In 2017, WertArt returned 4.3% underperforming the market with the benchmark increasing by 16.1%.
What are some of the reasons for this significant underperformance? I think there are four which had the largest impact on last year’s result:
1.) My portfolio is heavily weighted towards contrarian bets. Market valuations of portfolio companies like DFS Furniture, Houston Wire & Cable and Sarine Technologies reflect strong skepticism about future earnings streams due to uncertainty with regard to customer demand. While it may take some time until demand for their products will recover, they are fostering their competitive position and should profit even stronger in the next upswing in their respective industries. Investments like Pershing Square Holdings, Dundee Corp., and Francotyp-Postalia are disliked by market participants. They failed to meet expectations in the past and it will take time until market participants return with confidence to these names.
2) An underweight in large technology names. Changing industry dynamics have always been an important factor in the investment process, but disruptive trends are now the major concern for most investors. Almost all the long term businesses that have existed for such a long time are standing at the edge of a cliff today it seems. I believe that I own companies that can adapt to these dynamics by investing in new technology and transforming the business. However, I missed to take part in the disruptive process itself meaning that I had no exposure to US and Chinese large tech companies.
3) An underweight in eurozone small caps. European small cap equities increased 18.6% in 2017 (based on EMIX Smaller European Companies ex UK Total Return Index). At year-end, only a quarter of the portfolio was invested in the euro zone and a large part of this portion was allocated to special situations including Italian REIFs, Renk and Kanam Grundinvest. So instead of increasing my exposure to Italian, Spanish and French equities during the year to participate in this bull market, I added new small cap investments from the US, UK and Singapore. So far this was clearly the wrong decision. In addition, currency exposure to the US, UK and Canada had also a negative effect on performance as the euro strengthened against these currencies throughout the year (costing 300 bps of portfolio performance). The current portfolio allocation in terms of currencies looks as follows:
4) One investment that stands out is System1 Group (Brainjuicer). The share price almost doubled within a couple of months at the beginning of 2017. After that, the company began to release one trading update after the other indicating that the operating performance has deteriorated. When the share price peaked, the company was trading at an elevated multiple of future earnings potential. However, I liked the way management was incentivized for a continuation of the growth path over the next couple of years. At the same time, I ignored upcoming cutbacks of System1’s largest clients’ marketing budgets as consumer staples companies reassessed their marketing approach as big retailers (like Walmart and Amazon) put pressure on suppliers to cut prices. Throughout the remainder of the year the share price declined by 60%. The retreat in System1‘s equity value decreased 2017 portfolio performance by 400 bps.
You can see the attribution of each investment to portfolio performance in 2017 in the following table:
In 2017, A&O Johansen was again the largest contributor to performance. Management has proceeded very well in digitizing the sales channel. Recent construction activity in Denmark has picked up substantially and I expect the company to present good annual results at the end of February. Trading below ten times earnings the stock is still cheap. At the bottom of the attribution table, Dundee Corp had a horrific year from a share performance perspective, but management has progressed in streamlining the portfolio and positive news should finally be reported in 2018.
An overview of the portfolio’s largest ten positions can be found in the following table:
Over the last twelve months, the portfolio has become more concentrated with the largest ten investments representing 55.4% at the end of 2017 compared to 50.2% at the end of 2016.
In addition to Bellevue Group, I exited two small portfolio positions during the fourth quarter.
The first United Medical Services (UMS) is a liquidating special situation where I first invested in September 2014. The liquidation process went well and I was able to realize a 6.0% total return and an 8.4% IRR over a three year holding period with this relative low risk opportunity. Total contribution to portfolio performance was relatively small at 0.4%.
The second investment I exited was a restructuring case of the oldest German listed company. There were basically two reasons why the restructuring failed and therefore my investment went to zero. First, I was distracted by the company’s large asset base which seemed to be worth multiple times of the current market value. At the same time, I paid no attention to inadequate cash reserves and hidden liabilities. In addition to that, I misinterpreted the interests of the second largest shareholder (the local community) and misjudged the influence of the largest shareholder (a poorly organized coalition of pensioners) and the CEO. In the end, a capital increase to solve the liquidity constraint was prevented by the local community and the inability of the CEO to file a prospectus. Consequently, the company went bankrupt. This lesson is a very painful one. In this type of turnaround situation, I learned to focus on a company’s ability to pay the bills instead of spending to much time in valuing a company’s assets. Even more importantly, I learned to keep close attention to the interested parties. This sounds obvious but sometimes it takes a lot of effort to figure out what the different stakeholders plans are. I exited Aktiengesellschaft Bad Neuenahr at a 100% loss over a 2 and a half year holding period. Total detraction to portfolio performance was 0.8%.
To wrap things up, I am providing the quarterly portfolio cash streams in the table below:
The content contained on this site represents only the opinions of its author(s). I may hold a position in securities mentioned on this site. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. As always please do your own research!