Friday, September 25, 2009

“We are analysts.”

On 9/23/09 we talked with Vincent Sellecchia, co-manager of the Delafield Fund (and author of the quote above) about the fund, markets and some of the business issues of running an investment management firm. Here are some of the highlights:

Delafield is moving from Reich & Tang, a subsidiary of Natixis Global Asset Management to Tocqueville. Natixis made a corporate decision to only retain money market and deposit business at Reich & Tang (interestingly, they requested that the Delafield Fund remain available to their employees through the company’s retirement plan). The principals of Delafield are confident that the move to Tocqueville should prove a good fit. While there is not extensive overlap between the existing Tocqueville funds and Delafield, they will still sit in on research meetings and meet with the “one company per day” that goes through Tocqueville’s offices.

We spent a little time reviewing the company’s investment process. As they come up with ideas for the fund, they take historical financial information and Wall Street projections to complete a template they have developed. From that template they derive an Enterprise Value to EBITDA ratio. If the company appears interesting, they will then typically schedule a call with the company. If at that point they are still interested, they will meet with senior management in person and visit some of the company’s facilities. After a meeting, the Delafield team will re-evaluate and recast the projections with their financial estimates to see what Enterprise Value to EBITDA ratio comes out and determine if the stock appears attractive for purchase

In buying stocks for the portfolio, Delafield attempts to be very price sensitive. If the price declines after an initial purchase and they are confident in their analytical work they will average down. Typically they accumulate positions over time.

During periods when the fund’s share price is rising and performing well (like now) turnover also starts to increase as they peel off portions of their positions and hopefully recycle the proceeds into new names.

The sell discipline is a primarily a function of valuation. As a stock approaches fair value, the managers will begin to sell. Other reasons they may sell a stock include the business results are not what Delafield had anticipated through a mistake in their analytical work or assessment of management. They will also sell if management changes direction on them.

The fund had a difficult fourth quarter last year primarily due to the credit market freeze causing investors to view what had previously been considered reasonably capitalized companies as bankruptcy candidates. This has led the fund to be much more focused on credit issues on a firm’s balance sheets (debt maturities, debt covenants, etc.) as they go through their investment analysis. Many of those same companies that were driven down last year have surged up in price leading to Delafield’s 38.41% year-to-date return through August31 (vs. the S&P 500’s 14.97% return).

At August 31, Morningstar reported the firm held over 18% of its assets in cash, but Vince noted that the cash position is currently higher. Given lower cash yields, the fund has taken about 4.5% of its assets and invested in bonds maturing in 1-5 years.

The managers are not finding values in the market today, hence the even higher cash position. Their outlook is that the US economy (this being a domestic fund) has bottomed and the credit crisis is over but the recovery will be muted. They believe consumers will want to save more and so companies will have a tougher time growing their top lines. And after the recent market run up, Vince believes you need to look to 2011 to start justifying some of the valuations they are seeing in the market. Their thoughts on the markets are greatly influenced by the frequent conversations they have with company managements.

The fund currently owns 60 stocks in the portfolio, which is closer to the upper end of their range. The large number of stocks also reflects the fact the managers have fewer higher conviction ideas. Vince noted they are very conscious of risk and given their concerns about valuation and the consumer, the high cash position makes a lot of sense.

After our conversation with Vince, we both felt very comfortable with our holdings in the Delafield Fund. The fund managers (who have been with the company since inception) continue to remain very disciplined in their allocation of their fund holder’s capital. We share their belief that the market has moved up rapidly and there are not that many good purchase candidates available. We are very comfortable with their decision to raise some cash to be used later when more attractive ideas appear. We also found his honesty in discussing the 4th quarter of 2008 and the lessons they learned to be refreshing.

We continue to find the mangers at Delafield to be great stewards of ours and our client’s capital. We conclude with one of our favorite lines, “Our best risk management is knowing our companies as well as we can.” We couldn’t agree more.

Disclosure: Harvest Financial Partner owns the Delafield Fund in its client portfolios. The authors own the Delafield Fund. Positions can change at any time.

Wednesday, September 23, 2009

Chasing Yields Revisited

We thought this article in yesterday's Wall Street Journal provides additional support for our recent warning to avoid chasing high yields. While it is certainly tempting given the low yields available in money market funds and high quality bonds, we think that in the long run it will be better for your personal net worth to avoid the temptation.

The article also provides a little more clarity on why we prefer purchasing individual bonds or CDs for our clients’ portfolios as opposed to using a bond fund. We like the certainty of getting our principal back when a bond matures. We also like being able to use individual bonds to meet specific future liabilities, and to provide a steady stream of cash to rebalance the portfolio or simply to reinvest in another bond. At times, bond funds are the only alternative, but just remember, like all investments, they come with risks.

Wednesday, September 16, 2009

Roth Conversions

Next year opens up the possibility of converting traditional IRA balances to Roth IRAs for many more people. Prior to 2010, people who had an adjusted gross income (AGI) above $100,000 were not eligible to convert, but that income limit goes away in 2010. (Converting technically means taking a taxable distribution from your traditional IRA, paying income tax on the distribution and depositing the distribution into a Roth IRA account.) Another benefit to converting in 2010 is that income taxes due on the conversion can be deferred until 2011 and 2012.

Given that qualified withdrawals from a Roth IRA are tax-exempt and Roth IRAs are not subject to required minimum distributions (RMDs), a Roth presents some very unique advantages.

Is it right for you?

What are the mechanics of converting to a Roth IRA?

Unfortunately there is no one answer to either of these questions. Give us a call or send us an email and we can discuss your situation.