Now based in London, Gudefin runs the fund together with New York-based assistant portfolio manager David Segal. The team draws on the research of 15 of the firm's analysts, who include two specialists in merger arbitrage and four in distressed debt; the other analysts cover business sectors either on a global or regional basis, depending on industry.
Returns for the one year period were 15.3% as of Dec. 31, 2005 (compared with global equity peers' 10.8% average), and 21.6%, annualized, for three years (versus the peers' 19.1% average).
The fund's top country allocations as of Sept. 30, 2005 comprised U.S., 26.6%; U.K., 11.7%; France, 7.6%; South Korea, 5.5%; and Canada, 4.8%.
As of Nov. 30, 2005, the fund's top sectors were consumer staples (32.0%); financials (25.9%); materials (13.4%); consumer discretionary (9.9%); and industrials (5.8%). The fund's five largest individual holdings comprised British American Tobacco ADS (BTI), 2.84%; Weyerhaeuser Co. (WY), 2.55%; Orkla ASA, 2.28%; Berkshire Hathaway`A` (BRK.A), 2.24%; and KT&G Corp. 2.19%.
Although the fund delves into areas traditionally seen as speculative -- distressed debt and merger arbitrage -- it does so with calculation. Volatility as measured by standard deviation is a comparatively low 8.80, versus the global equity peer average of 11.19. The fund's expense ratio of 1.42% is in line with the peers' 1.48% average.
The Full Interview:
S&P: How would you describe your investment philosophy?
GUDEFIN: We consider ourselves a deep value fund -- we're trying to buy a dollar of assets for 60 cents. This limits our downside -- and we're all about capital preservation. We have a three-pronged approach, focusing on undervalued equities, distressed debt, and merger arbitrage. It allows us to capitalize on the life cycle of a company. When the equity markets come down and companies go bankrupt, we can buy distressed debt.
Meanwhile, merger-and-arbitrage investments are uncorrelated to the overall market. When a deal is announced, we buy the target when it is trading at a discount, if our analysts feel that the risk/reward ratio is good enough.
The fund doesn't have any geographic limitation, so we can go wherever we find value. Sector-wise, market cap-wise, and in terms of geographic breakdown -- it's all driven by the ideas we find.
Right now, we have more than 82% of our assets invested in undervalued equities, 7% in reorg or distressed bonds, and about 1% in arbitrage.
It's a cyclical business. In 2002, about 20% of the fund was in distressed bonds and merger-and-arbitrage. But a lot of money has gone into these opportunities for the last 12 months. The risk/reward ratios are not as interesting, so we don't have as many investments there.
There's about 10% cash in the fund. At the end of the year, I got some inflow. On average our cash stake would be a little over 5%.
S&P: What are your buy and sell criteria for stocks?
GUDEFIN: The most important criteria is free cash flow yield, because it includes the company's margins, financial structure, capital intensity, and tax structure. If I can get good businesses with high barriers to entry that generate high single-digit or double-digit free cash flow yield, I will buy them. Then when the yield becomes mid-single digit, I would sell. I have to be general here -- it's more difficult than that in practice.
We don't have any restriction in terms of market cap. If a company is very cheap, I would have some with $1 billion market cap, but not that many. I would prefer to have larger companies. For example, in Korea, I can find companies trading at a P/E of just one or two. But if it has less than $1 billion in market cap, a $50 million position would represent 5% of the company. From a risk perspective, it's easy to buy 5% of the company, but it's much more difficult to sell.
I am extremely careful not to make investment decisions based on macro data. I don't want to bet on, say, U.S. interest rates or growth in China. I want companies with an internal catalyst that will realize value almost independently of what the economy does.
S&P: Are there any areas or sectors that you avoid?
GUDEFIN: In general, I avoid companies that don't have any barriers to entry, and, therefore, no capital discipline. For instance, we avoid airlines, and even autos. Airlines keep adding new planes, and then they have to sell the old planes. The auto sector also keeps adding new capacity, and has to sell at marginal cost, with little profit. In theory, you would think the brand name is important, but look at the Korean and even the Chinese manufacturers. We didn't know their names a few years ago, and they're now taking a lot of market share.
I much prefer companies with unique products that are difficult to duplicate, where management can increase the selling price in a recurring way. But then we have to buy at a decent price, of course, because we're value investors.
S&P: What are some other ways that you manage risk?
GUDEFIN: By having a diversified portfolio. I think our 10 largest positions on average represent 25% of the fund's assets. And the best risk management you have is when you buy a dollar of assets for 60 cents, it's a huge discount that limits your downside.
S&P: Could you single out one or two top holdings and discuss how they reflect your investment style?
GUDEFIN: We bought International Steel Group Inc. in 2002 for the equivalent of $4.80 per share. With the improvement in cost structure of the company and the price of steel going up, the company was IPO'd. In February 2005 it was acquired by Dutch-based Mittal Steel (MT) for over $35 per share. We multiplied our investors' capital sevenfold on the deal.
Another is Orkla ASA, a Norwegian conglomerate. It traded at a huge discount to its net asset value when we bought the stock five years ago. The company decided to sell some assets, refocus its portfolio, and put in place a turnaround program for some of their consumer goods businesses. I think our average purchase price was less than 130 krone, and now the stock is bidding at 270 krone.
With Orkla, we saw the potential for things to happen, and we were lucky that management did them. But we don't hesitate to be our own catalyst. The analyst on our team who's in charge of the position can push management to do things to realize value for shareholders.
S&P: Any recent additions to the portfolio?
GUDEFIN: In February 2005, we added French winemaker Pernod Ricard at an average cost of about 133 euros. It's now trading at 150 euros and is among our top positions, at 1.6% of the portfolio.
This is just the beginning, because we take a three-to-five-year view of stocks. In 2005, the company acquired Allied Domecq plc, the No. 2 spirits company in the world. Because the management team has already executed the acquisition of many assets from Seagram, their track record make us confident they can do it again.
S&P: Do you have an outlook for various global markets?
GUDEFIN: I can talk about the outlook for our three investment strategies. With undervalued equities, I expect to find more opportunities in the U.S. in 2006. In the large-cap arena, I still expect to find many opportunities outside the U.S., both in Europe and Asia.
In terms of distressed debt, we see the potential for things to happen with auto suppliers. With the amount of junk bonds issued in the last two years, we're quite optimistic that there will be deals to be done.
With respect to merger arbitrage, we believe that many sectors need to see further consolidation. But because of the amount of capital invested in this strategy, we think the returns will be pretty bad, and don't expect to increase our allocation over the coming months.
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