Global Equity Income Newsletter - May 2020 Introduction In this third edition of our newsletter, I cover three subjects; firstly, the merits of equity income investing and its great utility for investors now, secondly, a tribute to Sir Anthony Habgood, Chairman of RELX and thirdly, I look in detail at the early years of Berkshire Hathaway to see what we can learn. Regulations prevent us discussing performance until the one year anniversary of the fund which will be near the end of May 2020. We can say we are pleased with the progress made by the companies in which the fund is invested. Whilst COVID-19 still rages and my sympathy goes to those suffering, its extreme unpredictability renders further comment by me as futile and so these pieces endeavour to look beyond its eventual defeat. Investment Jane Austen, income and the candy company The classic novels authored by Jane Austen often referred to her main characters’ having an ‘income’. This generally derived from saved capital and was typically around the 4% yield on investments provided by Government bonds at the end of the eighteenth century. The

capital was built through generations by families and the income from it allowed the recipient time to pursue varied interests. This is an objective of many in society now who want to pursue plural careers, entrepreneurial ventures, philanthropic pursuits or simply enjoy retirement. Chawton is the Hampshire village where Austen lived and wrote most of her novels and the inspiration for the name of our partnership.

Whilst Warren Buffett has yet to pay an ‘income’, namely a dividend, out of his Berkshire Hathaway investment vehicle, careful reading of his letters to shareholders shows that many of his successful investments, such as See’s Candy, paid substantial dividends up to the holding company. He discussed See’s, a high quality chocolate brand popular on the U.S. west coast, in his 2007 letter. By that time, it had paid $1.3 billion up to the parent company, which compares to the $25 million paid to acquire the company in 1972. Buffett frequently invests in high dividend payers. Equity income is important. Jumping forward to the present, there is a pressing need for many investors to convert capital sums into reliable ‘income’ streams over extended periods. In the U.K for example, there is an estimated wall of money of £0.5 trillion per year of pension capital seeking long term income. The average pension fund investor requires this to last for over 25 years. A white paper1 prepared by the Chartered Financial Planners in May 2019 provides a very compelling argument as to why equity income portfolios are the best and perhaps only way of achieving this. This is because they are capable of producing a relatively stable and growing income stream over time that preserves its purchasing power without having to dip into the capital. Strategies using small sales of capital each year as an alternative to income can suffer from the ‘sequencing’ risk of weaker general equity market performance in earlier years. Their study focused on mainstream U.K. listed investment trusts with differing investment strategies. An even better results can be secured by utilising Buffett derived principles. The strength of See’s Candy derives from two important qualities. Firstly, an enduring brand 1 Converting cash sums into monthly pay cheques: rational income investing in a post-QE environment

derived from the quality of the product underpins extreme longevity of the franchise. Secondly, as referred to above, great companies such as this require limited capital to grow the business resulting in considerable surplus cash available for distribution. Such companies are not common so a relatively concentrated portfolio is assembled. Risk is further reduced by avoiding companies that are financially leveraged. By combining the general benefits of an equity income strategy with specific active investment management refinements derived from Warren Buffett, all savers now have the prospect of ‘an income’ in the Jane Austen sense, for life. Sir Anthony Habgood One of my favourite books is ‘The Outsiders’ by William Thorndike. This charts the careers of a number of Chief Executives regarded as the greatest capital allocators. They include Henry Singleton of Teledyne, Tom Murphy of Capital Cities and Katherine Graham of the Washington Post. A common factor was their behaviour was different from the norm. In February, RELX PLC, a UK listed company held in size in the fund, announced that their Chairman, Sir Anthony Habgood, has decided to retire from the board. I have known Sir Anthony and been invested in companies he has run for around 25 years and I consider him a great capital allocator of ‘Outsider’ status.

After starting his career at Boston Consulting Group he was appointed Chief Executive of Bunzl in 1991, a company that was at the time regarded as a collection of poor businesses. He set about reorganising the group and then embarked on driving growth; both organic and acquisitive. This resulted in a 34 fold increase in profits by the time he moved to Non-Executive Chairman in 2005. Sir Anthony went onto engineer similar recoveries as Chairman at two substantial companies; Whitbread and Reed Elsevier; now called RELX. Similar substantial share price outperformance followed. Sir Anthony recognised what made a good business operation and his great insight was to see that corporate success involved ruthlessly devoting time and resource solely to such units at the expense of all others. His checklist for the potential of a unit involved the level

of returns on capital, whether it was gaining or losing market share and whether its end market was growing or dying. The unit upon which he built the future of Bunzl on was a relatively small one involved in supplying low value consumables to supermarkets. The bulk of the rest of the businesses were sold. RELX was strongly positioned in scientific publishing and legal data and analytics. Its educational publishing unit and parts of its business information unit were sold. Immediately prior to his arrival, the prior management team had embarked on a substantial and therefore high risk acquisition of a business involving supplying risk information used by insurance companies. Sir Anthony saw the potential of the unit and decided to retain and support it to the extent he issued equity rather than rely on its sale proceeds to reduce debt. This unit has powered the growth of the company ever since. Whitbread was an example of poor practice before his arrival. It was originally a brewer which diversified into multiple areas including soft drinks, hotels, pubs, restaurants and even tennis clubs. Sir Anthony oversaw narrowing down to just two regarded as good; Premier Inns and Costa Coffee. Both subsequently thrived. Sir Anthony also acquired well, an important and rare capital allocation skill. His philosophy is that acquisitions can be used for added value but only to supplement plans that focus on organic growth. They work if management understand the business and understand the position of the company being acquired. Dangers arise if companies enter into acquisitions to mask a poorly performing core. His classic quote is that management should ‘ want acquisitions not need them’ . Around half of Bunzl’s growth was and is still based on acquiring small local competitors that can easily be absorbed into existing operations. I would like to thank Sir Anthony for the great service he has performed for British Industry and the lessons he has provided in corporate management and capital allocation. Reading Berkshire Hathaway – the early years. Warren Buffett delivered a rather subdued webcast in the first Saturday of May 2020 as the global lockdowns prevented the normal annual general meeting ‘celebration’ of Berkshire Hathaway. Although much has been written on Buffett, I find his own shareholder letters by far the most useful source of his ideas and approach. In his letter to shareholders for 2007 the following table is included:

These are the returns delivered by his investments over the periods and do not include operating earnings from wholly owned businesses. It can be clearly seen that as the company has got larger, annual growth in investment returns has fallen. The emphasis

switched more to fully owned subsidiaries as this occurred and the growth pattern there is the reverse of this. However, Buffett often comments that if he reverted to a much smaller asset base he would be able to repeat the growth of early Berkshire. Indeed, the growth for the years 1965-1979 was truly phenomenal at almost 43% p.a. In the period before the purchase of Berkshire Hathaway, Buffett produced similarly stellar returns for his partnership. A common pattern that attracted him was companies that were recycling capital from divisions that were mature or in decline to better investments (see Habgood above). Their valuations reflected the poor prospects of the former and took no account of the solidity of the latter. Whilst this did not pertain to Berkshire Hathaway when he purchased the same, he did I believe, recognise there was surplus capital tied up in land, buildings and inventory that could be converted into more productive investments. Berkshire’s textile operations were in long term decline and therefore capacity requirements were shrinking. This hidden value was not reflected in the purchase price. The letters from 1966 to 1977 provide detail. These reveal he was able to add to the capital inflow by initially investing, with control, in general insurance companies. Such companies invest their premiums in fixed income which, at the time, had significant yields – above 7% in 1970 (10 year US treasuries). This coincided with a period of underwriting profitability. He also purchased full control of a very well run bank: Illinois Bank and Trust Company generating high returns on equity which were paid up and recycled. Buffett only starts to detail the full investment portfolio from around 1976 and in 1977 it looked like this:

There are some interesting observations one can make:

• It is concentrated – securities issued by seven companies make up two thirds of the portfolio.

• An insurance company; GEICO, is the largest holding; he knew this well from his time with Ben Graham.

• Media is the largest (of three) sectors represented- this was a new growing industry with the opportunity for companies to build local monopolies (newspapers, local TV).

• None of these companies would be considered large at the time; Oil and manufacturing companies dominated the Dow Jones (DJI).

I would also observe that by this time, he had effectively gained his interest in See’s Candy via an investment in its parent company; Blue Chip stamps. Most of these companies are still significant: Capital Cities is now operating as part of ABC owned by Disney, GEICO is still owned by Berkshire but much larger, the advertising agency; Interpublic is quoted whilst Ogilvy and Mather is part of the advertising conglomerate; WPP and Washington Post is owned by Amazon. I draw several conclusions from this . Firstly, that when smaller, Buffett invested in less sizeable companies but was able to identify those with potential and longevity including in an emerging sector. Secondly, well managed financials, handled with care, can play an important role. Quality is absolutely tantamount, but the difficulty of the industry means they can be purchased near book and therefore the benefit of superior returns be gained almost immediately. Finally, the non-financials including his first foray into consumer staples, were asset light with intangible assets such as creativity, innovation and brands. These and other factors contributed to huge growth which, compounded over many years, brings us back to Warren now. Whilst troubled by the current unusual crisis, he can reflect with pride on his early years that set him on the path to the fortress like company he has today.

Please note that Chawton Global Investors LLP does not provide financial advice to private individuals. If you have any doubt whether the TB Chawton Global Equity Income Fund is suitable for you and you wish to receive advice you should contact a financial advisor. Before making an investment you should ensure that you have read and understood the relevant Key Investor Information document.

Full details of the TB Chawton Global Equity Income Fund including risk warnings, are published in the Prospectus and Supplementary Information document. Fund documents can be found at: http://www.tbaileyfs.co.uk/funds/tb-chawton-investment-funds.

Every effort is taken to ensure the accuracy of the data used in this document but no warranties are given.