Ensemble Fund Investor Letter – Second Quarter 2019

17 July 2019 | by Ensemble Capital

Below is the Q2 2019 quarterly letter for the ENSEMBLE FUND (ENSBX)This quarter’s Company Focus is on Fastenal Co (FAST) and Starbucks Corp (SBUX). You can find historical Investor Communications HERE and information on how to invest HEREEnjoy!

Well it certainly has been an exciting first half of the year. It is amazing to think that just two quarters ago our letter focused on why we thought the market was already discounting a mild recession and it made sense for investors to stay long US equities. We appreciate your interest in hearing from us in good times and bad.

The performance of the Ensemble Fund (“the Fund”) this quarter was strong, showing the continued absolute and relative performance trends that we saw last quarter. The Fund was up 6.62% vs the S&P 500 up 4.30%. On a year-to-date basis, this brings the Fund up to 25.15% vs the S&P 500 up 18.54%.

As of June 30, 2019

2Q19 YTD 1 Year 3 Year Since Inception*
Ensemble Fund 6.62% 25.15% 11.72% 18.00% 13.30%
S&P 500 4.30% 18.54% 10.42% 14.19% 11.89%

*Inception Date: November 2, 2015

Performance data represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment in the Fund will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be higher or lower than the performance data quoted. Performance data current to the most recent month end are available on our website at www.EnsembleFund.com.

Fund Fees: No loads; 1% gross expense ratio.

The strength in the Fund during the quarter was driven by big moves from two of our largest positions with Broadridge (7.0% weight in portfolio) up 24% and Ferrari (7.1% weight in portfolio) up 22%. We also saw double digit gains from Starbucks (4.8% weight in portfolio), Mastercard (6.6% weight in portfolio), Trupanion (2.4% weight in portfolio) and Verisk (3.3% weight in portfolio). On the weaker side, Charles Schwab & Co (4.8% weight in portfolio) and First Republic (4.8% weight in portfolio) both declined as interest rates fell and Google (also known as Alphabet) (6.5% weight in portfolio) fell 8% as news broke that the company would be investigated by the Department of Justice on antitrust grounds.

Like most investors, we’ve spent a lot of time this year thinking about the ways in which a recession, and/or a heating up of the US-China trade war, might impact the economy and the companies in the Fund. However, at the same time we’ve advocated the idea that when it comes to recessions, the best approach is to invest in strong companies that will thrive coming out the other side of recessions rather than trying to guess when a recession is on the horizon and attempt to get out of weaker companies just in time. On the trade war, as much as we think what happens is quite important, we also think that a US-China trade war will likely be a key feature of the investment landscape for the next decade or more. So rather than trying to guess what short term changes might occur, we’re more focused on making sure we own companies that can navigate a shifting set of trade rules over the medium to long term.

But for all the focus on the trade war, when you look at the stocks that most influenced our performance, the trade war was not a material driver.

Broadridge, a service provider to banks and brokers, rallied 24% in the quarter as the company reported their third fiscal quarter and continued delivering the message that the quarterly misses of expectations that had occurred earlier in the year were due to timing issues, while their full year results continue to be on track. The stock has performed about in line with the market over the last nine months. But after hitting an all-time high last September, the stock sharply underperformed in the fourth quarter, dropping as much as 30% as investors got caught up in the optically weak quarterly reports. But as 2019 has worn on, it has become clear that the difficulties in quarterly results last year was entirely transient and was not at all an indication of a slowdown in the core business. This realization has led to the stock rallying 40% this year. While market overreactions to transitory issues are not always this dramatic and don’t always reverse so quickly, the decline and rebound due to the short time horizon of most investors offered us a great opportunity to add more shares during the weakness and then trim back our position after the huge, quick gains. While we are long term investors, we are also willing to opportunistically add to, or trim, our positions when market pricing swings as dramatically as it did recently with Broadridge.

Ferrari tacked on another 22% in gains after posting a 35% return in the first quarter. With the stock now up 64% this year Ferrari has been a big driver of our performance. But like Broadridge, part of these gains are a recovery of what we thought was an undeserved selloff in the fourth quarter of last year. In our view, the four quarter sell off was due to market worries about a recession and auto tariffs. But both of these concerns are misplaced. Ferrari is actually the most recession resistant of all car companies. This is because of the 18-month wait list to buy a Ferrari and the fact that people who have enough money to buy a Ferrari almost always still have enough money during a recession. And while Ferrari could be subject to auto tariffs, their buyers are not very price sensitive. We saw this dynamic at play last year when the company announced their Monza supercar would be sold at a price of “somewhere between $2 million and $3 million” and then promptly sold out before they ever revealed the final price. This dynamic of companies with strong pricing power having a weapon to offset the impact of tariffs is an important part of how we think investors should seek to insulate their portfolio from the very real risk of a prolonged US-China trade war.

The strong returns from Starbucks, Mastercard, Trupanion and Verisk were all related to these companies continuing to generate solid results. For many of our Fund holdings, it isn’t so much that we think they will generate surprisingly strong results relative to short term expectations. Instead, it is far more common that we simply think that the Fund holdings have such strong competitive advantages that they will resiliently bounce back from short term challenges and can continue to churn out solid results for far longer than the market gives them credit for. That’s why we are often most pleased by under the radar performers in the Fund that may not always be sexy and exciting, but which grind out results to be proud of for decades at a time. Later in the letter we’ll discuss Fastenal, a company that fits this description very well.

On the weaker side, we saw both First Republic and Charles Schwab & Co decline due to interest rates falling. Both companies generate a significant part of their earnings from their “net interest margin” or the spread between the rates they pay their clients for depositing cash with them vs the higher rate they earn from lending that money back out. Over the last quarter, not only have interest rates declined, but the yield curve has flattened or even inverted, meaning that there is little or even a negative spread between very short-term interest rates and longer-term rates. We are of the view that over the medium to long-term, the interest rate yield curve will be steeper, as it has typically been in the past, and that interest rates across the board will be higher. But we recognize that we could be wrong about this. Interest rates are not easy to forecast. However, one reason to only buy stocks when they appear cheap is because that cheapness can help offset weaker than expected financial performance.

In the case of First Republic, the company has long managed their interest rate risk in such a way as to make their net interest margin very stable, even during period of large changes in interest rate levels. They give up the opportunity to generate outsize returns during periods of attractive interest rates regimes, but they also protect themselves against tough environments like we see today. Charles Schwab & Co sees more volatility in their net interest margin, but the company has also proven themselves adept at figuring out multiple, alternative ways to monetize their customer relationships over the years. With both First Republic and Schwab winning tons of new customers in recent years, we know they are delivering on their value proposition. We believe that in both cases, the companies will generate significantly higher earnings in the future than they do today. But even if we are too optimistic in our interest rate outlook, we think both stocks are cheap enough today to perform just fine.




Investors should consider the investment objectives, risks, and charges and expenses of the Fund carefully before investing. The prospectus contains this and other information about the Fund. You may obtain a prospectus at www.EnsembleFund.com or by calling the transfer agent at 1-800-785-8165. The prospectus should be read carefully before investing.

An investment in the Fund is subject to investment risks, including the possible loss of the principal amount invested. There can be no assurance that the Fund will be successful in meeting its objectives. The Fund invests in common stocks which subjects investors to market risk. The Fund invests in small and mid-cap companies, which involve additional risks such as limited liquidity and greater volatility. The Fund invests in undervalued securities. Undervalued securities are, by definition, out of favor with investors, and there is no way to predict when, if ever, the securities may return to favor. The Fund may invest in foreign securities which involve greater volatility and political, economic and currency risks and differences in accounting methods. Investments in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities. More information about these risks and other risks can be found in the Fund’s prospectus. The Fund is a non-diversified fund and therefore may be subject to greater volatility than a more diversified investment.

Distributed by Rafferty Capital Markets, LLC Garden City, NY 11530.

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