Dear Unitholders,
The Fund generated a satisfactory return
during the year as you can see in the following table, which compares the
Fund’s return (net of fees) to the Australian All Ords Index and the MSCI World
Index.
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The Fund’s biggest winners during the year were
the liquidation securities we discussed in last year’s annual report. These
generated the following returns:
- Asset Resolution Ltd - up 160%
- BAO Trust - up 42%
- Hamilton Securities - up 80%
- Kangaroo Island Plantation Timbers - up 147%
Other notable winners were Australian wind farm
owner, Infigen (up 33%) and Japanese property investor Astro Japan, up 28%.
Asset Resolution Ltd
A large part of our time and effort during
the year, especially in recent months, has been devoted to Asset Resolution
Ltd. ARL is an unlisted Australian public company with a complex history. Over
the last two years, we acquired 18% of ARL at less than half of its net asset value.
As ARL’s publicly stated strategy was to sell all its assets, and return the
proceeds to shareholders, this was an unusually attractive situation. After
each of our ARL purchases, the company repaid us more than we paid, meaning
that our ARL shares effectively cost us less than zero.
In April 2015, Hamilton Securities, an
investment company 37% owned by the Fund, launched a takeover bid for ARL at
less than half of ARL’s net asset value. The Fund supported Hamilton’s bid by
providing Hamilton with an interest free loan facility and an offer to underwrite
a rights issue, for which it charged no underwriting fee.[1]
Hamilton’s bid was accepted by 6% of ARL
shareholders. Soon after the bid closed, we called a meeting of ARL
shareholders to replace the board. On 11th September 2015, Fred
Woollard and two of our nominees became directors of ARL, pledging to list
ARL’s shares on the Stock Exchange and turn ARL into an investment company.
ARL appears in our list of holdings as 10.9%
of the Fund. This is before a capital repayment in July that reduced the
weighting to its current level of about 5%. Arguably, this undervalues ARL as
it prices ARL at less than half of its net asset value.
Kangaroo Island Plantation Timbers Ltd (KPT)
KPT has been a long-running saga for the
Fund, and was for a long time a cause of much angst and substantial losses.
After we pushed through a recapitalisation in 2013 (that narrowly averted
bankruptcy), and a change of management, KPT is making great strides towards
monetising its substantial land and timber assets. This progress has been
reflected in KPT’s share price, which has risen seven-fold in less than three
years.
This has created a problem of sorts for the
Fund, in that our weighting in KPT was over 22% on 30 June 2015 and now exceeds
30%. As we own about 48% of KPT it is simply not possible to easily sell enough
shares on the share market to reduce our weighting to a level that we would
normally prefer, ie less than 10%. We are acutely aware of this problem.
As KPT’s publicly stated strategy is to sell
its assets at the best price, and we have a high regard for its board and
management, we have decided to retain our stake for the time being,
particularly as KPT shares still trade at a meaningful discount to the
company’s expected realisable value. Although we would like to restore a more
balanced weighting, we are not prepared to unnecessarily give away large
amounts of value to do so.
Cash and calls
The Fund’s biggest loser during the year was
Fred’s idea of investing in a portfolio of put and call options on various
shares, and indices. The logic behind it was partly that option prices, in
several markets, were statistically cheap for much of the year. This meant
that, in theory at least, buying options seemed to be an attractive gamble,
provided the options were bought cheaply enough.[2]
Buying options also fitted in with our
cautious view of markets. Owning put options protected us from large drops in
global markets. Owning call options on the S&P 500 Index gave us exposure
to any rapid rises in the US market, even though a large part of the Fund was
safely invested in cash. This strategy, which was our biggest loser, was
intended to give us “heads we win a lot, tails we lose a little” type exposure
to the US market. The US market was unusually flat, rising about 5% during the
year, so we lost money on these trades.
Although we made good money on some option
trades, overall they cost us about 2% of the Fund’s value during the year and
have cost us a further 2% in the first four months of the current year. Despite
these losses, we like using options to reduce risk in the Fund, or increase our
market exposure, when it appears statistically attractive to do so. Don’t be
surprised to see us do it again.
Changes to the Fund and its manager during the year
In December
2014, Nigel Burgess become a partner in STAM. He had been involved in the
Fund’s investment decisions for several years, and has made a significant
contribution to the Fund’s performance.
Two years ago, 29% of the Fund was invested
in securities that were in a form of liquidation. We had believed that these
securities were so cheap, and the likelihood of the discounts narrowing was so
high, that it would have been unfair to our unitholders to allow new investors
into the Fund.
Accordingly, the Fund was closed to new
investors from August 2013 until January 2015. The decision to re-open the Fund
was partly because the price of these securities had risen, and partly to
provide extra cash to fund Hamilton’s takeover bid for Asset Resolution Ltd.
We changed the
Fund’s custodian from JP Morgan to White Outsourcing. White is owned by
Steadfast Group, one of Australia’s largest insurance brokers. We have been
very happy with White’s role as the Fund’s administrator since 2005 and they
are doing a good job as custodian. JP Morgan, who remain our sub-custodian, did
a good job as custodian, but were much more expensive than White.
No distribution
As you may have
noticed, the Fund did not pay a distribution in 2015, the first time this has
happened. We try to ensure that the Fund has some distributable income each
year, if only to ensure that the Fund’s franking credits are distributed to
unitholders.
The reason this
year is different is due to ARL. At a meeting held on 24th June, ARL
shareholders voted to approve a capital repayment on 30th June 2015, which
would have formed part of our distributable income. Shareholders were told at
that meeting that the payment would be made on 30th June.
Late in June,
the ARL board decided to reduce the payment and defer it until July. The effect
of this was to reduce the Fund’s distributable income from a positive to a
negative number. ARL did not disclose the change until early July, which was
too late for us to take corrective actions.
Macroeconomic views
We have generally been cautious throughout
the year, believing that most major world markets are in the second half of a
major bull market that started in early 2009. We worry that the Australian
economy is at risk from the end of the mining boom and the possible end of the
property boom.
This stage of the cycle is a time to be
cautious, but also to recognise that markets can sometimes experience large
rapid rises. Hence our preference for owning defensive shares, lots of cash and
(when we can buy them cheaply) call options over major indices.
Our attitude to risk is summarised in the
following paragraph, which has appeared in previous annual letters.
Because we do not have the ability to
accurately predict economic and market conditions, we aim to diversify in a way
that can be expected to do reasonably well across the widest possible number of
potential scenarios. This requires that our strategy is able to overcome not
only occasional bear markets and dislocations, but all of the other hurdles
that are endemic to active investment management. The list includes bad luck,
bad timing, and occasional mistakes in judgment. Most importantly, any truly
robust long-term investing strategy must be built to survive the worst possible
scenarios the market can throw at us and allow us to live to play another day.
If we do this, we are unlikely to be the best performers in any given year, but
we do have a good chance of continuing to generate satisfactory overall
returns.
The Fund’s robustness is assisted by our
longstanding policy of having the majority of the Fund in cash, or in
securities which themselves have net cash on the issuer’s balance sheet. During
the year, an average of 18% of the Fund was in cash and at year-end, 29% of the
Fund was in cash. In addition, at year-end, 57% of the Fund was in companies
which themselves had net cash.
As we both have large personal stakes in the
Fund, this policy helps us to sleep soundly.
Outlook for the Fund
So far this financial year, the Fund is up 9.4%.
The strong performance of world share markets in recent years is making it
increasingly difficult for us to find attractive investments, but we are still
finding interesting opportunities and remain optimistic about the Fund’s
outlook.
Finally, if you
know of someone whom you think would benefit from investing in the Fund, please
don’t hesitate to give them our contact details.
Yours sincerely,
Fred Woollard and Nigel Burgess
31 October 2015
LIST OF HOLDINGS AT 30 JUNE 2015
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[1] It
is highly unusual, if not unique, for a supplier of capital to treat a borrower
as generously as we treated Hamilton in the ARL bid. Although we think what we
did was beneficial for the Fund as well as for Hamilton, we don’t expect this
approach to catch on. As shareholders in Goldman Sachs (a company not known for
making interest-free loans or charging zero for underwriting share issues) we
certainly hope not.
[2]
Usually, options are priced at levels that ensure that statistically,
option buyers are likely to lose, similar to the way gamblers in a casino are
likely to lose.
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