The Platinum Asset Management Trusts Muddle Along

I have for a long time been an admirer of Kerr Neilson, the founder of Platinum Asset Management. But in recent times I have begun to wonder whether Neilson was just fortunate to have obtained some very large returns fairly early on in the history of Platinum that has made the overall record of his funds look much better than what more recent investors have actually experienced.

It may be interpreted as some sort of signal that up to the 31 December 2009 Platinum Trust Quarterly Report, there were colour pictures of each portfolio manager smiling, then in the 31 March 2010 Report they changed to black and white pictures of each portfolio manager looking much more austere. Why? Was Neilson concerned that they looked too happy given the actual performance of the funds? Yes, I do think that’s the answer.

The latest Platinum Trust Quarterly Report (available on Platinum’s web site) shows that the International Fund (managed by Neilson and by far the biggest of the Platinum funds), has returned zero percent over the last five years and 12.1% compound since inception (in 1995).

I guess I have two issues with this.

Firstly, does a compound return of 12.1% per annum over 16 years justify Neilson’s estimated 2011 net worth (by Business Review Weekly) of $A2.1 billion?

I would say absolutely not, that sort of return should not be sufficient to propel a fund manager to that level of stupendous wealth. If you can return 20%+ over that time frame, sure, I would grant you billionaire status, but the difference between 12.1% and 20% over that time frame is the difference between turning $1 million into $6.2 million versus $18.5 million.

Secondly, the Platinum funds are able to take short positions (something the vast majority of mutual funds cannot do). Therefore, one would think that Platinum could have positioned itself to be far more market neutral than its performance indicates it has been. If the commentary in various Platinum Trust Quarterly Reports is any indication, Platinum has traditionally performed poorly with its short positions.

The problem it seems to me is that Platinum has tried to pick individual companies to short (with limited success) and has also not maintained a sufficient proportion of its portfolios short in order to make it more market neutral. I would have had a much higher percentage of the portfolios short and I would have done this over certain (European) markets – not individual companies.

The other problem is that Platinum seems to form (not always accurate) macro economic views and then invest accordingly (and I might add somewhat stubbornly, being slow to change a view when circumstances clearly change).

Yet another problem is the division of funds into geographic areas: Asia, Europe, Japan etc. If Europe is in deep trouble and you have a European fund (that only has 6% of the portfolio short), what’s going to happen to the investors money? Answer: Kiss it goodbye! And sure enough, the latest Platinum Trust Quarterly Report shows this fund lost 14% in the last quarter – yes, in one quarter, this is staggering!

The Platinum Trust Quarterly Reports are always written in a very articulate style and always give the impression that the writer knows exactly what he/she is talking about. Complex and uncertain economic situations are discussed with breathtaking simplicity and confidence.

But the actual fund results don’t fully support such confidence. For example, how can the Platinum Asia Fund (a $A3 billion fund) lose a whopping 17.2% over the last year when it has the ability to take short positions and is presumably being managed by people who know what they are doing?

(Incidentally, I have always thought that Kerr Neilson either writes or edits every single one of the various commentaries, the writing style is so similar for each fund, but that just might be me being a bit too cynical).

Absent a significant rally on global markets and Platinum’s continued refusal to take larger short positions, I cannot see how Platinum is going to improve its returns to investors.

Most of Platinum’s investors are Australian and as such have been able to get bank interest rates of anywhere from 5% to 7% over the last five years, so I would say, why pay fees to get zero percent?

The Insanity of Australian House Prices

Traditionally house prices in Australia have equated to approximately five times average weekly ordinary times earnings (AWOTE) as published by the Australian Bureau of Statistics.

Currently house prices are anywhere from six to nine times AWOTE (depending on which city you look at).

The real estate listings in Australia are littered with houses that cost $1 million+ and we are not really talking about prime properties here. Very average houses that happen to be reasonably close to a city centre now command sale prices of $1 million+.

Those who have a vested interest in absurdly high property prices will come out with all sorts of nonsense to justify the prices being paid: limited supply, zoning restrictions, immigration etc.

The truth however (as always) has got to do with interest rates – cheap credit, similar to the cheap credit that was available in many other countries prior to the collapse of their housing markets.

The seeds of the housing bubble (as in the US) were sown after the dot com crash when the Reserve Bank of Australia (RBA) foolishly followed the US Federal Reserve in lowering interest rates to artificially low levels.

The fact that Australia had very few dot com companies, that the Australian share market declined by nowhere near what the US market did in that period and that Australia was not about to have a recession (like the US did) seemed to have been lost on the RBA.

The top officials at the RBA are paid a fortune in comparison to their US counterparts and yet they get it wrong as often as they get it right.

When people can borrow very cheaply, what do you think they are going to do? It’s not a trick question.

They are going to borrow more than they previously could have which then allows them to pay more for housing. There is of course no free lunch – house prices increase in proportion to the availability of credit. As Buffett famously said, when everyone watching a passing parade decides to stand on their tip toes, no one gets a better view.

As the Australian banks source approximately 40% of the funds they lend offshore, there is always the risk that they will at some stage be forced to act independently of the RBA in raising mortgage rates (as they have already done on a few notable occasions).

The RBA and many politicians will protest vehemently about that but it’s precisely their policies that have caused the problem: The RBA for keeping rates at artificially low levels for a prolonged period causing a borrowing binge and successive Australian Governments for discouraging savings through punitive tax policies, while at the same time encouraging speculation in the housing market by allowing ludicrous practices such as “negative gearing”.

This offshore funding dependence is why Moody’s recently downgraded the credit ratings of the big four Australian banks.

There are only two things than can happen to Australian house prices, they can collapse dramatically like they have done in the US, the UK, Ireland and Spain or they can go through a prolonged period (perhaps 10 years) of practically no price appreciation. I would favour the latter, but no one can rule out a price collapse.

What is absolutely clear to me is than anyone buying a house today in Australia (who doesn’t have to buy one) is not investing – they are taking a gamble for which they are more likely than not to pay dearly for down the track.

Yes, it’s not conventional wisdom, I know, but I’ve made a lot of money ignoring conventional wisdom (or what some fool at the Housing Industry Association is telling another fool in the media).

It is somewhat amusing to see people (who understand nothing of financial mathematics) who think that house prices can keep doubling every 7-8 years (as they have done in Australia over the past 7-8 years). This is simply not possible over long periods of time because the point will be reached where practically no one can afford a house – and that won’t happen, prices will correct before that point is reached.

No one can be certain when this party will come to an end and it might very well end with a whimper rather than a bang, but end it will.

The Royal Wolf Holdings IPO: One to Watch

Royal Wolf Holdings will list on the ASX on 31 May 2011. The lead manager and underwriter is Credit Suisse and the co managers are Commonwealth Securities and E.L. & C. Baillieu Stockbroking.

A number of institutional investors were falling over themselves to get stock in this company and I can see the reasons for their attraction.

Royal Wolf makes its money from leasing and selling portable containers. It has a large market share of this business in Australia and New Zealand.

While the business may sound boring, it’s precisely the type of business that investors such as myself like.

Why?

Because it’s a straight forward business that provides essential products that will never be made obsolescent by technology, the company earns attractive margins on its products, has good opportunities for growth, is a dominant player in its market and most importantly the IPO is reasonably priced. The estimated dividend yield will be quite acceptable too at about 4% (unfranked).

The other nice thing about Royal Wolf is that it has a very diverse client base, so there are no individual clients that account for significant amounts of revenue.

While Royal Wolf has the value of its lease container fleet at $103 million in its balance sheet, the independent valuation is actually $133.8 million. Conservative accounting is to be applauded.

The IPO price is $1.83 and I wouldn’t be too surprised to see it list at a premium to that price based on what I’m hearing regarding demand for the stock.

There haven’t been any Australian IPOs in the last three years that I have been interested in. Too many of the companies have been of average quality and the prices asked have generally been too high. Royal Wolf is different. It is a good quality company and the price is reasonable.

Only clients of the lead and co managers were invited to apply for shares.

Please note that as always, none of the above constitutes financial advice, as with any investment there are risks. You need to do your own research and consult appropriately qualified people for advice (where necessary).

Berkshire Hathaway is looking rather cheap

Currently, Berkshire A shares are trading at around $120,000 and the B shares are at approximately $80.

Book value per share (BVPS) at the end of the first quarter of 2011 was just over $97,000. Therefore the price-to-book ratio is approximately 1.24.

The average (year-end) price-to-book ratio over the period 2005-2010 was 1.44, this compares to 1.76 from 2000-2010 and 1.63 from 1985-2010.

Over the period 2005-2010, BVPS has increased at 9.9% compound, compared to 24% compound from 1990-2000. Even despite its size, Berkshire is still comfortably outperforming the S&P 500.

Realistically, I think that Berkshire will manage to return 8-9% compound for the next 3-4
years. Let’s assume 8% growth in BVPS. This would mean that the BVPS of Berkshire will be approximately $103,000 at year-end 2011, $111,000 at year-end 2012 and $120,000 at year-end 2013.

I also think that 1.44 times BVPS (the 2005-2010 average) is a realistic and not too demanding multiple for the actual stock price to trade at.

What does this give us?

It gives us an intrinsic value of approximately $148,000 for the A shares at year-end 2011, approximately $160,000 at year-end 2012 and $173,000 ($115 for the B shares) at year-end 2013.

If I’m correct here and Berkshire is trading at approximately $173,000 at year-end 2013, the compound return from now (at a current price of $120,000) will be about 15% - not bad at all.

The returns come from the ever increasing BVPS of Berkshire plus the movement in the price-to-book ratio to a more realistic 1.44.

What can go wrong?

You know the answer. Buffett is now 80 years old and no one knows how long he will remain as CEO of Berkshire (even he doesn’t know that). However, my analysis only goes to the end of 2013 which is just over 2.5 years away. I’m not looking beyond that and believe that it’s more likely than not that Buffett will still be at the helm at that time.

Even without Buffett, Berkshire will carry on with some wonderful businesses that generate vast amounts of cash (Buffett currently estimates normal earnings power of $12 billion after tax).

The majority of large American corporations trade at much more than 1.24 times BVPS and they do not have Buffett or the diversity of businesses that he has hand picked, and of course, he isn’t finished yet. You get my point.

I’ve recently bought Berkshire, so we will see how this pans out. Of course I’ve used Australian dollars to buy it and I bought at a point when the $A was trading at $1.10 to the $US. This adds another dimension to my investment which obviously US investors won’t have.

Note: None of the above constitutes financial advice. You need to do your own research and consult appropriately qualified people for advice (where necessary).

The Volatile Australian Dollar

Alan Kohler wrote the following on 9th May 2011:

Don’t be misled by last week’s commodities crunch, the Australian dollar is heading higher – much higher. That’s partly because of the return of the carry trade.

On the same day, John Taylor (CEO and founder of FX Concepts) told the Australian Financial Review:

The Australian dollar is really high now – I thought it was going higher but now I’m not so sure. Things are going to turn… basically, the currency is going to come off the flame and things are going to start slowing down.

Kohler in his usual emphatic writing style is absolutely certain of an “explosive” Australian dollar. Of course he hasn’t done any research himself, he’s latched onto some thoughts of economist Tim Toohey on the $A/Yen carry trade.

Kohler is a journalist who has been wrong on many occasions previously but you wouldn’t know it from the way he writes. After all, he has grey hair, appears on TV, wears a suit and sounds plausible – enough for most people to believe him.

John Taylor on the other hand is a very experienced operator in the currency markets and has made many correct calls in the past. John Taylor doesn’t share the views of Kohler and Toohey.
Those of us who actually operate in markets, as opposed to writing about markets or living in economic ivory towers, will know instinctively why Taylor holds the view he does.

On any measure the $A is over-valued. The $A/Yen carry trade has been a factor, but the point that Kohler and Toohey miss is that playing the carry trade when the $A is at these levels (against most other major currencies) is a fool’s game. Why? Because:

1. The $A is trading at levels 40-50% above its long range valuation;
2. The $A is one of the most volatile currencies in the world - wild swings in value are normal (and dangerous for would be speculators);
3. The Reserve Bank of Australia is holding off on interest rate rises for as long as it possibly can (it really does worry about all those terribly over-leveraged “home owners” – but they won’t admit it);
4. There’s no point getting a few extra percentage points in interest if you end up ultimately losing a good part of your capital.

Of course, as is the case in any mature bull market, a large part of the price increase (just before the fall) is due to hedge funds and the like taking wild speculations with other people’s money, creating artificial demand, while trying to make some quick returns in an upwards trending market (i.e. collecting nickels in front of bulldozers).

All though much less of a factor, there are also all those individuals who are relatively new to markets and through CFDs are able to leverage their minimal capital 100-200 times and speculate in currencies. There will be some that have made easy money in recent times speculating on the $A/$US pair, but once again, they are picking up nickels in front of bulldozers. Just wait and see.

In any bull market you will always find those people who say “this time is different” as a means for justifying insane prices. However, things are never truly different – they just temporarily appear to be different before all of a sudden (and from seemingly nowhere), conditions return to their previous state.

The Stock Scribe Portfolio surges ahead

On 5 December 2008, I selected a portfolio of 11 stocks using techniques detailed by Benjamin Graham in his book The Intelligent Investor, (see the original post in my 2008 folder - A Portfolio selected using Graham’s techniques).

The initial portfolio value was $1 million with approximately $90,909 invested in 11 companies (see table).

As can be seen above, as at 18 February 2011 this portfolio had appreciated by 22% (compound) to $1,550,870. The All Ordinaries Index had appreciated by 19% (compound) over the same period. So I’m a bit ahead of the index (and I haven’t included dividends of approximately $70,000 over the two or so years).

An unmanaged index has returned 19% and one selected with some Graham and Dodd metrics has exceeded that. It’s a testament to ignoring so called experts.

When the above portfolio was selected, various “experts” were telling us that the world was about to end (I remember someone sending me some particularly apocalyptic articles that appeared at the time on the aptly named Business Spectator web site. I’ll say it again and again, don’t waste your time reading opinion pieces written by journalists).

Many of the companies in the above portfolio were priced as if this apocalyptic scenario was actually true. Of course smart investors were thinking the exact opposite – it was a magnificent time to invest, perhaps a once in generation time to invest. And invest we did.

When I saw companies of the quality of Soul Pattinson, Sims Metal, Caltex, Austereo and Flight Centre selling for the prices that they were in December 2008, I just knew it would be very hard to go wrong buying these companies at those levels. In other words, the odds were well and truly stacked in my favour.

I did sell WA News from my own portfolio at prices ranging from $6.79 to $8.08 (it closed at $6.34 on 18 February 2011).

Hills Industries was a mistake (although they may bounce back in time). Suffice to say, one mistake out of 11 equally weighted picks is of no consequence at all.

Austereo is now the subject of a takeover offer at $2.00 per share plus an additional 10 cents if the acquirer gains acceptances for 90% of the shares.

I knew that Austereo could not be acquired for less than $2.00 in a takeover and that is one of the reasons that I bought it for $1.11 in late 2008.

Austereo has a dominant market position, has been a very consistent performer, paid a very high (sustainable) dividend, and (in late 2008) was purchased at less than 9 times earnings. There was a very high margin of safety.

The ASX is also subject to a $48 per share takeover offer by the Singapore Stock Exchange, but there are doubts as to whether this takeover will gain government approval.

Most of the companies in the portfolio are no longer undervalued and I would be content to sell some of them at these levels.

Happy investing.


Note: None of the above constitutes financial advice. You need to do your own research and consult appropriately qualified people for advice (where necessary).

The S&P 500 gives reason for optimism

In his recent letter to investors, John Paulson stated that the most relevant indicator that they track in the current environment is the Equity Risk Premium (compiled by JP Morgan). Paulson states that the Equity Risk Premium is the highest it has been in 50 years, which indicates to him that equities will rise further to close the gap with bonds.

The JP Morgan data shows that the Equity Risk Premium has only exceeded 5% on five occasions since 1957, these years being 1958, 1974-75, 2009-10.

Of course the Equity Risk Premium can always be closed by bond yields rising rather than equity yields falling. However, for the time being that is probably not a likely scenario and that is why Paulson is enthusiastic about equities.

Paulson states that he believes growth will continue and will accelerate and that this is the part of the cycle where they want to have long event exposure and do not want to be under-invested.

I note that Robert Shiller (of Yale University) does not share Paulson’s optimistic view and is more or less forecasting anemic growth for the S&P 500. While I have a lot of respect for Shiller, I think he is more likely to be wrong than right. I’m not saying that I expect spectacular growth to occur – I don’t, but nor do I expect anemic growth.

An added dimension for those of us who live in countries with very strong currencies, is the play on the $US by going long US equities. For example, the Australian dollar ($A) is a highly volatile currency that has on average traded at around $US0.73 throughout its 27 year history as a free floating currency. Now the $A is trading at around parity (or more) with the $US.

Australia is highly dependent on commodity prices (largely iron ore and coal), has an under-performing anti-business federal Labor government in power and a grossly inflated housing market. These are not factors which would inspire enormous amounts of confidence in the $A staying at parity or above with the $US.

I don’t want to sound overly pessimistic, but economic conditions in Australia will not get much better than they have been in recent times – the risk is very much to the downside. The reverse is true for the US.

It has also largely gone unnoticed (by those outside Australia) that the Reserve Bank of Australia has been pushing out potential interest rate rises further and further into the future. Those foreign funds holding the $A would have predicated their investments on a current cash rate of approximately 50 basis points more than it actually now is. In other words, they are getting “suckered” into holding $A for much longer than they initially intended.

The US is slowly emerging from a very serious recession, there is cause for optimism. And I don’t mind at all having an exposure to the S&P 500 especially when I can buy that exposure with an $A that is worth more than the $US.

Note: None of the above constitutes financial advice. You need to do your own research and consult appropriately qualified people for advice (where necessary).

Is the Gold bubble about to burst?

Recent weakness in the price of gold would be sending a few jitters amongst those hedge funds that have built huge positions in the commodity.

I must confess that through 2009 and 2010 I actively traded gold. At one point I was fortunate enough to capture a $A163 upward move per ounce in the gold price in only 39 days. I would have captured even bigger profits, however, in recent times, my home currency (the Australian dollar) has largely risen with the gold price and taken out $US profits.

Why was I trading gold? Because it was logical to conclude that quantitative easing and sovereign debt problems would be positive for the gold price. Further, I had noticed that both John Paulson and George Soros had been doing significant buying. I have great admiration for both of them.

However, in recent months I have become less convinced that I can make money from trading gold. I unwound my final position in the week commencing January 24.

The gold price is being held up by three factors: sovereign debt issues in Europe, quantitative easing in the US (accompanied by extremely low interest rates) and ETF buying. The third factor (ETF buying) is creating artificial demand for gold that will disappear very quickly once sentiment turns bearish.

In the absence of another European country needing a bail-out (likely candidates Portugal and Spain), the gold price may well weaken further. And it is by no means a certainty that either of those countries will require a bail-out.

I am also not convinced that the $US will depreciate a lot further. It seems to have already done most of the depreciating it is going to do. It’s just my opinion. But if I’m correct, the gold price is not going to get further easy boosts through an even weaker $US.

The other problem is the massive positions in gold that various hedge funds have built up through ETF holdings. Once they sense that they are going to lose significant paper profits they will head for the exits. And they are likely to do this en masse. Individual investors do not want to be holding gold when that day comes. (And I can’t tell you when that day will come – but it will, unless of course you believe that they are going to hold their non-income producing gold forever).

So all I’m saying is be cautious.