Update No. 100 – 15/02/13

Regular readers have probably been expecting something special, this being the 100^th update since I launched EGP Fund No. 1 on April 1 2011.  You’ll probably be disappointed, for it will be just a regular update.  Though I am pleased to be able to report in our 100^th update that to date, since inception, our investors have returned 19.81% per annum (after all fees/costs) in the 22.5 months we have operated.  This is most pleasing because our benchmark, the ASX200 has returned a much more modest 6.71% per annum in the same time.  This nearly 13.1% annual advantage will surely fall, though I hope it is mostly trimmed by improvements in the benchmark returns, rather than falls in ours!

We have had only one stock post results this week (I had expected 2, but the other will report next week instead); the result we got was a little weaker than I had forecast, the stock rose more than 15%.  Market sentiment is a funny thing, I assume the reason the stock rose is due to the broader market being even more pessimistic than I was, the purchase was made with an eye to future years.

I have had a couple of questions from fellow holders about how the current EGP unit price works with respect to fees.  The table below shows the current price – $1.40343 assuming Friday was the close of the current period and any performance fees had been removed.  We are only 1.5 months in (for this 6 month period), the period ends June 30^th.

The way this calculation works is this:

1. The current price of the underlying EGP shares at Friday’s closing prices is $1.42926 this price is up 17.41% since January 1 (when the price was $1.21730)
2. The current price of the benchmark is 40244.46, this price is up 8.37% since January 1 (when the benchmark level was 37134.53)
3. The provisional fee, based on the movements above is 1.81% based on 20% of the difference between the two percentages.  This amounts to $0.02583 in dollar terms per share.
4. Subtract the amount in (3.) From the amount in (1.) and you arrive at the $1.40343 shown in the ‘Current Price’ column of the table below.
5. If the EGP unit price has risen by less than the market, or fallen in any given measurement period, then the reported figure will be the same as the underlying asset values as no fee is earned in our structure when either of these events occurs.

The reason I use the ‘ex-provisional fee value’ is because it more accurately reflects the value to the end holder and although I only officially take new subscriptions on 1 January & 1 July each year, I can at my discretion take on other investors in the intervening period. Such an investor should not be expected to contribute to a portion of fee already existing at their time of purchase, so the ‘ex-provisional fee value’ is the fairest figure.

Finally, I wanted to mention an article I read today (Friday 15 February) in the Australian Financial Review.  It was headed “Quality is still very much in demand” by Peter Wells.  Before I criticise the article, I should say that most of what he writes is usually very good, but I have to take exception with the theme of this article.  I am always dumbfounded when professional finance writers make the same mistakes as most retail (and truth be told many institutional) investors.  In the case of the article, it makes the statement “It’s just not the right time to be in small caps”.  The article then goes on to justify this position by demonstrating that the ASX200 has recently out-performed the Small Ords YTD and that the ASX200 Industrials has out-performed the Small Industrials.  I myself have mentioned this outperformance, most recently in the FY13 First Half Report (.pdf) – but I don’t agree with the conclusion drawn.  If I go back as far as January 1 2012, the ASX200 has (including dividends) added about 30%, whereas the Small Ords has added only about 12 or 13%.  Now I appreciate that financial writers often need to make broad thematic statements in articles, but it seems to me that if the underlying business prospects of the ‘Small Ords’ have improved at approximately the same rate as the improvement in the ‘ASX200’ over this period, then based on the changes in value being the same (and if value started at the same point), the ‘Small Ords’ would seem to be about 15% cheaper based on the change in respective index levels over the last 13 and a half months.  In my view, the ASX200 over a medium to long term should outperform the Small Ords, in fact this is why I selected it as our benchmark – despite the majority of our holdings being outside the ASX200 (and ergo the Small Ords being both an ‘easier’ and potentially more relevant benchmark).  The reason for that expected outperformance though is not because ‘the ASX200 has gone up by more recently’, but because most ASX200 entrants have relatively better businesses compared to the Small Ords components.  There is a larger amount of speculative rubbish in the Small Ords, which weighs down the better businesses.  I would liken the mindset described in the article to if I were making a decision to buy a car.  If last year car ‘A’ and car ‘B’ both cost $20k with exactly the same utility to me as buyer, and today, ‘A’ is $25k and ‘B’ is $22k, I will not decide to buy ‘A’ because it has increased most in value.  If, however, car ‘A’ can demonstrate that more than $5k in utility has been added, whilst car ‘B’ fails to demonstrate at least $2k of added utility, then (and only then) does car ‘A’ make more sense as the purchase preference.  Never reason from a price change is my advice here, in the case of both cars and stocks; we must consider the change in underlying values.  In the car this is the ‘utility to the consumer’ in the stock it is the ‘intrinsic valuation’ that matter.

I often try to shed light on the mistakes in the retail investors mind-set, from memory, my last major effort was in Update 89 where I reminded investors of the oft-made mistake of allocating wads of cash to the market at high prices and a trickle of cash at low prices, and demonstrated that this had likely been the case since 2010.  Even if you don’t invest with me, I would prefer the market were filled with better informed investors!

Just remember when you read the financial media and in particular the non-financial media that many times the thread of the articles often (unfortunately) serve to reinforce the mistakes most investors make time and again – Tony Hansen 15/02/13

EGP Fund No. 1 Pty Ltd. Up by 15.29%, leading the benchmark by 6.92% since January 1^st. Since inception, EGP Fund No. 1 Pty Ltd is Up by 40.34%, leading the benchmark by 27.40% all-time (April 1^st 2011).