The fund returned 21.09% net to investment partners in 2019. Since the inception of our fund some eight years ago, the gross annualised return is 11,57%. Investment returns should always be evaluated against the risk taken to achieve these returns.  At the time, we adopted a set of rules to manage the risk we were comfortable with. Today, those rules still stand unequivocally.

1. We invest our assets in companies with below-average risk profiles
2. We diversify the portfolio with a maximum position of 7% at cost; we diversify globally and avoid high concentration risk
3. We invest when we can buy at half our estimate of intrinsic value; we avoid costly mistakes by overpaying and receive downside protection due to the undemanding price we pay
4. We invest only when the portfolio candidates meet strict quality and valuation criteria; this means the fund will hold cash if not enough candidate companies meet these criteria
   

By putting this strategy into practice, we limit risk and it allows us to achieve a superior risk-return equation. Our focus is on businesses that sell products or services with stable or growing demand and with a sustainable competitive advantage that protects profit margins. Additionally, we look for operating margins to be high, with high returns on capital, a strong balance sheet and finally with management that has proven to be both good operators of the businesses and good capital allocators. Combine this with a price that is substantially below what we think the business is worth, and each of these criteria help us to lower the risk of our investment.  

In 2011, we set out to invest in companies that offered an expected return of 15% p.a. Since inception GVF has achieved a return of 20,74% on the equity investments, comfortably beating our target.

Such returns on quality companies are seldom available. Yet, from time to time, the share price of a quality company drops for reasons we believe to be temporary. By paying a low price, we build up a cushion to protect the downside in case our analysis is wrong or in case of unforeseen developments. Concentrating our capital on our best ideas makes sense, but we should never forget unexpected things do happen. Significant losses on very large positions can very quickly turn a good long-term track record into an average one. GVF’s returns would have been significantly higher if we had increased each position to make the fund 100% invested. However, we always tread on the side of caution and sleep well knowing that our largest positions are limited to 7% at cost.

GVF’s historical returns have been achieved with on average 56% of the capital invested since inception (2019=60%). Every day we strive to be better investors and become more efficient at identifying these rare investment opportunities. With more knowledge and experience as well as the flexibility of an unconstraint mandate combined with a low capital base, we aim to achieve higher average investment levels over the next 8 years. We will however not lower our quality or valuation standards.

At the end of the year, GVF was 67.59% invested. Despite a strong increase in the share price of many of our holdings in 2019, we’re confident in the value still embedded in the portfolio today. Several holdings reached our target price and were sold. We found new opportunities in the second half of the year which allowed us to refresh the portfolio with new positions at large discounts to our estimate of fair value. The four graphs best illustrate our style; even in a strong environment for equity markets, we found quality companies with share prices at historic lows.

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During the last quarter of 2019, investments in C. Uyemura & Co and Ifis Japan Ltd were sold when their share prices reached our estimate of fair value. We also made 2 new investments; Costain Group Plc and Imerys S.A.

Costain Group PLC

Costain is a UK-focused infrastructure engineering company and one of a small number of companies with a long track record of building and delivering large infrastructure projects in the transportation, water, energy and defence sectors. Population growth and a decaying infrastructure operating at capacity makes enhancing that capacity a real challenge. Historically, enhancing capacity implied building more assets. Today, regulators are shifting the balance away from building more assets and push for investments that allow for better and smarter use of the existing infrastructure. Examples of this trend are the smart motorways programme to increase capacity with technology, as the single largest expenditure by Highways England or Network Rail’s plans to change and upgrade 67% of the signalling over the next 10 years. Technology to allow trains to operate with fewer intervals and to get them in and out of stations faster is estimated to increase the capacity of the existing rail network by 20%.

Up until five years ago, complex programme delivery was most of Costain’s business. The company is now transforming into a leading smart-infrastructure solutions company. Costain has been investing to develop and to acquire the skills and expertise to grow these new services, which today already represent 35% of the business mix. The company hopes to grow these higher-margin services to 55%. Costain’s expertise and track record in building and delivering large infrastructure projects in the UK is a competitive advantage, when compared to other strategic consultants who can’t match their operational expertise. Costain’s track record, long-standing strategic relationships and strong balance sheet make the company very well positioned to be amongst a select group of strategic advisors to the main owners of the UK’s infrastructure assets.

Costain runs project risk and their objective is to keep this in a manageable band. Historically, the company has achieved this goal through the nature of their contracts, diversification of projects and realistic targets for both timing and cost. The order book now contains over 90% cost reimbursable contracts with the balance being consultancy contracts with little or no project risk. Cost reimbursable contracts clearly define estimates for timing and cost and if final costs deviate from target, Costain shares 50/50 in the gain and the pain. More recently, an unfavourable arbitration decision, cancellations and delays of some large contracts in a concentrated orderbook, mixed with poor sector sentiment (due to problems at construction companies such as Kier and Carillion) explain the drop in the share price from about 500p in 2017 to 185p today.  Costain’s business model of cost reimbursement, as opposed to fixed-price contracts, combined with a net cash balance sheet, makes it look very different from its troubled peers. The company generates GBP1.2bn in revenue and has an order book of GBP4.2bn. Management expects revenue and margins to grow as the higher-margin advisory work increases in the business mix. We were able to build a position at 8x this year’s estimated after-tax earnings. This valuation offers the potential for an attractive return, even when the largest infrastructure project, connecting the North and South of England by High-Speed Train (HS2), would be cancelled.

Imerys S.A.

This French company operates a specialty chemicals business and is the global leader in mineral-based specialty solutions for industry. The company sells its products to a wide range of industries and over 140 countries. Imerys’ products are used to add gloss and opacity in paints, improve conductivity and reduce weight in plastics, purify liquids and increase the lifespan and charging speed of batteries, to name but a few applications. After exiting the building materials and metal processing business, Imerys has become a pure player in specialty mineral solutions, focusing on specialty niches to bring high value to their customers. Imerys generates 75% of revenue in markets where it holds the number one position. Imerys provides key properties to their customers’ products, but this represents just a small proportion of the overall production cost (a small but necessary cog in a big wheel). This gives Imerys some pricing power and limits the company’s exposure to volatile commodity markets. During the great recession, profit margins were still 8.3% in 2009 vs 11.4% in 2008 and moved on to 12.2% in 2010, an indication of the strength and resilience of the business. Imerys now has a strategy to address the low organic growth and improve operating margins. The impact on profit from the sale or closure of several lower-growth or marginally profitable businesses, one-time charges from the operational turnaround, talc litigation fines in the US and a European industry malaise, all contributed to a share price decline of 60%. We were able to acquire a stake at less than 10x our estimate of current year’s earnings. The improved business mix and a substantial cost saving initiative are likely to drive higher organic growth and higher operating margins. The resilience of Imerys’ business and the price we paid for the shares protect our downside in case this scenario fails to materialise.

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Summary of the five largest positions of the fund:

Boustead Projects Ltd & Boustead Singapore Ltd (BP 5.47% and BS 3.50%):

We own both the holding company, Boustead Singapore, and its 51% owned real-estate entity, Boustead Projects (together Boustead). During the year, we increased the position to make it the fund’s largest holding with a combined weighting of approx. 10%. The key value driver is a portfolio of industrial properties in Singapore and an asset-light design & build business in the construction industry. After a few years of price declines, the property market in Singapore has been stabilising and Boustead recently announced a record order book including design & build as well as design & build-to-lease projects. This bodes well for future profits for Boustead and ensures that the portfolio of investment properties will soon reach the critical size required for Boustead to launch its own REIT. Today, Singapore REITs trade close to Net Asset Value thereby valuing the underlying properties at the appraised market value. Based on our analysis the share prices of Boustead Projects and Boustead Singapore imply a discount of more than 50% on the appraised market value of their property portfolio thereby offering both downside protection and substantial upside if management can execute its strategy and launch a REIT. Recent developments and a tripling of the order book increased our confidence in a successful outcome.

Sporton International Inc. (8.20%):

Sporton holds the global market leader position for international certification and testing of smartphone and wireless communication devices. Testing and certification include compulsory and compliant testing services for electronic devices. Sporton is one of the few companies that can provide both.  The main types of products tested are smartphones (44%), products such as keyboards, monitors and peripherals (34%) and the Internet of Things (22%). Most sales are generated in Taiwan and China, which is also where most products are developed and manufactured for the global market. Sporton also has the largest market share of US FCC filings for personal communication systems and is the only firm focused on this type of testing and certification. Its main competitors are smaller subsidiaries of much larger established companies such as Bureau Veritas, SGS, UL and Intertek. These smaller competitors generally test the lower-end smartphone and Wi-Fi equipment. New entrants face substantial barriers to entry; the testing industry is a capital and technology-intensive industry that heavily relies on its engineers and high-tech labs. No new meaningful competitors have entered this industry for over a decade. The smartphone industry is currently in a period of transition between maturing 4G technology and a nascent race to adopt 5G technology. The last waves of technological advances (3G & 4G) allowed Sporton to increase revenue and profit margins and the company expects the same to happen this time around. Other than the expected growth of 5G over the recent 4G, mostly due to the complexity in the new technology (and testing), Sporton expects to see a further driver of revenue growth with the Internet of Things (IoT) devices and smart cars. Management expects revenue growth of 8-10% p.a. over the medium term. The current operating margin is 27% and Sporton believes it can increase this to 35% when 5G testing takes off. The company’s CEO & Chairman still owns 27.1% of the business and takes no salary. Additionally, the risk of bad capital allocation is reduced as the company makes no acquisitions and sets a policy of paying out most of the profits through dividends. The dividend pay-out ratio is 79%. Sporton’s share price had been suffering from poor market sentiment. We see this partly due to the still relatively small quantity of 5G smartphones being certified, combined with a concern of a slowing Chinese economy and an unfriendly trade tariffs environment. We purchased shares at 15.2x trailing earnings or 12.8x net of the excess cash on the balance sheet. The dividend yield is also attractive at 5.3%. At this valuation, we do not need the company to reach management’s targets to achieve an attractive return. Over the last five- and ten-year periods, revenue grew at approx. 10% p.a. with average operating margins of 29% versus 27% today.

Shinoken Group Co Ltd (8.84%):

Shinoken is a Japanese real-estate developer based in Fukuoka-shi but active in the main metropolitan cities of Japan. Shinoken is a property developer offering services to both owners & occupiers; it sources and buys the land, applies for planning permission, builds and sells apartments and condominiums, and offers a whole range of property management services. Services offered include property management, finding tenants, collecting rent, provide rent guarantee, insurance, electricity and gas etc. This creates a recurring revenue stream that grows at more than 20% p.a. with a high profit margin and high returns on capital. We believe these growing management services are very attractive and today represent 25% of operating profit. We got involved with Shinoken when its valuation was very low after the industry exposed three cases of fraudulent malpractices. Certain competitors from Shinoken consorted with mortgage-banks and falsified loan applications by inflating the borrower’s income. While this was of no concern to Shinoken, their market valuation still dropped by 2/3 in less than six months. While the industry was facing severe scrutiny, we found no indications that Shinoken was involved in this malpractice. On the contrary, management explained to us in detail the procedures and measures taken to avoid the malpractices that affected some of the industry participants. The scandals did slow down property development at Shinoken and therefore the current profit declined. We invested in Shinoken at a valuation that implies less than 6x this year’s depressed after-tax profit and feel protected by the value of the properties owned by Shinoken (85% of our cost) and the value of the management services (102% of our cost at P/E 14x). We have made Shinoken a high conviction position in the fund (7% at cost).

Volution Group Plc (6.40%):

Volution is a leading supplier of ventilation products to the residential and commercial construction industries in the UK, the Nordics, Central Europe and Australasia. The ‘friendly middleman’ concept applies to this business as the end-customer is typically not choosing the brand of his ventilation products. These ‘friendly middlemen’ generally pass the cost through to the end customer and prioritize easy-to-install, reliable and familiar products that can be delivered quickly. Volution has a portfolio of long-established brands and guarantees fast delivery of thousands of different products through its distribution networks. The company benefits from scale advantages and can organise this at a low cost. The ventilation market in Europe is typically fragmented and consists of many companies of varying size and scope. The demand for their products is a function of activity in construction markets, both new-build and refurbishment. Regulation and consumer trends have been a tailwind for the demand of Volution’s products. Stricter building regulations have resulted in a shift towards air-tight buildings, resulting in increased use of Volution’s higher margin value-added systems and other more environmentally friendly solutions. CEO Ronnie George owns 2.8% of the company and approx. 50% of his compensation is performance linked. At 9x our estimate of current-year after-tax earnings, the valuation is attractive for a well-managed company with a strong market position in a niche with regulatory tailwind; a consistently strong cash flow generator with good prospects for both organic and inorganic growth. Management is focused on continuing its strategy of growth through acquisitions and it has the financial means to take advantage of the large opportunity-set in a fragmented ventilation market. Operating margins have the potential to improve as the company keeps growing and higher margin products become a larger part of the business mix. Cost overruns on establishing a new assembly facility in Reading (UK) also had a negative impact on profit margins for 2018. This is now completed, which should eliminate a major drag from the 2018 performance. We made Volution a 5% position for the fund.

Sberbank Rossi POA (4.79%):

The fund invested through the London-listed ADR’s in the equity of the largest bank in Russia. The opportunity presented itself following President Putin’s 2014 forays into Ukraine and the subsequent international pressure on the Russian Federation. For the record, we are not particularly big fans of financials, mainly for two reasons; we avoid leverage and we find bank balance sheets typically too opaque for our fundamental analysis. But the strength of Sberbank’s balance sheet, its exceptional historical profitability, its durable competitive advantages, it’s very strong management, its long runway for growth and finally a depressed valuation, all contributed to our conviction of investing in a very controversial situation. For the 10-years to December 2015, Sberbank’s book value per share in Euro terms compounded at 14.3% p.a., despite the financial crisis in 2008 and the Ukraine crisis. The Ruble also lost about 58% of its value against the Euro over that period. Sberbank dominates the Russian banking sector with >40% of all deposits and a retail branch network over 10x the size of its nearest competitor, resulting in a significant funding cost advantage. On the lending side, the bank focuses on higher quality borrowers. Viewed in a global context Russia remains substantially underbanked, based on the low percentage of GDP for banking products such as deposits, lending, insurance products and credit cards. We believe Sberbank is very well positioned to benefit from this long-term growth potential. We made our first investment in Q1 2014 at 4x trailing earnings and 80% of book value. We subsequently made further investments as the share price declined when the economic situation deteriorated. The shares currently trade at less than 6x this year’s earnings. Griffin Fund’s current country limit for Russia is 4% of AUM at cost.