Update No. 276 – 31/07/16

There is much in Kipling’s poem ‘If’ that can be applied to investing:

If you can keep your head when all about you
 Are losing theirs and blaming it on you,
If you can trust yourself when all men doubt you,
 But make allowance for their doubting too;
If you can wait and not be tired by waiting,
 Or being lied about, don’t deal in lies,
Or being hated, don’t give way to hating,
 And yet don’t look too good, nor talk too wise:

If you can dream—and not make dreams your master;
 If you can think—and not make thoughts your aim;
If you can meet with Triumph and Disaster
 And treat those two impostors just the same;
If you can bear to hear the truth you’ve spoken
 Twisted by knaves to make a trap for fools,
Or watch the things you gave your life to, broken,
 And stoop and build ’em up with worn-out tools:

If you can make one heap of all your winnings
 And risk it on one turn of pitch-and-toss,
And lose, and start again at your beginnings
 And never breathe a word about your loss;
If you can force your heart and nerve and sinew
 To serve your turn long after they are gone,
And so hold on when there is nothing in you
 Except the Will which says to them: “Hold on!”

If you can talk with crowds and keep your virtue,
 Or walk with Kings—nor lose the common touch,
If neither foes nor loving friends can hurt you,
 If all men count with you, but none too much;
If you can fill the unforgiving minute
 With sixty seconds’ worth of distance run,
Yours is the Earth and everything that’s in it,
 And—which is more—you’ll be a Man, my son.

Well, perhaps the line about risking it all on a turn of pitch-and-toss is poor risk management, which we obviously do not recommend…

We like to think that keeping our head when others all around are losing theirs is a key strength at your fund. Retaining our head when the market was losing theirs allowed us to deploy meaningful capital into Clydesdale Bank (CYB.AX) recently. When we bought our first stake in CYB at an average price of $3.92, we viewed it as a cost-out story where we were likely to earn a sound high-teens IRR (internal rate of return), the mid-point thinking was for an IRR exceeding 18%. We accept a slightly lower target IRR for large liquid stocks because they offer us some improved portfolio management flexibility we don’t get with our less liquid holdings.

It was our intention to meaningfully increase our CYB stake if the first set of results indicated the story was progressing as expected. Unfortunately, the stock ran up sharply into results and then exploded higher once they were released and we didn’t get to add to our stake as we had hoped. Then came Brexit… Somehow, over the course of a couple of tumultuous weeks, we tripled our original holding then sold a quarter of it as prices ran back up and reduced our cost base to $3.82 per share on a holding more than twice its original size, despite the investment proposition looking more attractive than when we made our fist purchase.

Our current IRR on CYB comfortably exceeds 100%, which is more a function of a relatively short holding period than especially good absolute performance. But CYB has added meaningfully to the recent increase in underlying value of your EGP shares, the unhinged behaviour of the market in relation to this business enabled large portions of these gains.

I mentioned our cash holdings in the July 2016 Monthly Update declined from around 24% to around 14%. It bears thinking about just how expensive holding cash can be in those occasional months when the market explodes higher. Had we been 100% invested in the same portfolio as at the beginning of July, our performance would have been over 8%. Had we done nothing, our cash levels would have declined meaningfully. A big part of the erosion of the cash levels of your portfolio was simply the growth in the equity portfolio!

Obviously, this works the other way in months when markets decline substantially, without doing anything, in that situation, the cash component of your portfolio grows. Cash can be pretty dangerous to overall returns in a rising market though.

Both the fund and the benchmark finished July 2016 at all-time highs. For the fund, the previous all-time high was set just a fortnight ago, but the benchmarks previous high-water mark goes almost 500 days to March 20 2015.

Lest you think there is too much focus on the things that have gone right of late, doesn’t my decision to sell our NWH position a couple of weeks back look like a painful mistake of timing in hindsight… It has almost doubled in a little over a fortnight. Thankfully it was a very small position, so the harm is minimal – Tony Hansen 31/07/2016

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^{*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}