Charles de Vaulx: “We Have Never Been as Cautiously Positioned”

Charles de Vaulx

Charles de Vaulx joined International Value Advisers, LLC (IVA) in May 2008 as a partner and portfolio manager. He now serves as chief investment officer and portfolio manager. Until March 2007, Charles was portfolio manager of the First Eagle Global, Overseas, U.S. Value, Gold and Variable funds, together with a number of separately managed institutional accounts. In addition to sharing Morningstar's International Stock Manager of the Year award in 2001 with his co-manager, Charles was runner-up for the same award in 2006.

I spoke with Charles on Sept. 9.

Your former partner, Jean-Marie Eveillard, once said he would rather lose half his clients than half his clients’ money. Is that also your business philosophy?

Yes, of course. Most of my team worked with me at First Eagle and we are trying to follow the same investment process and philosophy that we had at First Eagle and at the SoGen funds before that. Even though we are long only and invest predominantly in equities, we’ve been very clear about the fact that we are a lot more absolute-return oriented than we are interested in beating a benchmark. To be more precise, we are willing to try to beat the benchmark, but only in the long run, over a full economic cycle, and not on an annual basis.

Yes, we are willing to do certain things that, short-term, may not appeal to our clients, even though, especially, if it would be to help protect their capital. We have never ever been as cautiously positioned as we are today. At the end of July, the IVA Worldwide Fund had 29% in cash, but then we also had short-dated bonds in Singapore dollars and former high-yield corporate bonds that are of very short duration.. So at the end of July, we had only 53.3% in equities. We are willing to be significantly underweight equities if we believe that is the right thing to do for our clients, even if they may not perceive it that way at this time.

Another way we try to protect our clients - and not risk losing half our clients’ money - is to be mindful of our capacity. Two and a half years ago, in February of 2011, we closed our Funds to new investors. For us to remain multi-cap investors and to retain the ability to roam and, at times, buy into large stocks or at other times into smaller stocks, and for us to remain able to buy into high-yield corporate bonds that may not be the most liquid, it is important not to get too big. We have acted upon this by closing our Funds to new investors. As a result, today we manage $18 billion, and we are comfortable with that amount. We would not be comfortable managing $50 billion; it would become very difficult for us to invest in smaller, less liquid securities. So in a sense, by closing, we have “lost” half the clients we may have gotten had we not closed our Funds.

Let’s talk about the composition of your portfolio. You’re not alone among value investors who favor Genting Malaysia. Can you walk us through the value case for that company?

It is a company that we have known for a long time. In 1988, over 25 years ago, at SoGen funds we owned the parent company of that stock. The bulk of the value lies with a casino they own and operate in Malaysia. In fact, it is the only casino in Malaysia, and it is a money machine. It generates tremendous amounts of free cash flow. The only reason why, in the past, the stock has been undervalued is because of a feeling among investors that the management does not give enough of its free cash flow back to shareholders in the form of dividends. They have basically let the cash pile up on the balance sheet, as opposed to paying higher dividends or aggressively buying back their own shares.

Over the past two or three years, they have been buying back a little bit of their shares, and we wish they would have done more of that previously. A few years ago, they bought some casino operations from a sister company in the U.K. and London. Those acquisitions have been good for the company, but it still remains small. The bulk of their value lies in their assets in Malaysia.

You have very few financial stocks in your portfolio ‑ why? You do own a small position in Goldman Sachs. Why do you favor that one?

During the financial bubble from 2003 to 2007 — at my previous firm — we owned no financials to speak of, because we felt that most banks and insurance companies had become grossly undercapitalized and were also engaging in riskier and riskier activities. There is a central tenet of value investing, which is: “It is not enough for a stock to be cheap. It has to be ‘safe and cheap’,” to use the expression coined by Marty Whitman at Third Avenue.

After the financial crisis burst in 2008, many American banks were quickly recapitalized in late 2008 and early 2009. When that happened, their stock prices bounced back with a vengeance and were not cheap enough for us. I am talking about Citigroup, J.P. Morgan and Wells Fargo in the U.S. Conversely, in Europe, we found that most banks remain undercapitalized. There have been some exceptions, which was why two years ago now we bought stock in UBS, which we felt was adequately capitalized, especially since most of its value lies in its wealth management business, both in the US and in Europe.

But today, the banks – be they in Spain, Italy, Germany, like Deutsche Bank, or France – are undercapitalized. The stocks look cheap, and many of them trade at a big discount to book value. But these balance sheets have to strengthen, and additional rights issues will be needed for these banks to be adequately capitalized.

We invested in Goldman Sachs a year and half ago, in the spring of 2012, because the stock was trading at a pretty big discount to its book value. We bought it at around $114 per share. It had an interesting mix of businesses, including advising companies on M&A deals and wealth management, which is a pretty valuable business. We thought that over time, their capital markets activities would be able to earn good returns on capital going forward and, because of the unique culture of the firm and the global nature of its activities, Goldman Sachs would be a survivor. Many of its competitors would quit certain lines of businesses, and capacity would shrink in some parts of the businesses, and they would become highly profitable again.

Today, the stock trades at a slight premium to its tangible book value. It’s barely above book value. And we think, for such a superb global franchise, we still are eager to remain shareholders in Goldman Sachs.

Additionally, we bought a Bank of America preferred stock in the summer of 2011, just before Buffet made his investment and that position has worked well for us. We sold more than half the position a few months back when it was yielding around 6-6.5%.

Emerging markets has been very weak year-to-date, not only the stocks, but also the underlying currencies, including the Brazilian real. We have been buying stock in a Brazilian bank called Itau Unibanco. When banks are adequately capitalized on a price-to-book basis, and when the valuation is compelling, we are willing to buy into financials.

Right now, the Indian stock market has been very weak, and we are doing some research into banks there.

Read more articles by Robert Huebscher