The CQR is consistent, rational and quantitative. Based on 70 pieces of financial data taken from a company’s accounts, the CQR separates companies on the quality of their financial fundamentals at a point in time and over time.

Each company has a unique CQR which is calculated twice a year from their audited accounts. The current as well as past CQR appears as a percentage under the ‘Ratios’ page of the MyClime dashboard, while the current CQR is displayed as a 0 – 10 star rating on each valuation screen.

We encourage investors to shop for companies as they would hotels, the more stars the better!

Read the full report on the Clime Quality Rating

Download the full report on the Clime Quality Rating

The core of the article was the assertion that both the investment strategy AND the number of consultants employed were not in the best interests of the holders of the Fund.

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“The fund just keeps buying everything, spreads its investments too widely and hopes,” John Abernethy, the executive director of Clime Investment Management, said yesterday.

“Once you start doing that you are going to get mediocre returns.

“Why don’t they just try to invest and select stocks without buying the index?

“It is just another big pension fund being mismanagement by asset consultants.”

Mr Abernethy’s comments come after the $73 billion Future Fund released details of its portfolio as at the end of last year.

Its latest portfolio update shows the fund has substantially increased its holding of cash, from 8.8 per cent at the end of June to 13.8 per cent at the end of December.

It has cut back its stake in property from 6.5 per cent in June to 6 per cent at the end of December and its holding of debt securities from almost 20 per cent of the portfolio in June to 17.8 per cent.

The total value of the fund has fallen from just over $75bn at the end of June last year to just over $73bn at the end of last year, with its exposure to Australian equities down from 11.2 per cent to 10.8 per cent at the end of last year.

Its total return fell from 12.4 per cent over the year to June to only 1.6 per cent for the calendar year 2011, following a negative performance of 3.1 per cent in the last six months of 2011.

Mr Abernethy said the fund should employ its own in-house investment staff who bought shares directly rather than relying so heavily on such a wide range of different fund managers.

The fund’s latest statement shows it now has 14 different advisers for equities, 20 different advisers on private equity, 10 advisers for its property investments, seven advisers on infrastructure investments, 13 advisers for debt investments, 19 advisers for alternative investments, two advisers for its cash investments and five advisers for its “overlay strategy”.

“If it was a proper future fund for Australia it would not be making index-type decisions, it would be making investments in resources and infrastructure for the benefit of Australia,” Mr Abernethy said.

Mr Abernethy said the latest figures also highlighted the fact that the fund should not have dramatically cut its stake in Telstra.

“Selling Telstra was a pretty awful decision. They hammered the Telstra share price down. Now they have finished selling, the price is moving up.”

The fund had 2.1 billion shares in Telstra in February 2007. It held almost $1bn in Telstra shares as of June last year, a holding of about 320 million shares.

On August 15, it announced it had reduced its holding to what it calls a “market weight” of only 100 million shares.

Telstra shares were down to $2.60 in March last year, but have recovered in recent months to close yesterday at $3.33.

UBS head of investment strategy George Boubouras said yesterday that the move to a higher weighting in cash was in line with what most other superannuation funds had been doing in the last half of last year.

“It is indicative of a retail and pension industry in itself, which ties into a more cautious consumer post the global financial crisis,” Mr Boubouras said.

UBS funds were currently at 12.5 per cent cash for moderate investors, but he said it might be time this year to start moving some of the cash into equities and corporate bonds.

(The Australian, Wednesday 1st February 2012)

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…the approach might be indicative of the industry at large, but is it right?!!!

To the surprise of many, world equity markets have begun 2012 with a bit of a flurry. It certainly would have surprised the billionaires, the politicians, the economists, the hedge fund managers and the strategists who attended the rather somber Davos World Economic Forum last week. Their 3 day talkfest was as cold as the air outside and it merely provided a stage for many to talk their own trading book or of their coming books! We have an idea to make Davos more relevant next year – do not invite anyone who attended this year so that we can get a real perspective on the world outlook.

Whilst the Australian market’s rise of 5.5% in January is good, it is overshadowed by the lift in the German DAX Index (over 9%). Despite all of the doom and gloom permeating from Europe, the rally in the German market shows the power of the market to adjust to new events. The most significant of which is the sharply depreciating Euro. A falling Euro against the $US will stimulate German exports and export income. Export profits will rise with their engagement with China and thus the equity market is engaged in anticipating and revaluing the German Index.

This is similar to what happened with the US equity market in 2011. Despite the doom and gloom over there, the US market lifted in response to a sharply depreciating $US. Depreciation is generally good for a balanced economy that has a strong manufacturing base. Indeed, the $US depreciation should lead to the repatriation of US manufacturing jobs back from Asia and if it doesn’t then President Obama now proposes tax incentives to induce it to occur.

>> click to read the full Australian Dollar (A$) Report

MLD’s balance sheet is strong, with cash on hand of $50m and debt of $37m. Normalised return on equity is forecast to be above 40% in 2012 and 2013. Operating cash flow has been strong in recent years and well exceeded reported profits in FY2011.

A few points from the report:

MLD is well placed to take advantage of the record level of resources capital expenditure, and we expect significant growth in profit and a high level of profitability. It has a strong order book with work in hand, tenure of contracts, and cross selling opportunities.
MLD predominantly services mid-tier mining projects across a range of commodities, and has a workforce of 600 employees and subcontractors. The business is comprised of three complementary operating divisions: contract mining (90% of 2011 revenue); crushing services (10% of revenue); and the recently formed Civil Works division, which provides professional expertise and machinery to build infrastructure for mining and civil infrastructure projects.

As a contract miner, MLD is exposed to risks including reliance on the mining industry, commodity price risks, ability to win new contracts, contractual risk, disruption or discontinuance of operations.

Currently MLD is trading at $1.84, which is a reasonable discount to our assessed value of $2.59 and value looks to be growing in the medium-term.

Read the full report on MACA Limited

MLD is a leading supplier of mining and civil services to clients in the mining and construction sector primarily in Western Australia. MLD provides mine to mill contract mining services for open pit mining including loading and hauling, drilling and blasting, crushing and screening and civil works.

Since its 2010 listing, MLD has emerged as a company of interest, exhibiting sound fundamentals in an industry enjoying significant growth.

Read the full report on MACA Limited

• Since listing, FGE has displayed a consistently high NROE, averaging 42.7%:
• Compound annual growth rates since listing are revenue (+54.7%), NPAT (+95.3%), Dividends (+43.1%) and Equity (+70.0%);
• The business is conservatively financed with strong cash holdings ($78.3m), minimal debt ($8.2m) and moderate goodwill ($15.6m, 12.6% of equity);
• FGE has a low payout ratio of 20-25% of earnings, evident through the low dividend yield of 1.9%. Strong cash holdings provide an extra buffer against the cyclical and lumpy nature of cash flows within the contracting industry;
• Forge recently acquired CTEC Pty Ltd, a WA based contractor providing engineering, procurement and construction (EPC), operations and maintenance to the energy and utilities sector;
• FGE has been trading around 3 times its equity base. This represents an attractive price if the business is able to sustainably earn and compound at rates above 40%. At present the market is giving little value to the growth potential of the business.

Alex’s conclusion: “Forge is a competently managed business that is well placed to gain from the current mining capex. The shares are currently available at an attractive price on the market. We are happy to buy a stake in the business when the market is in a bad mood and the shares are trading at a significant discount to our valuation.”

Read the full report on Forge Group Limited

PORTFOLIO POINT: Investors who have steered clear of placing their money in managed funds should consider buying shares in those same funds.

The funds management industry provides an essential service in today’s economy. As a group it engages in the management of unit trusts, investment funds and products for retail and institutional clients. Participants generate revenue by providing services on a fee and commission basis. The industry’s growth is driven largely by the government mandated superannuation scheme that directs 9% of the nation’s wages toward long term savings. This superannuation contribution level is set to rise to 12% by 2020.

The business performance within the industry is particularly sensitive to the market cycles and can be characterised by:

• High profitability
• Low reinvestment opportunities
• Low capital intensity
• High payout ratios
• Little or no debt
• Robust cash flows
• Relatively fixed cost bases

‘Price volatility can be extreme, magnifying market moves both up and down’.

The cyclical nature of markets is clearly visible in the fundamentals of the businesses and the share price movements over time. This volatility is a source of opportunity, not risk to the astute investor with a focus on value and a long term view.

Figure 1. Volatility in share price

Risk comes from holding or buying shares when they are expensive, even if they are financially sound. Risk is mitigated by buying sound operating businesses when they are available cheaper than a fair assessment of value. In our view, a number of businesses in this group are available today at attractive prices.

An analysis of fund management businesses

Fund managers are fairly simple to understand, they offer to manage capital from retail and institutional investors and charge a fee for investing it. This is a little more challenging in practice however easy to understand. If a fund manager is successful (generally by outperforming a benchmark or providing a certain absolute return), it is likely to attract more capital from investors which leads to increased revenue. The industry is essential, as not all members of the community have the time or inclination to protect and grow their wealth.

Figure 2. Industry FUM growth set to much faster than the economy
Source: Rainmaker, ABS

Candidates
Perpetual Limited (ASX:PPT) offers a range of managed investment funds, advice, trustee and superannuation services for retail and institutional investors. The group also provides a range of corporate trust services to fund managers and trustees. Today, around 60% of revenue is derived from funds management activities and the business has funds under management (FUM) of $28B. PPT is currently ranked #11 by FUM, with a 2.6% market share.

Platinum Asset Management Limited (ASX:PTM) is a boutique fund manager which focuses on global equities offering a range of funds covering specific regions and sectors as well as a listed investment company. The business has FUM of $15B. PTM is currently ranked #18 by FUM, with a 1.6% market share.

Hunter Hall International Limited (ASX:HHL) is a boutique fund manager specialising in international equities as well a listed investment company. The business currently has $1.5B of FUM.

BT Investment Management (ASX:BTT) is responsible for the management of the BT wholesale and retail funds, as well as managing mandates on behalf of Westpac who owns 60% of the business. The business has FUM of $42.9B. BTT recently announced its intention to purchase UK based fund manager J O Hambro Capital Management. The acquisition cost of $314M, added $10.7B of FUM to the group and is to be funded broadly by a capital raising at $2.15 per share. BTT is ranked #18 by FUM, with a 4.0% market share.

Treasury Group Limited (ASX:TRG) is an investor in funds management businesses in Australia. Its currently has interests in nine fund managers. The business has funds under management (FUM) of $15.5B. The combined group is ranked #20 by FUM, with around 1.0% market share.

The major banks also have large investments in fund managers with FUM market shares of, CBA ~10%, WBC via BTT ~4%, ANZ ~4.4% and NAB ~1.1.% of the roughly $1.7T of assets under management in Australia. The industry is reasonably fragmented with the top 30 fund managers by FUM (15 with overseas origins) investing around 85% of Australian savings. Industry FUM grew at 13.9% CAGR for the 10 years to 2010.

Like any industry the best businesses to own provide:

• a great product or service to customers;
• display an edge over aspiring competitors; and
• keep costs as low as possible leading to high profitability.

Figure 3. Who is the leanest? Staff Expenses to Revenue

Figure 4. Profitability of companies
“There are economies of scale in funds management business (returns to shareholders) but diseconomies of scale to clients (lower absolute returns).”
We can see from the candidates we have included in this report, PTM and HHL are the standouts from an expense and profitability point of view.

The business of managing client savings is scalable however as FUM grows, maintaining strong performance becomes more challenging especially if the manager is focused on a small market such as Australia.

Studying the businesses in this group shows that many of the managers have products that focus on global markets to alleviate part of this challenge.

The largest expense for all fund managers is their employee expenses. This leads to the typical view that their best assets go down in the lift each evening. The rating agencies and asset consultants know this and focus on the teams that allocate capital and the processes to assess depth and rigour the manager displays. The term ‘key man risk’ is often discussed by investors and ratings agencies alike. Key man risk is hardly a new concept to Perpetual which previously endured the loss of highly regarded investment managers such as Anton Tagliaferro and Peter Morgan who left to establish competitors. More recently, John Sevior has left and it is speculated he will set up a boutique competitor; this has arguably been responsible for some of the short term share price weakness. Fund managers know this and often encourage key staff to hold equity in the business to reduce this risk. This indeed was a key reason that PTM floated, to enable a market for staff that chose to sell part of their stakes. In the recent acquisition by BTT of J O Hambro Capital Management, part of the payment was to lock in the key staff via an equity remuneration scheme. Each of these businesses has a number of key staff often holding meaningful equity stakes. Over time, it is the task of the individual boards to ensure adequate succession planning so that the transition of key people is minimised. Astute investors should quiz their boards at the annual meeting on this key issue.

The cost of operating a fund is lower the greater the quantum of FUM. This makes it difficult for new fund managers who are growing their assets from a low base, to compete on fees. Institutional investors with large amounts of capital often do not normally find it feasible to place capital in investment funds below a certain size. The relatively fixed cost base of fund managers means the businesses have significant operating leverage. The challenge comes in bear markets. FUM contracts due to markets movements, inflows slow or turn to outflows as sentiment turns sour, even if the manager is producing strong performance. This all leads to revenue falling, often magnified by the loss of performance fees. When combined with the largely fixed cost bases, earnings can fall dramatically leading share prices to fall meaningfully, a 50%+ fall is not uncommon. A point illustrated by the recent PTM profit downgrade. This however comes full circle in the next bull market when expanding markets lead to FUM naturally growing, fund inflows as sentiment turns positive for risk assets which leads to revenue growth often magnified by performance fees. Over the cycle, revenue is well supported by cashflow as the manager debits portfolios on a monthly basis. Earnings grow meaningfully above the market in most cases which tends to drive share prices much higher until the cycle repeats. This cyclical nature of markets and businesses leveraged to markets provides ample opportunities for alert investors who can tolerate share price volatility.

One challenge for the investor is that of forecasting FUM flows, a key determinant of revenue. In the short term there is no reliable indicator of FUM flows, however over longer periods, funds flow toward strong performance. Managers know this and invest in marketing and sales activities to increase awareness of the manager’s success.

The competitive advantage for a fund manager is their performance which is driven by their investment process and team. Performance is the ultimate aim of any fund manager, judged relative to a benchmark or on an absolute basis. This prized measure affects fund inflows and outflows. There is ample academic evidence over reasonable time periods that suggest fund managers as a group add little or no value. However within the group there are managers that consistently create value for clients. These are the ones to focus on and become part owners when they are available cheaply as success for clients leads to success for owners. Of particular focus is the adherence to a particular documented investing discipline (view example), a key red flag is if you notice a manager deviating from the discipline they espouse as poor performance is likely just around the corner with the resulting pressure on FUM.

Figure 5. Company Valuation Estimates

Figure 6. Value & Price: PPT

Figure 7. Value & Price: PTM

Figure 8. Value & Price: HHL

Figure 9. Value & Price: BTT

Figure 10. Value & Price: TRG

Observing value and price over time, all of these businesses were clearly expensive in 2007, as was the market in general. Indeed around 2007 was a great time to sell a fund manager following a number of strong years on equity markets, as did the smart money at WBC in floating BTT and at PTM via their IPO. At their troughs in 2009, each business was available cheaply as was the market. Today, the market cheap and each a number of these businesses are available at an attractive price, illustrating the magnified correlation these businesses have with general market levels.

Forming part of the overall investment return investors can expect the dividends that these businesses produce. One of the characteristics of this industry is low reinvestment opportunities as the operating businesses themselves are capital light. This leads rational management to return excess capital to owners and is observable in high payout ratios. As can be seen above, pre-tax dividend yields are at close to historical highs similar to those available during the recent financial crisis. This indicates that the sector is broadly out of favour and/or the market is questioning the sustainability of the dividend payments.

Figure 11. Elevated dividend yields

One of the hardest things for an investor is to buy a cyclical business in a downturn – think of retailers in a recession and fund managers in a share market downturn. However from an investment performance point of view, being a contrarian often produces outperformance on an absolute and relative basis. One must remember that equity markets always recover and go on to break new highs, although this hangover may last a little while longer.

As John Templeton was famous for saying, “if you want better performance than the crowd, you must do things differently from the crowd”. We suggest focusing much of your attention on separating the ideas of price and value, focusing on value and using price as a guide to opportunistically transact. If you are looking for high ROE businesses that have strong and reliable cash flows, no net debt, often have owner managers and provide an essential service then investing in a fund manager may be for you. Fortunately a number are available at a fair price today.

FGE has been a regular feature in both the MyClime forum and Clime’s portfolios. With a recently announced acquisition and a new CEO at the helm, we take the opportunity to refresh our view on this integrated West Australian contractor.

Forge Group Limtied (ASX:FGE) provides a range of diversified services to the resources, building and infrastructure industries through the following entities: Cimeco, Abesque, Webb and the recently acquired CTEC. The group began as AI Construction, a subsidiary of the now delisted AI Limited. In June 2007 AI Construction demerged from the parent company AI Limited to form Forge Group Limited. Following the demerger the newly issued FGE shares traded at $0.60, which gave an initial market cap of $32.5m. As at writing, FGE shares were trading at $5.11, translating to a market cap of $441M.

Cimeco

Prior to the demerger, AI Limited acquired Cimeco Pty Ltd on the 5 September 2006 for $9.30m. Cimeco’s predecessor operated as Devaugh Pty Ltd for 30 years. Following the acquisition, the assets of AI Construction were rolled into Cimeco and the combined business continues to operate under…..

Read the full report on Forge Group Limited

Let’s give the Europeans and their debt problems a break this week and talk about more positive news. Resources Minister Martin Ferguson announced last week “Australia is well on track to become the major gas supplier in the Asia-Pacific region… We are entering a golden age of gas.”

The occasion for such an upbeat pronouncement was the final approval given for the $34 billion Ichthys liquefied natural gas (LNG) plant off Darwin. The joint venture project will be operated by Japan’s Inpex with France’s Total, and brings committed investment in Australia’s burgeoning LNG industry to $175 billion. Ichthys will become Australia’s second largest resources construction project behind the $43 billion Gorgon LNG project operated by Chevron, and adds to the hectic pace of expansion activity that has been building over the past two years. First production from Ichthys is expected in 2016.

>> click to read the full A golden age for LNG report

“When rural residents move to urban areas, they tend to do more economically productive work, learn more skills, earn more money, and buy more goods. They also boost demand for urban infrastructure and housing, which can boost economic growth.”

The political, social and economic consequences of urbanisation are enormous and will have an impact far beyond China’s borders – not least upon our own economy, dependant as it is on the high prices we receive for our commodity exports to China.