February 2021 Newsletter
The Center of the Hurricane
When you learn to meditate, you are introduced to the concept of equanimity. The mental state of equanimity is an even headed reaction to the stimulus around us, whether it be positive or negative. You learn to be centered and not overly affected. I mention this because the financial markets have appeared to resemble a carnival as of late. It felt possible that we would have left the over stimulating activity in 2020, but 2021 brought us the meme stock episode, as well as Bitcoin reaching new all-time highs.
As value investors, this is episodic entertainment, but not much more than that. An outsider from the fields of law or medicine might glance at the news and think, “Wow, my career would be so much more interesting if I worked in the stock market!” Not that there are cocktail parties these days, but if there were, it would be cringe worthy to have to mention being an Equity Portfolio Manager these days. Imagine the excitement on someone’s face as they exclaimed, “What do you think of Gamestop?”, only to get bored to tears as you explain that your firm doesn’t own meme stocks, and you don’t check Reddit for stock ideas. It would be a little like telling people that you are a DJ, but that you only work the boring parties. Yes, being a value investor can be like avoiding the fun parties.
There were, and are, many salient reminders in the speculative frenzies that continue to occur in our current markets. One is that risk management matters. Value investors can sympathize with those that did a ton of work on Gamestop, and decided that the fundamentals were dangerously flawed, and that the stock was most certainly doomed. We at Ballina Capital do not short stocks. However, putting on our risk management portfolio construction hats, we cannot at all fathom a hedge fund shorting a stock that is already sold more than 100% short. There was clearly too much excitement about their position, and this was a risk not worth taking.
Again, if we are practicing our Equanimity, how would we handle the positive upside in a meme stock that we could possibly own? Value investors with a decent sense of equanimity often unfortunately leave upside on the table. At Ballina Capital, we try all the time to not be quick to sell winners. But we still end up selling stocks that move ahead of our price targets, only to see them scale higher heights. (This has occurred with Fortescue Metals, Kulicke & Soffa, and Tianneng International Power within the past year) If we are experiencing very extreme upside volatility in a stock, we want to ask ourselves if there is greater likelihood of positive scenarios that we have not captured in our models? If the drivers of the upside are ones that we could not ourselves find a sympathy with, we would be aggressively trimming the stock. One good reason to trim would be sheer size. We’re happy to let outperforming positions run at more than 4% of portfolios, even if we stop adding to them closer to 3%. But we do not allow individual positions to go over 5% of portfolios. There begins to be far too much to lose relative to the portfolio.
A second takeaway from the recent episodes is the pain of anything but optimism these days. Short selling has been in a tough position for much of the last 12 plus years. Short sellers play a very important role in markets because companies have powerful short-term incentives to mislead minority investors. Short sellers, who often publicize their findings, can provide powerful checks and balances with their intensive, contrarian research. Note that in the recent Wirecard fraud in Germany (see below), the regulators, accountants and the rest of the establishment defended the company. It was the short sellers and the media that kept shining the sunlight on the company’s deception. Writers at the Financial Times had to have employed their own equanimity in the face of investigations by the criminal prosecution office in Munich (these have since been dropped). Short sellers will from time to time write reports on our positions, and we welcome their work. It is not exactly the right time to see short sided research reduced, since we have seen so many Special Purpose Acquisition Companies (“SPAC’s”) come public over the past year. The SPAC’s are run by “promoters”, with incentives skewed to the upside, and they typically acquire companies that want to go public without all the onerous disclosures that come with the traditional IPO process. See the problem there.
Life is now different in many respects, and the financial markets are changed as well. Some describe practicing Equanimity successfully means imagining yourself as the center of a Hurricane (which happens to be the calmest spot). Category 4 and 5 hurricanes are clearly no joke, but the stimuli a value investor practicing their equanimity today have to ignore is by and large positive for investment market valuations. Money is being made. Whether these gains will be sustained in the long run is another question. We at Ballina Capital have stuck to the same consistent process and beliefs that we did when things were working less well, and that is that a portfolio constructed of fundamentally undervalued securities will win out over time.
International All-Cap Value returned 8.15% (gross basis) in February 2021 versus 2.3% for the benchmark. Year to date performance was 7.77% (gross) versus 2.56% for the benchmark.
Global Small Cap Value returned 6.35% (gross) in February 2021 versus 5.1% for the benchmark. Year to date performance was 7.33% versus 7.31% for the benchmark.
Top Contributors and Detractors
International All-Cap Value’s top contributor in February was Societe Generale SA (“SocGen”). The French Banking stock gained 32.3% as SocGen reported a more profitable Q4 than expected. SocGen also boasted that they would reinitiate dividends and buy back shares in 2021. This is a sharp contrast to the bleak year that was 2020 for the bank. The top detractor in February was Unipres Corp, which declined 6.1%. In contrast to Soc Gen, the Japanese auto parts supplier reduced their FYE March 2021 forecasts as customer production schedules are still weak.
Global Small Cap Value’s top contributor in February was Canfor Pulp Products. The stock returned 20.5% in February, as the Canadian Pulp and Paper company highlighted that their end markets are firming in 2021. The top detractor in the strategy for February was Qudian Inc. The Chinese Fintech stock was actually up for the month, but because we added to the position at relatively higher prices during February, our average cost ended up contributing negatively. Qudian has been struggling to get to grips with changing lending regulations back home in China.
 Benchmark for Global Small Cap Value comprised of 50% weight iShares Russell 2000 Index (IWM) and 50% weight Vanguard FTSE All-World ex-US Small-Cap ETF (VSS)