Portland Investment Counsel

Emerging Markets: a great money making opportunity too impressive to neglect…

2011-09-13T10:42:00.000-04:00

The June 2011 edition of Institutional Investor magazine featured an article that highlighted the relevance of investing in emerging markets and I summarize the rationale as follows:

The economies of the emerging markets are growing and their debt and fiscal positions are relatively better; and
Institutional investors are underallocated to emerging markets and many are increasing their emerging market exposure

The combination of those two trends would be expected to drive up valuations, thereby driving investment returns but also increasing the risk of overpriced markets. As a result, whereas investors may have historically played emerging markets for “beta” by investing in indices and large caps, the value of being more selective in these markets is likely to increase in importance. We believe that investors should be increasing their investments in emerging markets but doing so selectively.
The following are some selected excerpts from the article:

“Emerging and developing markets are expected to grow by 6.5 percent this year, nearly three times as fast as the 2.4 percent pace of the advanced economies, according to the International Monetary Fund.”
Joyce Chang is global head of emerging-markets and credit research at JPMorgan Chase & Co. in New York. “’EM countries continue to look better on the debt and fiscal front as developed market debt and fiscal positions have deteriorated over the last three years.” says Chang.
Timothy Moe, chief Asia-Pacific strategist of Goldman Sachs, forecasts that “Over the next 20 years…Although developed markets are likely to more than double in size, to $66 trillion, capitalization of the emerging markets should grow nearly sixfold, to $80 trillion.”
“To be sure, the growth of emerging-markets investing does face challenges. Some investors and analysts warn about the danger of lofty valuations, which in many countries exceed those in developed Western markets.”
Yngve Slyngstad is CEO of Norges Bank Investment Management, the manager of Norway’s giant sovereign wealth fund. “Slyngstad is looking to pursue diversification across a broader front. Last month he went to the Ministry of Finance and requested authorization to substantially increase the emerging-markets allocation of the Government Pension Fund Global, as the sovereign fund is called, because of the growing size of those countries in the global economy. The fund has roughly $50 billion of its $555 billion in assets in emerging markets or in companies heavily involved in those markets. Slyngstad wants to increase that figure by two thirds, to almost $85 billion, by the end of next year.”
“In addition to expanding the fund’s emerging equity allocation, Slyngstad wants to put more of that exposure in the hands of dedicated emerging-markets managers. He believes most emerging markets are less efficient than their developed world counterparts, providing an opportunity for knowledgeable local managers to generate alpha.”
“As more institutions look to emulate active emerging-markets players like the Norwegian fund, the potential for further capital flows to these economies is great.”
“The University of Notre Dame, which has almost 16 percent of its $7 billion portfolio in emerging markets, is looking to increase that weighting, possibly doubling it in the next five to seven years, with private equity accounting for half of the growth.”
Newlight Associates is a New York investment firm that specializes in emerging growth stocks. “’Investors who neglected the emerging markets in 2009 missed one of the great moneymaking opportunities of the decade,’ says Newlight’s Raucci. "Those who continue to neglect the EM going forward do so at their peril.”

*Source: 6Upta, Udayan. "Bric and Beyond". Institutional Investor. June 2011

Defining Risk

2011-07-25T09:10:00.002-04:00

The link that follows is to an article about a recent report by Fidelity about 5 key risks to retirement income. What I found interesting is that not one of the referenced risks is "portfolio value volatility"; and yet, our industry has broadly defined "risk" as meaning "portfolio value volatility" such that a "low volatility portfolio" is considered "low risk" and a "high volatility portfolio" is considered "high risk". If one thinks about retirement income and "longevity risk" and "inflation risk", investing in a "low volatility portfolio" may actually be "high risk". Could the overwhelming industry focus on "volatility" actually be creating greater long-term risk for clients?

http://www.advisor.ca/investments/market-insights/five-key-risks-to-retirement-income-%e2%80%93-part-1-53675

Guaranteed returns may be riskier than you think

2011-06-27T08:47:00.001-04:00

I found the article titled “Boomers shaken by 2008 rout” published on June 21, 2011 on Advisor.ca to be quite disturbing.

http://www.advisor.ca/news/industry-news/boomers-remain-shaken-by-2008-rout-51457

The current economic pressures, which are making it more challenging to save, when combined with risk-averse investing, could be a recipe for future retirement savings deficits. In this regard, I recently read an article that I thought did a great job of articulating something that I have been having a hard time putting into words. In summary, the writer said that there are basically 3 ways to fund retirement:

Save more;
Retire later; and
Earn a higher rate of return.

Current economic pressures (unemployment, sandwich generation, etc.) make it harder to save more. Retiring later is far from certain as it depends on health and continued employability. Therefore, it is imperative that people manage the returns they earn on their savings.

Earning 2-3% so as to avoid risk very often means one of two things:

Accepting the certainty of a lower standard of living in the future; or
Betting that one will remain healthy and sufficiently employable to work longer and retire later.

That doesn’t sound like risk reduction to me.

The writer goes on to observe that it is no wonder that older people fall prey to investment scams – when confronted with the realities associated with years of safe 2-3% returns, they become more vulnerable and are more likely to chase “too good to be true” scams.

http://guardian.co.tt/business-guardian/2011/06/16/finding-strategy-works-you

While, in the short-run, investing in good quality equities may entail more volatility than investing in GIC’s, in the long-run there is an argument that it is actually a lower risk strategy. I have a difficulty classifying a strategy as “low risk” if the consequence of it is very risky – and yet, that is exactly what is happening all too often. Consider the following illustration: A person needs $50,000 per year to live. In scenario A, they invest in the “low risk” portfolio which will ensure that they run out of money in 20 years. In scenario B, they invest in a portfolio which is expected to never run out but which may run out in 15 years. Which is more risky?

It is easy to advise people to “save more” and “play it safe” – but I wouldn’t want to pay for that advice. A financial advisor who can design a portfolio that helps a client prepare sufficiently for a quality retirement without overly sacrificing enjoyment today – that I would pay for.

Macro fear makes it a good time to buy.

2011-06-14T08:33:00.000-04:00

The most popular headline on Bloomberg on Monday June 13, 2011 was:

“’Perfect Storm’ May Threaten Global Economy”, based on comments from Nouriel Roubini.

For those who choose to read on a bit further, they would read the following:

“There’s a one-in-three chance the factors will combine to stunt growth from 2013, Roubini said in a June 11 interview in Singapore. Other possible outcomes are “anemic but OK” global growth or an “optimistic” scenario in which the expansion improves.”

Said another way, there is two-in-three chance that growth beyond 2013 will be good.

We are now over 3 years past the start of the “financial crisis” and over 2 years past the bottom of the crisis. The economy and markets move in cycles and not linearly with, on average, at least one downturn per decade. Therefore, one would not have to be prescient to predict that there will be another economic and market downturn during the next 7 years. The question is whether that expectation is sufficient justification for not investing or disinvesting. History suggests that the gains to be made in between downturns dramatically exceed the losses during downturns. Doesn’t that history suggest that, notwithstanding the likelihood of a downturn somewhere in the future, the way to earn attractive investment returns is to be invested during the up-cycle, especially when fear drives the prices of quality businesses down?

Warren Buffett visited India last week

2011-03-30T11:49:00.000-04:00

(The link should take you to a transcript and video link to one of his interviews. There are many more on the site.)

http://www.moneycontrol.com/news/business/buffett-charms-india-says-this-isdream-market-for-investors_531481.html

The reference to India being a "dream market for investors" is consistent with our belief that India presents many good investment opportunities.

In this video and the others available on the site, Buffett makes a number of other comments that are vintage Buffett and yet still relevant and insightful. Below, I note a number of them that I found particularly relevant.

Optimistic on the world -- India growth is not at the expense of US growth or vice versa. It is a growing pie.
Monetary and fiscal stimulus are easy to measure but the real driver of growth is creative, passionate people.
Corruption does not only happen in India. It takes place all over the world. Even Berkshire Hathaway is not 100 % immune. Berkshire Hathaway tries to only partner with honest partners, communicate its expectations of good behavior and detect/deal with instances of bad behavior as quickly as possible.
He likes businesses led by people who "love their businesses". Family owned/managed businesses where the family has the passion and the competency to manage the business and, for one reason or another, are looking for outside investors are great -- not easy to find, but great.
Stay within circle of competence. Where he is not an expert in the business, he has invested in people who are -- feels he is pretty good at that.

Things are not always "normal"

2011-03-07T14:04:00.006-05:00

As investors, we subscribe to certain principles that may not seem relevant through "normal" times.

But, as the last few years have reminded us, things are not always "normal" and it is the periods of turmoil that we must use to remind us of the relevance of our principles and protect ourselves from permanent losses of capital.

For example, we prefer to invest in businesses in which management has a large ownership interest; i.e. they have more to gain and lose based on the company’s long-term value than they stand to gain from growing their compensation by increasing the size, complexity and/or short-term performance of the company. The financial crisis reinforced our conviction around this principle.

More recently, the events taking place in Egypt, Libya, etc. have reinforced our conviction around investing in countries that we believe to have “functioning democracies” and a “growing middle class”. We believe that increasing levels of information, education and communications capabilities are increasing the instability of countries with high concentrations of wealth and power. I think that it is this principle that Warren Buffet was referring to when he made the following reference to the “American System”:

“’There is a resiliency to the American system,’ he added. ‘It does work. It sputters from time to time, it will sputter from time to time, but you don't want to get worried.’”

http://www.reuters.com/article/2011/03/02/berkshire-buffett-idUSN0218786020110302?pageNumber=1

Mr. Buffett also reinforces our belief that investments in quality businesses can actually reduce the risks associated with inflation and rising interest rates. He maintained that stocks are a better investment over the long term than bonds, saying "it's a terrible mistake to buy into fixed-dollar investments at current rates.”

http://www.reuters.com/article/2011/03/02/berkshire-buffett-idUSN0218786020110302?pageNumber=2

At a more tactical level, the recent events in the mid-east also serve to reinforce our belief in the value of oil reserves in regions that are geo-politically stable, Canada being one of them.

“If Demography Is Destiny, Then India Has the Edge”

2011-01-31T11:42:00.000-05:00

Business Week recently published an interesting article entitled “If Demography Is Destiny, Then India Has the Edge”. Make sure to look at the chart that is part of the article. The article can be found at:

http://www.businessweek.com/magazine/content/11_04/b4212009727572.htm

Keeping Company Valuations in Context

2011-01-11T08:27:00.003-05:00

As we all know, any valuation metric needs to be kept in context. In assessing the P/E of Adani Enterprises, the following context should be noted:

The year-end in March 31 which means that the 2012 fiscal year really represents 1 year forward earnings.
The expected growth rate. In this case, India is experiencing real GDP growth in the 8-9% range. In addition, the company’s investments in coal mining, power generation, ports and real estate are just starting to kick in. The mean analyst estimates on Thomson are calling for EPS to almost double from March 2011 to March 2012.
Adani is primarily in infrastructure type businesses which tend to produce more predictable recurring cash flows.
Upside optionality based on asset potential and capital capacity.

Looking ahead to 2011

2011-01-04T10:14:00.003-05:00

As we start 2011, it is a good time to think about the context in which we invest. Here are a few articles that are generally consistent with my thinking.

Moderately positive expectations as North America approaches 3rd year of recovery.
http://www.bloomberg.com/news/2010-12-31/wait-til-next-year-for-new-normal-as-s-p-index-gains-86-since-march-2009.html

Growth in India.
http://www.theglobeandmail.com/report-on-business/economy/india-asias-other-economic-powerhouse/article1853707/page1/

Debt worries persist.
http://www.theglobeandmail.com/report-on-business/europes-debt-woes-could-be-harbinger/article1854721/page2/

The attractiveness of Canadian Wealth Management and Emerging Markets

2010-12-20T08:53:00.001-05:00

One of the themes I have been talking about is the growth of emerging markets in absolute terms and, in particular, relative to that of the developed markets. Along these lines, the inference to be drawn is that advisors should be assessing their clients’ portfolios to ensure that they have sufficient exposure to these markets or else they risk falling behind relative to the world. The attached is a link to an article referencing Scotiabank’s recent acquisition in Uruguay. Based on their recent investment activity, Scotiabank would clearly appear to favour Canadian Wealth Management and Emerging Markets.

http://online.wsj.com/article/BT-CO-20101206-707245.html

Insights from my recent travels

2010-11-29T10:19:00.000-05:00

The last 3 weeks have included a lot of travel for me. While travel is tiring it is also very insightful and, in this note, I would like to share with you the two main insights I gained from this trip.

Perception versus Reality
Growth and Risk

Perception versus Reality
One of the stops on the trip was Turkey. I had never been to Turkey before and my perception of Turkey would have been formed by movies, news, and other media. However, from the magnificent airport at which we landed (which we were informed is one of the 5 busiest airports in Europe and partially owned by a major Canadian pension plan) to the highways that had me thinking I was in Canada to the very orderly organization of buildings, malls, etc., my perceptions were completely invalidated. I’m sure there are parts of Turkey that are poorer and more chaotic but that applies to every country. What is the relevance of this to investing? Don’t allow perceptions to drive decisions.

Growth and Risk
The majority of the trip was in India. While we had several meetings with companies and other Indian parties, the inescapable insight was the “context of growth” and what that means to the assessment of risk. We tend to think of emerging markets as higher growth and higher risk. However, when immersed in a market experiencing roughly 8% real GDP growth and nominal growth in the 10-15% range, there are good investment opportunities all over the place and the entrepreneurial spirit, which is the lifeblood of any economy, is in high gear. This caused me to ask the question: “Which is a more risky pool from which to select investments: one with 8% growth or one with 0% growth?” My conclusion was that a growth market offsets a lot of risks. So, notwithstanding that there are many risks associated with lesser developed markets (eg. corruption, unpredictable regulation, etc.), I believe that the risk reduction provided by a growth context can be greater. In the case of India, I believe that combination of high macro economic growth combined with the transparency and democracy that is inherent in the country makes for a relatively attractive risk profile.

Bank of Nova Scotia and Dundee Wealth
More recently, Bank of Nova Scotia announced an agreement to acquire 100% of Dundee Wealth. This was widely reported, so I won’t focus on the details. One of the most frequent questions I was asked in the aftermath was “Do you think CI is next?” Now, we are not prone to speculate on merger and acquisition activity. However, we think that there are inferences that can be derived, from the BNS/Dundee transaction, in respect of Canadian Wealth Managers. We have long articulated the strength of the Wealth Management business model (strong demographic drivers, minimal on-balance sheet risk, scalable, financial and operating leverage, etc.) and that our view was validated by the desire of the banks and insurance companies to increase their presence in this space. In this case, let’s look at what Bank of Nova Scotia’s behavior is saying. They could allocate their capital anywhere. And, it would be surprising if their minimum rate of expected return was anything less than 15%.

So, what they are saying is that they expect to earn a minimum 15% return on their investment starting from the price of the transaction. And, that pricing is higher than the pricing that applies to some of the other Wealth Managers. So, if we believe that Bank of Nova Scotia is a prudent investor, then that would imply that some of the other Wealth Managers could be well positioned to generate 15% plus returns – if that turned out to be true, it would make Wealth Managers a good investment today.

Wealth Managers Still on Target

2010-11-08T09:45:00.000-05:00

Followers of this blog will have noted that I have been of the view that:

While the shape or pace of a recovery is not necessarily predictable, I believe that there will be a recovery and that we are still relatively early into that recovery;
Well capitalized Wealth Managers provide positive leverage during a recovery and have the ability to sustain recessions.

Earlier this week, Dundee Wealth Inc. reported its results for the quarter ended September 30, 2010. These results stood as evidence in support of the two views noted above. Year over year, Revenues increased 30% and Earnings per Share increased 107%. The annual dividend was increased 114% and changed to a monthly payout of $0.05 per share.

Like all Wealth Managers, DundeeWealth suffered revenue and earnings declines during the 2008 market crash. Unlike most other Wealth Managers, Dundee Wealth also had a banking subsidiary which suffered relatively heavy losses on asset backed commercial paper. Its stock price closed at $4 per share on November 20, 2008 – On November 5, 2010, the closing price was $19. I see the rebound in its performance as indicative of:

The economy and markets have been recovering and continue to recover;
Wealth Managers are able to withstand extreme adverse conditions;
The returns and earnings of Wealth Managers are positively leveraged to a recovery.

“Recession? Entrepreneurs barely noticed” – Why?

2010-10-18T13:27:00.001-04:00

There was an interesting article published this week on Advisor.ca.

It was titled:
Recession? Entrepreneurs barely noticed

The first paragraph states:

“You may have noticed that your small business-owner clients have remained upbeat during the recession — and you probably weren't alone. It turns out that less than half of small businesses felt a negative impact from the downturn, according to a poll by RBC.”

So, the question I ask myself is, how is it possible that so many of these entrepreneurs did not feel a negative impact from the downturn? I think the answer lies in two important aspects of being an entrepreneur/business owner:

Entrepreneurs/business owners have most of their wealth tied up in their business. Accordingly, they are focused on, and determine their financial health based on the revenues, costs and profits of the business. They are NOT focused on the daily valuation of their business. In other words, while the entrepreneur/business owner may have been focusing on a 5% revenue increase or decline, his non-business owning, highly diversified fund owning neighbor was probably focused on a 40-50% drop in public markets.
Entrepreneurs/business owners understand their business and are able to adapt to changing market conditions – “reviewing their business plans and assessing their financing options”. This would mean that they have a sense of “understanding” and “control”. On the contrary, their broad based fund owning neighbor has the feeling of being a “victim”.

Knowing your clients and their risk tolerance are cornerstones of the financial advisory profession. Understanding these attributes of clients who are/were entrepreneurs and business owners is important to serving them well and should, in my opinion, be given serious consideration in designing optimal investment portfolios for these clients.

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During the week, the following news items were of relevance to some of the companies we follow and in which we may have an economic interest:

Infosys Technologies Limited results for its 2nd quarter ended September 30, 2010:

Revenue increased 12% over the prior quarter and 24% over the prior year;
Earnings Per Share increased 17% over the prior quarter and 13% over the prior year;
Management’s guidance for full year ending March 31, 2011 was increased from “112.21-116.73” to “115.07-117.07”which would represent year-over-year earnings growth of 6.4% to 8.2%.

We see this growth as indicative of the unique strengths of the company combined with a global economic recovery.

Don’t judge a book by its cover

2010-10-12T11:07:00.001-04:00

S&P 500 Index - Xource: Bloomberg

On October 4, 2010, a Bloomberg headline read “S&P 500 Profits Cut for First Time in Year by Analyst”. (see here). However, in the body of the article, the following appears:

“While estimates for U.S. corporate profit fell last quarter, they still indicate that firms in the S&P 500 will report record earnings in 2011. The equity benchmark is valued at 12 times projected income for 2011, according to data compiled by Bloomberg. That’s the cheapest level since 1988, excluding October 2008 to March 2009 after New York-based Lehman’s bankruptcy, relative to reported profit from the past 12 months.”

While the headline would probably lead the average reader to conclude that stock prices are likely to fall, the excerpted paragraph would probably lead to the exact opposite conclusion. My point of view is that, while the magnitude of earnings growth may be in debate, it is broadly anticipated that US corporate profits will grow and share valuations don’t adequately reflect that expected growth.

Reflections on the week ending October 2, 2010

2010-10-04T10:31:00.001-04:00

On September 29, 2010, Bloomberg Business Week had the following headline: “Fidelity Loses Top Mutual-Fund Spot to Bogle’s Index Investing” ( http://www.businessweek.com/news/2010-09-29/fidelity-loses-top-mutual-fund-spot-to-bogle-s-index-investing.html ). Now, I am not one to see this event as symbolic of the death of active investing. Index investing is premised on the efficiency of markets and the efficiency of markets, in turn, is premised on active investors keeping the markets efficient – that would mean that active investing and index investing are mutually dependent. However, I do believe that the event should remind us that active managers need to be active – closet index funds are easily substituted by lower cost index funds.

Turning to the markets, the month of September ended positively for the North American markets. As I have repeatedly noted, in addition to providing healthy dividends, I expect Canadian wealth management stocks to amplify market returns. September’s results provided further validation of that thesis as the average price appreciation of CI Financial, AGF Management, IGM Financial and DundeeWealth for the month was 7.9% versus 3.8% for the S&P TSX index. While the near term outlook for markets is always uncertain, the S&P TSX is still approximately 20% below its peak and I remain confident in market appreciation over the longer term. With relatively low balance sheet risk and attractive dividends, I believe wealth managers are ideal holdings in such a scenario.

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During the week, the following news items were of relevance to some of the companies we follow and in which we may have an economic interest:

AGF Management Limited reported results for its third quarter:

Assets Under Management of $42.6 billion were 3.8% higher than the corresponding quarter in the prior year. EBITda increased 8.7% over the corresponding quarter in the prior year, reflecting the operating leverage that we expect. Diluted EPS increased 24% over the corresponding quarter in the prior year reflecting the combination of financial and operating leverage. In addition to quarterly dividends of $0.26, AGF reported share buybacks in the quarter of 846,100 shares. It should be noted that Investment Management EBITda in Q3 was less than that in Q2 reflecting adverse market conditions in the period. However, September has seen market improvement which we expect should make for a further improved Q4.

Financial Technologies (India) Limited, a developer of capital markets infrastructure in India and other Asian markets:

The following release was issued on September 30, 2010 in relation to its subsidiary Global Board of Trade (GBOT): “GBOT set to be launched on 15th October by the Hon. Prime minister of the Republic of Mauritius.” http://www.prnewswire.com/news-releases/gbot-set-to-be-launched-on-15th-october-by-the-hon-prime-minister-of-the-republic-of-mauritius-104067833.html In our opinion, GBOT, and the recently operationalized Singapore Mercantile Exchange, present significant potential for value creation for Financial Technologies as the owners and operators of pan-Asian securities exchanges.

Reflections on the week ending September 26, 2010

2010-09-27T09:37:00.000-04:00

The business model and share price of Wealth Management companies are typically correlated with, and amplify, the overall market. On September 25, 2010, Bloomberg had the following headline, “U.S. Stocks Rise for Fourth Week as Economic Concerns Ease” (http://www.bloomberg.com/news/2010-09-25/u-s-stocks-rise-for-fourth-week-as-goods-demand-eases-economic-concerns.html). And while the S&P 500 rose 2.1% on the week, wealth manager Invesco Limited rose approximately 3.8%. We continue to believe that, notwithstanding the potential for turbulence in the near term, the market will experience a recovery. And, investors stand the risk of missing the recovery as they are holding record levels of cash and investing in low return income and balanced funds. For conservative investors who want to stay overallocated to cash and low return fixed income investments, investing in wealth managers can help them not miss out in a recovery scenario.

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During the week, the following news items were of relevance to some of the companies we follow and in which we may have an economic interest:

Financial Technologies (India) Limited, a developer of capital markets infrastructure in India and other Asian markets, received a setback towards the end of the week when the Indian regulator declined their application to operate a stock exchange in India. The company continues to have leading positions in many areas of Indian capital markets infrastructure and recently operationalized the Singapore Mercantile Exchange. Accordingly, we continue to be optimistic on the profit and growth prospects for the company. Nonetheless, as this is a highly regulated sector, we are closely monitoring the company’s response to the latest regulatory ruling.

Reflections on the week ending September 12, 2010

2010-09-14T16:47:00.001-04:00

The business model and share price of Wealth Management companies are correlated with, and amplify, the overall market. That makes them a particularly good investment during a recovery. While it is difficult to say precisely where we are in the cycle, we strongly believe that we are “closer to the bottom than to the top” (i.e. while the short term is unpredictable, the medium longer term outlook is up). The attached Bloomberg link provides evidence in support of that hypothesis:

http://www.bloomberg.com/news/2010-09-06/dividends-top-bond-yields-by-most-in-15-years-as-u-s-cash-pile-increases.html

Reflections on the week ending September 5, 2010

2010-09-07T10:37:00.000-04:00

A little bit of positive news helped the markets record a positive week. We believe that Wealth Managers are particularly good investments during a market recovery. Their earnings are highly correlated with the markets and their trading multiples also expand as market sentiment switches from pessimistic to optimistic. This past week offered a good example of this leverage as Invesco Limited’s share price appreciated over 8% while the S&P 500 appreciated approximately 4%.

During the week, the following news items were of relevance to some of the companies we follow and in which we may have an economic interest:
TD Bank reported its results for the 3rd quarter ended June 30, 2010. For the quarter, adjusted diluted earnings per share were $1.43, compared with $1.47 in the prior year. For the 9 months year to date, adjusted diluted earnings per share were $4.40, compared with $3.88 in the prior year. The quarter reflected growth in retail earnings and a reduction in wholesale earnings to levels that management described as more normal. We are pleased with the earnings stability and growth that TD is demonstrating.

Financial Technologies (India) Limited, a leading provider of financial infrastructure (including exchanges) for emerging markets, is capitalizing on the growth of capital markets in these regions. On August 31, 2010, they announced the commencement of operations of their newest exchange:

“Singapore Mercantile Exchange (SMX), the first pan-Asian multi-product commodity and currency derivatives exchange, commenced operations on its cutting-edge electronic trading platform with the ringing of the opening bell by Mr. Ong Chong Tee, Deputy Managing Director of the Monetary Authority of Singapore (MAS)….SMX operates as an exchange regulated and licensed by the MAS. It offers multi-currency and multi-asset clearing, trading, and pricing for contracts with guaranteed settlement and delivery. The contracts are developed to meet both generic and specific hedging requirements over Asian trading hours. The SMX product range, together with the agility and accessibility of its systems, and strategic location in Singapore - a reputable financial centre - will enable the Exchange to be a sophisticated one-stop risk management channel for global liquidity to plug into Asian trade flows.”

Reflections on the week ending August 27, 2010

2010-08-30T10:00:00.003-04:00

Advisor.ca published an article on August 26, 2010 entitled “Demographics favour Indian investments”.

http://www.advisor.ca/advisors/news/industrynews/article.jsp?content=20100826_145411_8124

The following is an excerpt from the article that I believe sums up one of the critical reasons we are investors in India:

"The most compelling story of India is its demographics; about 25% of the world's population under the age [of] 25 resides in India," says Cevey, pointing out that India's current middle class population of 330 million is expected to double over the next 10 years. "This should provide quite a substantial boost to consumer demand in a pretty sustained fashion, which we view as the main contributor to growth over the next five to 10 years."

Reflections on the 2 weeks ending August 20, 2010

2010-08-23T08:24:00.001-04:00

Substantial investments in India were reported by each of Soros and Blackstone, some of the most respected names in global investing.

On Friday August 20, 2010, the Globe and Mail reported that George Soros’ Quantum Hedge Fund had acquired 4% of the Bombay Stock Exchange.

http://www.bloomberg.com/news/2010-08-20/soros-controlled-fund-said-to-acquire-4-holding-in-bombay-stock-exchange.html

“Soros's investment comes as India works to modernize its capital markets, opening new exchanges, streamlining trading and introducing new products, like currency futures. With retail stock ownership still low and a booming economy, India's stock markets are of increasing interest to foreign investors.”

On Wednesday, August 18, 2010, reported “Blackstone to invest $4bn in India”

http://www.ft.com/cms/s/0/193fda74-aa54-11df-9367-00144feabdc0.html?ftcamp=rss

Like physical infrastructure (eg. roads, ports, power plants, etc.), we view communications infrastructure (eg. fiber optic cable) and financial infrastructure as both, key enablers, as well as significant beneficiaries of economic development. Unlike physical infrastructure, however, communications infrastructure and financial infrastructure are more easily scalable and, in our opinion, present the opportunity for larger potential economic returns. Accordingly, we expect to see substantial growth in the financial infrastructure in emerging markets and, earlier this year, added Financial Technologies (India) Ltd, a leading Indian developer of financial infrastructure to the Indian physical infrastructure investments that already existed in some of the portfolios we manage. The above referenced investment by the Soros hedge fund into the Bombay Stock Exchange would appear to support our point of view.
We view recent earnings results reported by some Canadian asset managers as indicative of the earnings leverage (i.e. earnings growth in excess of growth of assets under management) possessed by these businesses. (see below for further information)

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During the week, the following news items were of relevance to some of the companies we follow and in which we may have an economic interest:

Financial Technologies (India) Limited, a provider of capital markets technology and infrastructure, issued the following releases:

August 11, 2010: Results, on a standalone unconsolidated basis, for the quarter ended June 30, 2010 which saw a 26% year over year increase in operating revenue, a 53% increase in Profit from Operations before Other Income and Interest, and a 120% increase in Net Profit. In addition it reported the following in relation to the exchanges in which it has ownership interests: “MCX witnessed 30% growth in volumes with 87% market share in commodities market, MCX-SX garnered 56% market share in FX-Derivatives segment, IEX had 86% market share in electricity spot market.”
August 12, 2010: http://www.ftindia.com/PR-SMX-Approval-12AUG2010.pdf “Monetary Authority of Singapore (MAS) has granted ‘Approved Exchange’ (AE) status to Singapore Mercantile Exchange (SMX), the final approval to operate as a regulated and licensed exchange. SMX is the first pan-Asian multi-product commodity and currency derivatives exchange. Mr. Jignesh Shah, Vice Chairman of SMX and Group CEO, Financial Technologies Group, said, “SMX will create a new generation international commodity and currency derivative trading platform at par with best global exchanges in New York and London. The development also stands testimony to FTIL’s domain knowledge and technological expertise in creating next generation financial markets. The approval from MAS is a significant milestone towards realizing SMX’s vision of creating a pan-Asian exchange from Singapore, one of the world‟s most respected and reputed international financial centres and the best IFC from the East.” Mr. Thomas J. McMahon, Chief Executive Officer of SMX, said, “Today‟s development brings SMX a step closer towards revolutionizing the Asian commodities ecosystem. It will empower Asian economies to be ‘price setters’, facilitate the creation of premium Asian benchmarks and effectively position Asia as the centre of global commodity market growth.” To date, SMX has announced four products which will be traded when the exchange goes live - a Gold Futures Contract with physical delivery, West Texas Intermediate (WTI) Crude Oil, Brent-Euro Crude Oil and Euro-US Dollar Futures Contracts. It also recently concluded the successful market-wide testing of its electronic trading platform, risk management and clearing & settlement systems.”

Adani Enterprises Limited, a leading Indian conglomerate with operations in coal mining/trading, ports and power generation, reported its results for the quarter ended June 30, 2010. Consolidated EBITda increased 51.3% year over year and Profit After Tax But Before Extraordinary and Exceptional Items increased 61.8%.
CI Financial Inc., a leading asset manager in Canada, reported its results for the quarter ended June 30, 2010. Earnings per Share of $0.31 was 19% higher than the quarter ended March 31, 2010 and 72% higher than the prior year. Of note, Average Assets Under Management increased 18% year over year. We see the 72% EPS growth relative to the 18% growth in Average Assets Under Management as indicative of the substantial earnings leverage in the wealth management business model.
IGM Financial Inc., the leading non-bank mutual fund manager in Canada, reported its results for the quarter ended June 30, 2010. Earnings per share of $0.68 was 24% higher than the prior year while June 30, 2010 Assets Under Management were only 5.5 % higher. We the relative difference between earnings growth and AUM growth as further evidence of the substantial earnings leverage in the wealth management business model.
Dundee Corporation, whose main subsidiaries operate in the wealth management, real estate and resources sectors, reported its results for the quarter ended June 30, 2010. Diluted Earnings Per Share of $0.64 increased from $0.27 in the prior quarter and $0.39 in the prior year.

Reflections on the week ending August 8, 2010

2010-08-09T10:00:00.000-04:00

Demographics and Deleveraging – These are undeniable realities in North America and Europe. An aging population with underfunded retirement savings needs to save. An overleveraged population needs to reduce debt. The natural consequence of those realities would be pressures against consumer spending and increased consumer savings. The following is an excerpt from an Associated Press release on August 3, 2010:

“U.S. consumers did not boost their spending in June and their incomes failed to increase, further evidence that the economic recovery slowed in the spring. And Americans saved at the highest rate in nearly a year.”

Separately, Advisor.ca reported the following about Canadians based on the Russell Financial Health Index:

“The findings of the survey show that investors are also more concerned about having sufficient income to cover their essential expenses and the financial impact on medical and healthcare needs.”

In my opinion, the wealth management sector stands to benefit from the trend towards increased savings while sectors reliant on consumer spending are not likely to see robust growth.

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During the week, the following news items were of relevance to some of the companies we follow:

The Adani group of companies is comprised of businesses that surround the consumption of energy in India. From fuel sourcing (coal mining) to logistics (ports, shipping, pipelines, rail) to power generation and distribution to trading (coal, oils and electricity), the synergies within the group facilitate market leadership, growth and enhanced profitability.

Mundra Port & Special Economic Zone reported its results for its first quarter ended June 30, 2010. Compared against the corresponding quarter in the prior year, Revenues increased 35%, Operating Income before Depreciation increased 31% and Earnings Per Share increased 24%. Cargo volume to 12.6 million metric tons, an increase of 28% year over year and 21% sequentially versus the immediately preceding quarter.
Adani Enterprise Limited (“AEL”)(parent company of Mundra Port & Special Economic Zone and Adani Power Limited)

Announced the acquisition of the Galilee Coal Project in Australia from Linc Energy. The Galilee Coal Project is reported to represent 7.8 billion of coal reserves and, when completed, annual production capacity of 60 million tons per year. In addition to increasing AEL’s market share position in coal trading in India, this acquisition serves to secure additional coal supply for Adani Power Limited’s power generation needs and will also provide further cargo volume growth for Mundra Port.
On August 2, 2010, Bloomberg Business Week reported that Adani Enterprises Limited had secured orders from Indian cement companies ACC Ltd., Grasim Industries Ltd. and Jaypee Cement Ltd for a combined total of 400,000 tons of coal to be imported from South Africa.

Adani Power Limited reported its results for its first quarter ended June 30, 2010. Earnings Per Share of Rs. 0.53 for the quarter compared against Rs. 0.82 for the full year ended March 31, 2010.

Berkshire Hathaway Inc. reported its results for the quarter ended June 30, 2010. Earnings per Share of $1,195 compared against $2,123 in the prior year. The decline was more than accounted for non-cash Derivatives Gains/Losses. The majority of these derivatives, which don’t mature until 2018 or later, create mark-to-market gains losses each quarter. Excluding these gains/losses, Earnings before Income Taxes and Equity Method Earnings per average share outstanding increased to $3,105 from $1,569 in the corresponding quarter of the prior year.

Reflections on the week ending July 18, 2010

2010-07-19T10:22:00.000-04:00

There is a lot of focus on volatility these days. So, with that in mind, I would like you to consider the following two investment options:

Since December 31, 1999, Investment A generated a 3% return in the first year of investment and the annual return has steadily grown to 10%. Investment B has generated more volatile returns ranging from 29.5% in 2005 to a loss of 25.1% in 2008. The question is, which investment would you prefer.

Would you be surprised to find out that Investment A and Investment B are actually one and the same investment – the only difference is how annual returns are measured.

In the case of Investment A, Annual Returns are defined as the Annual Dividend Income divided by the Amount Invested on December 31, 1999; in other words, the cost base has not been marked to market. Note, the current market price at December 31, 2009 is over two times the cost base.
In the case of Investment B, Annual Returns are defined as the Change in Share Price in the year plus the Annual Dividend divided by the Opening Share Price; in other words, the value is marked to market annually.

I would think that a long-term investor is more likely to be viewing the investment as Investment A and be quite happy with the returns – a 3% yield enjoying preferential dividend tax treatment that has escalated over the last decade such that she is now earning a 10% yield on her original investment in a low interest environment.

On the other hand, I would think that the investor checking the daily stock price and measuring returns based on changing prices would be more inclined to view the investment as Investment B and be a lot more stressed.

What this illustrates is the importance of how we define and measure performance. Investment A and Investment B are one and the same -- the only difference is the method of performance measurement.
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During the week, the following news items were of relevance to some of the companies we follow:

Invesco Limited reported June 30, 2010 Assets Under Management of US$ 557.7 billion, a 24% increase over the prior month including assets acquired from Morgan Stanley’s retail asset management business.
Infosys Technologies Limited reported its results for the quarter ended June 30, 2010. The company reported revenue growth of 13.3% over the corresponding quarter in the prior year. Earnings per Share of Rs. 26.06 was a decline of 2.6% from the corresponding quarter in the prior year, reflecting the timing of wage increases.

Reflections on the week ending July 11, 2010

2010-07-12T10:24:00.000-04:00

PE Finding Value in Public Companies

Cerberus Capital Management has acquired DynCorp International (NYSE: DCP) in a deal valued at $1.5 billion. The firm paid DynCorp stockholders $17.55 per share of common stock, a premium of approximately 49%. Cerberus invested $591.6 million of equity in the transaction and obtained additional financing from a group of banks led by BofA Merrill Lynch and Citigroup. DynCorp provides specialized critical services to civilian and military government agencies.

Since the beginning of 2009, 46 public companies have been or are being acquired by PE firms, according to the PitchBook Platform. Public-to-private buyouts are gaining more interest from investors this year. With just a little over half of the year passed, the number of completed or announced public-to-private buyouts in 2010 has already matched 2009's final count of 23. Bigger public-to-private deals are more common in 2010 as well with 8 deals over $500 million, as opposed to only 2 in all of 2009. The largest deal so far this year is the February buyout of IMS Health, estimated at $4.2 billion, by TPG Capital, Canada Pension Plan Investment Board and Leonard Green & Partners.

When private investors acquire an entire business, they are typically doing a thorough analysis of the business, detailed due diligence investigations and concluding that the acquisition price provides them the opportunity to earn attractive returns. So, when a lot of Public to Private transactions are taking place, I see it as indicative that the Public Market is undervaluing businesses. An alternative view is that access to cheap and easy credit is causing private investors to overvalue businesses; however, after the credit crisis that we just went through, I don’t think that is the case currently.

Reflections on the two weeks ending July 4, 2010

2010-07-05T12:43:00.006-04:00

During the week, the following news items were of relevance to some of the companies we follow:

In last week’s blog, I noted the symbiotic relationship that exists between “Active” and “Passive” investing. I subsequently came across a research paper published by FundQuest Incorporated, a BNP Paribas company in April 2009 and authored by Jane Li, CFA, CAIA. The report is based on a study of 30,435 U.S. domiciled non-index mutual funds in 60 categories representing almost $4 trillion of assets as of the end of 2008. The time period was January 1, 1994 to December 31, 2008 using 13 rolling 3-year periods.

Their main conclusion was “that we should not paint either active or passive investments with a broad stroke. Both types of investments have their strengths and weakness. It depends on the market segments they are in: less efficient, more active.”

Not surprisingly, out of 60 Morningstar Categories, the following categories were included in the list in which Active management experienced relative outperformance: Foreign Large Value, Foreign Small/Mid Growth, Foreign Small/Mid Value, Japan Stock, Pacific/Asia ex-Japan Stock and World Stock. This is consistent with the “less efficient, more active” conclusion.

My version of the study’s conclusion is that active management is most likely to outperform when the manager actively invests in inefficient categories and sub-categories. Conversely, active management is most likely to underperform when the manager is a closet index hugger of an efficient index.

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The Reserve Bank of India increased its Repo and Reverse Repo rates by 25 bps as part of the process of unwinding stimulus policies and managing inflation pressures in the context of growth.

Wealth Managers generating healthy free cash flows.

On June 30, 2010, IGM Financial Inc. reported that it had purchased for cancellation 850,000 (0.32%) of its currently outstanding common shares. This share buyback is in addition to IGM’s dividend yield, which currently exceeds 5%.

Reflections on the two weeks ending June 20, 2010

2010-06-28T09:57:00.000-04:00

During the past two weeks, I’ve read a number of articles debating the merits of “Active” versus “Passive” investing. Upon reflection, I concluded that the irony of these debates was that, rather than any single position being right, the strategies were actually dependent on each other for their success.

Consider the Active versus Passive debate. The debate is essentially premised on the hypothesis that an “efficient market” comprised of:

Lots of unemotional, knowledgeable investors
With abundant capital
And timely and complete information

will ensure that security prices reflect their true value and, accordingly, “Active” investors are unable to earn a premium return. Put another way, the argument in support of “Passive” investing relies on “Active” investors to keep the market efficient. Conversely, as the market gets more efficient, and the premium earned by “Active” investors diminishes, it would be reasonable to expect a decrease in “Active” investors relative to “Passive” investors which, in turn, would be expected to result in a less efficient market and the potential for higher returns for “Active” investors.

So, as a practitioner of fundamental analysis driven investing, I am glad for the growth trend of passive index investing – it provides another source of premium returns for an investor focused on investing in a few quality businesses at attractive prices.

During the week, the following news items were of relevance to some of the companies we follow:

While industry growth is one key element in the investment thesis for Wealth Managers, operating and financial leverage is another.

On June 23, 2010, AGF Management Ltd reported fully diluted Earnings Per Share of $0.30 for its second quarter ended May 31, 2010. This compares against $0.19 in the prior year for a 58% increase. Operating leverage was evident as May 31, 2010 Assets Under Management were 14.6% higher than the prior year.

At the end of the week, the Indian government made a major announcement towards removing subsidization of fuel prices.

This is consistent with the general direction of policy reform towards being “market driven”.
The cost savings to the government along with the revenues earned by the government from auctioning mobile communication spectrum is reducing the size of the Indian fiscal deficit to well below its GDP growth rate.

During the week, Suncor announced another sale of non-core natural gas properties as it continues to monetize non-core assets and focus on oil-sands development.

Reflections on the week ending June 13, 2010

2010-06-14T15:04:00.000-04:00

As market volatility continues, I hear a heightened concern about the “risk” of investing in mutual funds. In my opinion, this concern is substantially caused by “risk” being erroneously defined as “the standard deviation of price change”. Sophisticated investors know that “the standard deviation of price change” is a measure of “price volatility, not risk”, and seek to exploit price changes to acquire quality, low risk businesses at cheap prices.

To illustrate the point, consider the following two investment options:

A real estate property in which the investor directly owns a fractional interest; eg. assume the investor owns 10% ($100,000) of a shopping mall that was purchased for $1 million and generates $100,000 in net rental income. During the course of the year, the investor receives their share of net rental income. The property is not revalued regularly and, accordingly, there is no price change, nor standard deviation of price changes.
The same real estate property is held in a publicly traded REIT which issued 100,000 units at $10 each. The investor now owns 10,000 REIT units at $10 each. The daily trading price of the REIT units fluctuates with a standard deviation of $0.50; i.e. one standard deviation is plus or minus $0.50, or 5%.

The asset in both options is exactly the same. Yet, Standard Deviation would suggest that owning publicly traded REIT units is more risky than owning the exact same asset through a non-publicly traded partnership interest. How can that be correct?

An uninformed investor who sees rising price volatility of the REIT units may panic and choose to sell their investment at a lower price, thereby providing the sophisticated investor the opportunity to acquire a quality asset at a bargain price.

Recognizing the distinction between “standard deviation of price changes” and “investment risk” becomes especially important at a time like the present, when share price changes are quite high. An obsessive focus on standard deviation is likely to increase the probability of long-term investors:

selling otherwise high quality assets at the wrong time; and
missing opportunities to acquire quality investments at discount prices.

During the week, the following news items were of relevance to some of the companies we follow:

On June 11, 2010, The Economic Times of India reported that “IT bellwether Infosys will hire 30,000 professionals this year as growth has returned to the sector, Chief Executive Kris Gopalakrishnan said here on Thursday.” In related news, Reuters reported on June 9 that the President of India’s National Association of Software and Services Companies told reporters that India’s back-office outsourcing business will post a growth of 15-16% in the year to March 2011.
The main driver of growth for the wealth management sector is expected to be the need for Canadians to increase their accumulated wealth so as to protect their standard of living in retirement. On June 10, 2010, TD Economics released a report that said, “Looking ahead, the share of retirees failing to meet the desired savings for 70% replacement is projected to rise from 15% for those born in the 1940s to just over 24% for those born in the 1980s.” This shortfall will need to be made up through increased savings or higher returns. Either way, the increasing need to increase wealth is good for wealth managers.
On June 9, 2010, Invesco reported total Assets Under Management at May 31, 2010 of $430 billion, a decrease of 5.9% from April 30, 2010.

Reflections on the week ending June 6, 2010

2010-06-07T15:43:00.000-04:00

“In a crisis, all correlations go to 1”

Last week, I highlighted the divergence that is appearing between countries which are highly leveraged and those that have relatively low amounts of debt per capita. Against that context, it is interesting to note that, the more fear that exists in the markets, the more global market correlations tend to 1; i.e. markets tend to get more correlated during crises. If you accept these two hypotheses and then try and put them together, you get an interesting paradox, and potential opportunity. On the one hand, the fundamentals suggest divergence of growth prospects for different countries. On the other hand, in the midst of a crisis, like the European debt crisis, global markets tend to perform similarly. That would suggest that the current market conditions potentially present a particularly good time to invest in companies in certain emerging markets. In our opinion, the thesis for investing in the growth of India’s domestic economy is relatively independent of the European debt crisis and, accordingly, the macro market driven declines in the stock prices of select Indian companies are presenting compelling buying opportunities.

During the week, the following news items were of relevance to some of the companies we follow:

Preliminary IFIC statistics for May indicated a 3.4% decline in Canadian mutual funds industry net assets.

CI Financial reported gross sales of retail managed funds in May of $1.1 billion and net sales of $265 million. End of May Fee Earning Assets of $87 billion were about 3.6% lower than at the end of April 2010.
AGF Management reported gross sales of mutual funds in May of $162 million and net redemptions of $204 million. Total Assets Under Management at the end of May were $42.9 billion or about 4.5% lower than at the end of April 2010.

On June 1, 2010, Invesco Limited announced the completion of its previously announced acquisition of Morgan Stanley’s retail asset management business, including Van Kampen Investments. Invesco announced that they expect the transaction to yield total EPS accretion in the first and second year after close of 21 cents and 23 cents, respectively; this is an increase in the first 12 months accretion of 4 cents relative to what had previously been announced. This transaction not only strengthens Invesco’s already broad product lineup and add economies of scale, but the strategic relationship with Morgan Stanley also strengthens the distributions of Invesco’s products.

The saying is “in a crisis, all correlations go to 1”. For the month to date May 27, 2010, India’s markets had experienced approximately US$2.3 billion of net outflows from Foreign Institutional Investors which has brought the YTD net inflow down to US$4.3 billion. That is a material swing in flows and is consistent with the flight of capital to “safety” during periods of high global uncertainty. Of course, fund flows impact share prices and the Indian markets have declined accordingly. However, it is important to note that India’s exposure to trade, especially with Europe, is relatively small; i.e. the India domestic growth thesis is relatively independent of the factors that are driving current global fund flows. Macro market volatility provides the opportunity to purchase mispriced assets.

Reflections on the week ending May 30, 2010

2010-05-31T16:51:00.000-04:00

The financial news continues to be dominated by reports of the amount of leverage that exists in the developed markets with the current focus on the European countries of Portugal, Italy, Ireland, Greece and Spain. An interesting divergence is appearing between countries which are highly leveraged and those that have relatively low amounts of debt per capita -- consumers high amounts of leverage are likely to spend less and save more and vice versa for consumers with low amount of leverage. During the past week, I attended an event where the speaker effectively proffered a very simple investment strategy to profit from this divergence:

In developed markets, consider businesses that help people save money.
In emerging markets, consider businesses that provide goods or services to domestic consumers; i.e. help people spend money.

Sounds simple and makes sense to me; how about you?

During the week, the following companies of interest reported results:

TD Bank reported results for its second quarter ended April 30, 2010. Adjusted EPS for the quarter of $1.36 compared with $1.14 in the prior year. TD’s 3 main messages were:

Exceptional performance in Canadian Retail
Credit environment stabilizing
Wholesale earnings beginning to normalize

While referencing macro concerns regarding the European debt situation, TD communicated that its exposure to European debt was manageable. In addition, Ed Clark indicated that he felt, on balance, the drivers of positive improvement were stronger than the headwinds emanating from the European debt problems. On a more company specific basis, TD’s business franchises in Canadian retail banking, US retail banking and Wealth Management appear to be further strengthening and this provides TD with the potential to generate above-average growth.

On May 29, 2010, Financial Technologies (India) Limited (FTECH) reported its results for the year ended March 31, 2010. Diluted EPS of Rs. 74.96 was slightly lower than the Rs. 80.33 earned in the prior year. FTECH is among the global leaders in offering technology intellectual property and domain expertise to create and trade on next generation financial markets, that are transparent, efficient and liquid, across all asset classes. Our investment thesis regarding FTECH includes both, its current profitability and, more importantly, its growth potential. From the perspective of growth potential, FTECH reported the following regarding the market shares of its subsidiaries and affiliates:

In fiscal year 2010, IEX markets share for electricity spot trading stood at 87%;
NSEL garnered a market share of 91% in commodity spot market for last quarter;
MCX-SX’s market share stood at 55% in the currency derivatives segment for last quarter;
MCX witnessed 40% growth in the volumes, maintaining leadership position with 82% market share for FY10;
Custody warehouse NBHC facilitated collateral funding in excess of Rs. 120.9 billion.
Payments processor, ‘atom’ processed transactions worth Rs. 8.9 billion during the financial year.

Establishing and maintaining market leadership is the key to FTECH being the beneficiary of the growth of capital markets activity that is expected to accompany the growth of emerging markets in Asia and Africa.

Reflections on the week ending May 23, 2010

2010-05-25T10:11:00.002-04:00

Fear returned to the markets and the share prices of wealth managers were hard hit. It is important to remember that, while a 10% drop in markets is highly likely to drive a roughly 10% and 10%+ drop in revenues and earnings, respectively, of wealth management companies, a 10% drop in their share prices implicitly assumes that the 10% drop in markets is permanent. We do not believe this to be the case. It is important to remember that fear, and the volatility associated with fear, is the value investor’s friend – volatility provides the opportunity to purchase mispriced assets.

Continuing with the theme noted above, Ben Graham had said that you need both cash and courage when investing. As banks in the US continue to fail and be taken over by the government / regulators, the opportunity arises for these banks to be acquired in a “cleansed” state and at attractive prices. Earlier in the week, TD Bank acquired South Financial Group Inc. , a Florida bank with almost USD$10 billion in deposits. When TD acquired Banknorth and later Commerce, it was building a platform. Now, with the integration of that platform completed, a well capitalized balance sheet and “courage”, TD is able to take advantage of the opportunities being presented.

Reflections on the week ending May 16, 2010

2010-05-17T11:29:00.004-04:00

“Invest in Fund Firms To Beat Their Funds”. That was the headline of an article in the Wall Street Journal on May 6, 2010 (by Sam Mamudi, page c9; CLICK HERE FOR FULL ARTICLE Quoting from the article, “From the latest quarter to the second quarter of 1986, shares of fund companies easily outperformed almost all other stocks as well as their own funds.”

“Leading the way: Eaton Vance Corp. , whose stock rose nearly 7,000% cumulatively over that roughly 24-year span. T. Rowe Price Group Inc. rose almost 5,000%, while Franklin Resources Inc. rose about 3,700%. Investors in those companies’ best mutual funds didn’t fare as well. The top-performing fund from each company over the same period was Eaton Vance Worldwide Health Sciences Fund (trading symbol ETHSX), with a total cumulative return of about 1,500%. Franklin Mutual Quest Fund (MQIFX) rose almost 1,300%, and T. Rowe Price Capital Appreciation Fund (PRWCX) gained close to 1,200%. Those are impressive results, albeit from the finest funds out of hundreds that these three giants offered over the past 24 years. By contrast, the S&P 500 index rose 366.2% in the period.”

To summarize, cumulatively over the last 24 years:

The fund company, Eaton Vance Corp rose nearly 7,000%
The top-performing fund of the fund company, Eaton Vance Worldwide Health Sciences Fund rose about 1,500%
The index, S&P 500 rose 366.2%

This is not a new phenomenon. Ironically, the empirical results come as a surprise to most people.

The following companies of interest reported results:

CI Financial reported its results for the first quarter ending March 31, 2010. Assets Under Management at March 31, 2010 were $90.6 billion, 26% higher than the prior year. Adjusted Earnings per Share for the quarter of $0.27 was 29% higher than the prior year.

DundeeWealth reported its results for the first quarter ending March 31, 2010. Assets Under Management at March 31, 2010 were $38.8 billion, 51% higher than the prior year. Investment gains in the most recent quarter and investment losses in the prior year quarter, make the profits at the corporate level less comparable. EBITDA for the Wealth Management segment of $55 million was approximately 93% higher than the prior year quarter.

Mundra Port reported its results for the year ending March 31, 2010. Consolidated Net sales of Rs. 13.8 billion and Diluted EPS of Rs. 16.81 compare against the prior year’s Rs. 11.9 billion and 10.79, respectively, representing year over year growth of 16% and 56%, respectively. The approximately 3.5 times ratio of EPS to Revenue growth is indicative of the operating leverage we see as inherent in the business model.

Adani Enterprises also reported its results for the quarter and year ended March 31, 2010. As the largest part of this conglomerate is its subsidiary, Adani Power, and since Adani Power is still in the early stages of commissioning power generating plants, we were not looking for significant revenue or EPS growth at this time. Consolidated EPS for the quarter of Rs 7.24 was 16% higher than the prior quarter ended December 31, 2010.

Reflections on the week ending May 7, 2010

2010-05-10T09:56:00.003-04:00

Concern about the debt of the PIIGS (Portugal, Italy, Ireland, Greece and Spain) dominated the news this past week and sent markets reeling. As always, it is instructive to remember that “it is a market of stocks and not a stock market”. Consider IGM Financial Inc. Since the earnings of wealth managers are heavily correlated with the value of markets, the share prices of wealth managers like IGM were hit hard as the broader markets declined. However, during the week, IGM reported its results for its 1st quarter ended March 31, 2010. March 31, 2010 year over year increase in Assets Under Management of 25% combined with operating leverage to produce 33.3% year over year growth in Earnings per Share. With minimal on-balance sheet risk, we expect temporary market declines to only create temporary pressure on the earnings of wealth managers. In our opinion, the share price declines of wealth managers like IGM incorrectly assume permanent declines in markets.

The week also saw a battle between two opposing forces on the price of oil. On the one hand, as market sentiment turned bearish, the price of oil declined (over 10% in the week). It is assumed that this decline in oil price is driven by view of soft demand resulting from the troubled economy. On the other hand, the exploded oil well in the Gulf of Mexico was turning into a potential environmental disaster which we believe poses a significant risk to increases in the supply of oil from new offshore wells. We believe that the implications on the future supply of oil, resulting from cancellations and/or deferrals of offshore drilling, will have lasting positive implications for holders, like Suncor, of large proven reserves of on-shore oil. However, the market did not take this view, driving the price of oil and companies like Suncor down in the 10% range. Once again, the market is demonstrating that it is more short-term in its outlook – which we believe creates opportunities for long-term , value investors.

Reflections on the week ending April 30, 2010

2010-05-03T10:48:00.002-04:00

Invesco Limited had a few announcements this week that reinforced some of my views on the company.

On April 28, 2010, Invesco reported results for the quarter ended March 31, 2010. Adjusted Cash Earnings per Share of $0.27 was almost 2.5 times that of the same quarter in 2009. Similarly, Franklin Resources reported that its Diluted EPS for the quarter ended March 31, 2010 had more than tripled versus the same quarter in the preceding year. I find these results to be consistent with the investment thesis that Wealth Managers disproportionately benefit during market recoveries.

On April 27, 2010, Invesco announced it held a final closing for its Mortgage Recovery Fund with total commitments of more than US$1.46 billion. This unique offering from Invesco, which is part of the US Treasury’s Public-Private Investment Fund initiative, is illustrative of the unique ability of Invesco to bring together the specialized capabilities of Invesco Fixed Income, Invesco Real Estate and W.L. Ross & Co., the distressed investment affiliate of Invesco.

As part of its earnings announcement, Invesco also announced that its acquisition of the Van Kampen/Morgan Stanley asset management business is on track to be completed by June 1, 2010. This acquisition increases the depth and breadth of Invesco’s investment capabilities and offering, strengthens its access to distribution through the relationship with Morgan Stanley and is expected to increase efficiency and economies of scale of its operations.

Reflecting on these announcements, I could not help but think “crisis = danger + opportunity”. During the last year, not only has Invesco benefitted from the market’s partial recovery but, during the crisis it was able to make strategic acquisitions and seize new opportunities that, in my view, position it well for the future.

Reflections on the week ending April 23, 2010

2010-04-26T10:05:00.003-04:00

On April 21, 2010, Wells Fargo & Company reported its results for the quarter ended March 31, 2010. EPS for the quarter was $0.45 per common share after integration costs of $0.05 per common share. Of particular interest to me, the Company noted:
•   All business segments contributed to the strong earnings results
•   Credit believed to have “turned the corner”
•   Wachovia merger integration on track
•   Record retail bank cross-sell
•   Tier 1 capital ratio of 10%

My takeaways from these results are as follows:
•   Further signs that the US economic recovery is taking hold
•   Wells Fargo appears to be executing on its own strategy of leveraging its strong retail platform through cross-selling

On April 23, 2010, Financial Technologies ( India) Limited (FTECH) subsidiary, Singapore Mercantile Exchange (SMX), announced that it had entered into a Memorandum of Understanding with Tokyo Commodity Exchange (TOCOM), Japan’s largest commodity futures exchange, to explore co-operation and partnership mutually beneficial for both exchanges and market reach expansion.

•   Thomas McMahon, CEO of SMX said, “TOCOM’s enthusiasm for bilateral advancement of the Asian Commodity Derivatives Market in partnership with SMX firstly is testament to the special position SMX is in to unify what is still a very fragmented Asian derivative landscape into a consistent workshop for global benchmark trading prices and indices. Our MoU with TOCOM falls in line with our long term strategy to be the one-stop comprehensive product-range hub exchange which ties in all physical and derivative commodity players during pan-Asian trading hours. “SMX and to a good extent Singapore, stands poised to be the central point of contact between all the world’s commodity derivative trading players and the individual pan-Asian markets where fundamentals dictate realistic price discoveries.”

In my view, this is indicative of:
•   the evolution of capital markets taking place in Asia and that this evolution is both, the driver and the result of the economic development taking place in Asia; and
•   the significant value to be created by businesses that can entrench themselves as leaders during these developmental stages.

Reflections on the week ending April 16, 2010

2010-04-19T10:51:00.000-04:00

Earlier in the week, Infosys Technologies Limited reported its results for its 4th quarter ending March 31, 2010. Quarter over quarter revenue and earnings per share growth were 3.5% (14% annualized) and 2.5% (10% annualized), respectively. For the new fiscal year, management’s outlook is for revenue growth of 9 – 11% after accounting for expected rupee appreciation. On the same day, it was reported that Microsoft had outsourced its internal IT services to Infosys. I see these results/announcements as indications of:
•    a recovering economy and increasing business confidence;
•    the continued trend towards offshore outsourcing; and
•    Infosys’ relative strength within the industry.
On April 16, TD Bank Financial Group announced that it had acquired certain assets of 3 Floridian banks from the FDIC. This transaction is indicative of TD’s commitment to its US growth strategy. Through this transaction, TD has not only accelerated its growth in the Florida market but, by acquiring from the FDIC, TD also gets partial protection against losses incurred on the acquired assets. In my opinion, this transaction is also indicative of TD’s confidence in:
•    The state of the economy;
•    The capability of its US banking platform.
Finally, the week ended with the SEC charging Goldman Sachs with fraud. While there are many different points of view on these charges, one of the issues that keeps on coming out is whether or not investors knew (Goldman fully disclosed) what it was investors were buying. We, at Portland Investment Counsel, have consistently encouraged investors to ensure that they know and understand the assets/companies in which they are invested.