Value Square Fund Equity World · Value Square NV | Maaltecenter Blok G | Derbystraat 319 | 9051...

Value Square NV | Maaltecenter Blok G | Derbystraat 319 | 9051 Gent | T09 241 57 57 | F09 245 18 96 | RPR Gent 885.750.253 | www.value-square.be Pagina 1

Value Square Fund Equity World

5 YEAR ANNIVERSARY REPORT - OCTOBER 2008 to SEPTEMBER 2013

Five Annual Meetings

Value Square Fund Equity World is a self-managed open-ended investment fund under Belgian law. Prospectus and Key Investor Document

(KID), as well as the most recent (semi-)annual reports can be obtained without costs in English, French and Dutch at the manager of the

fund, Value Square, Derbystraat 319, 9051 Gent, Belgium Tel.: +32 9 241 57 57, [email protected]. Do not make an investment

decision before reading the KID.

mailto:[email protected]


TABLE OF CONTENT

1- The start of the Fund – Investing in uncertain times ..................................................................................... 7

2- Our investment process ................................................................................................................................. 8

How do we know which market will go up or down? ......................................................................................... 8

What is QI? ......................................................................................................................................................... 9

Country QI ........................................................................................................................................................... 9

3- Demographics and Entitlements .................................................................................................................. 10

4- 1997-1998 versus 2013 ................................................................................................................................ 13

Central Bankers: a force to be reckoned with ................................................................................................... 15

5- Travelling around the world to meet companies ......................................................................................... 16

6- The Fund Today ............................................................................................................................................ 18

Valuation .......................................................................................................................................................... 19

Costs.................................................................................................................................................................. 20

Turnover ............................................................................................................................................................ 20

Trading costs ..................................................................................................................................................... 20

7- Annual meeting ............................................................................................................................................ 22

8- Our 10 LARGEST INVESTMENTS AS OF 30 September 2013 ........................................................................ 28

9- The REALLY long term ................................................................................................................................... 29


Investment strategy

The assets of this fund are predominantly invested in shares of listed companies with no geographical limitation and in any securities giving

access to the capital of these companies. The shares are selected on the basis of fundamental analysis and a bottom-up approach with the

emphasis on the principles of value investing. The aim of the fund is to achieve as high a return as possible in absolute terms rather than

the improvement of stock market indices and simultaneously limit risks. In circumstances where the manager estimates the downward

risks higher than the potential return, the portion invested in shares can be reduced in favour of investments in liquidities and money

market instruments.The fund will at all times invest at least 50% in shares.

Volatility can be high, due to the composition of the portfolio.


1- The start of the Fund – Investing in uncertain times

On the 1st

of October 2008 Value Square Fund Equity World was founded with 6,29 million EUR in invested

capital. Two weeks prior to the start of our fund one of the world’s biggest investment banks, Lehman

Brothers, had just filed for Chapter 11 and the entire European and American banking system was in shock. We

sometimes hear investors say: “oh, that was a great time to start as equities were cheap.” Well that is easy to

say now that most worldwide equity markets have recovered but at that time people were extremely sceptical

about investing in stocks anywhere.

The first few months of the fund were some of the most turbulent ones in recent stock market history and

hopefully we will not find ourselves in such a situation often. In the first two weeks of the fund Nic was in

Turkey visiting companies between 8-10th

of October 2008 and was chatting with Patrick via phone, e-mail and

sms in between meetings. Friday the 10th

of October was an extremely negative day in the markets (European

equities were down 5-6% on average and many individual stocks much more) and the managers decided to

spend their 5 million euro cash hoard aggressively. In hindsight, we should have waited a few months longer

but many stocks were pricing in extremely unlikely scenarios for their future earnings.

As you can see from the small amount we started the fund with it is safe to say investors were not jumping up

and down to give us money. On the 10th

of September 2008 we gave an interview to a journalist of the Belgian

newspaper De Tijd and we told him that according to us stocks were extremely undervalued and there was lots

of value to be found. As so often with value investors, we were right, but also early, as stocks continued to slide

for another 6 months and reached their bottom only in March 2009.

The easy, and probably human response, to the entire market turbulence would have been to stay in cash and

wait until the uncertainty subsided. However, you will never get a period where all uncertainty is lifted. The

future is always uncertain even when people were investing in the 1960’s, 1970’s, 1980’s, etc. Hence, if you

wait for the uncertainty to subside you will never invest as the timing will never be right. Or as Buffett says: you

pay a high price for a cheery consensus.

If we would have told you in September 2008 that Lehman Brothers, Dexia, Fortis, AIG, Citigroup would all go

bankrupt or be rescued by the state, that bond yields in Southern Europe would explode, that unemployment

in many European countries would hit new all-time highs, that many Middle-Eastern countries would see a

regime change, that Greece was on the verge of leaving the Euro-zone, Cyprus was bailed out, etc. Would you

have invested or would you have been too scared? Most likely the latter, yet companies adapt to changing

circumstances and do their best to manage their business to the best of their ability.


2- Our investment process

As an investor you are most likely interested in our value oriented investment style. It is therefore useful to review how we select companies in the fund. If we look at it from a birds-eye perspective the following diagram gives a good overview.

How do we know which market will go up or down?

We don’t know. As managers of this fund we try to make few predictions on what will happen in the future but we try to gather as much information as we can on specific companies. We assemble this information by reading annual reports, meetings with management worldwide, attending analyst briefings and annual meetings. All this work can be summarized in our 8-step investment process as shown below.


All the information we gather on a company is processed into our internally developed valuation model and our proprietary Quality Index (QI). Every company gets a score from 0 to 100%. In principle we want companies that score on average over 70% on the QI Index. We do invest in companies that have lower QI scores but the margin of safety would then have to be higher.

What is QI?

For every company we follow we have a detailed model with historical figures. When we believe that company X is worth 20 EUR today and it is trading at 12 EUR on the stock market we think this is an interesting discount, or a substantial margin of safety. We screen each company on 6 different parameters. Each parameter in itself consists of multiple factors. Apart from our model investing is always a judgement call which is hard to quantify:

1. Valuation: how cheap are the shares trading? Absolute and relative to its history?

2. Profitability: how profitable has the company been in the past? Does the company have a moat?

3. Solvency: how strong is the balance sheet? Will the company survive the next recession?

4. Liquidity: can the company pay-off its debts in the short term?

5. Track Record: does the company have a long history and a good track record creating value for shareholders?

6. Insiders: does the company have a reference shareholder/family? Are insiders buying shares? Do several generations depend on the dividend?

Country QI

Apart from our QI score, which is company specific, we manage a worldwide fund and there is a difference

between having your money in Zimbabwe, Venezuela, Germany or Belgium. In 2009 we therefore developed

our proprietary Country Quality Index (CQI). The CQI was developed with the help of our American intern,

Laurence Unger, who could not find a job on Wall Street and decided to come over to Europe for an internship.

Laurence has since graduated from Columbia University in NY. The result of our study (first published in

September 2009) was that we found that there was an important shift ongoing in economic power from West

to East. The pendulum of power is going from Europe and the US to other countries in Asia and the Middle

East. This is not the first time a shift like this has happened and we can never be certain that history will repeat

itself but we believe strongly that overly indebted nations (US, Europe, Japan) with large entitlement programs

will see their growth stagnate and other countries with less debt and few existing entitlement programs will

benefit. An interesting book about this topic was written by Harvard Professor Neil Ferguson. The title of the

book is ‘Civilization: The West and the Rest’. Now not everyone will agree with this assessment but one fact

you cannot deny is demographics.


3- Demographics and Entitlements

The NASA image above shows a map of the world and the circles give a rough estimation of the percentage of

the worldwide population that lives in a certain continent/region. Asia clearly dominates, followed by

Europe/Russia and everybody else is far behind.

Demographic trends seldom reverse themselves quickly. It is safe to say that there’s a much younger

population in many parts of Asia (India, Indonesia, Malaysia, Philippines) than in Europe, Japan or the United

States. Below we have put together a summary of the median age in a list of countries in 2010 and the United

Nations’ expected median age by 2020 and 2030.

An older population goes hand-

in-hand with large entitlement

programs. As the population

(often referred to as the baby-

boomers) gets older in the US,

Japan and Europe the cost of

supporting social programs and

pension benefits skyrockets.

While not all problems in Europe

can be blamed on demographics;

it does have a huge impact. The

retirement age in most EU

countries is officially 65 but in

many countries like France,

Belgium, Greece, Spain the

average man on the street retires

before that due to several

government schemes that entitle

you to welfare/pension privileges

at a much younger age. This is not

an argument that these privileges should be revoked but primarily that most countries just cannot afford them

and have to face reality. We think Singapore’s Prime Minister said it well in his 9th

of August speech to

celebrate Singapore’s 48 year independence. “People have to be self-reliant and resourceful. We will help the


needy but most important one should take care of themselves and not expect the state to solve all your

problems”. The newly appointed Dutch King, Willem-Alexander, also made similar comments recently. The

youngest monarch of Europe said people must take responsibility for their own future and create their own

social and financial safety nets. He was quoted as saying: ’The classic welfare state of the second half of the

20th century in these areas in particular brought forth arrangements that are unsustainable in their current

form.’

http://www.independent.co.uk/news/world/europe/dutch-king-willemalexander-declares-the-end-of-the-

welfare-state-8822421.html

Angela Merkel wrote an op-ed piece in the Financial Times on 16/12/2012 where she commented that Europe

has 7% of the world’s population, contributes 25% of World GDP but has 50% of worldwide social

expenditures! In many ways the US is not much better as its government is continuously hitting its debt ceiling.

You can wonder why they call it a debt ceiling and not a debt hole (as that is what it essentially is) but we

suppose ceiling just sounds better to the public. Below chart shows the debt ceiling and its continuous rise over

the last decades. According to the US government’s own estimates, debt will grow by 12 trillion between 2008

and 2018, more than it did in the 63 years between 1945 and 2008.

The US is certainly not alone as most governments around the world continue to defy logic when it comes to

the income (revenues mostly generated from taxes) and their expenditures. Below a great graphic made by the

Heritage Foundation comparing the government to a typical family. Anyone who runs their own household

budget understands that this is completely unsustainable.

http://www.independent.co.uk/news/world/europe/dutch-king-willemalexander-declares-the-end-of-the-welfare-state-8822421.html

http://www.independent.co.uk/news/world/europe/dutch-king-willemalexander-declares-the-end-of-the-welfare-state-8822421.html


4- 1997-1998 versus 2013

Many Asian countries were spending irresponsibly in the late 1990’s but managed to survive some really

difficult times in 1997-1998 and were forced to make large adjustments. Considering we have many

investments in Asia we obviously follow the developments in the Asian region with great interest.

Since May 2013 emerging markets in Asia have slowed down with equities and currencies selling-off sharply

and we have read several articles comparing today to the period in 1997-1998 and predicting a new Asian

Financial Crisis. According to us there are however important differences:

In 1997 many currencies in Asia were pegged to the USD. When foreign exchange reserves were

exhausted countries like Thailand had to devalue their currency. This led to sharp depreciation of the

Thai Baht by 40 to 50% in less than 12 months. Today most currencies are floating and able to adjust.

Corporate balance sheets of publicly listed companies are in much better shape. (see overview made

by CLSA in August 2013)

The average net debt level of Indonesia’s largest companies is below 25% and banks are generally

much better capitalised with Tier 1 ratio’s that are often double the 8% required in the West. While

many Western banks continue to struggle to have 8% Tier 1 capital, many banks in Asia, appear to be

more prudent. Travelling around the region over the last five years has taught us that many of the

business leaders of today still vividly remember 1997-1998 and want to avoid a repeat.

Government balance sheets in Asia are generally sound, although we should not be delusional that

good times over the last few years naturally make it tempting for politicians to spend heavily. China’s

debt situation is also worse than the officially reported figures as loans given to local governments are

not included in the below figure.


Source: Gavekal


Central Bankers: a force to be reckoned with

Don’t fight the Fed is often quoted in presentations about investing in today’s environment. We can not ignore

the impact current policy decisions have on the short term performance of our fund. For the past five years we

have been living in a world where central banks dominate world news. Never in the history of the world have

central banks added so much liquidity. These flows can cause short term imbalances. Most investors react like

a herd and every word of Ben Bernanke or Mario Draghi is interpreted in a certain way. We try to ignore the

noise and focus on the fundamentals, but whenever central bankers open their mouth it can have an impact on

the short term performance of the fund.

An excellent example are the outflows out of emerging Asia when investors expected the FED to taper QE (i.e.

diminish or stop the money printing) (May 2013) only to completely reverse when Bernanke & co gave the

market a clear message that they would not alter QE (September 2013).


5- Travelling around the world to meet companies

Over the last 5 years the managers and analysts of the fund have travelled extensively to the following

countries: China, USA, Brazil, Argentina, Malaysia, Philippines, India, Thailand, Indonesia, Hong Kong,

Singapore, UK, Vietnam, France, Luxembourg, Netherlands, Belgium, Norway and Japan. On average we talk to

the management of about 250-300 companies per year, hence over the last 5 years it is safe to say we have

spoken to more than 1000 companies. The air miles flown to achieve this: ...we lost track.

We believe it is important to visit factories, meet management of companies we invest in or their competitors

and search for interesting new investment opportunities. We also do, what Philip Fisher called, scuttlebutt

research when we go to cities around the world to do checks if the products/services of the companies we

invest in are really available. An example would be when Nic and Heinz travelled to Beijing and Shanghai in

November 2012 and went to visit numerous large department stores such as Wal-Mart, Carrefour and

CenturyMart to check on the availability of Prince Frog shampoos and baby lotions. When we started looking at

Prince Frog (listed in Hong Kong) there were short sellers out there spreading rumours that this company was

fake and the products were nowhere to be found in large hypermarkets in Tier-1 cities. Our random checks

confirmed the company was very much present and had shelf-space next to Johnson & Johnson (US) and

Pigeon (Japan), its main

competitors. We also saw their

commercials on Chinese TV and

confirmed that their spokesperson

Kelly Chen was indeed a well

known singer/actress. Prince Frog

has since had a huge re-rating as

more investors took notice. Large

brokers like CLSA have picked up

coverage and in their China Reality

Research (CRR) it was again

confirmed that Prince Frog was

indeed a fast growing brand in

China and recognized by the

public. (CRR interviewed over 200

families across China to check

brand awareness of Prince Frog,

see CLSA charts above)

Euromonitor’s latest estimates

(March 2013) also confirm our work and indicate that in some sub-categories (moisturizing lotions) the

company has in fact overtaken Johnson & Johnson in terms of market share.


Apart from this one example there is more evidence that meeting management of companies does lead to

better results. The Financial Times published an article in April 2013 that highlights a study performed by

Harvard professors David Solomon and Eugene Soltes (What are we meeting for? The consequences of private

meetings with investors). In our experience meeting company management can oftentimes lead you to better

understand a company, its industry and the competitive landscape. Some information about a company is just

not available in annual reports and can only be understood from kicking the tyres and going on the road.

To be honest we have also had our fair share of utterly useless management meetings; so it’s not because you

meet the CEO/CFO that you will learn anything useful. Hereby we give a small sample of some of the visits we

did over the last five years, what we learnt and what has happened to the companies valuation since our visit:


6- The Fund Today

After five years the fund has grown to 163,7 million EUR, or 221 million USD. The managers of the fund have

remained the same but we have strengthened our team.

Patrick Millecam Nic Van Broekhoven

Heinz Deweer

In May 2011 Heinz Deweer joined the team. Heinz joined us straight out of University but has already proven to

be a very valuable member of the team and has travelled to China, Thailand, Brazil and the UK to help us in our

research.

On the 13th

of August 2013 Value Square Singapore Pte Ltd was founded and is aiming to get a registration as

an RFMC (Registered Fund Management Company). As soon as the Monetary Authority of Singapore will have

registered Value Square Singapore, this subsidiary will start providing us with valuable local insights and

research in Asian markets . Nic has re-located to Singapore and will run the Singapore office

We managed to outperform the MSCI World AC return index in most years but 2011 and 2013 (so far) have

been challenging years for the fund. Especially 2013 has been disappointing. Until the end of May we were

performing satisfactory but the last few months we have lagged substantially. Even if this is a short period of

time, we are not happy about this. The average annual return of the fund since inception 5 years ago is 7,67%

vs. the MSCI World Index which over the same period had a return of 6,21%. On page 6 of this report you can

find more detailed performance figures. You can also check our monthly factsheets on www.value-

square.be.


However as we have stated many times in our previous reports, investors should NOT expect us to outperform

the market every 3,6,9 or even 12 month period. We are not an index-fund, hence we do not copy or mirror

any particular index at any given time. This style of investing makes it a near certainty that some periods when

particular indexes are in ‘favor’ we will lag. Investors can continuously question us if our investment decisions

are correct but should understand that if you want to outperform the MSCI World Index (or any other index of

your choosing) we should be doing something different versus the composition of the index and not be a

virtual copy.

The fund has now been in existence for five years and we realize that this is not a long enough period to be

statistically significant. Our large outperformance in the first few years might just be luck and our

underperformance since May might prove the point that we are merely reversing to the mean. As managers we

obviously believe we can add value but our performance will not be in a straight line. Quite a few of the

companies we invest in are well off the beaten track. Some of them are illiquid and it takes years to accumulate

positions in them. We believe these illiquid investments will give good returns over time but it can take a long

time before the market agrees with our analysis . We are also continuously looking to improve our investment

process. Off course we do not make big alterations, as our model has proven to be reliable in the past.

Drastically changing the way we invest would be detrimental to our credibility and performance. However

investing is a process of trial-and-error and fund managers should always be able to open to learn. That is why

we are always looking to add details to our model with the goal of improving our long term performance.

Just to give a few examples of companies we buy that are definitely not the flavour of the month. We have

investments in the Regional savings banks of Credit Agricole, we invest in palmoil via London listed players

who, on an EV/HA basis, trade at 50% discount to many of their Asian peers. We have exposure to African

rubber and palmoil via Socfinaf. Tea is another soft commodity we have exposure to via Mcleod Russel and

Camellia. These companies are definitely no household names among investors. All these companies have

individual reasons we invest in them and we believe our analysis of their fair value will be vindicated over time.

Valuation

As managers of the fund we track the overall performance of the fund but also the valuation of the fund versus

the Bloomberg World Index on different metrics. As shown in following comparison our fund is cheaper on

both P/E and P/B metrics, has lower gearing while achieving a higher ROE.


Costs

Asset managers charge a fee for managing the assets in a fund. We charge a fee of 1% on the assets under

management and our TER (total expense ratio) comes to 1,27%. The fund also has an annual hurdle of 6%. If

the fund increases above 6% we charge a 10% performance fee.

Turnover

According to Morningstar the average fund has an annual turnover or rotation of 80%. This means that the

average holding period is slightly more than one year. As explained before we are long term investors and

generally hold our positions for a long time. This is confirmed by the rotation in our fund. Below calculations

show that the average rotation in the fund between 2008 and 2012 was 16%.

Trading costs

When you look at a fund’s costs it is important to include all costs. One popular metric is the Total Expense

Ratio (TER) as mentioned before. Another aspect are the trading costs we pay brokers to execute our trades. As


managers of the fund we strive to keep our trading costs as low as possible since we do not gain anything by

trading often, it just eats away at our performance.

Below we give you an overview of our trading costs the last few years.

Trading costs 2009: € 67,403 on assets of €23,5 million = 0,29%

Trading costs 2010: €220,127 on assets of €73,9 million = 0,30%

Trading costs 2011: €164,822 on assets of €91,5 million = 0,18%

Trading costs 2013: €131,501 on assets of €109 million = 0,12%


7- Annual meeting

The two managers of the fund met each other for the very first time on a trip to Omaha to attend the annual

meeting of Berkshire Hathaway (the investment vehicle of Warren Buffet) in 2006. For those who have not

made the annual pilgrimage to Omaha one advice: GO! As long as Buffet is alive you should at least go to

Omaha once to experience the witty comments of Charlie Munger and the smart advice of Warren Buffet.

What we learned there clearly was an inspiration to also make our annual meetings worthwhile. We are not

hoping to entertain 30.000 people an entire weekend (at least not yet) but we did want to do it on a Saturday

so everybody who wanted to come would have the time to spend at least one day per year with the managers

of the fund and hear our thoughts.

The first meeting was held in March 2009 and the idea was that the managers would give a presentation on

their strategy and we would invite two of our investments to present their company to our investors.

We want our investors to feel like partners and co-owners of the fund. As in the end, the fund is merely a

vehicle through which all our investors are part owners of various different companies that we select for them.

The last few years we always had between 200 and 250 investors come to our annual meeting. On the first few

pages of this report we showed you a compilation of the past meetings.

Below we give an overview of the companies who presented at our annual meetings from 2009 until 2013:

During the annual meeting Patrick makes an effort to show in great detail what our investors are currently

owners of. Below we will show some slides of the most recent annual meeting (March 2013).


8- Our 10 LARGEST INVESTMENTS AS OF 30 September 2013


9- The REALLY long term

This chart gives a good overview of long term stock market returns in the United States. This chart was

compiled by Value Square with publicly available data from Yale University and the New York Stock Exchange. It

shows that from 1825 to 2012, 131 years had a positive stock market return (including dividends) and 57 years

had a negative return.

Value Square Fund Equity World · Value Square NV | Maaltecenter Blok G | Derbystraat 319 | 9051...

Documents

Transcript of Value Square Fund Equity World · Value Square NV | Maaltecenter Blok G | Derbystraat 319 | 9051...