Long term investment advisors Q1 2010 results:+2.22%

Dear Reader and Fellow Investors,

The gain in net worth of the portfolio under our management during the first quarter of 2010 was +2.22% on a bid to bid basis (denominated in USD).

Considering that during this period we held approx. 20% of assets under management in cash, we are mildly satisfied with our performance. However, our cash load during this period helped ensure we under performed the S&P 500, which achieved +4.87% during the same period.

Our fear of asset markets tipping the balance from being fairly valued to slightly over valued has reduced our appetite for equities in a macro environment that remains fragile due to the debt burden that continues to exist. Hindsight would suggest we have been over defensive during this quarter. However, as many of you already know, we do not judge our abilities by quarter to quarter performance. I hope you also do not judge performance by this metric, otherwise we are likely to disappoint you (repeatedly).

In such a situation we must ask ourselves what could we have done differently. Often the answer lies in the psychology of the market - our approach requires us to remain as distant as possible from the sentiment of the market - focusing only on our perceived difference between price and value. It is because of this we will often, if not always, miss out on the end of a bubbles spectacular return in favour of hoarding cash to buy when prices collapse. As a result, we are likely to underperform competitors when the market is strongly positive and over valued. However, we strongly believe that if you want to finish first, first you have to finish. In the long run, those that buy expensive securities will realise they will burn more than their hands. However, on this occasion, we may be guilty of not placing sufficient emphasis on a major force that is pushing up the valuation of risk assets - near zero interest rates.

It seems the fear of the return of capital has been overcome by the demand for return on capital. We did not feel the market would make this adjustment so quickly. How short it’s memory can be: all is safe now that Ma and Pa have said they will create money at ease to dilute yesterdays problems...and so happily ever after they lived... we feel this is just that, a fairy tale. The creation of capital from nothing to support non productive capital can only be useful if overall the return on the capital invested increases. With the government responsible for allocating that capital, we find it hard to believe using history, and the current incentives of our political system, that this will be the case. As a result, it is more likely than not that the excesses of years past will still be a drag on our global economic system (especially, it seems, for developed economies that have a number of other negative factors in parallel, such as demographic issues). We appreciate that if the return on this new capital is greater than the current rate of interest, the new debt can start to be reduced immediately. However, whilst the receiver of the new debt will be working to pay the new debt back, the old debt remains where it was before, accumulating dust and waiting to eat a chunk of future profits, should they exist. Recall, it was the old debt that caused the problem!

Consequently, we feel economic growth if left to fend for itself, would be weak. We appreciate that if enough stimulus is added, and for long enough, sufficient momentum can be created that economies can grow, even flourish. However, just like the tired student who drinks coffee all night can be viewed as being bright eyed and ready in the morning, the reality is his body yearns to rest. He may even do his morning exam well, so his judges will be silenced for some time. But eventually, the tiredness will catch up with him, the only question is when, not if. Debt can be reduced/removed by only two means: default or inflation. Both bring pain when out of control: since the debt level still remains high on a historical level, our perception is that our due of pain has not been fully invoiced as of yet.

In essence, we feel the asset markets are being distorted by the governments actions. Interest rates at near zero are forcing investors to move out of near cash assets to generate any respectable yield. As a result, capital is moving out of money market funds and cash deposits into equities, bonds and other risk assets. Eventually, the yield on government bonds will have to increase so that sufficient funds will move to the public sector to pay for the stimulus that is allowing asset prices to rise today. If it seems a little circular, you would be right in thinking that. This new capital is likely to be buying only one thing - time. Time that generates little value and hence exacerbates the low return of unproductive capital as it increases the cost of interest.

To return to our principal point, we felt that government bond yields would have started to increase by now, and they haven’t to the extent we felt they would. We must appreciate that this paradigm shift may not occur overnight. If it does take time and the current circumstances remain, risk assets could continue to rally, not for any fundamental reason in terms of the quality of the businesses underlying the financial assets, but because certain variables are being distorted to ensure risk assets remain on morphine. We have reacted to this scenario by continuing to use our approach of buying good companies at good prices. However, today we are clearly finding fewer opportunities than in early 2009 due to the strong rally in the price of almost all risk assets. Having said that, only in the last two weeks we have purchased the stock of three different companies that we feel the market have left behind and are currently offering good value for money. In total, for Q1 we have executed five trades: two sells and three buys. We continue to spend a considerably greater amount of time researching good ideas rather than trading mediocre ones. We try to ensure only our finest ideas become part of the portfolio.

Over the last six months we have also started placing more focus in generating income as well as the potential of capital gains as a means of returns for our investors. We feel the market (S&P 500 as a reference) at current prices close to 1,200 is approx. 25% over valued. As a result, we feel there is a significant probability that the S&P 500 can close the year lower than the current market price. Should this occur, we like the idea that we have an ever increasing cash component accumulating in the portfolio. This will allow us to have the armoury to buy more good companies at even better prices. We estimate the current dividend yield of the portfolio is approx. 2.5% in USD terms. Though this is better than current cash rates for most developed country currencies, and better than bond yields for good companies for paper less than 2 to 3 years in duration - it is clearly nothing impressive when compared to average interest rates over the last hundred years. We like the idea of having this closer to 3.5% on a consistent basis for the portfolio. However, we will not push for this if we see that companies with lower dividend yields are trading at a significant discount to companies with high dividend yields because they may retain earnings to take advantage of higher returns on capital.

We conclude this brief review by thanking you for your continued confidence in us. If you would like further details or have any questions, please feel free to ask them on this blog or send them to my personal email address at alessandro.sajwani@gmail.com


Yours sincerely,

Alessandro Sajwani