Q3 Commentary (2008)
| ANNUALIZED RETURNS | ||||||
|---|---|---|---|---|---|---|
YTD |
TRAILING (ending 9/30/08) |
|||||
3Q08 |
2008 |
1 YEAR |
3 YEAR |
5 YEAR |
INCEPTION TO DATE VS S&P** |
|
| Coho Tax-Exempt Composite* | 0.9% |
- 4.1% |
-8.2% |
6.0% |
8.4% |
6.3%/yr. vs -0.9%/yr. |
| Coho Taxable Composite* | 0.3% |
- 4.5% |
-8.1% |
6.1% |
8.4% |
5.9%/yr. vs -1.0%/yr. |
| S & P 500 Index | -8.5% |
-19.4% |
-22.1% |
0.1% |
5.1% |
|
*net of fees |
||||||
“We firmly believe that the best method to create and sustain long-term wealth is to protect principal in down markets and to generate competitive returns in all but the most speculative of up markets. “
October 8, 2008
The third quarter ending 9/30/08 marked the fourth down quarter in a row for the S&P 500. While not the worst quarter in this bear market from a returns standpoint, this one felt particularly painful and certainly more frightening due to the systematic risks that came to the fore, highlighted by the major financial firm failures and the unprecedented Fed and Treasury responses. Despite all of this, and the market being down -8.5%, we were pleased to have produced a modestly positive return for the quarter. Our conservative investment philosophy and process are specifically and deliberately geared to protect principal in periods such as this, and we are gratified to see it work once again.
We are now essentially a year into a nasty bear market for the S&P 500 and unfortunately we are not confident as to its ultimate duration or depth. Despite our efforts and wishes to the contrary, our companies, and by extension our portfolios, are not immune to frightened markets and severe economic downturns. We are disappointed to be down over the last 12 months on an absolute basis, but also pleased that Coho’s portfolio has provided significant protection relative to the market, down approximately -8% vs. -22% for the S&P 500, and capturing less than 40% of the negative returns generated in the last year. This marks the second major bear market in Coho’s almost nine year history. While each had a very different “personality” and, again, we acknowledge this bear is not over, we have produced a similar pattern of returns in both periods.
We are proud of our inception-to-date performance. Below is a graphical display of our performance against the S&P 500, the Russell 1000 Value and Russell 1000 Growth indices:
Annualized Return |
|
|---|---|
12/31/1999 – 9/30/2008 |
|
| Coho Partners Taxable Composite | 5.9% / yr |
| S&P 500 | -1.0% / yr |
| Russell 1000 Value | 3.7% / yr |
| Russell 1000 Growth | -5.1% / yr |
When we analyze our results over our almost 9 year history, we see three distinct and different market phases, comprised of two bear markets and one bull. The first phase, came during the “growth bear market” which lasted from August 2000 through the fall of 2002. This market was driven by the implosion of the tech bubble and the collapse of high valuation multiples across the large cap indices. The Russell 1000 Growth was particularly savaged over this down period:
Cumulative Decline |
|
|---|---|
8/31/2000 – 9/30/2002 |
|
| Coho Partners Taxable Composite | -8.5% |
| S&P 500 | -44.7% |
| Russell 1000 Value | 23.6% |
| Russell 1000 Growth | -61.8% |
Our portfolio of reasonably valued, stable growth stocks held up very well compared to the broader indices and indeed exceeded the performance of large cap growth and value styles handily.
After the market bottomed in September 2002, we started on the next phase, a practically uninterrupted bull market run for five straight years (seems like a long time ago, doesn’t it?). We have a dual goal in our pattern of returns: first to protect principal in the down markets and second to participate meaningfully in the up markets:
Cumulative Advance |
|
|---|---|
9/30/2002 – 10/31/2007 |
|
| Coho Partners Taxable Composite | +94% |
| S&P 500 | +108% |
| Russell 1000 Value | +129% |
| Russell 1000 Growth | +98% |
We were satisfied with our performance in this strong bull market as we captured approximately 87% of the upside of the S&P 500. When combined with the strong relative returns from the preceding bear market, we managed to hold on to most of our lead over the market returns since inception.
Now fast forward to the third distinct market in our existence as a firm. We believe this corrective phase started in the summer of 2007 with the rollover of the Russell 1000 Value index, and we honestly have no way of knowing how long or how deep this will go. This marks a much different bear market from the previous one, driven now by the housing debacle and the ensuing credit crunch as opposed to the demise of the tech bubble in 2000. Comparative performance over this period (so far) is as follows:
Cumulative Decline |
|
|---|---|
5/31/2007 – 9/30/2008 |
|
| Coho Partners Taxable Composite | -6.3% |
| S&P 500 | -21.9% |
| Russell 1000 Value | -25.5% |
| Russell 1000 Growth | -18.8% |
Note the reversal of the value and growth indices in terms of the leadership on the downside vs. the previous bear market. We would specifically like to highlight Coho’s relative performance again leading the entire pack.
The most important point of these illustrations is that the drivers of performance over these three distinct market phases since our inception have been dramatically different, but our focus has remained the same. We did not “market time” or “sector rotate” our way into strong relative performance across these disparate markets. Indeed, our turnover since inception has averaged well below 20% per year, and many of the stocks that we held in the first bear market are still present in our portfolio 7 or 8 years later!
Our focus has always been on companies that produce steady, reliable growth in earnings, cash flows, and dividends in almost any economic environment. It is this combination of reliability and growth which we believe gives us the best chance to achieve the pattern of returns that we seek: protection in the down markets and participation in the up. We screen the markets for companies that have done this historically, and then research them individually to further narrow that list to those we believe may continue to provide steady, reliable growth into the future. We look for strong, defensible, differentiated market positions, with diverse end markets. We appreciate high profit margins, low capital expenditures, and strong free cash flows which allow for reinvestment in the brands and flexibility. Strong balance sheets are critical in a couple of ways. Our companies can stay above the fray during a credit crunch and control their own destiny as opposed to relying on outside funding. They also allow for offensive spending to gain or take share from the weaker players during a downturn. Dividend yields which are not only higher than the market, but are increasing at a rate faster than the market’s, add another layer of protection and return to our portfolios. Of note is that 90% of our holdings have raised their dividends this year. We get to know the managements of the companies we own, because we want to be confident not only of their competence, but in their ability to make proactive decisions to adjust their business models to the current environment. Finally, our valuation discipline ensures that within this advantaged universe of select companies that we follow, our portfolio holds the stocks with the most reasonable valuations relative to their expectations.
These are business models that we understand, with financial statements that are transparent and decipherable. Honestly, it is this attention to these particular fundamental attributes which have kept us inherently underweighted in the very financial stocks that are having so much trouble today. The large money center and investment banks have shown enormous earnings variability in past economic cycles – witness near collapses in 1980-81, 1986-87, 1990-91, and 1997, just to name the standouts. And despite the tremendous drop in their share prices, they remain essentially impossible to accurately analyze because of their complexity and the opacity of their financial statements.
Putting this all together, we remain committed to our style and our desired pattern of returns. We have remained true to our disciplines and the process that produces a well diversified portfolio with very specific characteristics that improve our chances of outperforming during the difficult times and still being able to post competitive returns during the advancing periods. Importantly, too, there will be another advancing period when this mess gets sorted out. We like the hand we hold for that eventuality as well. We own some great companies with outstanding long term business prospects at what appear, especially now, to be very attractive prices. Thank you for your continued interest in Coho Partners Ltd.
Sincerely,
Peter A. Thompson
