Tuesday, 31 December 2013

2013 - Year in review

So as the markets close for the last time in 2013 I've totaled up my figures for this year in terms of investment performance as well as over my investment lifetime. All stocks are valued to bid prices, with dealing charges and stamp duty costs included (but before capital gains tax). As I am often adding to / withdrawing from my portfolio for various reasons I track IRR as my main investment metric and benchmark myself to the FTSE All Share and Small Cap Indices:


My IRR: 50.45%
FTSE All Share IRR: 14.22%
FTSE Small Cap IRR: 40.00%

Lifetime (Began 2011):

My IRR: 44.88%
FTSE All Share IRR: 9.48%
FTSE Small Cap IRR: 29.06%

So it's been another year of a strong bull market in small and micro caps UK stocks and a rising tide has lifted all boats - my 50.45% IRR doesn't look all that exceptional when you consider the Small Cap index has risen a whopping 40% this year. In fact I'm surprised I'm actually ahead of the index at all as looking around the UK small cap market now the equities that are really taking off are often low-quality 'story stocks' as the bull market becomes more mature. This year I feel like I've been pretty lucky overall with my investments as I've had so many different ones work out positively and few losers (C21, CLIG and 3LEG have been the main detractors). I certainly still expect my Lifetime IRR to trend down over time to a more reasonable figure as the benchmark IRRs mean-revert to their long term averages although I'm happy with a ~16% out-performance since I began investing.

My main mistakes this year have been those of selling investments too early. As a fundamentals-oriented investor, I have a natural bias towards over-focusing on two of the three main sources of empirically confirmed equity out-performance (value and quality) and ignoring the third - momentum. Whilst I'm aware of this and try to compensate by holding on to well performing equities that were cheap until I feel full value has been realised I have sold a number of stocks that have gone on to do very well in a relatively short period post selling. Staffline I sold at 339p and it went on to touch over 600p. I sold ACSO at 340p and it's now trading at 780p. I don't feel that bad about the prices and multiples I was generally able to sell these at (I sold ACSO at a ~30x multiple at the time and it's gone to ~55x!) but I often find that I when I sell a well-performing share they often go on to do another 15-20% in a short period afterward, although that's probably an artifact of the bull market in general anyway.

Right now I'm finding it harder and harder to find undervalued equities in the micro and small cap markets although I'm still happy with my existing investments - the nice thing about micro caps is you can be very selective and there's always something about that's cheap. On a valuation basis most markets seem at best 'fair value' to me and often quite a bit toppy - some of the small caps have re-rated on to multiples that imply low forward returns on any reasonable expectation of business performance and when people can get away with stuff like this you know the temperature of the market is starting to get quite hot.

I hope you've had a good year investing, here's to many more in the future!

Sunday, 22 December 2013

CLIG - City of London Investment Group

There’s been a few mentions of CLIG on TMF before so I have to give credit to other write ups worth reading: Burgdorf’s, TMFFlaneur’s and TMFMayn’s but I’ll try and synthesise these all together, with my own comments.

CLIG are an asset manager focused on emerging markets (EMs). EMs have had a pretty rough time recently compared to developed markets and so are fairly out of favour (See the performance of the Vanguard EM ETF here) after having an exceptional run for many years prior to 2008. This has impacted CLIG pretty badly as revenues and earnings are tied to the assets under management (AUM) the firm has. This means that AUM falls in years where the EM indices fall, and rises when the EM indices do – consequently earnings also follow the same pattern.

From 2005 to 2011 CLIG grew AUM from about $1.6bn to $5.8bn through a combination of raising more capital and EM index growth and hence earnings also shot up from 11.85p to 34p. However, since then earnings have fallen to 24.6p as AUM has fallen to $3.7bn. This is due to the underperformance of EM markets as well as a big loss of one client who took their business in-house and away from CLIG. Due to this fall it’s likely earnings will also fall for next year – brokers forecast a consensus of 19.3p but TMFMayn has used the earnings model CLIG provide in their annual report to calculate that their current run rate is 17p.

CLIG have a great management culture and a pro-shareholder attitude. The founder, Barry Olliff, owns 11.4% of the shares whilst other directors, staff & ESOP own another 12.1% of the company. The staff also participate in a profit-share agreement, whereby 30% of PTP is allocated as bonuses, so staff have a strong incentive to grow earnings and shareholder value over the long term. It’s worth quoting Barry Olliff himself on this structure in 2012:
"As shareholders are aware, we run a business with a very simple business model. We collect fees from our clients for our services, we pay our bills which are both forecastable and to a great extent fixed. We don't use leverage, nor off-balance sheet instruments, nor do we trade derivatives as principal (other than occasional low level hedging). There are no associated companies or minority interests within the Group. We do not use tax havens. We do not handle client monies. We have a significant amount of cash in the bank relative to our size and we basically stick to what we know.
With regard to remuneration we continue to distribute 30% of our profits as profit-share. Our staff, clients and shareholders understand this formulaic approach. It's a pity that this approach has not been embraced by the financial service industry generally. As it is, in many parts of the financial services industry it seems as if losses are not the responsibility of mangers rather it's the shareholders who take the rap. Whilst our formulaic approach seems out of keeping with many in our industry, at least our shareholders have an idea that our returns go up and down together with theirs 
We have continued to manage our business very conservatively. We have continued to attempt to keep costs down. We do not spend shareholders' funds entertaining and we generally attempt to manage our business as if shareholders were present in our offices every day of the week. One reason I would suggest that expenses are kept down is because staff are either shareholders themselves or own shares via the CLIG ESOP. At present staff own (including ESOP ownership) 27.9% of CLIG shares, and 75 out of 82 of us are incentivised in this way (a handful of more recent recruits do not yet hold options).”
Importantly for an asset management firm, I think CLIG’s investment strategy adds excess returns (‘Alpha’ in the financial lingo) and hence is a desirable one for long term asset allocators (i.e. potential customers). CLIG’s main strategy is investing in closed-end funds, funds which have a fixed AUM (pre-distributions & returns) and have shares which trade publically. CLIG like to buy these when the share price trades at a discount to NAV, hoping to benefit when the discounts return back to their historical norms. They meet with all the managements of the funds they invest in and try to influence their use of strategies which help narrow that discount (87% of the funds they invest in have an Open Market Repurchase Program in place)) as well as investing in funds where they think the managers are better than average.

Unfortunately, this strategy has done badly recently as the Size Weighted Average Discount (SWAD) has risen from 8% back in 2008 to almost 14% in 2013, providing a headwind to their main source of excess returns. However, this headwind is sure to turn in to a tailwind as discounts mean-revert. This should also be a marketing advantage, as this is a simple message to sell to new clients (“Come invest now at the highest discounts we’ve seen in years and take advantage of the tailwind for excess returns!”). In fact, CLIG are looking to do just that and given the recent loss of a client have capacity now to add new clients and expand AUM. They are looking to raise $500m in 2014 and potentially another $500m in 2015 to replace the $1.3bn lost in FY12 and FY13.

CLIG also have another tailwind from the run-off of their marketing commission structure over the next 7 years. They currently pay £3.6m in commissions to marketing firms for introductions to clients they have however by 2020 this will have reduced to nearly £0 and the benefit should all flow directly to the bottom line. CLIG have also introduced nearly £1m of cost savings in the past year from closing underperforming products, reduced headcount and lower business development costs.

The other large negative factor weighing on the share price recently has been the departure of CEO and the FD under unexplained circumstances. It does appear to be fairly amicable however when Roger Lawson asked at the AGM no further explanation was given as to the reason behind it. It seems highly likely that due to whatever agreement was signed the board are unable to give the real reason for the departure. The question is what impact is this likely to have on the business? In the short term £1.1m had to be paid as termination fees to the departing management (although this was offset by Barry Olliff volunteering to waive his bonus) but the longer term fear is that this is sign of internal trouble within the staff – a very bad sign in a business that is highly dependent on the people it employs. This is partly offset by the fact that Mr Olliff believes that CLIG’s investment strategy isn’t dependant on ‘star managers’ but rather a ‘star process’, allowing internal talent to be developed. Also the firm’s focus (driven by Mr Olliff) on otherwise very good corporate governance and a pro-shareholder mentality offers reassurance, although this is clearly an area to be kept a strong eye on as prospective clients will want to see a solid investment team

On a valuation front, CLIG don’t ‘appear’ cheap as they trade at over 12x forward earnings (broker forecasts) however this is perhaps the wrong metric to focus on as earnings are volatile and the business is operationally geared. Given CLIG have the SWAD tailwind, the marketing run-off tailwind, the £1m cost-savings and are looking to raise ~$1bn of extra AUM over the next two years it seems likely that earnings could be significantly higher in 2-3 years time as AUM (and hence revenue) grows whilst costs come down. PTP margins are currently at 31% (a relative low) but have been as high as 41% previously and have averaged 34.2% since 2005.

Valuations for EMs also appear attractive and the case for EM investment is as strong as ever (See Wexboy’s excellent analysis) so it would not be unexpected to see a recovery in EM indices, further boosting AUM and earnings.

Investors are also paid handsomely to wait, with a 10% dividend at the current price (only just covered by earnings and probably uncovered next year, but 15.6% of the market cap is made up of cash on the balance sheet so CLIG should be able to maintain the dividend whilst earnings build back up). The wonderful thing about asset management businesses is that they are very high quality – earnings convert predominately in to cash and the business takes next to no capital investment in order to grow, so growth is highly value creating for shareholders. To confirm this, CLIG have earned an average of over 50% return on equity over the past three years. This lack of a requirement for earnings to be ploughed back in to the business means management have excess cash which can be distributed as dividends or used for acquisitions to expand the business (CLIG have tended to be more generous with the former, growing the dividend from 10p in 2007 to 24p today). It’s a great business to be in.

In conclusion, I think CLIG are both a great ‘value’ and ‘quality’ play (Stockopedia agrees with scores of 89/100 for Value and 88/100 for Quality) together with a number of favourable tailwinds and mean-reversion factors which should come through in the medium term, combined with top-notch corporate governance. I look forward to seeing them present at the next Mello event and highly recommend investors come and take a look at what I think is a great business at a great price!

An update on my portfolio since the last update: 

I've added SEA at 22.75p (yay!), NCON at 15p (yay!) and 3LEG at 24p (D'oh!). I bought more LCG at ~33p average price and topped up ZIOC at 15.6p as attractive prices presented themselves. I top sliced RNWH at £1.60 and TNI at £1.58, £1.72 and £2 as prices appreciated. I completely sold out of C21 for a big loss at 6.2p and out of JD. at £11.33 (too early, but at a decent profit) I've also bought one more 'mystery stock' I've blocked out of the list above as I'm still accumulating and it's a very illiquid stock. A full year review of my investment performance to come soon!