March 31, 2014
Redwood Fund Commentary
August 2016 Commentary – Emerging Markets Fund
Risk means more things can happen than will happen
We have been pleasantly surprised by how strong markets have been since we came to the conclusion that they should be, though we have been modestly disappointed that we have not captured a little more of that upside. Meanwhile, taking a step back I think part of that disappointment is justified and part of it is misplaced. Regarding the reasons disappointment is misplaced, the first is simply that the time horizon is too short to know all that much for certain (though we always say this). The second is that we have had a consistent stylistic bias over the last 6 years to build more defensive, slower moving portfolios so a certain amount of lag at what we think may turn out to have been a decisive turning point in February of this year really ought to be expected. Whilst it is aspirational to want to perform at all times in all market conditions, it is unrealistic to always succeed. Thirdly, and perhaps most importantly from my point of view, since the beginning of this year the decisions we have taken (such as investing in oil stocks, HSBC and reducing cash) have enhanced the performance of the fund compared with what we would have achieved without the changes. Tentatively analysis suggests the improvement might be around 1%.
However, the reason that the disappointment is at least partially justified includes something, examples of which I have mentioned previously: namely that probably a number of decisions in 2015 were either wrong, or at least have proved to have negatively impacted performance. In particular I have mentioned the decision to reduce exposure to Taiwan Semiconductor (TSMC). This is a difficult decision to assess in my view, in light of the fact that some of our fundamental thesis (i.e. that TSMC might lose out on foundry orders to Samsung) proved correct (when Qualcomm shifted production of its snapdragon processor). Yet the deterioration to TSMC’s bottom line has proved slight, and market sentiment on the stock has been buoyed by ETF flows. I have built back a small position in the stock.
Conventional attribution of performance by country also highlights, as we have touched on previously, that our over exposure to Turkey and our under exposure to Brazil have both been key factors in relative performance. What the conventional analysis does not capture, which actually made the problem worse in the case of Brazil, is that we reduced our exposure to Brazil in the middle of 2015. Again my own assessment of this, whilst critical, is mixed. For example the sale of Smiles (airline frequent flyer brand) seemed sensible at the time given the parent company’s continuing financial difficulties (net debt to EBITDA is no longer at 30x, but is still at 10x). Meanwhile a significant portion of the missed contribution from both this and Cielo (which was also sold in 2015) comes simply from the currency effect. The stocks themselves are little changed from Real prices 12 months ago.
More pleasant in the analysis of 2015 decisions has been the few areas where we stuck to our thesis and doubled down on positions which we still think were fundamentally strong though the market had gotten cold feet. This explains the reason Hynix semiconductor (DRAM and NAND memory manufacturer) is such a large positive contributor to performance this year. Whilst we knew 2014-2015 was a down cycle for the memory subsector, we remained convinced of the view that the downturn would be the least severe since I was about 10 years old. Indeed, industry veterans (who are often not working in the industry now) are now amazed that we are talking about the possibility that DRAM memory manufacturing will remain free cash flow positive at the bottom of the cycle; and yet the stocks are inexpensive.
Finally the positive bias we have towards emerging markets remains and at least investors can benefit from that if not from a few of our active judgements; but we look forward to some of the concentrated opportunity cost risk we have taken in recent months swinging more in our favour.