You are on page 1of 42

Investment Outlook

&
Portfolio Strategy
Conference Call Information

Conference Dial-In Number: (218) 339-3600

Participant Access Code: 722682#

Conference Playback Number: (218) 339-3699

Access Code: 722682#

Tuesday, April 19th, 2011

The call will begin promptly at 11:00AM EDT


Agenda

 A Word About Career Risk

 Today’s Investment Landscape

 Affinity Fund Current Positioning

Agenda | 3
Blowing
Bubbles
Never Ever Be Wrong On Your Own

CAREER RISK MAKES THE INVESTMENT WORLD GO AROUND

Concept: Courtesy of GMO

Blowing Bubbles | 5
You Can Be Wrong in Company

PRESIDENTIAL CYCLE EFFECTS ON SPECULATIVE STOCKS 1964 - 2007

Speculative rally is
consistent with
year three of the
presidential cycle.

Source: GMO Quarterly Letter – Night of Living Fed – October 2010

Blowing Bubbles | 6
But Ultimately, Investors Must Face Reality

STOCKS ARE EXPENSIVE RELATIVE TO REPLACEMENT COST

The Q Ratio is a long term measure of stock market value relative


to the replacement cost of all its underlying companies.
Overvalued extremes are indicated in red on this chart. Today,
stocks are trading roughly 70% above the historical average.

Secular bear
markets historically
bottom below
replacement cost.

Blowing Bubbles | 7
The Tricky Part is Getting the Timing Right

Yet it rallied from


1100 to over 1500
during the next
eighteen months.

In June 1998, the S&P


was priced to deliver
negative returns for
the next decade.

Blowing Bubbles | 8
Timing Uncertainty Creates “Career Risk”

Yet the market


rallied from 1250
back to 1500 over
the next year.

Again, in June 2006, the


S&P was priced to
deliver negative returns
for the next decade.

Blowing Bubbles | 9
But Value Ultimately Pulls Stocks Back to Earth

After “The Greatest


Sucker’s Rally in
History” from 2002-
Shortly beyond the 1998-
2007, stocks fell to
1999 rally, stocks
trend losing over
subsequently lost nearly
half their value.
half their value.

Blowing Bubbles | 10
“Stocks for the Long Run” is a Flawed Investment Plan

“Everyone has a plan 'til they get punched in the mouth.”

- Mike Tyson

Blowing Bubbles | 11
Today’s Market
Landscape
Broadly Speaking, Stocks Are Expensive

S&P PRICED AT 24X NORMALIZED EARNINGS MARKET HAS RARELY BEEN THIS EXPENSIVE

Current Market Landscape | 13


Equities Are Priced To Deliver Lackluster Returns

THE RECENT RALLY HAS LEFT LITTLE PROSPECT FOR ADDITIONAL GAINS

Current estimates based on normalized


earnings are for about 3.3% annual growth,
including dividends.

You
are
here

Source: Hussman Funds

Current Market Landscape | 14


Under A Variety of Proven Valuation Methods

SHILLER PE QUINTILES

You are here

Source: Ned Davis Research

Current Market Landscape | 15


While the Economic Outlook is Uncertain at Best

FINANCIAL CRISES TYPICALLY PRODUCE AN ACUTE DISRUPTION OF ECONOMIC ACTIVITY

Source: NBER Working Paper 16334, After the Fall

Current Market Landscape | 16


Crisis Creates Opportunity

“The best investors in the world do not target returns. They focus on risk.”

-Seth Klarman

Current Market Landscape | 17


Current
Portfolio
Positioning
If you “must” own stocks . . . demand a Margin of Safety!

BROYHILL AFFINITY FUND CORE LONG PORTFOLIO INVESTMENT THEMES

* Asset Allocation is illustrative of the delta-adjusted exposure of our core long portfolio as of March 31, 2011 (excluding macro hedges).

Ten Themes| 19
Mr. Market’s Free Lunch - High Quality, Japanese Equities

THE RANGE OF VALUATION ACROSS MARKETS IS EXTRAORDINARILY WIDE


GMO 7-Year Asset Class Return Forecasts
As of March 31, 2011
12.0%

Conservative estimates put expected returns 10.0%


10.0% for Japanese equities at 5% over the next
seven years. If profit margins rise to
8.0% international levels, expected returns would
climb to double digits.
6.0%

Long blue chips, short junk is a 4.6% 4.3%


4.0% “layup” over the next ten years,
but anyone’s guess over the next
2.0% ten weeks or months.

0.0%
-0.1%
-2.0%

-2.8%
-4.0%
US Large Cap Equity US Small Cap Equity US High Quality Emerging Equity Japanese Equity
Source: GMO

Ten Themes | 20
Attractive pipeline of Special Situations – Visteon Corp

UPSIDE POTENTIAL W/ LOW CORRELATION BROYHILL INVESTMENT THESIS:


Visteon Corp (VC)

77.50
• Visteon management has addressed
75.00
loss‐making operations and reduced debt
by over $2 billion through bankruptcy.
72.50

70.00
• Net cash position with no near term
67.50 maturities and tremendous exposure to
65.00 secular growth in Asian auto sales.
62.50

60.00
• Consistently beat estimates during
Began purchasing shares at prices
bankruptcy and management has been
57.50
which valued the core business at granted 3% of restricted stock - plenty of
55.00
roughly 1x EV/EBITDA. incentive to get it right this time.
52.50
Continued accumulating shares as
price fell to levels where the market
50.00 was assigning a negative value to the • We believe VC can ultimately generate
company’s core business.
47.50 low double‐digit EBITDA margins,
45.00 relative to the 8.8% level today.

Ten Themes | 21
Education is cheap in America today – Apollo Group

REGULATORY RISK . . . LITTLE MARKET RISK OUR INVESTMENT THESIS


Apollo Group (APOL)
100.00 • We believe the uncertainty caused by
increased regulatory scrutiny has created
90.00
an attractive opportunity for patient
80.00 investors.
70.00
• New regulation is likely to impact the
60.00 industry in the form of slower enrollment
growth, lower pricing and the elimination
50.00
of some programs.
40.00
After shorting the stocks in the
education industry for the better part • However, this uncertainty has driven the
of the past few years, we believe the
30.00
sector offers compelling opportunities entire sector materially lower – average
for those willing to work through the EV/EBITDA ratios are below 5x.
20.00
“noise.” At current valuations, even
50% declines in cash flow would still
10.00 make these businesses attractive. • We favor companies with established
-
brands, strong balance sheets, and ample
free cash flow to buy back stock.
Ten Themes | 22
Macro Hedges to profit from Mean Reversion

Deleveraging is a delayed and lengthy process often lasting a full decade or longer.

Ten Themes | 23
Private Sector Balance Sheets Are Improving, But . . .

Ten Themes | 24
Deleveraging remains a headwind for the consumer

We aim to maximize positions when both secular


and cyclical forces are working in our favor. Today, a
number of indicators are pointing to increasing
difficulties for consumers ahead. Given the long
term structural headwinds driven by consumer
deleveraging, consumer cyclicals represent our
largest equity hedge today.

Source: Wolfe Trahan

Ten Themes | 25
While Debt is Simply Transferred to the Public Sector

CUMULATIVE INCREASE IN PUBLIC DEBT FOLLOWING A BANKING CRISIS

In the aftermath of banking


crises over the past century,
public debt has risen on
average over 86 percent.

Source: Reinhart & Rogoff, The Aftermath of Financial Crises

Ten Themes | 26
Invariably Leading to a Wave of Defaults

PERCENT OF COUNTRIES IN DEFAULT OR RESTRUCTURING: 1800-2006

The current period


can be seen as a
typical lull that
follows large global
financial crises.

Source: This Time is Different: A Panoramic View of Eight Centuries of Financial Crisis

Ten Themes | 27
Hope is Not an Investment Process

Ten Themes | 28
The Situation in Europe Continues to Deteriorate

DEBT RESTRUCTURING IS INEVITABLE BROYHILL AFFINITY FUND POSITIONING

• European Sovereign CDS:

• Annual Carry: 0.8%


• Notional Exposure: 78.0%

• European Financials CDS:

• Annual Carry: 0.5%


• Notional Exposure: 34.5%

• European Equity Shorts: 6.8%

• EUR Short: 1.8%

Ten Themes | 29
Japanese End Game - The Elephant in the Room

Ten Themes | 30
There’s No Easy Way Out

Ten Themes | 31
When All Else Fails – “Put Some Lipstick on This Pig”

AD FOR GOVERNMENT BONDS IN TAXI CABS!! BROYHILL AFFINITY POSITIONING

• Japanese CDS:

• Annual Carry 0.1%


• Notional Exposure: 19.7%

• JPY Put Options:

• Capital at Risk: 1.1%


• Notional Exposure: 115.4%

• JGB Caps:

• Capital at Risk: 0.4%


• Notional Exposure: 166.5%

Ten Themes | 32
Heads I Win, Tails You Lose

The range of outcomes in a deleveraging process can be extraordinarily wide.

Ten Themes | 33
Optimal Portfolio Must Protect Against Either Scenario

THE CHOKING POINT FOR HIGHER RATES IS MUCH LOWER TODAY

We continue to hold call options on long


term US Treasuries as a hedge against
deflation.

Capital at Risk: 0.4%


Notional Exposure: 193%

$/OUNCE AT WHICH US MONETARY BASE WOULD BE FULLY BACKED BY GOLD

At the same time, we maintain our long-held core


position in precious metals to hedge against the
destruction of fiat currency.

Silver: 5.1%
Gold: 1.8%

Ten Themes | 34
China – The 800 Pound Gorilla

Ten Themes | 35
A Chinese Credit Unwind Would Crush Risk Assets
Leaving “Chinese Suburbs” Highly Exposed

Source: Steve Keen’s Debtwatch


Aussie Face Palm

BROYHILL AFFINITY FUND POSITIONING


• Australian CDS:

• Annual Carry: 0.3%


• Notional Exposure: 30.9%

• Industrial Resource CDS:

• Annual Carry: 0.2%


• Notional Exposure: 9.5%

• AUD Swaptions:

• Capital at Risk: 0.7%


• Notional Exposure: 254.4%

Ten Themes | 38
Forced Selling . . . Opportunity for Patient Investors

Ten Themes | 39
Broyhill Bottom Line

POSITIONED TO ACHIEVE ACCEPTABLE RESULTS UNDER A WIDE RANGE OF ENVIRONMENTS

Great Businesses at Reasonable Prices


Historic opportunity in Quality franchises – Key positions in MSFT, JNJ, PFE, DELL, CVS, etc.

Good Pipeline of Special Situations


Spin-offs, Restructurings, M&A, Thrifts, etc.

Housing Bubble - Act Two


Risk reward is very attractive on our housing related investments – LL, O, AUD

No “shortage” of Attractive Shorts


Low quality cyclical companies are overleveraged and overvalued.

Cheap Insurance
Positions designed to protect capital from impairment without pressuring portfolio returns

Ten Themes | 40
Contact Information

Broyhill Asset Management


800 Golfview Park
Post Office Box 500
Lenoir, NC 28645
Phone: 828 758 6100
Fax: 828 758 8919

For more information please contact:

Mr. Christopher R. Pavese, CFA


chris@broyhillasset.com

Appendix| 41
Disclosures

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

This material has been prepared solely for the purposes of illustration and discussion. “Broyhill Asset Management” is the marketing name for the investment
management business conducted by Broyhill Asset Management, LLC. and its affiliates. Broyhill Asset Management, LLC is an SEC Registered Investment
Advisor. Private investment vehicles are offered through Broyhill Wakin General Partners LLC, Surety Capital Management LLC, and Broyhill Strategic
Partners LLC, and are only offered by delivery of confidential offering memorandum and subscription materials to eligible investors who meet certain statutory
and/or regulatory criteria. Each General Partner is a separate legal entity and is affiliated with Broyhill Asset Management, LLC through common ownership
and control.

Under no circumstances should the information contained herein be used or considered as an offer to sell, or solicitation of an offer to buy any security. Any
security offering is subject to certain investor eligibility criteria as detailed in the applicable offering documents. The information contained herein is
confidential and may not be reproduced or circulated in whole or in part. The information is in summary form for convenience of presentation, it is not
complete and should not be relied upon as such.

Any information, data, statement, opinions, or projections made herein may contain certain forward looking statements, projections, and information that are
based on the beliefs of Broyhill Asset Management as well as assumptions made by, and information currently available to, Broyhill Asset Management. Such
statements reflect the view of Broyhill Asset Management with respect to future events and are subject to certain risks, uncertainties and assumptions
(including, but not limited to, changes in general economic and business conditions, interest rate and securities market fluctuations, competition from within
and without the investment industry, new products and services in the investment industry, changes in customer profiles, and changes in laws and regulations
applicable to Broyhill Asset Management). Should one or more of these other risks or uncertainties materialize, or should underlying assumptions prove
incorrect, actual results may vary materially from those described herein.

All information, including performance information, has been prepared in good faith; there are no representations or warranty expressed or implied, as to the
accuracy or completeness, of the information, and nothing herein shall be relied upon as a promise or representation as to the past or future performance. This
material may include information that is based, in part or in full, on hypothetical assumptions, models, and/or other analysis (which may not necessarily be
described herein). No representations or warranty are made as to the reasonableness of any such assumptions, models, or analysis. The information set forth
herein was gathered from various sources which are believed, but not guaranteed, to be reliable. Unless stated otherwise, any opinions expressed herein are
current as of the date hereof and are subject to change at any time. Accordingly, neither Broyhill Asset Management nor its principals or affiliates make any
representations as to the timeliness of any information in this presentation.

Appendix| 42

You might also like