April 15, 2008
1Q08 Client Commentary
1Q08 Client Commentary
I am writing to you from the fifth largest city in China, Chengdu and outside my hotel widow I can count at least ten tower cranes in operation. Unfortunately, I can verify that at least three of them are working twenty-four hours a day, seven days a week as they are located directly outside my room. Admittedly, I feel a bit like the chap in the advertisement that did not use the travel web site company that guarantees they will pre-warn you of any construction that might disrupt your sleep – thank goodness for ear plugs. From here I will be visiting facilities and management of several of our portfolio businesses in and around Beijing, Shanghai, Xiamen, Hong Kong, and Mumbai, India before returning to Memphis on the 24th of April. As a result, I will reserve most of my observations for next quarter’s commentary when our investment team has had the time to synthesize my findings however, it is fair to say that most of the views we have previously suggested, particularly regarding infrastructure development, remain in tact.
Now to the quarter - It would not be a stretch to use the illustration of a roller coaster if one were attempting to describe the daily and weekly behavior of the equity markets this past quarter. That said, SouthernSun’s Small, Mid-Cap, and U.S. Focused Composites resembled the analogy more on a monthly basis with January and March more painful than February whilst the Russell 2000 and Russell 2500 performed better in March than January and February. Our Global Focused Composite strategy moved more along the lines of its benchmark the MSCI All Country World Index but posted a positive result for the quarter versus an almost double digit loss for the index.
Global liquidity issues and soaring commodity prices seemed to take center stage during the quarter, particularly from a media coverage standpoint. More conversation, now to include statements from the Federal Reserve and the IMF, revolved around recession in the U.S. and a general slowdown in world-wide growth prospects. Our observations would not contradict these points of discussion. However, we would continue to suggest, as we have indicated for some time now, that while growth slows and there most certainly will be some structural re-building in the financial sector, there remain interesting opportunities for our businesses as a result. As previously communicated, a number of our portfolio companies have used this environment to make strategic acquisitions that we believe will add meaningful value to shareholders over the next few years. We are, in general, quite pleased with our portfolio companies. In most cases their balance sheet flexibility, ability to generate discretionary cash, and management’s balance of near term opportunity with long term positioning, supports our view that our portfolios continue to be great undervalued. We continue to be concerned that many banks in the U.S. and elsewhere will continue to have restrictive lending policies due to their lack of certainty about the value of their own balance sheets as write downs have topped $200 billion. Further, potential debt default in Argentina, Iceland, and Kazakhstan may only fan the flame of popular global liquidity crisis opinion.
We continue to believe that there is notable speculation in many agriculture commodities and that commercial buyers have been less active than the hedge funds and other speculators at an elevated pace this past quarter. Whilst our investment team believes that these prices should come down – some rather sharply – our team also believes that ultimately higher floors will be set for many of these hard and soft commodities. Our team has also observed unimpressive bid volume in equities – maybe lack of conviction - and days of what we can only label as hopeless selling. At this juncture it may be appropriate, and reasonable, to point out that since the beginning of 2008 global equity markets have experienced their worst quarter in five years with some markets down almost 20%. Also relevant to our particular niche is the hedge fund industries accelerated woes. According to Chicago-based Hedge Fund Research the hedge fund industry experienced its worst first quarter in the history of their record keeping and according to Oxford Analytica, at least six hedge funds, valued at over $5.4 billion have had to liquidate or sell holdings since the 15th of February. You may recall that we have previously discussed the increased activity of hedge funds in the small and mid-cap space and the subsequent near term impact on the stock prices, for better or worse. This too adds to our view that some of our businesses have suffered from this activity whilst their fundamental outlooks remain sound.
To conclude by returning to the room from which I write to you, I believe that what may be lost or oppressed in all of this noise may be the continued infrastructure demands of the worlds emerging economies, even considering all of the aforementioned obstacles. Countries like Brazil, India, Africa, China, and others should continue to address significant infrastructure, food and energy safety deficiencies even if only for near-term protectionist reasons. We continue to find new and interesting opportunity in this environment as we maintain careful scrutiny of our current businesses.
As always we appreciate you confidence in SouthernSun. We are here because of you.
Michael W. Cook, Sr.
CEO & Chief Investment Officer
SouthernSun Asset Management
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