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Our ho-hum, slightly positive 0.7% Q4 absolute return beat the Russell 3000 index, while lagging the Russell 3000 Value index. The 21% net return for the year was quite nice, handily beating the respective benchmarks. Since inception, which is now 9 1/2 years, our 10.8% net annual return exceeds the two benchmarks by over 400bps each. We unfortunately continue to note that the longer-term returns have not achieved our "dream" objective of 15% -- indicating plenty of misjudgements on our part.

Other people can expound intelligently about the macroeconomic environment. We don't have substantial insight, but do observe that the housing and automotive industries seem to be improving off massive cyclical troughs. While it's anyone's guess as to what happens, we continue to see these areas as fundamentally depressed, with room for further improvement if the economy continues to normalize.

Our quarterly performance was helped by stronger results at CarMax and Mueller Water, with improved sentiment toward housing-relating names seeming to boost Simpson Manufacturing. We were fortunate to initiate our stake in Q3 when investors were fearful.

The strength of the above-mentioned names was offset by weakness at athenahealth, IAC/Interactive, and VASCO Data. The former two names fell after short-term earnings reports/outlooks disappointed investors whose expectations had risen throughout the year. We took advantage of the corrections to further build our positions. We were more concerned by the weak results and outlook at VASCO, which led us to the decision to sell and redeploy the capital elsewhere.

The market's volatility in the quarter continued to lead us to churn names (and position sizes among continuing names) more than we are accustomed. This characteristic has been true for the past couple of years. While we prefer the idea -- and tax efficiency -- of buy and hold investing, we will trade around the portfolio if such moves appear to improve the overall risk/reward profile after taking into account transaction costs and a margin of safety.

We added three new names to the portfolio in the quarter:
Washington Post is a rebounder, having just been sold out of the portfolio in the second quarter. At that time, we were concerned about the impact continued abysmal performance would have on the stock and preferred investing the capital in other names (including pure-play traditional media names Scripps, Gannett, and Meredith that seemed attractively valued with better short-term fundamentals). That industry exposure has now been pared as those stocks rose with booming results from political advertising (and continued economic improvement). More important, we have increased confidence in the value (and growth opportunities) for the Kaplan International education and technology business. The potential stabilization/rebound of the domestic education business is an option that could prove valuable over time. The outlook for the company's other businesses are challenged, but we believe the cable/internet and TV stations will provide substantial cash flow before their current business model is upended by technological shifts. We hope that the company will successfully transform these businesses before they die, but take some comfort that the cash flow can be used to invest in new businesses -- or share repurchases -- as the changes occur. We actually think a going-private transaction at a depressed valuation is one of the biggest risks to holding this name. (One final note: we are also drawn to the company's balance sheet strength, which in addition to a net cash position, includes a dramatically overfunded pension plan, some real estate, and a few miscellaneous smaller investments.)

Sorry for the rambling, I'll try to be more concise the rest of this post.

We bought two other new names last quarter. Both are controversial -- hence the potential opportunity -- and we fall in the camp that the stock prices during the fourth quarter provided appealing risk/reward situations.

AIG is a global property/casualty and life insurer that was on the brink of bankruptcy as it helped precipitate the recent financial crisis. After a government takeover, installation of new management, and substantial pruning and restructuring, we believe the company is on the road to recovery. While the route will likely be strewn with some stormy weather, we think the company will continue improving executing in its property/casualty unit and profitably redeploy its excess capital. We see substantial room for both valuation expansion (from just over 0.5x book) and growth in book value, a very profitable combination if it comes to fruition.

JCPenney is a retailer in the midst of a total transformation under the leadership of Ron Johnson, one of the visionaries behind Apple's retail stores. The early signs of the JCP renewal have been discouraging (comps were down 26% in Q3) as he went for a cold-turkey stop to promotions with an only gradual roll-out of new ideas and departments. We still think his approach to modernizing the store and offering hold longer-term promise. If they work, the company could be embarking on a transformation akin to Macy's in the 2000's. We find the risk/reward characteristics intriguing at less than 0.3x (seemingly depressed) sales. (Macy's now trades at about 0.6x sales). We note that the company's financial profile is a bit stronger than many ascribe thanks to its ownership of 426 store properties as of 1/28/12.

As mentioned above, we sold out of VASCO Data after it reported a weak outlook, feeling that we could better deploy our capital elsewhere (for the non-cynical, that's a euphemism for "we made a mistake"). A tougher decision was to sell-out of Travelers, as the valuation still seems reasonable and the company should be poised for continued success despite a nice rise since our initial purchase in August 2011. That said, we felt other portfolio names (including new purchase AIG) were more compelling


Q4:12 2012 3 Yr 5 Yr ITD
Contrarian Focus (net) 0.7% 21.1% 19.0% 9.1% 10.8%

Russell 3000 0.3% 16.4% 11.2% 2.0% 6.7%
Russell 3000 Value 1.7% 17.6% 10.9% 0.8% 6.7%



Note: ITD is inception to date, starting June 27, 2003. All performance figures for periods over one year are annualized.

The preceeding performance data is preliminary, approximate, and not calculated according to to CFA Institute performance presentation standards. For simplicity sakes, dividends have been accounted for on payment date (rather than ex-dates) since April 30, 2011. This performance only represents one portfolio that has been managed since 6/27/03. "Net-of-fee" performance deducts a 1% annual management fee (that was charged when the portfolio was managed at an investment advisor and is now hypothetically deducted to maintain realism).
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