June 2020 Balmoral Fund Investor Update
The Balmoral Fund has outperformed global share markets over the first six months of 2020 due being conservatively positioned going into the major sell-off earlier this year. As with the sell-off at end-2018 Balmoral’s rigorous risk management proved its value.
As at 30 June our Fund remains conservatively positioned due the scarcity of good opportunities priced to reflect risks. The US equity market for example is the most expensive it has been this century. Given the macro backdrop we can put expensive share prices down to the confluence of central bank driven cheap and plentiful credit, an investing community extrapolating the market’s recent past, personal debt and mortgage payment pauses and enormous government crisis payments finding their way into capital markets. Because of that increased speculation global capital markets’ pricing efficiency is weaker than usual, which should in particular alarm index investors.
Asset prices cannot be sustained at these levels over our multi-year investment timeframe. The backdrop is the global coronavirus pandemic crippling economic and trade activity, synchronised global recession, falling corporate earnings, rising insolvencies, high unemployment, excessive household, corporate and government debt and escalating geopolitical risks.
You might remember how fast the market corrections occurred from the GFC and the tech bubble bursting. Sentiment changes rapidly. We had the first inkling of market panic in March 2020 and investment risks have increased since then. Bond markets, banks and global credit rating agencies could not be clearer on this.
At end June the Balmoral Fund was over 70% in cash with its main risk exposure being currency fluctuations give it has a high exposure to foreign currencies, mainly US Dollars.
We are positioned to ride out a return of market anxiety at some point and actively take advantage of opportunities that will eventuate. This positioning carries opportunity cost in the short term; if shares prices do just march higher from here then we would only capture some of those gains.
Overview of Performance
The financial review of the Balmoral Fund has now been completed by the Fund’s chartered accountants Page Harrison. At the end of June 2020 our Fund’s unit price has been confirmed at $1.09766 which translates to us doing 4.95% better than global share markets (as defined by the MSCI World Index) after fees over 2020 to date.
As at 30 June 2020 we were collectively part-owners of 9 companies. Between end March 2020 and end June 2020 we purchased stakes in 6 new businesses. With the exception of Rapid7 the other 5 businesses are all growing, consistently cash generative, use modest amounts of debt, proven through previous periods of hardship and leaders in their specialist fields. These businesses have established relationships with specialist end users, understand their customer requirements well and their specialist products’ quality are proven; a really difficult combination to compete against. We acquired all these businesses at attractive valuations. Rapid7 is the exception in that it’s a rapid grower which we acquired for its expected future cash generation. I regard our 6 new investments as great businesses which could all become long term holds.
1. Alfa Laval AB – a 137-year-old Swedish world leader in equipment and systems for heat transfer, separation and fluid handling..
2. Bucher Industries AG – a 213-year-old Swiss leader in the manufacture and distribution of food processing machinery, vehicles and hydraulic components.
3. Gurit Holdings AG – a 185-year-old Swiss global leader in high performance plastics, foams, resins and other composite materials.
4. Morgan Advanced Materials PLC – a 164-year-old UK business which is a global leader in carbon, advanced ceramics and composites.
5. Service Stream Limited – is a 24-year-old Australian business providing integrated end-to-end asset life-cycle services to utility and telecommunications asset owners, operators and regulators across Australia.
6. Rapid 7 – is a US leader in cybersecurity and corporate compliance whose systems manage cyber vulnerabilities, monitor investigate and shut down malicious behaviour as well as collecting data from across a business’ environment.
In addition to those new investments we also retain the existing portfolio of three investments below:
1. Sartorius Stedim Biotech - a young French spin-off company which we first acquired in April 2017 and has been a stellar investment for us. The company produces single use laboratory, pharmaceutical and medical items.
2. Fresenius SE & Co. KGaA is a 108-year-old German health care company. It provides products and services for dialysis, in hospitals and inpatient and outpatient medical care.
3. Johnson & Johnson is an iconic 134-year-old US medical and consumer products company.
Given the share market excitement over the last few months well priced opportunities have become less common than they were in March and April. We are not in a hurry. When opportunities improve then I will be looking to continue rebuilding our portfolio.
As at end June our portfolio looked as follows:
· 71.2% cash
· 6.4% US companies
· 14.9% European companies
· 4.8% UK companies
· 2.6% Australian companies
Due the ongoing expected disruption from high US coronavirus infection rates, and given its relative expense to other share markets, at 30 June 2020 we remained very lightly invested in US companies. Many of the world’s best businesses are in the US market so, when opportunities are better priced to reflect risks, we will be looking to substantially increase this exposure.
We continue to have no direct exposure to bond markets. This is due elevated risk of defaults and low expected returns.
Our end June 2020 cash exposure remains very high because asset prices are expensive in an environment where systemic risks remain high. Cash provides us stability and optionality for the future.
The Impacts of Currency Movements
Our Fund’s underlying investments increased in value over the 3 months to end June however the unit price is down from March because of significant currency movements.
The Australian Dollar increased in value against the US Dollar 12.6% and the Euro by 10.5% over the three-months to end June, which are very big movements in a short space of time, and those movements reduced the value of our foreign currency exposures in Australian Dollar terms.
The centrality of the US Dollar to global economic activity remains unquestioned. I remain comfortable that we continue to hold a large exposure to USD in our Fund and expect that at some point over the rest of the year we will be using US Dollars to purchase US investments.
Our Conservative Positioning
In June 2019 I provided some analysis why our conservative positioning was appropriate at that time. The market has changed a great deal over the subsequent 6 months so I am sharing an updated analysis paper explaining why we continue to remain conservatively invested.
I expect to be back in contact in early October. In the interim if you would like to discuss anything in this letter, our portfolio’s positioning or our investments please contact me.