As of September 30, 2009, Auxier Focus Fund returned 12.58%, versus 15.61% for Standard and Poor’s 500 Index (S&P) for the third quarter of 2009. Year-to-date, with approximately 70% stock exposure, the fund gained 19.35%, beating the S&P’s 19.26%. For the 12 months the fund earned 1.87% vs. -6.91% for the market (S&P). Since inception (7/9/99) the fund has returned 75.71% vs. a negative 9.72% for the S&P (an 85.43 percentage point cumulative outperformance).
Over the past nine months, the fund profited by scooping up high-yielding corporate bonds. Forced liquidations by institutional holders of such bonds led to drastic misappraisals and historic bargain prices. By carefully monitoring company capital structures, and being flexible, corporate bond bargains can occasionally achieve equity type returns with far less risk. Higher yield corporate bonds have actually far outperformed domestic stock indexes this year. We try to understand each business and its capital structure to determine its cash generating potential. It is rare when you can buy senior debt securities sporting double-digit returns like we have seen the past year.
Stocks stellar rally since March is a reminder of how costly it can be to focus on unknowables such as the market, interest rates and the economy instead of specific investment opportunities with mouth-watering odds. The window of opportunity is often very brief. So being prepared in advance is critical to have the conviction to act. Having a database built over a number of years helps to decipher facts from fiction in the height of a crisis.
This past quarter, ironically, our high-quality companies lagged riskier stocks (those most dependent on the capital markets and crushed in the market decline). One reason: the aggressive fiscal and monetary action by the Federal Reserve tightened credit spreads dramatically over a short period of time. Just goes to show that outperformance is possible for any asset class when starting from a point of severe undervaluation. Everything has a price.
A Solid Investment Approach
We have endured one of the longest recessions (22 months as of June), the third worst stock market decline since 1900 (a 57% drop to the March 9 lows) and one of the poorest 10-year periods for stocks since 1871. As we have seen, markets tend to be harsh to those who don’t follow a sound investment approach. To win the race you must first finish, focus on the balance sheet and understand risk factors that can lead to permanent capital loss. Supply and demand must be monitored closely. The misperception of risk and odds continues to take many investors out of the game.
Economic Recovery May Surprise
A current worry is that we will have structurally high unemployment for years—that we will have a “jobless” recovery. Historically, companies coming out of recession operate lean to insure survival. Caution is evidenced by corporate cash levels now near 40-year highs, according to the Wall Street Journal.
As Jim Grant, editor of Grant’s Interest Rate Observer has recently commented, “Currently, 25% of American workers are employed in jobs that the Census Bureau didn’t even list as occupations in 1967. We underestimate the resiliency and capacity of market economies to reinvent the nature of work.” Contrary to the current consensus, Grant adds, the key determinant to the strength of an economic upturn was the severity of the downturn that preceded it. There were no exceptions to this rule. The recent downturn ranks as the worst since World War II.
Master the Game -10 year minimum
Geoff Colvin’s Talent Is Overrated studies high performance in a number of fields. Colvin cites highly specific “deliberate practice” over a 10-year period as a key to extraordinary achievement in any field. The most important is solitary practice, and the advantage is cumulative. More total practice is powerfully associated with better performance. Anders Ericsson’s “The Role of Deliberate Practice in the Acquisition of Expert Performance” noticed a theme that emerged in research on top-level performers. No matter who they were, or what explanation of their performance was being advanced, it always took them many years to become excellent. If a person achieves elite status only after many years of toil, assigning the principal role in that success to innate gifts becomes problematic. The phenomenon seems nearly universal whether in math, science, chess, musical composition, swimming or tennis. No one, not even the most “talented” performers, became great without at least 10 years of hard preparation. Many scientists and authors produce their greatest work only after twenty or more years of devoted effort. The “deliberate practice” made all the difference. Colvin says, “The difference between expert performers and normal adults reflect a lifelong period of deliberate effort to improve performance in a specific domain.”
Final Thoughts: The Search for Drive and Passion
We are constantly on the lookout for corporate managers who have integrity and a passion for the business. They also have a focused obsession to navigate through the most challenging of economic conditions. USA Today published a list in April of 2007 of the top 25 US stocks over a 25 year period starting in the 1982 recession. You see returns ranging from 17,808% to 64,224%. And you can see why the goal is to be a diligent business analyst, not a stock market prognosticator.
Thank you for your continued trust.
There can be no guarantee of success with any technique, strategy, or investment. All investing involves risk, including the loss of principal. The S&P 500 Index is a broad-based, unmanaged measurement of changes in stock market conditions based on 500 widely held common stocks. One can not invest directly in an index.
The views in this shareholder letter were those of the Fund Manager as of the letter’s publication date and may not reflect his views on the date this letter is first distributed or anytime thereafter. These views are intended to assist readers in understanding the Fund’s investment methodology and do not constitute investment advice.