For the year 2015, the founders’ A-Share Class increased by 15.32%[1]. The fund was on average 57% invested throughout the year. Since inception in October 2011 the annualised return was 9.70% and the estimated annualised return on our equity investments was 19%[2]. The difference is explained by a large cash position (49% on average over the life of the fund). The reason is that we have gradually invested the fund’s cash from inception, and we did not compromise on our investment criteria in order to be fully invested at all times.

In December 2015, after building a 4-year track record, we welcomed our first investment partners into the fund. As founders we have, since inception, gradually invested a substantial part of our investable assets in the fund and continue to do so whenever we can. Welcoming like-minded investment partners into the fund is an important step and one that did not come without giving it some serious thought. In investing, as in any business endeavour, we think it’s important to choose your partners carefully. Hence, we would like our investment partners to have more than only financial interests in the investments we make, because we believe that giving a better understanding of the businesses, allows for the confidence needed to weather the volatility of public equity markets.

In the future we hope to welcome more like-minded investment partners in the fund, but we have come to accept it will be despite limited commercial efforts on our behalf. Our mileage is primarily a function of driving to and from the office and we are still on our first box of business cards we ordered over 5 years ago. The truth is we’d rather spend our time doing what matters most to achieve superior returns; focussing on finding the best companies, understanding the business models we invest in and having a good understanding of the risk-reward equation.

Whilst the fund is internally well documented, we have never published any material. We have been reading letters from other managers for many years and over time have identified key points we like to see included in an investor letter. We hope the result of our writing efforts will be informative, useful and on-point.

This being our first investor letter we would like to summarize our investment strategy. The aim is to build a portfolio of approximately 20 companies with the allocation to our highest conviction ideas not exceeding 7% (at cost).

What are the characteristics of our ideal portfolio company?

1. Predictable sales and a long runway for growth
2. Sustainable, high operating margins as a result of a durable competitive advantage
3. High returns on incremental invested capital
4. A strong balance sheet
5. Management with a good track record as both operators and capital allocators and strong alignment with shareholders
6. A share price that allows for a target return of 15% p.a. under conservative assumptions

Our first priority is protecting our capital and the above criteria contribute to that goal. The sceptical reader might ask how we would be able to buy high quality companies at below average prices. The answer can be found in an understanding of the constraints under which most professional investors operate:

1. They focus on short time performance: investors evaluate performance over a short period of time forcing the professional investor to stay close to benchmarks or risk redemptions during unavoidable periods of underperformance
2. They operate in a limited investment universe: more than 90% of all listed companies are not accessible to large investors because their shares do not trade in the volume they require to be meaningful vis-à-vis their large assets under management  
3. They are too diversified because of their liquidity constraints and because these professional managers cannot afford to stray far from the many components making up their reference benchmark.
   

We believe Griffin’s potential for superior risk-adjusted returns comes from the fact that we do not operate with the same constraints as most professional investors do. Our global approach and Griffin being a relatively small fund ensures that our opportunity set is much larger than for the majority of professional investors. At the same time, our investment partners must accept that our returns will deviate from market averages with inevitable periods of underperformance. This allows us to invest in our best ideas without being concerned by our tracking error versus a benchmark. The result of the advantages we hold over most other investors is that we can buy higher quality companies at lower valuations. That's why we attribute so much importance to having like-minded investors. In addition, as founding partners we have a substantial percentage of our personal investible assets in the fund, and thus have a big incentive to protect this competitive advantage.

This large universe in which Griffin can operate consists of approximately 73’000 companies listed on any of the world’s stock exchanges, but finding high quality businesses or assets that sell at attractive prices is not an easy task. A quick look at the financials does not reveal bargains and performing detailed analysis on a large number of companies is not feasible. We have therefore developed several tools to efficiently screen and source ideas. Reading is what we do most in the office, and occasionally we use screening software. Outside of the office we have created a network of like-minded investors across the globe; we attend specialist investment conferences and are contributing members of value investor platforms such as the Value Investors Club to source investment opportunities.

Despite our large investment universe, we will go through periods where valuations are too expensive for us to find enough companies that meet our criteria to be fully invested. In this case the fund will hold cash and equity in attractively priced asset-rich companies. These asset-rich companies usually attract our interest when negative market sentiment, often in combination with limited liquidity, drives the stock price of a company to a substantial discount versus the value of its marketable assets (real estate, securities, cash etc.). These large discounts offer us downside protection and an attractive risk/reward. However, given the choice, we have a preference for high quality companies that meet our criteria described above, because they have the ability to grow their intrinsic value at a higher rate than these asset-rich companies. The fund’s cash holding should never be read as a reflection of our view on the global economy or the level of the equity indices; instead it will be the result of our ability to find companies that meet our strict investment criteria. We believe that having cash available when opportunities do present themselves will result in superior returns versus lowering our standards to be fully invested at all times.

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Trip to Japan

2015 was the year we visited potential portfolio companies in Japan. Whilst the financial media attention is often focussed on the high valuation of the US equity market, we see opportunities in other parts of the world. Griffin Value Fund has no geographical boundaries and we exploit this whenever we see an attractive opportunity.

Similar to our investment in Compugroup Medical AG (described below), for which we developed a strong affinity for software for doctors and pharmacies, we found EM Systems Ltd by looking in other areas of the globe where these types of businesses could exist.

EM Systems has a large share of the pharmacy software market in Japan with recurring revenues, high operating margins and the most competitive offering in the market. The company is best positioned to lead the consolidation of its industry by organically gaining market share and acquiring subscale competitors with its superior application software-offering and in-house sales-force.

The share price and the company’s results had been under pressure because of several reasons such as 1/ negative impact on revenues from the transition from outright sale of software to a cloud-based subscription model 2/ a loss-making software for clinics division and 3/ large integration expenses from 2 recent acquisitions.

When we are able to invest in high quality companies at attractive prices, often the reason is negative market sentiment for reasons that we believe to be temporary.

In this case our analysis convinced us that we could buy this high quality business, almost for free.

During the trip to Japan we were able to spend time with the founder/CEO and several senior managers. The CEO explained that when he was looking for a new office space in 2005, he had the opportunity to purchase land, very well situated next to central Shin-Osaka station, at an attractive price. Despite being far in excess of the company’s needs, he decided it would be a good investment and built a 15-story earthquake-proof prime office building. EM Systems occupies just 2 floors for its headquarters and leases out the rest. Because of the recent stock-price correction, our purchase price was covered by the value of this property if we value it at a rental yield of 6%, which we believe to be conservative based on comparable property sales in Osaka at approx. 5%.

We were initially sceptical of a company investing its capital outside its core business competence but after meeting with the CEO and careful analysis of his past capital allocation decisions, we found enough evidence to conclude that management is focused on creating long-term value for its shareholders.  We also noticed that the CEO was, uncharacteristically for the Japanese, aware of and concerned with the undervaluation of the company.

A defensive business model, good quality management that is aligned with shareholders, a strong balance sheet with a prime property and a low valuation all contributed to the attractive risk-return profile of this investment.

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At the end of 2015 the fund had 15 listed equity positions. The 5 largest positions represented 30.21% of the fund.

Summary of the 5 largest positions of the fund:

EM Systems: (described above)

Boustead Singapore Ltd:

This Singapore-based company is a conglomerate of 3 quality businesses, which are fundamentally different. The underlying divisions simultaneously went through headwinds, which allowed us to invest at an attractive valuation. The businesses consist of 1) a 48.8% participation in recently spun-off Boustead Projects Ltd; a design, build & lease real estate business that owns a portfolio of new and recently build high-end fully let industrial buildings. It counts IBM, Airbus, Bombardier, Rolls-Royce, SD Schenker and SDV amongst its tenants. 2) an asset light global engineering business active in the niche market of direct-fired process heater systems, mainly for oil & gas refineries. 3) a distribution business of Esri geospatial software, which has a 60% market share in geographic information systems (best explained as a professional Google Maps, mainly for governmental use). These 3 businesses have high operating margins and generate a high return on invested capital. They are led by a chairman who focuses his entrepreneurship on shareholder value creation. We were able to purchase this conglomerate for respectively 5x and 12x the normalised earnings of the energy and geospatial business, and paid 55% of intrinsic value for the real estate assets. A potential catalyst exists in moving the real-estate assets into a REIT structure and the conservative balance sheet also allows for opportunistic acquisitions.

Compugroup Medical AG:

This is the second time we were able to invest in this Koblenz-based medical software vendor. It was one of the first investments of the fund, which we successfully entered and exited between 2012 and 2014 for a 105% return. We think this medical software business is of very high quality with high barriers to entry and a dominant position in virtually all the markets it operates in. It has very sticky customers (mostly doctors) with extremely low churn rates, no cyclicality and high free cash flow generation due to the low capital requirements to run the business. The business model is also helped by the continuous pressure from governments to cut public health spending by increasing connectivity. As we kept in touch with this company after our exit, we got more comfortable with a German initiative that was recently turned into Law. It will connect all the public health stakeholders with compatible software. Compugroup, being a leader in this field, was part of the government development program and once implemented, we believe the company will secure years of sustainable growth. We re-entered the equity at 12.5x cash earnings.

Keck Seng Inv (HK) Ltd:

This Hong Kong listed company originally started accumulating and developing real estate in 1977 in the Portuguese enclave of Macau. Over the years the founding family moved from ‘build to sell’ to ‘build to hold’. Today it is a diversified real estate investment holding company, majority owned by its founding owner-operator chairman. Its real estate assets are spread across the globe, primarily in the U.S., Vietnam, Macau, China, Canada, Japan and Singapore. Keck Seng’s main assets are the W-hotel in San Francisco, the Sofitel hotel in New York, the Sheraton hotel and casino in Ho Chi Minh City and residential real estate in Macau. The company also has a very conservative balance sheet. Using market values, the company compounded at 17% p.a. between 2003/2013. We made our investment at a discount of 85% to Net Asset Value, excluding the excess cash.

STI Education Systems Holdings Inc.: This company is based in the Philippines and is a provider of Tertiary (Higher) Education. STI is the largest vocational college in the Philippines, offering practical education that opens doors to attractive employment opportunities. This is not the top ranked college, but it is one of the best-run for-profit colleges, where prestigious companies like Starbucks Inc. recruit from. Today, the education system in the Philippines is going through a major change to set itself on par with global education standards by adding what was missing: Kindergarten and the final 2 years (grade 11&12) of the Secondary Education. This vacuum created by the absence of a normal yearly intake (students now need to finish grade 11&12 rather than immediately going in Tertiary Education) caused the company’s value to collapse. In the meantime it became clear that the government is also not capable to supply all the logistics for these newly introduced grades to be taught in the public education, and colleges like STI are helping by filling their empty classrooms with students they later hope to attract for Tertiary Education. The company has a strong balance sheet and we were able to make our purchase at an undemanding valuation of 3.9x 2015 after-tax earnings. Alternatively, if we look at the company’s assets as opposed to its earnings, we bought this company at a 46% discount to the cost of the college’s own real estate portfolio.