NEDGROUP INVESTMENTS BRAVATA WORLDWIDE FLEXIBLE FUND Quarter Four, 2017 For the period ended 31 December 2017
NEDGROUP INVESTMENTS BRAVATA WORLDWIDE FLEXIBLE FUND FUND PERFORMANCE The fund had a subdued return for the year, against a backdrop of markets continuing to rise to new highs on the back of very little negative news, the US change in Tax policies, rising commodity prices and interest rates remaining subdued. On a relative basis, our lack of exposure to growth assets held back the fund and our cautious outlook made it very difficult to perform. Fortunately, we made very few errors of commission and perhaps we could have had less exposure to dollar cash. Most of our existing investments did well for us including our new investment into a company called L Brands which is better known for its ownership of Victoria s Secret. The investments made in Asia continue to do well for us and remain relatively undervalued. Looking forward, there appears to be little pessimism and all indicators point to investors believing the positive market momentum to continue. Cash is at an all-time low amongst investors, expected volatility is low and insurance for protection is cheap. Professional investors such as hedge funds have leveraged themselves to the highest levels in five years and numerous other indicators point to the abundance of optimism. Usually this can be a very dangerous time for investors. Our cautious stance of 2017 continues and we will try use some correction to introduce new ideas into the fund. The local currency has strengthened, and on balance much of the positive news surrounding the new leader of the ANC has accounted for this. Our inclination is to use the recent strength to move additional cash offshore. Furthermore, stocks in South Africa had a good run in the last quarter and some pull-back may be required for us to invest. In the meantime, we will continue to focus the fund and make sure the existing ideas in the fund are worthy of their position. INVESTMENT PHILOSOPHY At Aylett & Co, we look for quality businesses first and bargain prices second. This order is important, and it is part of what differentiates us from traditional value investors. The other differentiator is that contrary to most value managers, we believe that company management is critically important. In William Thorndike s book, The Outsiders, he looks at 8 companies that significantly outperformed their peer groups (i.e. companies doing similar things in similar industries) over the very long-term. The key take-away was that the biggest differentiator between these companies and their peer group was a CEO and FD who intricately understood the value of capital allocation as well as the true value of their own businesses. Good businesses throw off large amounts of free cash flow and it is how successfully that capital is deployed that makes all the difference. These managers issued shares when they felt their companies were significantly overvalued and bought back shares when the market became overly pessimistic on their prospects. They understood when an acquisition made sense and were constantly assessing these versus buying back their own shares. Interestingly, a result of us placing a high degree of emphasis on the quality of the management team has been us owning many stocks where management (and/or their families) are significant owners of the business. We haven t gone out looking for these, but instead were looking for management teams that display rational behavior. Logically this should not be surprising, people think far harder about what they do with their own money than with other peoples money. Page 2
This year we saw some clear examples illustrating both good and poor capital allocation: We saw a management team, which we know well, spend a substantial amount of money buying a poor quality business and paying top dollar for it. This action was pursued in an effort to achieve growth and diversification targets set by the board (the power of incentives is amazing). Not surprisingly management are not significant shareholders - they were happy to spend other peoples money. Conversely, we saw another management team make what appears to us to be another rational, value-enhancing acquisition of a business operating in a space they understand and can add value to. They paid a low price, and from day one it should be materially value-enhancing. It should not surprise you that management own a large share of the stock outstanding - they were spending their own money and thought very carefully about it! BITCOIN More than any other topic over the last quarter, our clients have wanted to know what we think about Bitcoin and cryptocurrencies generally. To date we ve avoided adding our voice to an already noisy topic, instead we ve been spending our time reading about, transacting with (mining even!) and trying to understand Bitcoin (BTC) - having an opinion requires some work. To keep this brief, we re going to skip explaining what cryptocurrencies are and how they work and assume you re up to speed. First the good Other than the price going up, Bitcoin does have some attractive attributes. It's not government issued and is completely decentralized - there is no Bitcoin company. The SARB or the Fed have no say in its value. It can t be counterfeited or confiscated. The supply of Bitcoin is fixed and non-inflatable, so unlike cash which loses its buying power because central banks print more of it over time, the number of Bitcoin (in theory) will never exceed 21 million. Now the bad Bitcoin is frighteningly volatile. We offered to pay staff salaries in BTC and got no takers. Why would you accept your salary in something that regularly moves 15% in value in a day? It's actually quite hard to use. While we know there are some businesses that accept Bitcoin as a form of payment, ask yourself if you ve ever heard of anybody actually using Bitcoin? We note with interest that a recent conference on Bitcoin stopped accepting BTC as payment because it was too slow and expensive with which to transact. There are more than a thousand cryptocurrencies. Bitcoin is just one of many, some of which have engineered out some of the negatives that Bitcoin has, like the slow transaction speeds. Does Bitcoin end up the winner? Is there a winner? Why not Ethereum, Ripple, Litecoin, Neo or even KODAKCoin? Could Bitcoin s success be its downfall? While currently unregulated, should Bitcoin or another cryptocurrency gain wide acceptance as a means of exchange, it seems likely that governments around the world would introduce some form of regulation or control, thereby weakening one of its key attributes. We ve recently added two members to our investment team. One of them came with an amount of Bitcoin in his portfolio, bought long enough ago that he risked little and has now made significant gains. We asked him what he thought his holding in Bitcoin might be worth one day - he (wisely) replied that he didn t know. Page 3
He identified what we think is Bitcoin s biggest negative - we have no idea what it (or Ripple or Ethereum or KODAKCoin) is worth! We can t even estimate a range. Bitcoin produces no cash flow and isn t backed by anything. We have zero confidence in our ability to predict what Bitcoin might be worth tomorrow or in ten years time. That fact alone makes it uninvestable for us. What happens if we re wrong and Bitcoin (or some other cryptocurrency) ends up being the reserve currency of the world? Well, if that happens (it's possible) we believe that a portfolio of good businesses bought at a discount to intrinsic value, like the companies you own in the portfolio, will be able to protect and even grow your purchasing power - be that in ZAR, USD or BTC. Page 4
DISCLAIMER WHO WE ARE Nedgroup Collective Investments (RF) Proprietary Limited, is the company that is authorised in terms of the Collective Investment Schemes Control Act to administer the Nedgroup Investments unit trust funds. It is a member of the Association of Savings & Investment South Africa (ASISA). OUR TRUSTEE The Standard Bank of South Africa Limited is the registered trustee. Contact details: Standard Bank, Po Box 54, Cape Town 8000, Trustee-compliance@standardbank.co.za, Tel 021 401 2002. PERFORMANCE Unit trusts are generally medium to long-term investments. The value of your investment may go down as well as up. Certain unit trust funds may be subject to currency fluctuations due to its international exposure. Past performance is not necessarily a guide to future performance. Nedgroup Investments does not guarantee the performance of your investment and even if forecasts about the expected future performance are included you will carry the investment and market risk, which includes the possibility of losing capital. PRICING Funds are valued daily at 15:00. Instructions must reach us before 14:00 (12:00 for Nedgroup Money Market Fund) to ensure same day value. Prices are published daily on our website and in selected major newspapers. FEES Certain Nedgroup Investments unit trust funds apply a performance fee. For the Nedgroup Investments Flexible Income Fund and Nedgroup Investments Stable Fund, it is calculated daily as a percentage (the sharing rate) of total positive performance, with the high watermark principle applying. For the Nedgroup Investments Bravata World Wide Flexible Fund it is calculated monthly as a percentage (the sharing rate) of outperformance relative to the fund s benchmark, with the high watermark principle applying. All performance fees are capped per fund over a rolling 12-month period. A schedule of fees and charges and maximum commissions is available on request from Nedgroup Investments. DISCLAIMER Unit trusts are traded at ruling prices and can engage in borrowing and scrip lending. Nedgroup Investments has the right to close unit trust funds to new investors in order to manage it more efficiently. For further additional information on the fund, including but not limited to, brochures, application forms and the annual report please contact Nedgroup Investments. NEDGROUP INVESTMENTS CONTACT DETAILS Tel: 0860 123 263 (RSA only) Tel: +27 21 416 6011 (Outside RSA) Fax: 0861 119 733 (RSA only) Email: info@nedgroupinvestments.co.za For further information on the fund please visit: www.nedgroupinvestments.co.za OUR OFFICES ARE LOCATED AT Nedbank Clocktower, Clocktower Precinct, V&A Waterfront, Cape Town, 8001 WRITE TO US PO Box 1510, Cape Town, 8000 Page 5