First Quarter 2021
The Frank Value Fund Institutional Class returned 2.57% in Q1 2021 compared to 6.17% for the S&P 500 TR Index and 13.05% for the Russell Midcap Value Index. Please see the end of this letter for more performance information.
We are proud to announce that as of March 1, 2021, the Frank Value Fund has lowered fees by 10%. As disclosed in our most recent prospectus update, we lowered fees in response to asset growth. We are well-positioned to be a leader in active management in the next decade as passive, closet-indexed, and benchmarked strategies potentially inflict irreparable harm to their shareholders. Just as stock fundamentals matter in the long-term and ultimately drive performance, a lower expense ratio makes our absolute-value, active strategy better for everyone.
The Frank Value Fund increased its positioning in small, well-capitalized energy companies from 7.5% to over 10% with the addition of Civeo (NYSE: CVEO) in the first quarter. Civeo provides lodging and hospitality services in remote oil, pipeline, and mining locations in Canada, Australia, and the US. Unlike the major oil companies, who have added debt during the energy bust, Civeo has reduced its leverage by nearly 50% since 2018. Management is guiding $50 to $60 million of free cash flow in 2021 on a current market capitalization under $300 million. At this valuation, free cash flow could be used to repurchase 20% of the shares outstanding in just one year! Though immediate free cash flow will more likely be used to further reduce debt, it is clear the equity is dramatically undervalued. Furthermore, as the Canadian oil segment recovers, we expect Civeo to produce significantly more free cash flow. One of the major reasons for its current low valuation, lack of passive ownership, could cause the stock to remain undervalued until a larger buyer purchases the company outright, but our research indicates CVEO is worth multiples to the upside.
The “Big 3” passive investing firms appear nowhere on the list of top holders of Civeo. While this precludes the stock from getting “dumb” daily flows as investors contribute money into their indexed-401ks, we believe Civeo will be largely insulated when passive flows turn flat or negative. To highlight the absurdity, passive investors have driven stocks like Nvidia to a 1.4% FCF/EV yield. Compare this to Civeo’s 10.5% yield to see the madness embedded in passive. Should Nvidia’s free cash flow quadruple with no additional stock appreciation, the yield would then be 5.5% which is still half of Civeo’s! Analysts are expecting Nvidia revenue to grow 30% in 2021, followed by a slowing to 10% in 2022, making a 4x increase in free cash flow unlikely, while we expect Civeo’s cash flow to increase materially as room utilization rates increase as the oil market recovers. This will boost Civeo’s free cash flow yield further into attractive territory. As a reminder, passive completes zero fundamental analysis and only buys stocks in the index when investors are adding money to passive strategies.
We are staking our shareholders’ money in CVEO on two pillars: first, eventually a private equity fund or larger company will want Civeo’s cashflow, as it is available at much higher returns. If an institution acquires Civeo at a 5% FCF/EV yield, the equity would be worth $120 compared to current price of under $18, and that institution would still be making a better return on free cash flow than buying the S&P 500 at current levels. Our second principle is this: buying index companies like Nvidia at a 1% FCF yield is a colossal mistake only someone conducting no research could stomach. Here is a recent example of what happens when significant sellers overwhelm passive buyers:
As we have seen with recent high-profile blowups like the Archegos family office, when motivated sellers enter the markets, there is no liquidity at current prices. Recently, stocks like Viacom and Discovery Holdings (pictured above) suffered quick, 50% declines in their trading prices, and there are compelling reasons to believe the liquidity profile for the other companies in the S&P 500 are just as pitiful. Zero liquidity means stocks can take the staircase up to new highs, only to suffer the express elevator to the basement when sellers emerge. Passive holders are sitting atop a house of cards, marveling at their spectacular past performance. Nobody is prepared for what happens when passive becomes a net-seller – except us! When passive flows can no longer support the market, long-term financial plans will be experience downside shocks like the chart above. The prudent investor looking to preserve wealth needs to prepare for this. In the meantime, party-on, passive!
Measuring after the 30% decline in stocks in early 2020, US equities posted one of their best 12-month returns of all-time, marking perhaps the steepest and best recovery from a bear market ever. Retail traders burst into stocks in Q1, affecting parabolas in stocks like Gamestop ($50 to $400 and back in a few weeks) by using options and other derivatives, creating and destroying fortunes overnight. As mentioned, at the time of writing, the (institutional) $15 billion Archegos family office has lost everything thanks to leveraged derivatives positions in various stocks. “Free” trading apps like Robinhood have ignited a frenzy in a new generation of traders, none who have invested in markets like 2008 or 2000. The “investing idols” of the late 1990s tech bubble have passed the torch to brash, ballyhooed hucksters like Cathie Wood and Dave Portnoy, each now wielding ETFs ready to collect fees on those willing to forego reality-rooted fundamental analysis. If there are clearer psychological signs of a stock bubble, we are unaware of any historical comparisons. This time is different in this respect: this bubble is bigger, faster, and more leveraged than the other times, and it will most certainly end with permanently impaired 401ks and black marks on investing legends and institutions. As we shield our ears from the cacophony, we continue to shield our shareholders from poor expected returns by avoiding stocks trading at record levels across every valuation decile. Thankfully, while we await the bubble fallout, our portfolio businesses are performing well and rewarding shareholders.
Frank Value Fund holding Barrick Gold announced a special dividend of $0.42 per share to be paid in 2021, which at the current price is a yield of 2.0% in addition to the recurring 1.7% dividend. Barrick’s free cash flow grew an astounding 155% in Q4 20 compared to Q4 19, and management is rewarding shareholders and stockpiling cash on the balance sheet. For the first time in over 15 years, Barrick has more cash than debt on its books. Our other major gold miner, Newmont, raised its quarterly dividend from $0.40 in Q3 20 to $0.55 in Q4 20, an increase of 37.5%. This brings the yield on Newmont to nearly 4.0%. Finally, portfolio holding H&R Block announced it will complete a $600 million share repurchase by June 2022, which is about 20% of the company at current prices. H&R Block still boasts a 4.6% dividend at current prices. Investors are noticing and buying our holdings, while current price appreciation remains slower than the fundamental improvement. We believe our equities are poised for continued outsized returns.
Rates, Inflation, and Your Money
As interest rates in the United States increased rapidly in the first quarter, the financial media buzzed with talk of reflation, reopening, and money-printing. However, all long-term trends we follow support a return to deflation and lower rates in the US. First, many economic indicators provided by various government departments look year-over-year, meaning these reports compare April 2021 with April 2020 and so on. Since the US was in lockdown in April 2020, the one-year charts on nearly every indicator show explosive growth and inflation. Instead, the more prudent economists we read highlight longer-term trends, showing the US still suffering from all-time highs in government debt, with a job-market unable to coax idle workers back into the workforce thanks to generous government support programs. Government stimulus programs provide bursts of energy to the US economy, but they quickly fade. The economy will ultimately have to stand on its own, and considering government spending was 44% of GDP in 2020 compared to 36% in 2019, there is a large hole to fill when stimulus fades.
We expect the current administration to continue to float infrastructure and additional stimulus plans, but when the spending sprees stop or merely slow, GDP growth will stall or enter recession again. When this happens, rates will decline, and our bond positions will appreciate. Currently, as the market raises borrowing costs, we believe the Federal Reserve will eventually intervene by manipulating long-term rates lower, also benefitting our holdings. Our research still shows long-dated government bonds are a great hedge against aggressive monetary policy as well as elevated valuations in US stocks.
Stay Patient, Stay Sane, and Buy Value
Thankfully, we can find some stocks meeting our criteria. This is a nice change from the pre-Covid lack of opportunities. The bulk of our new positions have come from the Energy sector, which was the worst hit during March of 2020 – we purchased some of our positions at a 75% discount off their highs. Given the fragile liquidity at current valuations, we would be unsurprised to see similar meltdowns in other sectors. Frank Value Fund still has ample cash and wherewithal to become fully invested when opportunities arise. Until then, we are patient with our cash and pleased our bond positions offer protection against further monetary intervention.
Frank Value Fund Lead Portfolio Manager
|Performance as of 3/31/21||Total Return||
Average Annualized Total Returns
|YTD %||1 Yr. %||5 Yr. %||10 Yr. %||Since 7/21/04 %|
|Frank Value Fund*||2.57||18.40||3.08||6.11||6.39|
|Russell Midcap Value||13.05||73.76||11.60||11.06||10.03|
|S&P 500 Total Return||6.17||56.35||16.26||13.89||10.19|
Please see our website for distribution information. Performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted. You may obtain performance data current to the most recent month-end by calling the Fund at 1-888-217-5426 or visiting our website at www.frankfunds.com. Returns include reinvestment of any dividends and capital gain distributions.
Non-FDIC insured. May lose value. No bank guarantee. The Fund’s investment objectives, risks, charges and expenses must be considered carefully before investing. The prospectus contains this and other important information about the Fund, and it may be obtained by calling 1-888-217-5426. Please read it carefully before you invest or send money.
This publication does not constitute an offer or solicitation of any transaction in any securities. Any recommendation contained herein may not be suitable for all investors. Information contained in this publication has been obtained from sources we believe to be reliable, but cannot be guaranteed.
The information in this portfolio manager letter represents the opinions of the individual portfolio managers and is not intended to be a forecast of future events, a guarantee of future results or investment advice. Also, please note that any discussion of the Fund’s holdings, the Fund’s performance, and the portfolio managers’ views are as of April 12, 2021 and are subject to change without notice.