Q4 Commentary (2005)
We endeavor to report performance in a fair and honest way. As we look back on this year’s results, we are disappointed and frustrated by both our absolute and relative results. No one enjoys underperforming their benchmark, but the reality is that it is virtually impossible to outperform all the time. As a good friend and client reminded me recently, “clever people do not become stupid overnight.” We often remind clients that in math, the shortest distance between two points is a straight line, but in long term investing, there will be some detours along the way. We believe that 2005 was one of those detours. Our experience has been that periods of outperformance tend to follow immediately after a period such as this.
So, what impacted performance in 2005? One negative influence throughout the year was the surprising strength of the US dollar, particularly against the euro and the yen. In 2005, the dollar appreciated by 13% against both the euro and the yen. We had our traditional overweight in the consumer staples sector, but this year the dollar’s strength reduced operational growth outside the US, as those revenues and earnings were reduced by currency translation accounting. We believe further dollar strength is unlikely in 2006. Another factor was our limited exposure to energy companies and in particular the “high beta” industries, such as drillers and refiners. Our exposure was to large integrated companies, which did well absolutely, but still lagged other components of the overall energy sector. For instance, integrated oils, which accounted for 60% of the overall S&P energy weight rose by 17.6% last year, but the other 40% appreciated by 51%, with such notable groups as drillers, +53% and refiners +78.5%. The final factor was sub-optimal stock selection. The biggest problem holding was Fannie Mae, which reduced performance by well over 1%. A few other high quality companies struggled with exogenous issues that dampened operating performance, but we believe that their outlooks remain favorable and their valuations compelling.
Despite 2005, our tax-exempt composite performance since inception remains quite good as evidenced by the Table below. We look forward to 2006 as the beginning of a new period of renewed outperformance.
| 2000 | 2001 | 2002 | 2003 | 2004 | 2005 | Annualized Since Inception |
|
|---|---|---|---|---|---|---|---|
| Coho Partners** | 17.7% | 1.9% | -13.2% | 23.9% | 15.4% | 0.5% | 6.9% |
| S&P 500 | -9.1% | -11.9% | -22.2% | 28.6% | 10.9% | 4.9% | -1.2% |
** Gross of fees
Our mission has not changed.We continue to invest in such a manner to protect our client’s monies during the difficult periods, yet, still participate meaningfully during the good times. If we achieve our goal, we believe we will outperform the broader market while taking less risk than the market. We have achieved this goal over our inception to date period, but we clearly fell short in 2005.
Our focus remains on investing in high quality companies with well defined operating and financial strategies. All of our investments pay an appropriate dividend given their growth prospects and we expect this dividend to grow annually. These companies also tend to be non-capital intensive and as such, they generate generous amounts of free cash flow, which in many cases is used for stock repurchase. In 2005, about 75% of our holdings had a net reduction in their outstanding share base. These financial characteristics have proved effective in the past and we believe they will prove effective in the future as well.
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