Author: Sherman Lee, Prudent Value
Covestor model: Prudent Value
Disclosure: Long CHL, YHOO
In the third quarter of 2012, Prudent Value’s model portfolio returned +2.3%* while the S&P 500 Index (S&P 500) returned +5.5%. Year-to-date as of Sept. 30, Prudent Value’s model portfolio returned +2.6 while the S&P 500 Index returned +14.6%. Prudent Value’s underperformance relative to the S&P 500 index is attributable to the portfolio’s large cash and fixed income positions.
We ask investors to judge us over the long-term and on a risk-adjusted basis (i.e., active return on risk borne). To us, risk (permanent capital loss) arises from paying too much for an investment compared to the value received. Therefore, we do not define risk of loss by price volatility. On the contrary, we view price volatility as opportunities to buy and sell.
In hindsight, we were not aggressive enough when we started purchasing common stocks in the third quarter of 2011. We did not buy on a larger scale because of the heighten contagion risks surrounding the European debt crisis.
Additionally, we underestimated the strength of the European Central Bank’s and other central banks’ quantitative easing measures that backstopped imploding sovereign debt while lifting asset prices. Given the ever-changing global macro environment, we remain steadfast in seeking above-average returns while accepting what we believe to be below-average risk.
Looking ahead, the only certainty is uncertainty as looming U.S. fiscal cliff, European debt crisis and China slowdown have high-jacked economic growth around the world. While it is very difficult, if not impossible, to truly predict the future of the markets, it would be reasonable to expect sluggish stock prices in a very accommodative monetary policy environment (zero to low interest rates, quantitative easings, operation twists) in context of slower growth and high uncertainty in the three largest economies.
On a more encouraging note, housing is on the mend. Housing prices in the U.S. have risen six straight months, with the Case-Shiller 20-area index rising 1.2% from a year ago, and up 5.9% for the first seven months of the year.
Since our last quarter’s report, we initiated two new positions. These investments fall into the telecommunications and internet services space. In telecommunications, we added China Mobile (CHL).
CHL is the leading mobile services provider in mainland China, with approximately 650 million subscribers. CHL provides a full range of mobile telecommunications services in 21 service regions in China, covering 16 provinces, four municipalities, and one autonomous region. It provides its customers with Internet access through, wireless local area networks (WLAN). It has thousands of WLAN hotspots at such locations as airports, hotels, conference centers, schools and exhibition centers in the People’s Republic of China. The total population residing within CHL’s service area exceeds one billion.
In internet services, we added Yahoo (YHOO). YHOO is one of the world’s largest Internet companies. It has classified properties in three categories: Communications and Communities (mail and messaging offerings, Yahoo Groups, and Flickr), Search and Marketplaces (search offerings, Yahoo Shopping, Yahoo Travel, Yahoo Real Estate, Yahoo Autos, and Yahoo Small Business) and Media (Yahoo homepage, including information/entertainment offerings related to news, sports, finance, entertainment, and lifestyles).
These offerings are available on PCs, mobile devices, tablets and TVs. Hundreds of millions of users every month visit the online properties of YHOO and its unconsolidated subsidiaries (not including the 35% stake in Yahoo Japan and a 23% interest in privately held Chinese Internet conglomerate Alibaba Group). YHOO generates revenue from the display of graphical advertisements (display advertising), the display of text-based links to advertisers’ websites (search advertising), and other sources.
In Q3-2012, the top three performing U.S. sectors were precious metals (+27.51%), natural resources (+13.12%), and communications (12.11%). The worst three performing U.S. sectors in the quarter were real estate (+3.10%), utilities (+4.02%), and consumer staples (+6.30%). The top two performing regions in Q3-2012 were India (19.37%) and Europe (12.39%).
The worst two performing regions in the quarter were Japan (1.07%) and China (6.14%). While we do review market performance from time to time, our primary focus is to find great businesses run by shareholder-oriented management. Our favorite investments are undervalued wide economic moat businesses. Wide economic moat is a type of sustainable competitive advantage that a business possesses that makes it difficult for rivals to wear down its market share and profits.
Disclosure: Performance discussed is net of advisory fees. The index comparisons herein are provided for informational purposes only and should not be used as the basis for making an investment decision. There are significant differences between client accounts and the indices referenced including, but not limited to, risk profile, liquidity, volatility and asset composition. The S&P 500 is an index of 500 stocks chosen for market size, liquidity and industry, among other factors.
The investments discussed are held in client accounts as of September 30, 2012. These investments may or may not be currently held in client accounts.The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or that investment decisions we make in the future will be profitable.
Certain of the information contained in this presentation is based upon forward-looking statements, information and opinions, including descriptions of anticipated market changes and expectations of future activity. Covestor believes that such statements, information, and opinions are based upon reasonable estimates and assumptions. However, forward-looking statements, information and opinions are inherently uncertain and actual events or results may differ materially from those reflected in the forward-looking statements. Therefore, undue reliance should not be placed on such forward-looking statements, information and opinions.
