de LARDEMELLE: SCARCE VALUE TRANSCRIPT

October 17, 2014

For most investors, both amateur and professional, the primary goal of investing is to make money. However a handful of our guests have another top priority – capital preservation. IVA Worldwide Fund’s co-portfolio manager Charles de Lardemelle is one of them. On this week’s WEALTHTRACK he explains why he is now holding more cash and fewer stocks in his value seeking portfolios.

CONSUELO MACK: This week on WEALTHTRACK, a value investor who is willing to sit on large piles of cash while others invest in what he considers to be overvalued markets. IVA Worldwide and International funds’ Co-Portfolio Manager Charles de Lardemelle explains why patience is a virtue, next on CONSUELO MACK WEALTHTRACK.

Hello and welcome to this edition of WEALTHTRACK, I’m Consuelo Mack. There is no question that the world’s economy is slowing down. The international monetary fund recently trimmed its estimates for this year and next due to more weakness in Europe, Japan, and Russia, as well as a modest deceleration in China. The biggest exception? The us, where the IMF forecasts the expansion will pick up.

The IMF also warned about rising geopolitical tensions and a potential correction in the financial markets, describing stock prices as “frothy.”

That is also the view of some of our guests, who look forward to a market correction so they can buy securities at lower prices.

For most investors, both amateur and professional the primary goal of investing is to make money. However there are a handful in the WEALTHTRACK universe who have another top priority: capital preservation.

The most famous among them is Jean Marie Eveillard, the legendary former portfolio manager of the First Eagle Global fund, which is now ably steered by WEALTHTRACK regular Matthew McLennan. This week’s guest is an alumnus of the Eveillard school of investing, having worked at First Eagle for many years before leaving with a colleague to launch their own firm, International Value Advisors in 2007.

He is Charles “Chuck” de Lardemelle Co-Founder and Co-Portfolio Manager of the IVA Worldwide fund and IVA International fund which he launched with Co-Portfolio Manager Charles de Vaulx in October of 2008, the depths of the financial crisis and it turns out the month the market bottomed. Both funds closed to new shareholders in early 2011 after the firm surpassedg $15 billion in combined assets. Since inception the flagship IVA Worldwide fund is in the top quartile of its world allocation category with 11% annual returns beating both its benchmark and its competitors by a sizable margin. De Lardemelle says capital preservation is his firm’s first priority. I began the interview by asking him to explain why he is holding so much cash, more than 30% in both fund portfolios.

CHARLES DE LARDEMELLE: Well, because there is a dearth of opportunities in the stock market today in our opinion, so it’s very difficult to find quality companies with large discounts to intrinsic values where a knowledgeable buyer would pay in cash for the whole business, and it’s in part due probably to quantitative easing and the fact that interest rates are so low, but we’re not willing to take the bait, and we’re not willing to play the game.

CONSUELO MACK: Now not willing to take the bait. When you and I talked early in 2013, cash levels were at 25 percent I think in the IVA Worldwide fund, and you said the same thing, that that was a very contrarian position at the time. Needless to say, the markets have done extremely well since then, so you missed some opportunities. Right?

CHARLES DE LARDEMELLE: Well, we’ve continued to compound nicely and faster than nominal GDP, and we do offer a cautious approach to value investing, and so to us the first goal is to preserve capital. Not everybody can afford to take on volatility. We have a number of clients who need this money either for retirement or to pay for the kids’ education. So we always look at the down side, and the stock picking has really helped us compound nicely over these years, and so far our clients seem to be satisfied.

CONSUELO MACK: Capital preservation, however, you’re getting on cash basically nothing.

CHARLES DE LARDEMELLE: Nothing.

CONSUELO MACK: So you’re actually, on a real return basis, you’re actually losing money on that cash.

CHARLES DE LARDEMELLE: Correct.

CONSUELO MACK: So how do you view that as a capital preservation tool?

CHARLES DE LARDEMELLE: Well, we view that as an option on tomorrow’s bargains, and so hopefully we have opportunities to put that cash to work at much better valuations at some point in the market cycle, and so it’s really an option. There is some option value embedded in that cash.

CONSUELO MACK: What about gold which I know has also been a longstanding holding of your shop, and what, it’s down to about three percent of the portfolio now.

CHARLES DE LARDEMELLE: Correct.

CONSUELO MACK: From five over a year ago?

CHARLES DE LARDEMELLE: Correct.

CONSUELO MACK: I mean, gold obviously has declined. It’s not been a great time for gold.

CHARLES DE LARDEMELLE: It’s a hedge. It’s a hedge against equities, and it’s a hedge against cash. So when there is uncertainty in the world, equities tend to go down and gold tends to go up, and that was definitely the case at the beginning of the year with Ukraine, with China being a bit wobbly. Recently gold has been under some pressure, and that’s due to, in our opinion, the U.S. dollar going up strongly, and so you have a very negative correlation there, but I think it makes sense in these times of money printing to have a little bit of gold to hedge your equities, to hedge your cash.

CONSUELO MACK: Is three percent the bottom of the range of what you consider to be a hedge position in gold?

CHARLES DE LARDEMELLE: Correct. I think that’s correct. Our weight in gold depends on how much we have in equities, and we don’t have that much in equities these days, about 50 percent in the worldwide and 60 percent in international, and so as a consequence we don’t have much gold either.

CONSUELO MACK: The 50 percent allocation to stocks. Explain how you’re investing your stock.

CHARLES DE LARDEMELLE: Well, that’s really driven by the bottom up. We have 10 analysts who are very gifted and help us determining intrinsic values, worst case scenarios. We always do a worst case scenario. What’s the down side if we’re wrong?

CONSUELO MACK: In each specific security.

CHARLES DE LARDEMELLE: In each specific security we own, and that will guide the size of our position. If we have a lot of leverage, there might be more down side and, therefore, if we were to make an investment in that security, it would be a much smaller weight than if you don’t have any leverage. So it’s stock-by-stock basis which is unusual for asset allocators. We don’t view ourselves as asset allocators. We view ourselves as stock pickers, and then if we can’t find anything that fits our criteria, then we’ll sit in cash. So you end up with an asset allocation, but we don’t wake up in the morning saying we’re going to have this much or that much in cash or in other parts of the market. High yield we only use when it provides equity-like returns, and so we used to have during the crisis of ’09 we went as high as 30 percent in high yield with yields to maturity of 12 to 15, 20 percent. Today we have almost nothing in high yield. There are no opportunities whatsoever.

CONSUELO MACK: What opportunities are there in the bond market?

CHARLES DE LARDEMELLE: Here is how I see our allocation today in the bond market. Most of it are those bonds we bought back in ’08, ’09, and they are getting very close to maturity. So part of that 10 points of allocation is what I would call long-term commercial paper, you know, maturity of a year or two max, yielding one or two percent, but I’d rather keep those rather than take the gains and recycle that in cash yielding even less. And then we have about five or six points in Singapore government bonds.

CONSUELO MACK: Singapore. Why?

CHARLES DE LARDEMELLE: Yes. Well, it’s really a way to park some of our cash outside the U.S. Dollar. So it’s quasi cash as well. So I would tack on this to our cash position rather than see it as … There is very little interest rate risk in that remnant of those investments that were done in ’08, ’09, and there is very little credit risk in our opinion as well.

CONSUELO MACK: Your emphasis on capital preservation first and then capital appreciation …

CHARLES DE LARDEMELLE: Yes, second.

CONSUELO MACK: So how do you address the capital preservation question when you’re talking about equities and your equity positions?

CHARLES DE LARDEMELLE: First as I mentioned earlier. We always do a worst case scenario, and if we see a lot of down side, then the size of the position will be small. Second, we do not overly concentrate in our equity positions, and so that’s one of the puzzle of the worldwide fund is that even though we own 100 to 150 securities, we tend to not correlate with benchmarks. How do you do that? Well, it’s because we’re very willing to have very a large what I would call negative allocation. So having zero in a big part of the benchmark? No problem. Jean-Marie Eveillard and Charles de Vaulx had zero in Japan back in ’87, and then Japan doubled and became the largest market in the world, and they had zero in what was the largest market in the world, and it just doubled. They had zero from ’87 to ’85.

CONSUELO MACK: In the First Eagle days.

CHARLES DE LARDEMELLE: Correct. Then during the TMT, Telecom/Media/Technology bubble we had zero in those sectors, and then in banking, ’06, ’07, we had zero as well. So where are the big zeros is always a question that investors should ask about allocation.

CONSUELO MACK: Where are the big zeros?

CHARLES DE LARDEMELLE: Exactly, exactly.

CONSUELO MACK: You just fed me a question. I will respond to you.

CHARLES DE LARDEMELLE: So up until recently, the big zero was in BRICs, Brazil, Russia, India, China.

CONSUELO MACK: Up until recently?

CHARLES DE LARDEMELLE: Yes, and so we’ve started to dabble a little bit in China.

CONSUELO MACK: Russia?

CHARLES DE LARDEMELLE: No, not Russia. Not Russia.

CONSUELO MACK: Oh, good. All right, I was going to say. You are really crazy.

CHARLES DE LARDEMELLE: Not Russia, although I would say the most contrarian bets today would be Russia and Chinese banks, but we have started to find a few investments in Hong Kong that are related to China, and so the Chinese market and the Hong Kong stock market have gone nowhere in a number of years now, yet the Chinese economy has continued to grow, and we…

CONSUELO MACK: More slowly.

CHARLES DE LARDEMELLE: More slowly, yes, but the price is starting to meet value in some of those smaller companies in China. So they go mostly for now in the international fund because they tend to be less than a billion of float, but…

CONSUELO MACK: Are these mid-cap, small-cap?

CHARLES DE LARDEMELLE: Mid to small-cap, yes.

CONSUELO MACK: Listed in Hong Kong.

CHARLES DE LARDEMELLE: Listed in Hong Kong.

CONSUELO MACK: What are you investing in in Hong Kong?

CHARLES DE LARDEMELLE: In Hong Kong, to just give a few examples, we own two satellite companies in Hong Kong, APT Satellite and AsiaSat. Satellite business is a good business because basically at core we view it as a real estate business. You have slots in the sky. There are only so many slots for geostationary satellites, and they’re all occupied, and once you understand that, you understand the pricing power behind having a satellite up in space. We have a company that masquerades as a department store company, Springland, but basically they own the real estate, and it’s not a model where you have inventory and you have to run the stores. You just take 17 percent of your tenents’ revenues as income, and so it’s really a real estate company, and it gets priced as a department store company but you don’t have the same risks at all. So I think it’s one that is completely misperceived, misunderstood by investors, so that’s an example. Another one would be Digital China where they distribute it products throughout China, and Dell, Cisco, HP are clients, and both Dell and HP at some point tried to do without Digital China, but they couldn’t. Interestingly enough, on some of the positive basis, they have some cash. They have a stake in an it services company that’s listed on the Shanghai Stock Exchange, and the two together are more than the market cap, and then you get the core business for free basically which is distribution of it products and Digital China seems to be.

CONSUELO MACK: Are these small holdings?

CHARLES DE LARDEMELLE: In the International fund, they’re starting to show up as about six percent of total assets, so in the context of…

CONSUELO MACK: And that’s what … you’ve got three billion…

CHARLES DE LARDEMELLE: Three and a half billion in the International. That’s right.

CONSUELO MACK: Three and a half billion in the International fund.

CHARLES DE LARDEMELLE: Yes, so Hong Kong’s starting to show up. Hong Kong/China is starting to show up as an allocation there, and it surprises even us because obviously the Chinese economy has a number of issues but, hey, when the price is right we’re willing to step in.

CONSUELO MACK: What was your view of Alibaba, just out of curiosity.

CHARLES DE LARDEMELLE: I think it’s another sign that the market cycle is fairly advanced. So you have the high-yield bond market is very lax. You have the largest IPO ever with Alibaba. You have buybacks which I view as a contrarian indicator.

CONSUELO MACK: And explain that.

CHARLES DE LARDEMELLE: Reaching new highs.

CONSUELO MACK: Why are stock buybacks a contrarian indicator? And you said they were at records now?

CHARLES DE LARDEMELLE: Yeah, they’re very close to records, and so they were at records at the last peak, you know, in ‘07, and they troughed in ’09 at the trough of the market, and so it looks like boards don’t do a much better job than some investors, and they tend to buy at the top when everything feels right, but that’s not usually when you get the best prices.

CONSUELO MACK: Warren Buffett recently informed the public much to everyone’s surprise that he would advise his wife’s trust to be 90 percent in an S&P 500 index fund possibly run by Vanguard and 10 percent in U.S. Treasuries, and you addressed that issue in a recent shareholder letter to clients and, in fact, said that now kind of more than ever or more than in recent years that this is the time to be with an active manager.

CHARLES DE LARDEMELLE: Correct.

CONSUELO MACK: And a stock picker. Of course, every active manager always says that, but why is this the time?

CHARLES DE LARDEMELLE: For two reasons. One, if you’ve got a billion dollars, you can afford the volatility, but not everybody…

CONSUELO MACK: You can afford the volatility.

CHARLES DE LARDEMELLE: You can. You can. Absolutely, and so you put your money in a trust. Instead of the T-bills I would probably put 10 percent gold. I think it’s a better hedge and then go to beach. That’s fine. You live off the dividends. You’re fine, but not everybody is in that position, and so our clients for the most part cannot tolerate the volatility, and the other reason why I think today may not be the best time to do this is that we see markets as very elevated across the globe in good part because of QE.

CONSUELO MACK: Interest rates are so low globally…

CHARLES DE LARDEMELLE: That they have pushed…

CONSUELO MACK: In just about…

CHARLES DE LARDEMELLE: Yes, and then they have pushed everything up, and what’s…

CONSUELO MACK: You have to go into other assets to get any returns at all.

CHARLES DE LARDEMELLE: Or hide in cash. You don’t have to be fully invested all the time, and what’s also different from previous cycles perhaps is that we’ve seen correlated cycles in Japan, in Europe and in the U.S. In other words, in all three big regions prices are being manipulated by central bankers. Usually you find a region that’s doing better than another, so one is depressed and as value investors you can go and sift through the rubble in a depressed part of the globe, but today because QE has been prevalent throughout developed markets, it’s very difficult to do that, and I would say that today if you look at again market cap to GDP in the U.S. but in other markets as well, you are at quite elevated levels. One question we get a lot these days is about Europe. Europe seems to be, if you look at market indices, a lot more depressed.

CONSUELO MACK: MSCI Europe for instance.

CHARLES DE LARDEMELLE: Correct, and we think that’s somewhat misleading. If you were to take out of the Europe, the MSCI Europe index, the banks, telecom and utilities, really the market recovery in Europe has been almost as good as in the U.S. since ’09.

CONSUELO MACK: Oh, interesting.

CHARLES DE LARDEMELLE: And so really if you think that Europe is going to catch up, well, the high-quality companies are as expensive as the high-quality U.S. companies if not more expensive in Europe, and you’re really making a bet on banks, utilities and telecom catching up, and I could argue why that may not be the case, but you’re not buying a market as a whole that’s depressed. You’re buying three sectors.

CONSUELO MACK: One of the companies that you and I have talked about in the past is Berkshire Hathaway which is one of your top five holdings, but as you said you don’t run a concentrated portfolio, so I don’t know. It’s four percent of your portfolio or five percent, something like that.

CHARLES DE LARDEMELLE: It used to be. It’s been cut to two and a half, three.

CONSUELO MACK: Oh, cut to two and a half or three? And at the time I remember you saying that kind of the intrinsic value that were valuing Berkshire Hathaway was at $175,000, and now it’s over $200,000, so that’s why you’ve cut your holdings.

CHARLES DE LARDEMELLE: That’s correct. The discount to intrinsic value at Berkshire Hathaway has shrunk very substantially.

CONSUELO MACK: That was your one investment in early 2013. What would your one investment be today?

CHARLES DE LARDEMELLE: With a long-term view, something I could put in a trust for the kids and forget about it?

CONSUELO MACK: Yes.

CHARLES DE LARDEMELLE: Today I would pick Nestlé.

CONSUELO MACK: Nestlé, another one of your top five holdings.

CHARLES DE LARDEMELLE: Yes, and I think what might be missed is that about 40 percent of the profits come from emerging markets. So you get emerging market exposure for a very reasonable price. The balance sheet is solid, and obviously the business is rock solid. The worst thing that could happen probably would be food poisoning that would taint the brand globally, but they are well diversified in terms of geographies, in terms of products. The balance sheet is strong. Management is great. It will do fine with a long-term view.

CONSUELO MACK: And value now is decent?

CHARLES DE LARDEMELLE: Well, the discount used to be very large back in the late ‘90s, and at the time you had big discrepancies between the Cokes of the world and food and beverage in Europe, and a lot of these values have arbitrage over time because of hedge funds, because of more global investors. So value has been better for Nestlé, but still with a long-term view that’s definitely something that I would be very comfortable holding.

CONSUELO MACK: What are the two companies that you’re most excited about that you think offer the most appreciation value and at the best price in your portfolio today?

CHARLES DE LARDEMELLE: I would mention maybe two additional names, Expeditors in the U.S. which is a freight forwarding company. Freight forwarding company, what they do is they take a commission to move a container from say China to Chicago. Okay? And so it’s asset light. You don’t have to make too many investments. Top-notch management. Used to trade at very brilliant multiples. Since the great financial crisis, global trade is still down substantially, and that company has deteriorated substantially in terms of multiples and today trades as if global trade was never going to pick up. So if it doesn’t pick up, it’ll compound nicely, and if global trade does pick up, I think you make an even better return on your investment. Again, very strong management, very strong balance sheet. I would be very comfortable holding this for the long term as well, put into that same trust for the kids and forget about it. And the last one I will mention then is Samsung Electronics, and that one is a bit more of a contrarian play. Samsung is a very strong company obviously, many different legs.

CONSUELO MACK: Conglomerate, huge, just a lot of different businesses.

CHARLES DE LARDEMELLE: Yes, that’s right. Semiconductors and smart phones are today the big legs on which Samsung stands. In smart phones, there are issues. There is competition coming from the Chinese, and margins are going to come down. There is no doubt in our mind.

CONSUELO MACK: And Apple.

CHARLES DE LARDEMELLE: Well, yes, but…

CONSUELO MACK: You consider that to be different?

CHARLES DE LARDEMELLE: Yes, and I’ll explain, but we think that basically markets have been too harsh with Samsung that they’ll survive in the smart phone business and they’ll survive with decent margins. The difference between Apple and Samsung, Apple to me is the Gillette business model in reverse, i.e., Gillette, you know, they give you the razor and then they sell you the blades for a crazy price.

CONSUELO MACK: A very high price.

CHARLES DE LARDEMELLE: Yes. Apple is the reverse. They sell you the blades which are the phones for a very high price, and then they give you the blades, the songs and the videos and the movies for reasonable prices. You’re kind of stuck once you go on iTunes. Unfortunately, their use is streaming now, so they’re not buying any content anymore, but for me who bought an iPhone, I’m stuck with them and I have to pony up for the expensive razor every couple years.

CONSUELO MACK: Because you’re in their universe.

CHARLES DE LARDEMELLE: That’s right. At Samsung it’s different. If you want to toss the Samsung phone, you can. I can’t toss my Apple phone because I’m stuck with my library of songs and movies, but Samsung has shown an ability to fight dogfights and win these fights. I would say that the smart phone business at Samsung is very akin to Dell 10 years ago when Dell had very high margins, and Dell refused to fight the dogfight. They refused to bury HP in 2000. They could have buried HP which was losing money hand over fist in their PC business. Instead Dell decided to make very fat margins. I think Samsung will not make that mistake. Samsung will fight the Chinese. Actually they churn out 100 million cell phones a year with zero margin, but there is no capital


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