We refer you to “part 1″ below for an introduction to our post on IP’s Q4 2009 report. In this “part 2″, we highlight excerpts from both funds’ “Perspectives” sections. It’s no accident that they address the same theme and mention the same measures we’re taking.
Q4 2009 report excerpts, part 2
“PERSPECTIVES”
Brazil
It is common for this section to be optimistic, where the managers explain why the future will be better, or at least like the past. Unfortunately, at least with regard to our expectations for our Funds’ returns, this is not the case. Results like those in 2009 are infrequent. The chances of seeing two years in a row similar to this one are very low.
In 2009 there was a fall in interest rates, the Real appreciated, and the country was in vogue, which – at least for us – was unprecedented. There is nothing to stop these factors from continuing (for one thing, because there is a certain correlation among them) and it would not even be extraordinary. But there are two problems that keep us awake. They are related to each other:
- There is an almost unanimous feeling, internally and externally, that “now we’re off, this time it’s different”. This feeling is supported by the supposed validation of the thesis that “the global pneumonia is nothing more than simple flu” around here.
- The big problem, of course, (and a direct consequence of the above-mentioned point) is the price base.
There is a great resemblance between the stock market at the end of 2008 and 2009: the sensation of inevitability of a trend and an almost unanimous opinion. These climates have proved mistaken in most cases.
We remember very well when IP was in its infancy, in 1989, and the Nahas case closed the stock exchanges in Brazil. We remember when President Collor froze bank accounts and investments in 1990, the Mexican crisis in 1994, the Asian crisis in 1997, the Russian one in 1998 and the Brazilian one in 1999 (the unforgettable “endogenous diagonal band” in the exchange rate). In all these cases, “this time it was different” and still “the house fell down”. Of these, the only one that seems to us to have had long-term effects was President Collor’s plan, which in fact has undermined the country’s credibility among many to this day.
Without fear of being repetitive, it is the changes in expectations that determine market fluctuations. Today, most people see the glass half full (or fuller). But there are more than enough reasons for a different view. Our growth has been supported by deficits in the balance of payments and in the fiscal balance, not based on savings or a measurable increase in productivity. The system remains jammed and very corrupt (for obvious reasons, it is impossible to state whether more or less).
No less important, in 2010 we will have presidential elections. Up to now, the economy and investors have allowed themselves the luxury of ignoring the relevant macroeconomic problems and the political risks. We have never seen a pre-election period involving a change of president with so much tranquility in the Brazilian capital market. Is it possible that everything has really changed, and that the political issue, so discredited and surreal, has embarked once and for all into a parallel universe? It would be marvelous, but in the end, “they” are the ones who define the rules, raise taxes, hamper the day-to-day routine. Like the androids of the film series “Terminator”, at each new film, precisely when the villain seems to be more harmless, he is much more dangerous. We have nothing to add to everything that is in the papers every day. Except to stress and remind our readers that unfortunately political decisions do have an impact on the economy.
In line with this view, we closed the year with a high cash percentage. If the market continues to climb, we will still capture at least part of this rise. But the ideal scenario would be a crisis of expectations that would take prices back to levels where implied expectations were much worse than the present ones. As a result, we could “put the turnstile back to zero”. As we have mentioned several times in the past, volatility is not a risk measurement. It is our great friend.
And what if we are wrong? We are running the risk of earning less than if we were more exposed. In fact, that is what happened this year. (…) Market timing is something we do not know how to do and do not intend to do. In the course of time, all those we have seen trying to do fine timing on a large scale, based on market “feeling”, have ended up being faced with the reality that, in the long term, this is a losing proposition. We do our timing as a consequence. We buy more when prices are low in relation to an expected reasonable value for the assets, based on well founded assumptions. We sell as the opposite starts to occur. Above all, before any other consideration, IP’s history of over 20 years has taught us that, to arrive in first place, first you have to arrive.
Global perspectives
We believe that the drastic changes at the global level have not yet ended. We continue to hold our view that current prices, in general, imply a more optimistic expectation than what experience and analysis of the interests involved recommend as prudent to follow. In fact, we see the governments of several countries (the USA in the lead) as great Madoffs, operating a great make-believe scheme. The story here is that future tax revenues will be sufficient to pay interest and all the “social” commitments. As in the Madoff case, it is much more convenient and pleasant to believe. But the truth is that the account hardly ever balances out. As in that case, the tendency is for there to be a disastrous ending for those who do believe (pensioners, long-term US Government security holders, etc.).
It is here that greater flexibility is most significant. (…) We do not propose to look at everything. On the contrary, we can reject everything that is less than optimal and concentrate on what we consider very good. At a time when it is even more difficult to find sound assets, with businesses carrying sustainable competitive advantages reflected in high returns on equity, managed competently and capably, at attractive prices, and when everything – even the traditional refuge in the dollar and in treasury paper – is questionable, this is a great advantage.
Our favorite cases continue to be independent of conventional classifications, such as by sector, geography or company size. However, certain sectors and certain geographical areas do have their biases, making them more attractive in certain situations.
In the course of the last few years, we have been trying to learn a little more about the health sector in the USA. Besides being the largest sector in the US economy, its complexity, segmentation and stratification make it the largest entrepreneurial laboratory we know of. The quantity of business models is virtually endless, given that in addition to vast diversity, the dynamism induced by the competitive, regulatory and technological aspects makes sure that there are always new models. At the very least, we have a wonderful tool gain, given that in many cases the models, or parts of them, end up being adopted by other sectors and/or in other geographical areas, giving advantages to those who have already studied and understood them.
Despite all the turbulence in the sector (in fact, thanks to it) generated by the Obama administration’s reform plans for the sector, this year we were able to reap some rewards from our effort, as in the cases of IMS Health (a position that we have already closed) (…); but we believe that there is still a lot of “juice” to be extracted from this fruit. The studies continue and it seems to us that, as in most cases, the media noise is helping to push down the prices of some assets more than could be considered normal.
Another sector that is still rather depressed (deservedly) in terms of asset prices, in the most developed markets, is the real-estate sector. It is difficult to know when growth will pick up, but it is certain that this will happen. Meanwhile, we continue to study the players, getting to know people and to understand the models and the “little tricks” of each sector/company.
Natural candidates are the businesses based on the pro-active and differentiated use of information. From our point of view, there are several attractions. Returns tend to be high due to the low levels of capital needed. The practical difficulty of implementation has historically been extremely high. Many companies have a vast pool of potentially valuable data, but the cases of those that manage to turn them into the great value creator they may represent are very rare. Those that set themselves up this way have a fantastic business, whose focus is the intelligent processing of information and which is “disguised” in companies classified in the most varied sectors, such as IMS Health (health sector), Amazon (retail), Google (media), Harrah’s (casinos), Co-Star (real estate), and Verisk (insurance), among others. In our traditional retail sector – an obvious candidate – despite our efforts we have found very few cases.
In short, we continue seeking companies with sustainable competitive advantages from a long-term perspective, which are able to generate value even in scenarios that are adverse for most, including those where changes in relevant paradigms occur. At the same time, we try to be on the alert for possible significant market distortions, caused by time imbalances or the application of models based on the adoption of assumptions that seem inappropriate to us.
Tags: ipreports, report, riskmanagement, yellowstone
