Update No. 277 – 15/08/16

The recent positive bias for the market has mostly continued into August.

Despite ceding about a 1.5% advantage to our benchmark on July 1^st (when the effects of Franking Credits are added to our benchmark) we have managed to put it into our rear-view mirror after only a month and a half. It took roughly as long last financial year to get ahead of our benchmark. Hopefully we can stay ahead of it for the remainder of FY2017 as we did in FY2016.

We have had only one of our holdings formally report so far this reporting season, but a couple of good guidance numbers and the generally positive market momentum have seen the portfolio value continue to rise through August so far.

The recent behaviour of the market has reminded participants the danger of trying to ‘time the market’. Our benchmark is up 15.5% since early April and an astonishing 10.4% since late June. When momentum turns, the market can blow right by you like Usain Bolt while you’re waiting for it to ‘find the bottom’.

In communicating with one of our investors today, I asked what he thought might be a topic of interest for readers this week and he suggested writing about how such strong positive returns are unlikely to last. I do like the way EGP holders think…

For the purpose of understanding, our financial YTD return is about 8.3%. Bear in mind we are only one and a half months into FY2017. That annualises to over 90% if it were sustained for the remainder of the financial year. I’m here today to remind that it definitely will not be. In fact, the fund’s best ever year, laid down in FY2013 was ‘only’ 32.6% after fees. If we had a result like FY2013 only once every 10 years, I would be quite pleased.

Furthermore, if we can continue to average mid-teen results, I would be likewise pleased. I harp on endlessly with my children about what an amazing result 15% annually is if it can be attained over a decent period. Doubling better than every five years, quadrupling in less than ten years. A better than 16-fold gain over twenty years and 15% annually will get you $267.86 for every dollar if you can sustain it for forty years. My kids are all in the ball-park of 40-years away from retirement (assuming they work until between 56 and 64…), which is why I focus so hard on the 40-year figure. As I point out to them, if you can achieve 15% annually, all you need saved by age 25 to have $5m by age 65 is $18,667. Obviously, one wouldn’t quit saving once they’ve got $20k at 25 years of age, but it’s a reminder that the earlier we start and the better the returns we get, generating truly awesome amounts of wealth is not as inconceivable as people think. The problem as always is keeping your grubby mitts off it while it compounds…

The problem with such an outcome is that people incorrectly imagine it unfolding like this:

And so on…

Were such a result to be achieved, it would more probably look much lumpier. The price one pays for the better returns available through a well-managed portfolio of equities is considerable volatility. The thing that the equity investor must possess to deserve these returns is the stomach to handle the swings. Well, the swings and the very long periods where your portfolio will seem to do next to nothing. As Munger once said “If you can’t stomach 50% declines in your investment with equanimity, you will get the mediocre returns you deserve”, now he’s talking about an individual stock in this quote, but our personal portfolio over calendar 2008 (before I was running the fund) declined about 18% and top tick to bottom tick might have been more like 23 or 24%, but the rewards generated through equanimity in this period were exceptional, 2009 was better to us than even calendar 2013, and long-time EGP investors thoroughly enjoyed 2013.

Despite what looks like a chart that is ‘upward and to the right’, EGP investors have also had two quite long flat-return periods. The 331 days between inception and the end of February 2012 saw holders earn exactly nothing and the 377 days between early December 2013 and mid-December 2014 saw EGP investors earn less than 1.2%. In the context of only a five and a half year long record, believe me when I say these felt like very long, very dry spells. And they won’t be the worst of it over the next twenty or thirty years, even if results continue to be strong. That’s just the nature of equity returns.

These things are drawn out to demonstrate that your gains in the equity market will come suddenly and unexpectedly. The periods of very strong return will often begin just when everything looks like it’s going to hell in a hand basket – Tony Hansen 15/08/2016

^{*1 after a 31 May 2013 dividend of 2.333 cents per share (cps) plus 1.000 cps Franking Credit, a 31 May 2014 Dividend of 7.000 cps plus 3.000 cps Franking Credit and a 31 May 2015 Dividend of 8.6667 cps plus 3.7143 cps Franking Credit and a 31 May 2016 Dividend of 6.0000 cps plus a 2.5714 cps Franking Credit}

^{*2 calculated based on dividends reinvested}