Q2 21

Q2 21

Q2 21 Letter to Shareholders

Second Quarter 2021

The Frank Value Fund Institutional Class returned 3.57% in Q2 2021 compared to 8.55% for the S&P 500 TR Index and 5.66% for the Russell Midcap Value Index. Please see the end of this letter for more performance information.

New Energy Positions

Our research process is unearthing great opportunities in this challenging, record breaking, high valuation market. The foremost position of the fund is now in small energy companies. Collectively, these names represent 16% of our assets and offer the best upside/downside expected value in all the US stock market. Why are energy stocks attractive? There are two major forces. First is indexation. Thanks to underperformance of large energy companies and outperformance of large technology issues, energy now represents less than 3% of the S&P 500. Other indices like the Russell 2000 are also stuffed full of technology and even meme stock names like Gamestop and AMC. Energy is forgotten. The larger a weighting in an index, the more passive dollars a company receives. Technology, at 26% of the S&P 500, receives the bulk of every passive dollar while energy is virtually ignored. Our process avoids these dangerously overpriced tech companies and exploits the lack of research done by passive investors. The second force enabling us to take positions in energy stocks at attractive valuations is the institutional aversion to oil and gas companies due to pressures to appear environmentally enlightened. This is known as “ESG,” or Environmental, Social, Governance focused investing. This fad has driven electrical vehicle companies, many of which have no profits or could even be frauds, to incredible heights, while doing little to help the emerging global middle class and thus diminish the underlying global demand for oil and gas. One could even argue a focus on electrical vehicles increases harmful lithium and rare-earth metals mining and changes reliance to carbon intensive electricity sources like coal. In fact, underinvestment in oil exploration will most likely result in higher future oil prices, leaving less dollars available for investments in renewable energy.’

 

According to reports by both OPEC and the US EIA, global demand for oil will continue to increase over the next thirty years despite alternatives like solar and wind increasing share. Emerging markets like India and China comprise the bulk of this marginal demand for oil, as countries without the wealth of the United States or Europe have growing populations of upwardly mobile people who need the cheap and easy energy oil provides. Our small cap energy companies are in an enviable position where they are cash flow positive and have strong balance sheets, yet these positions are priced as if oil demand will disappear in a few years. Instead, our research indicates steady oil demand and significantly increasing cash flows resulting in stock prices with at least 100% upside and in some cases much more.

 

As such, in Q2 we added a position in a small hydraulic fracturing equipment company, potentially trading at 2x 2022’s EV/EBITDA, as well as increasing some of our existing energy positions. As a reminder, our maximum position size for a series of correlated companies is 20%. The last time we approached this limit was in 2009 when we bought large positions in healthcare, when those companies were trading with similar setups as energy is today. Our concentration in healthcare drove market-beating returns for years in the post financial crisis bull market. We believe energy will provide our shareholders with similar outsized returns.

New Dividend Position

As mentioned in previous letters, some dividend payers have been left out of the frenzy of passive investments. If the Big 3 passive firms employed stock analysts, even they might have seen the opportunity we found in the second quarter. However, passive only buys the index, making this opportunity just for our shareholders. The Frank Value Fund took a position in Coca-cola FEMSA (NYSE: KOF) the largest distributor of Coca-cola products in the world, which pays nearly a 5% dividend and trades around 5x EV/EBITDA. Compare that to Coca-cola Consolidated (NASDAQ: COKE), the US distributor of Coca-cola products, which has a 0.25% dividend and trades at 9x EV/EBITDA. Adding to the opportunity, KOF operates in Mexico and Brazil, faster-growing emerging markets where the company enjoys significantly higher margins than its US counterpart, COKE. What’s going on? If you guessed passive investing, you’ve been paying attention. COKE is 20% owned by the firehose of flows, the Big 3 passive firms. Because these firms continue to rake in dollars from 401k plans and investors suffering from FOMO, money continues to flow into COKE, driving the price higher and setting up for a valuation crash in the future. Coca-cola FEMSA, on the other hand, has large insider ownership, making it untenable for the float-focused passive world (insider ownership is excluded from shares available for trading, or float.) The Big 3 passive firms own less than 2% of KOF, potentially eliminating the downside from a passive shock. In the meantime, Frank Value Fund shareholders get paid a market-beating dividend while Coca-cola FEMSA’s largest markets of Mexico and Brazil boost profits further as they recover from COVID-19 demand shocks. Given the few attractive valuations left in the world today, we would be unsurprised should a large buyer attempt to buy-out all the public float of KOF at a significantly higher price.

The Road to Fully Invested

We have detailed two excellent opportunities in this letter, but the Frank Value Fund still maintains a large cash and US treasury position. During the second quarter we opportunistically increased our position in US treasuries that appreciate as long-term interest rates decline. While the whole investing world is focused on short-term inflation, we are confident in our research that shows the more intervention by the Federal Reserve, the lower interest rates will fall. In fact, despite CPI prints of greater than 4% in Q2, rates reversed the Q1 uptrend, with the US 30-year bond peaking at 2.4% and ending the quarter at 2.0%. This provided a source of return from our US treasuries, while continuing to protect against broad downside in stocks. Generally, when stocks decline, investors (and the Fed) ramp-up their purchases of US government bonds, thereby lowering interest rates. We sleep better knowing the fund can generate returns while also defending against the massive downside from record valuations in US stocks. Our confidence remains in our extensive research on passive investing, which concludes prices will continue to drift upwards with increased upward and downward volatility until valuations crash. By remaining in value stocks that produce cash and pay dividends, we will generate returns, and our cash plus US treasury positions enable us to take advantage of downward volatility when it occurs.

 

With passive beneficiaries technology and momentum stocks providing the “easy money” in the past few years, we have had to become much better investors and analysts. Knowing we are up against the juggernaut of the Big 3 passive firms has honed our research to a sharp point. We take advantage of the weaknesses of passive investing and central bank intervention rather than fighting them. Market manipulation never works in the long-term and the schemes of indexation and intervention will ultimately fail, but as the adage says, “the market can remain irrational longer than you can remain solvent.”  Instead of fighting irrationality, we believe we are adding significant diversification and value to portfolios by investing in the margins, finding contrarian, unloved, and obscure ideas, and applying the time-tested principles of value investing. The Frank Value Fund portfolio is the strongest it has been in years, and we are proud to serve our shareholders.

Sincerely,

Brian Frank

Frank Value Fund Lead Portfolio Manager

Performance as of 6/30/21 Total Return  

Average Annualized Total Returns

YTD % 1 Yr. % 5 Yr. % 10 Yr. % Since 7/21/04 %
Frank Value Fund* 7.79 13.47 4.09 6.25 6.60
Russell Midcap Value 19.45 53.06 11.79 11.75 10.23
S&P 500 Total Return 15.25 40.79 17.65 14.84 10.57

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 July 19, 2021 and are subject to change without notice.