Boussard & Gavaudan Holding Limited: Closed-end hedge fund at an unjustified discount?

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Boussard & Gavaudan Holding Limited (BGHL) is a Guernsey closed-end investment company. It invests in multiple hedge fund strategies: convertible bond arbitrage, volatility trading, event-driven equity strategies, capital structure arbitrage, credit long-short, credit special situations, equity quantitative trading. It also holds an investment in Mexican real estate.

The company was founded by Goldman Sachs alumni, Emmanuel Boussard and Emmanuel Gavaudan. Fee structure : 1.5% + 20% with a high watermark. The monthly newsletter gives a good overview of the activity.

BGHL’s track record is shown below.

  • This translates to over 8% per year since 2007 – a strong performance compared overall and compared to many other hedge fund strategies.
  • Performance suffers in difficult equity markets – -12% in 2008, -3% in 2011, -6% in 2018 – and is boosted afterwards.
  • However, no capture of the 2019 rally: performance has been flat so far this year.

As with many closed-end structures (see here for some background), the fund trades at a discount to NAV. But whilst the discount has remained at around 20% for many years, it has jumped to around 27% currently.

Are investors losing patience with the poor performance of the past 2 years and with the low-vol environment that is hurting the fund?

Should we ignore the past track record or argue that now is a good time given potential catalysts such as M&A activity, potential volatility spikes etc.?

Common Stocks and Common Sense by Ed Wachenheim: 25 points that make sense

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This useful book – with case studies on Goldman Sachs, Home Depot IBM, etc. – ends with a letter to a younger investment manager that includes the following 25 points (I only summarized these points ; the book includes many further insights):

  1. Be careful not to let your mind acclimate to a present circumstance, and then lose perspective.
  2. Beware of projecting past or present trends into the future.
  3. Beware of seeking out information that reinforces your existing points of view.
  4. Intensively research stocks and industries, and pay attention to the quality of the information.
  5. Be wary about basing investment decisions on predictions about the economy, interest rates, or stock market.
  6. Pay more attention to what managements do than to what they say.
  7. Be particularly wary of projections made by managements ad others who have vested interests.
  8. Be wary of companies that largely have been “put together” through recent acquisitions.
  9. Be aware of the laws of supply and demand.
  10. Be wary of stock recommendations made by others.
  11. Do not be overly influenced by the media.
  12. Avoid over-relying on numbers and models.
  13. Separate your analysis from your emotions.
  14. Seek simplicity.
  15. Realize that the trees do not grow to heavens.
  16. Knowledge of where the market is selling relative to its historical metrics often is helpful.
  17. Every investor must analyze risks of permanent loss and must decide how much risk he is willing to assume.
  18. While an investor should work hard to avoid permanent loss, he must guard against being so risk averse that he turns down too many promising opportunities for fear of making a mistake.
  19. Be prepared and willing to change your mind if your initial decision was flawed or if circumstances change.
  20. Invest for the longer term and de-emphasize the significance of short-term results.
  21. Do not attempt to “time” the market.
  22. Try to remain relatively fully invested as long as you can find a sufficient number of attractive securities.
  23. Try to generally think and act positively and optimistically.
  24. Structure a concentrated portfolio, yet a diverse portfolio.
  25. Be relaxed and invest with a passion.

Warren Buffett’s 2018 annual letter – The American Tailwind

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This is the time of the year where Warren Buffett shares his investment wisdom in his annual letter. You’ll find below his passage on The American Tailwind.

On March 11th, it will be 77 years since I first invested in an American business. The year was 1942, I was 11, and I went all in, investing $114.75 I had begun accumulating at age six. What I bought was three shares of Cities
Service preferred stock. I had become a capitalist, and it felt good.

Let’s now travel back through the two 77-year periods that preceded my purchase. That leaves us starting in 1788, a year prior to George Washington’s installation as our first president. Could anyone then have imagined what their new country would accomplish in only three 77-year lifetimes?

During the two 77-year periods prior to 1942, the United States had grown from four million people – about 1⁄2 of 1% of the world’s population – into the most powerful country on earth. In that spring of 1942, though, it faced a crisis: The U.S. and its allies were suffering heavy losses in a war that we had entered only three months earlier. Bad news arrived daily.

Despite the alarming headlines, almost all Americans believed on that March 11th that the war would be won. Nor was their optimism limited to that victory. Leaving aside congenital pessimists, Americans believed that their children and generations beyond would live far better lives than they themselves had led.

The nation’s citizens understood, of course, that the road ahead would not be a smooth ride. It never had been. Early in its history our country was tested by a Civil War that killed 4% of all American males and led President Lincoln to openly ponder whether “a nation so conceived and so dedicated could long endure.” In the 1930s, America suffered through the Great Depression, a punishing period of massive unemployment.

Nevertheless, in 1942, when I made my purchase, the nation expected post-war growth, a belief that proved to be well-founded. In fact, the nation’s achievements can best be described as breathtaking.

Let’s put numbers to that claim: If my $114.75 had been invested in a no-fee S&P 500 index fund, and all dividends had been reinvested, my stake would have grown to be worth (pre-taxes) $606,811 on January 31, 2019 (the latest data available before the printing of this letter). That is a gain of 5,288 for 1. Meanwhile, a $1 million investment by a tax-free institution of that time – say, a pension fund or college endowment – would have grown to about $5.3 billion.

Let me add one additional calculation that I believe will shock you: If that hypothetical institution had paid only 1% of assets annually to various “helpers,” such as investment managers and consultants, its gain would have been cut in half, to $2.65 billion. That’s what happens over 77 years when the 11.8% annual return actually achieved by the S&P 500 is recalculated at a 10.8% rate.

Those who regularly preach doom because of government budget deficits (as I regularly did myself for many years) might note that our country’s national debt has increased roughly 400-fold during the last of my 77-year periods.
That’s 40,000%! Suppose you had foreseen this increase and panicked at the prospect of runaway deficits and a worthless currency. To “protect” yourself, you might have eschewed stocks and opted instead to buy 3 1⁄4 ounces of gold with your $114.75.

And what would that supposed protection have delivered? You would now have an asset worth about $4,200, less than 1% of what would have been realized from a simple unmanaged investment in American business. The magical metal was no match for the American mettle.

Our country’s almost unbelievable prosperity has been gained in a bipartisan manner. Since 1942, we have had seven Republican presidents and seven Democrats. In the years they served, the country contended at various times with a long period of viral inflation, a 21% prime rate, several controversial and costly wars, the resignation of a president, a pervasive collapse in home values, a paralyzing financial panic and a host of other problems. All engendered scary headlines; all are now history.

Christopher Wren, architect of St. Paul’s Cathedral, lies buried within that London church. Near his tomb are posted these words of description (translated from Latin): “If you would seek my monument, look around you.” Those skeptical of America’s economic playbook should heed his message.

In 1788 – to go back to our starting point – there really wasn’t much here except for a small band of ambitious people and an embryonic governing framework aimed at turning their dreams into reality. Today, the Federal Reserve estimates our household wealth at $108 trillion, an amount almost impossible to comprehend.

Remember, earlier in this letter, how I described retained earnings as having been the key to Berkshire’s prosperity? So it has been with America. In the nation’s accounting, the comparable item is labeled “savings.” And save we have. If our forefathers had instead consumed all they produced, there would have been no investment, no productivity gains and no leap in living standards.

Mastering the Market Cycle

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Many intelligent investors spend most of their time on:

  • “Security analysis” – assessing the fundamentals of industries, companies and securities.
  • “Value investing” – determining the intrinsic value of securities and being disciplined as to the appropriate price to pay for them.

Howard Marks adds an important third element – deciding what balance to strike between aggressiveness and defensiveness – “Mastering the market cycle“.

The picture below – drawn during an interview with Jason Zweig and beautifully described here – summarizes the key thoughts.

  • The intrinsic value of securities tends to slowly move up over time.
  • Market prices are cyclical and often move away from intrinsic value.
  • A cycle is a pattern of up-and-down oscillations around a midpoint. Cycles are inevitable and self-correcting (because economies are made up of people and people have feelings which vary over time).
  • Risk means more things can happen than will happen, hence the dotted lines illustrating possible future outcomes.
  • By studying how the economy, the markets and the psychology of investors move, one can improve portfolio positioning.

Marks devotes separate chapters to the different cycles – the economic cycle, the profit cycle, the cycle in attitudes toward risk, the credit cycle, the distressed debt cycle, the real estate cycle – and puts it all together in a chapter on the market cycle.

The book draws heavily on Marks’ great memos, which are available here. Like in these memos, Marks superbly describes how sentiment evolves, time and time again.

For instance, below is the expand-and contract process that drives the credit cycle (from the November 2001 memo “You Can’t Predict. You Can Prepare.“):

  • The economy moves into a period of prosperity.
  • Providers of capital thrive, increasing their capital base.
  • Because bad news is scarce, the risks entailed in lending and investing seem to have shrunk.
  • Risk averseness disappears.
  • Financial institutions move to expand their businesses – that is, to provide more
    capital.
  • They compete for market share by lowering demanded returns (e.g., cutting interest rates), lowering credit standards, providing more capital for a given transaction, and easing covenants.

What are the implications for investors? I suggest they have a couple of choices:

  1. Just “stay the course”, as advocated by the late Jack Bogle.
  2. Try to get the odds on your side by adjusting portfolio risk based on a sense for where the market stands in the cycle.

For the latter, Howard Marks is the best guide one can think of.

For further info on mastering the market cycle, check out:

Book review: Investing for the Long Term

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Francisco Garcia Parames, “the Spanish Warren Buffett”, wrote 2 years ago Invirtiendo a Largo Plazo. The English version came out recently: Investing for the Long Term.

The book starts with biographical chapters and continues with investment thoughts.

In the first part we learn that the key thing about university years is “to have a spark of interest awoken in us at a particular point in time, which opens up an appealing and limitless path”. Liefelong and self-learning is much more useful than the formal academic curriculum. We also understand that a career is often depending on serendipity – Parames interviewed almost by chance with Bestinver, the asset management arm of Acciona (the Entrecanales family), where he spent 25 years before founding Cobas Asset Management. He almost died in a plane accident in 2006.

In the investment part, there are a number of particularly interesting points.

The chapter of the Austrian School of Economics is refreshing, as few successful stockpickers heavily refer to economists. In the Austrian School, the main protagonist is the creative entrepreneur who tries to capitalize on market disorder to earn a profit. Hence human behaviour takes a key role and markets are never in equilibrium. There is little room here for formalism and mathematical models. The author gives a number of real-world applications of the Austrian School, such as “investors should steer clear of economies whose growth is based on credit creation under the auspices of low interest rates established by central banks”.

A remarkable element of Parames’ impressive investment track record is his ability to adapt his investment style to the prevailing environment. Whilst he has clearly remained a value investor, with his key principle being “buy attractive shares at a time when they were unwanted or not valued by the markets, without worrying too much about general economic or stock market developments”, his portfolios have changed quite a bit over time. In the early 1990s, key positions included banks like BBVA and Santander as well as real-estate companies. Towards the end of the decade, many of these investments were sold and cash reached elevated levels as “the only way to cope with end-of-cycle euphoria is with time and patience”. In the mid-2000s, portfolios were fully invested again, with an emphasis on industrial businesses including mid-caps (e.g., BMW, Kinepolis, Camaieu, Buhrman).

When reviewing his portfolios, it seems that Parames is more comfortable than others with relatively risky stocks. The author rightfully stresses that volatility is not the best measure of risk. Rather, risk is the possibility of a permanent loss of purchasing power. Yet, we observe that his portfolio often contains cheap but apparently not-so-safe stocks due to a mix of deteriorating economics and a high level of debt. Recent examples are investments in the likes of Aryzta and Teva. Time will tell whether these investments will turn out to be as successful as buying BMW and Ferrovial in 2009.

The book also has interesting chapters on passive vs. active management (Parames thinks there’s room for both) and on behavioral finance (a few biases are well-explained). Appendix I – 26 small ideas and a guiding principle – is a must-read. The guiding principle: “Invest all savings that you don’t need for the immediate future in shares”.

At times when market participants behave increasingly short-term, Investing for the Long Term provides an excellent framework for genuine investors. I expect to re-read parts of the book several times.

The Berkshire Hathaway annual meeting as if you were there

Here are 3 ways to “participate” in the Woodstock for Capitalists, the Berkshire Hathaway annual meeting:

  • Attend the meeting physically. You’ll need at least 1 share of Berkshire and some logistics and patience.
  • Watch the meeting recordings. The last couple of meetings have been streamed. Older meetings can also be found, for instance 1994 (with a question from a young Bill Ackman), 1995, 19961997, 1998, etc.
  • Read The Warren Buffett Shareholder. The book, edited by Lawrence Cunningham and Stephanie Cuba, contains 40 personal stories of regular attendees, including Jason Zweig, Tom Gayner, Thomas Russo, Vitaliy Katsenelson, Prem Jain, Joel Greenblatt, Whitney Tilson, John Bogle, François Rochon, Chuck Akre. With such a calibre of contributors, you inevitable get interesting anectodes. It seems a lot more happens outside of the actual meeting than during the hours of Q&A.

I suppose nothing compares to the “real thing” – being there – but listening to the wit and wisdom of Warren Buffett and Charlie Munger, and reading about the personal testimonies of attendees, gets you a bit closer

Warren Buffett’s 2017 annual letter

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This is the time of the year where Warren Buffett shares his investment wisdom. As usual he did not disappoint. I’m sharing snippets from his latest annual letter. These are quotes as it would be harmful to change anything from the original text. If you have time and interest, read the full letter; otherwise enjoy what’s below.

On stocks as long-term investments and on market fluctuations

“Charlie and I view the marketable common stocks that Berkshire owns as interests in businesses, not as ticker symbols to be bought or sold based on their “chart” patterns, the “target” prices of analysts or the opinions of media pundits. Instead, we simply believe that if the businesses of the investees are successful (as we believe most will be) our investments will be successful as well. Sometimes the payoffs to us will be modest; occasionally the cash register will ring loudly. And sometimes I will make expensive mistakes. Overall – and over time – we should get decent results. In America, equity investors have the wind at their back.”

And more:

“In the next 53 years our shares (and others) will experience declines resembling those in the table (note: Berkshire’s stock price has suffered 4 major dips of 37%-59% each). No one can tell you when these will happen. The light can at any time go from green to red without pausing at yellow. When major declines occur, however, they offer extraordinary opportunities to those who are not handicapped by debt. That’s the time to heed these lines from Kipling’s If:

If you can keep your head when all about you are losing theirs . . .
If you can wait and not be tired by waiting . . .
If you can think – and not make thoughts your aim . . .
If you can trust yourself when all men doubt you . . .
Yours is the Earth and everything that’s in it.”

And even more:

“Though markets are generally rational, they occasionally do crazy things. Seizing the opportunities then offered does not require great intelligence, a degree in economics or a familiarity with Wall Street jargon such as alpha and beta. What investors then need instead is an ability to both disregard mob fears or enthusiasms and to focus on a few simple fundamentals. A willingness to look unimaginative for a sustained period – or even to look foolish – is also essential.”

On leverage

“This table offers the strongest argument I can muster against ever using borrowed money to own stocks. There is simply no telling how far stocks can fall in a short period. Even if your borrowings are small and your positions aren’t immediately threatened by the plunging market, your mind may well become rattled by scary headlines and breathless commentary. And an unsettled mind will not make good decisions.”

On risk

“Investing is an activity in which consumption today is foregone in an attempt to allow greater consumption at a later date. “Risk” is the possibility that this objective won’t be attained.

I want to quickly acknowledge that in any upcoming day, week or even year, stocks will be riskier – far riskier – than short-term U.S. bonds. As an investor’s investment horizon lengthens, however, a diversified portfolio of U.S. equities becomes progressively less risky than bonds, assuming that the stocks are purchased at a sensible multiple of earnings relative to then-prevailing interest rates.

It is a terrible mistake for investors with long-term horizons – among them, pension funds, college endowments and savings-minded individuals – to measure their investment “risk” by their portfolio’s ratio of bonds to stocks. Often, high-grade bonds in an investment portfolio increase its risk.”

On fees

“Performance comes, performance goes. Fees never falter.”

On portfolio turnover

“Stick with big, “easy” decisions and eschew activity.”

On specific stocks

Not much in this letter. Berkshire’s largest positions are still Wells Fargo, Apple (position significantly increased in 2017), Kraft Heinz, Bank of America, Coca Cola,  American Express. IBM is gone as a key position. Low portfolio turnover in action !

On the current M&A environment

“Prices for decent, but far from spectacular, businesses hit an all-time high. Indeed, price seemed almost irrelevant to an army of optimistic purchasers.

Why the purchasing frenzy? In part, it’s because the CEO job self-selects for “can-do” types. If Wall Street analysts or board members urge that brand of CEO to consider possible acquisitions, it’s a bit like telling your ripening teenager to be sure to have a normal sex life.

Once a CEO hungers for a deal, he or she will never lack for forecasts that justify the purchase. Subordinates will be cheering, envisioning enlarged domains and the compensation levels that typically increase with corporate size. Investment bankers, smelling huge fees, will be applauding as well. (Don’t ask the barber whether you need a haircut.) If the historical performance of the target falls short of validating its acquisition, large “synergies” will be forecast. Spreadsheets never disappoint.”

Book review: Deep Value Investing (2nd edition) by Jeroen Bos

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I very much enjoyed the first edition of Deep Value Investing, in which the author clearly described his investment process and illustrated it with 15 helpful case studies, focusing on UK small caps. The book was published in 2013 and my initial review can be found here.

The newly published second editionis much more than a refresher; it has 6 additional case studies and walks us through what happened to the old ones in the past 5 years. The case studies are still organised in 3 groups: deep value successes, deep value failures, and deep value shares of tomorrow (Enteq Upstream, Hargreaves Services, Lamprell, Hydrogen Group, Record). The latter group can be found in the author’s fund.

It’s always interesting to see which sector offers deep value opportunities. Recruitment agencies were a fertile ground with the onset of the recession in 2008. Housebuilders offered great opportunities in 2008 and again after Brexit. Most of the current ideas relate to the oil sector.

Deep Value Investing remains one of the only investment books in which the reader can clearly follow the thought process on specific investments of an experienced investment manager, backed with the necessary financial information. As such, I recommend it to bargain hunters.

While reading the book it becomes obvious why deep value invesitng works over time – it’s simple but not easy! There are inevitably big failures (4 case studies); you need loads of patience and perseverence. Also, some of the net-nets are very thinly traded and not always available through a generalist broker. Quality Investing is so much more comfortable…

My conculsion: there is a lot of value in Deep Value Investing, especially today afer a period of underperformance. If you cannot implement the strategy yourself, delegate to a capable manager.

Thoughts on the market selloff

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I put together below some thoughts on the market selloff.

10 things to know about the stock-market selloff by Mohamed El-Eirian. A lot of common sense in these 10 points.

Testing times: market turmoil and investment serenity by Aswath Damodaran. The Professor shares some tips to stay rational and provides a model to value the market.

Why share prices are see-sawing by the Economist’s Buttonwood. “There is room for a lot more choppiness…”

The stock market didn’t get tested – you did by Jason Zweig. Stop trying to make sense of the stock market. “If a 6% daily drop makes you squirm, then you probably have too much invested in stocks for your own psychological good”.

Markets volatile Valentine by John Authers. Key things to watch in the coming days: inflation and bond yields.

Volatility – virus, bubble, or both by M&G. Why did volatility spike in the absence of notable news?

Beware the volatility bubble’s popping by Edward Chancellor.

People get creative when explaining the market correction by Barry Ritholtz. Beware of narrative fallacy and hindsight bias.

And finally, some statistics about “corrections” ie. market declines of 10% to 20%: