Tweedy Browne held its first ever webinar on February 3, 2010, hosted by its four managing partners: John Spears, William Browne, Robert Wyckoff and Thomas Shrager.
The webinar included a review of Tweedy’s investing philosophy, with an emphasis on the role of dividends in its stock selection process. Investment opportunities outside the US were also discussed, and the partners explained their rationale behind a number of individual holdings. Macro issues were addressed sparingly.
On a somber note, Wyckoff began the presentation by noting the passing of Chris Browne, a long-time partner of Tweedy Browne. He died suddenly in mid-December, following a 40-year career at the firm. In 2009, he stepped back from his day-to-day role at the firm, and his death was a sudden and tragic loss.
The value investing discipline
Tweedy Browne distinguishes itself from its value-investment peers by focusing on downside risk, with the belief, based on the teachings of Graham and Dodd, that “the upside will take care of itself.” Tweedy purchases stocks at prices that typically represent discounts of 30-40% from intrinsic value. They look for financially strong companies that can weather economic downturns and emerge stronger from periods of crisis like the one markets recently experienced.
Wyckoff noted that “value investing is often about one’s ability to behave rationally when confronted with great stress and uncertainty.”
Three of the firm’s four funds beat their benchmarks for 2009. Its flagship fund, the Global Value Fund, has beaten its benchmark in nine of the last 10 years and has outperformed its benchmark over its 16 year history by 480 basis points per year.
Wyckoff warned that “returns will continue to be lumpy over time,” as is the nature of value investing. He expects the firm’s funds to outperform their benchmarks 60-70% of the time.
Turnover in the Global Value Fund went from 13% in 2007 to 30% in 2008, but that is still about a third of the industry average.
Wyckoff discussed the positioning of the funds over the last year. He noted that the funds have been investing in many “quality” names – not the traditional “cigar butts” common to the value-investing discipline. He cited Nestle, Unilever, Novartis, and Johnson and Johnson as quality names they now own – underleveraged and globally diversified firms.
As is typical among value investors, Tweedy Browne does not make macro forecasts. It does not have a view on the inflation-versus-deflation question; instead it seeks out companies with pricing power and defensible competitive “moats.” Wyckoff noted that equities were an “effective hedge” in the last serious period of inflation, in the late 1970s and early 1980s.
Wyckoff said that value investing requires an acceptance of random short-term fluctuations, which have been amplified over the last 10 years through short-term trading by banks and other intermediaries, often with the use of leverage. “This happened all across our financial system,” he said. Buying stocks with cheap valuations and diversifying, though, have proven to offer long-term success, he said.
When asked about whether Tweedy would offer a hedge fund, Spears said that the fees typically charged by hedge funds are daunting and almost require the use of leverage to get decent returns. “This is not a comforting way to hit the pillow,” he said. He believes most hedge funds make their money on the long side. The tax ramifications of shorting are not good – a NY resident could pay close to 50% on gains from short positions. The skill set for shorting, including market-timing and tolerance for unlimited downside exposure, falls outside of Tweedy’s circle of expertise. And Tweedy is not inclined to use public relations to attack companies in the way that many short sellers do.
The role of dividends
In general across global markets, Wyckoff said, “quality is where the value is today.” The “bounce off the bottom” was led by lower-quality stocks – those that suffered the worst declines during downturn. Higher-quality businesses, particularly dividend-payers, underperformed lower-quality names.
For 2009, in the S&P 500, the 370 dividend-payers were up 27.7% versus 82.4% for stocks not paying a dividend. In the MSCI world index, dividend-payers returned 32.3%, versus 75% for non-dividend-payers.
The higher the dividend yield, the lower the return in 2009, although this pattern started to reverse in late 2009, according to Wyckoff.
The Tweedy Browne fund holdings now have a dividend yield of approximately 3-4%.
Dividend-paying stocks have a number of critical attributes, Wyckoff said: dividends have been significant contributors to total return over the long term; they are often more defensive, with the yield providing a floor on returns; dividend reinvestment during market declines can lessen time to recoup losses; and the ability to pay a dividend is often a good indicator of corporate health. Dividends remain tax-advantaged, he said. The first round of Obama’s budget proposals had dividends being taxed like capital gains, but bumped up to a 20% rate.
Wyckoff said it is not clear why dividend-paying stocks return more, but it could be because they are often in the low P/E category.
Tweedy Browne avoided financial stocks (which are typically high-dividend payers) during the financial crisis because its “fundamental test is not the dividend. It is the value of the business,” Will Browne said. “What leads us in and leads us out is the valuation prism through which we look at everything.” Tweedy got out of the banks prior to the financial crisis because they were “too hard to understand.” The banks’ balance sheets suggested that their excess leverage made them too risky.
Opportunities outside the US
Wyckoff noted a growing consensus about the prospects for superior economic growth in the emerging markets and increased flows to emerging market funds. Tweedy Browne’s funds, however, focus on the developed markets. Nonetheless, Wyckoff said, the firm’s funds have significant indirect exposure to emerging markets through companies like Nestle, Philip Morris and Heineken, an approach he called “safer and cheaper.”
Emerging market funds, Wyckoff said, have significant exposure to Brazil, Russia, India and China (the “BRIC” countries), but typically as few as five companies make up 40-60% of the market capitalization in BRIC indices. Those companies are typically in one of several industries: banking, oil, telecommunications, cement, or some other resource-driven industry. Investing in BRIC indices is a “fairly concentrated bet,” Wyckoff said, versus the “safer and cheaper” path of indirect investing.
Tweedy now offers both hedged and unhedged versions of its non-US funds, but he said that over the long term historical data shows that there is very little performance difference between these two approaches.
When asked about Japan, Shrager said Tweedy’s primary concern has been the lack of a shareholder-oriented culture in that country. Browne added that Tweedy holds four Japanese stocks with low P/E ratios and low debt that are priced at discounts of up to two-thirds of net current assets. Consistent with their overall discipline, they look for companies that pay dividends or buy back shares as a signal of shareholder-oriented practices.
Shrager said Tweedy avoids direct Chinese investments because of the Chinese regulatory environment. For many big companies, only a minority of shares are traded publicly. They have some indirect exposure through firms like Nestle, which has extensive Chinese manufacturing facilities.
Shrager said Tweedy’s energy exposure, in companies like Total and Conoco Phillips, is based on the belief that those companies are trading for less than the value of proven oil reserves. Demand for energy will continue to grow while supply will grow more modestly, he said, because in the 1980s and 1990s oil companies reduced exploration expenditures, and because oil reserves are increasingly located in “unfriendly” countries.
The long-term outlook
Based on Jeremy Siegel’s data, Wyckoff said there were four 10-year slices of flat to negative returns for the S&P 500. In nearly every instance, this was followed by double-digit compound returns for the ensuing 10-year periods.
“In general, we are long-term optimists, but near term we are rather cautious,” he said. He did not make a short-term forecast of market direction.
(c) Tweedy Browne