital again in the near future at more attractive prices. We also have defensive tools available to manage this risk as the situation evolves, although at present I am very comfortable and see no need to utilize those tools just yet.

As always I will be monitoring bond and equity markets closely, listening to the messages each has to tell, and looking for attractive opportunities for us to compound our capital. As we have successfully done in the past when opportunities appear it’s in our interests to have the ability to move decisively and with conviction – retaining cash is the best way to have that flexibility.

Turning to quite a different matter I want to note this recent activism in the Balmoral Fund’s exposure management is the opposite of what investors experience with Index Funds and ETFs.

The benefits of our active stock selection and exposure management is especially relevant given how much markets have gyrated around in the last 6 months. When markets move this much it entirely appropriate and sensible to actively manage exposure, ie sell some assets at high prices when the market is excited and buy some assets when the market is fearful.

The impacts of our activism in exposure management is as follows. The large sell-off which commenced on 22 September 2018 and ran to late December 2018 saw global share markets rapidly lose over 16% in value whereas Balmoral’s exposure management reduced those paper losses to 12.7%. Because we had cash available before the sell off, and we invested those reserves pretty much at the bottom in good investments, we also did better in the subsequent market recovery – our portfolio gained 15.2% from the market bottom on 22 December 2018 to end March 2019 (inclusive of fees paid in early January and end March!) whereas the overall global share market increased by ‘only’ 14% over the same period.

In short, due Balmoral’s active management in fast moving conditions, we did substantially better in both the falling market and the subsequent recovery.

Skilled exposure management and security selection have both contributed to performance providing substantially more return than Balmoral’s fees. Provided this equation continues in your favour then I think this arrangement is mutually satisfactory.

Summary position as at end March 2019 Unit price of the Balmoral Fund, after fees and expenses, as at end March 2019: $1.21933

Portfolio summary

As at end March 2019 we are collectively part-owners of 14 companies, down from 20 at the end of December. Our current portfolio of investments is below:

1. Villeroy & Boch – German super premium porcelain. 2. Hugo Boss – German corporate and smart casual clothier 3. Sartorius Stedim Biotech – French laboratory equipment supplier 4. Kroger – US retailer 5. H&M – Swedish fashion retailer 6. Gentex – US engineering group 7. Snap-On Incorporated – US specialty tools company 8. Mattel – US toy, and increasingly entertainment, company 9. Subaru – Japanese car company 10. Telstra – Australian telecommunications company 11. Euronext – European securities market exchange 12. Skyworks – Dominant US semiconductor tech company 13. LAM Research – Dominant US wafer fabrication tech company 14. Biogen Incorporated – US biotech

Between end December 2018 and end March 2019 we sold our part ownership of 6 businesses:

  • 1. Cheesecake Factory was sold for an 8% capital gain. We also received a further 0.8% of dividends over our short holding period. This builds on the 42% capital gains we made on this stock when we sold it the first time in the June 2018 quarter. As I mentioned in the June letter I like this company and its highly capable management team however its vulnerable to inflation so I am cautious of its long term cash generating capacities.

  • 2. CPL Resources was sold due BREXIT risks for 12% capital gain. We also received a further 1.4% dividend over the holding period. The share price has increased since we sold which is a little disappointing however as I write above my strong view is its better to avoid risk and preserve capital for more certain investment opportunities.

  • 3. Inwido has been a big disappointment and was sold for nearly 41% capital loss. Its small commiseration however the position was a small one in the portfolio and it has paid us a dividend yield around 6% over 2017 and 2018 which reduces this loss somewhat.

  • 4. Dunelm was sold due BREXIT risks around 37.4% capital gain and the position has paid us some nice dividends over the years, around 5.1% yield over calendar 2018.

  • 5. Borregaard was sold for a capital gain of 14.9% and we also received around 3% dividends over our short holding period.

  • 6. Headlam was another disappointment, it’s a good company with very clean financials, however I sold our stake due BREXIT risks for 17.9% capital loss. Dividends we received from our 2017 entry point reduce this somewhat, indicatively our 2018 dividend yield was 5.3%.

We have now completely exited our investments in the United Kingdom and Ireland on a tactical basis given the BREXIT mess just seems to be getting worse. Dunelm and Headlam Group were our remaining UK positions, CPL Resources was our only Irish position.

Our Scandinavian positions have also been heavily reduced – Borregaard (Norwegian) and Inwido (Swedish) were both completely exited. H&M is our remaining Swedish company and at end March was trading at 13% unrealised capital gains and the company continues to pay a strong dividend yield a little over 7%.

As I note below we have reduced exposure across the whole portfolio to rebuild our cash reserves to prepare for future opportunities, to protect our capital in an outright sense and to protect a good part of the capital gains we have earned so far this year.

Portfolio construction

As at end March 2019 our portfolio looks roughly as follows:

• 37% cash (+35% from end December) • 39% US companies (-17% from end December) • 17% European companies (-11% from end December) • 0% UK companies (-6% from end December) • 3% Japanese company (Subaru, unchanged) • 5% Australian company (Telstra, unchanged)

Please reach out to me if you would like any additional information.

Regards Angus

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