April 2012 Review

Portfolio Update 

April saw some changes to the portfolio:

- Portfolio Redemption:  April is tax season in the US (and home improvement season in Mrs OM's mind!) and with this in mind Our Man and Mrs. OM decided earlier in the year to reduce their allocation to the portfolio at the end of Q1.  Given the large amount of cash in the portfolio and Our Man’s conviction in his names/theses, rather than selling positions to match the outflow, Our Man has reduced his cash position.  This has the impact of increasing the exposure to existing positions by c10%.

- NCAV Book changes:  As mentioned in the most recent NCAV post a number of positions within the NCAV bucket reached their sell-by date (see here for sell rules).  These positions were sold during April, leaving the NCAV portfolio with a solitary position.

Performance Review

April proved to be the portfolio’s first profitable month (+64bps) of the year though the portfolio is still negative for the year (-1.2% YTD).  While April saw the return of some uncertainty to the markets, which fell slightly over the course of the month, the portfolio’s profits were surprisingly broadly spread.

A number of books posted marginal gains/losses, which largely cancelled each other out.  The NCAV book (-4bps) was down for the month, though this largely represented the costs (mainly brokerage commissions) of exiting the majority of the portfolio.  The Currencies book (+7bps) benefited from the uncertainty in Europe and the China book (+2bps) from the mixed signals on Chinese growth.  The Puts/Hedges book (-5bps) was a mild detractor despite the small fall in equity markets

The Treasury Book (+21bps) and the Bond/Absolute Return Funds (+19bps) were both aided by the strengthening of US Treasuries over the course of the month, as uncertainty (especially over Europe) increased.  This uncertainty negatively impacted the Energy Efficiency book (-15bps) to a relatively large degree, given the speculative nature of one of the names (AXPW) and the mediocre recent history of another (XIDE).

The Value Equity book (+40bps), which has largely been disappointing to date, bucked the trend and had a strong month despite the small fall in the equity markets.  The performance was driven by the position in THRX, which rose after announcing that GlaxoSmithKline, its joint venture partner, was further increasing its stake in the business at a price above the then market value. 

Portfolio (as at 3/31 - all delta and leverage adjusted, as appropriate)

17.7% - Bond/Absolute Return Funds (DLTNX and HSTRX)

6.1% - Value Idea Equities (THRX, and DRWI)

4.5% - Treasury Bonds (TLT)

2.3% - Energy Efficiency (AXPW, and XIDE)

0.4% - NCAV Equities

0.0% - Other Equities (none)

-1.5% - China-Related Thesis (46bps premium in EWZ Jan-13 puts)

-2.4% - Hedges/Put Options (24bps in IWM Jan-13 puts, 20bps in SPY Jan-13 puts and 13bps XLY Jan-13 puts)

-10.7% - Currencies (EUO – Short Euro)

62.5% - Cash

Disclaimer:  For added clarity, Our Man is invested in all of the securities mentioned (TLT, DLTNX, HSTRX, THRX, DRWI, AXPW, XIDE, , EWZ puts, IWM puts, SPY puts, XLY puts, and EUO).  He also holds some cash.  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you.

Perception & Reality

“It was six men of Indostan
To learning much inclined,
Who went to see the Elephant(Though all of them were blind),
That each by observation
Might satisfy his mind”

- Verse 1 of Blind Man & the Elephant, John Godfrey Saxe

Our Man’s father is likely quite disappointed that he's quoting the John Godfrey Saxe poem (rather than say the version in Persian Sufi poet Sania's "The Walled Garden of Truth"), since the parable about “the blind men and an elephant” is of Indian origin.  The story tells of how 6 blind men come upon (or are introduced to) an elephant and each touch it to learn what it is like.  The men touch a different parts of the animal (side, tusk, trunk, knee, ear and tail) meaning that when they compare notes, each of them have a completely different (and incomplete) opinion of what an elephant is like.

The markets and global economy have offered a similar conundrum over the last 4-6 weeks, and like the blind men, there’s some evidence to support most perspectives. 

For example, the advance estimate of Q1-12’s real GDP growth (in the US) came in at +2.2%, a healthy enough number but beneath analyst estimates (of +2.5%) and the previous quarter (Q4-11: +3.0%).  On the surface, we should be pleased, after all GDP has now grown for 11 consecutive quarters.  Things seem less rosy when we consider a little more data and realize that the economy has only now returned to its 2007-peak and that historically-speaking, the pace of our post-recession growth is exceptionally slow.  This disappointment becomes clearer yet when we consider the extraordinary measures, including a zero-interest rate policy, massive budget deficits and the numerous attempts at unorthodox monetary policy (including QE1, QE2, QE-Lite, Operation Twist, etc), which have been used to try and stimulate the economy and drive growth.

And what to make of Europe?  The initial success of their unorthodox monetary policy (LTRO – where the ECB flooded European banks with cheap 3-year loans, and encouraged them to buy European sovereign debt with the money) was undeniable, silencing talk of potential crises in Italy and Spain by helping drive long-term bond yields substantially lower.  For example, Spanish 10-yr yields fell from over 6.7% in December to under 5% when the LTRO ended on 29^th February.  Yet, barely 6-8 weeks later the same bond-yields are rising slowly back towards their pre-LTRO level and the worry is that LTRO has failed to buy enough time.  Furthermore, if the (admittedly British-centric view that) Euro was a political creation rather than an economic one, then the political carnage bears noting.  Every one of the PIIGS (Portugal, Ireland, Italy, Greece and Spain) has seen its government swept away, or replaced by unelected EU technocrats (e.g. PM Mario Monti in Italy, or PM Lucas Papedemos in Greece), irrespective of the previous ruling party’s history* and achievements.  Additionally, with politicians working not for their citizens but focused on defending the “Euro project”, nationalism (and the hard-Right and hard-Left) is on the rise not just in the PIIGS but in the core countries.  The last fortnight has seen Netherlands’ government collapse after the Freedom Party’s Geert Wilders brought down the coalition after openly calling for defiance against the "Diktats from Brussels".  Then there is France, where the National Front recorded their best ever election performance (17.9% of the vote) in the first round of voting and the recently formed Left Front (11% of the vote) almost doubled their share of the vote.

Finally, there’s China.  The last few weeks have seen a divergence between the different manufacturing PMI (Purchasing Managers Index) readings, with HSBC’s showing a continued slowdown and the official government one showing a decent bounce-back.  These readings followed the weaker than expected Q1 GDP Growth (+8.1%), which was the lowest reading since the end of the 08-recession.  While it’s clear that China’s growth has slowed, the prevailing attitude remains that the government remains accommodative and that the slowdown is contained and being managed with limited risk of a hard landing (GDP growth of <3%).  For the skeptics (including Our Man) however, the worries of falling house prices and the impacts of non-economic credit-driven investment continue to mount.

What does this all mean for Our Man?  Not much, as observers of the portfolio would recognize.  The opportunity to generate strong investment returns is at its peak when; (i) your perception of reality diverges significantly from the mainstream, (ii) you have high conviction that your perception accurately reflects reality and (iii) reality is likely to be acknowledged in the markets (or instruments you’re trading) within an acceptable time period.  This allows you to take risks that others feel imprudent and to do so in size, with some faith that if you’ve sized the positions appropriately (and in the right instruments) you can hold them until reality conforms to your perception (or your perception adjusts).  Today, Our Man’s issues is primarily temporal; I have a more bearish medium-term view of global growth (especially Chinese) than most and reasonable conviction in it, but more limited faith that the markets will conform to this view in the near-term.  As such, the portfolio continues to hold smaller (than optimal) positions that reflect my views and will allow it to participate should things change quickly, but also substantial amounts of cash that waits for greater clarity before being invested.



* To put this into context consider:  Ireland’s Fianna Fail, the largest party in the government in every election from 1932 to 2011, lost over 1/2 of its share of the vote and 3/4 of its seats in 2011.  Greece’s PASOK, which has dominated Greek government since the collapse of the country’s military dictatorship in 1974, are polling at 15% (vs. having never won less than 38% of the vote since 1981!) for Sunday’s election.