The Frank Value Fund Institutional Class returned 13.10% in 2020 compared to 18.40% for the S&P 500 TR Index and 4.97% for the Russell Midcap Value Index. Please see the end of this letter for more performance information.
Large, uncomfortable changes marred 2020, and no, we are not counting our logo and color changes! From Zoom calls to worrying about the health of the most vulnerable, daily life became burdened with isolated drudgery. The US stock and bond markets initially panicked, focusing on deeper job losses than any other recession in US history. Happily for those stuck in risky portfolios, the US Federal Reserve rescued markets with their own brand of large, uncomfortable changes: outright intervention in the corporate bond market, cutting overnight rates to 0%, and ultimately pledging to keep rates below inflation for the foreseeable future. These policies have changed finance and proved our worries correct: Fed overreach has now added deflation and uncomfortably high inflation to the range of outcomes. Thankfully, we have prepared for this. The Frank Value Fund portfolio benefitted from our conservative positioning earlier in the year, and later, our new and existing holdings appreciated as investors adjusted their portfolios. Participants flocked to inflation and deflation protections, as well as beaten-down energy stocks, yet the crowd left us opportunities in select dividend-payers. Though the fund did not keep pace with the bubble in US stocks, we are pleased to deliver superior risk-adjusted performance. The fund’s peak drawdown in the last three years is -5.74% compared to -28.36% for the Morningstar Midcap Blend Category. You can see this and other information about the Frank Value Fund at our revamped website, www.frankfunds.com.
We are now in the largest stock market bubble of all time. We believe index investors will lose at least 50% of their money when the speculative frenzy recedes, severely damaging the retirement plans of anyone currently over the age of 50. Let’s look at some stats, what the Frank Value Fund is doing to protect capital, and potential scenarios for the endgame.
- According to Jeremy Grantham, a financial expert who correctly identified the stock market bubbles of 2000 and 2007 in real time:
- In 2020 there were 480 IPOs (including an incredible 248 SPACs,) more listings than the 406 IPOs in 2000.
- 150 companies with market caps greater than $250 million more than tripled in 2020, which is over 3 times as many as any year in the previous decade.
- Small retail call options purchases (less than 10 contracts) increased 8-fold compared to 2019.
- Research shows the current Marketcap / GDP ratio is over 190%, the highest of all-time.
- Using this indicator’s history, where high readings have always led to a low return over the following ten-years, index investors should expect a -2.8% return per year for the next ten years including dividends!
- Investors wholeheartedly believe in the “Fed Put” where the Federal Reserve can arrest any decline in stocks of the economy.
- Similar mentalities persisted in 1999 with the “Greenspan Put” and the 2007 “Bernanke Put.” In the end, the Fed could do nothing to stop the tech and housing bubbles from bursting.
Investing in the Largest Bubble of All-Time
Our belief is purveyors of passive products are doing their clients a disservice if they fail to disclose the abysmal returns indices have posted from similar levels throughout history. To our knowledge, none of the large players are publicizing a -2.8% expected 10-year annual return from these levels, yet history shows negative long-term returns have always resulted from valuations at, or even below, today’s levels. Nothing – not interest rates, fiscal or monetary intervention, inflation, or deflation, will allow assets to be permanently priced at these valuation levels. Despite all this historical evidence, investment advisors, brokers, and other financial intermediaries continue to recklessly market passive mutual funds and ETFs. If you have been a shareholder or a follower of the Frank Value Fund for any length of time, you should be confident in our discipline and adherence to our principles. Rather than hiding in a dark room and muttering about valuations, we have continued to follow our process, which has uncovered numerous excellent opportunities throughout the year. We are still positioned conservatively, as the passive bubble has engulfed nearly every stock, but there are pockets of opportunity that drove our performance in 2020 and have also added to our future expected returns.
The Fund started 2020 with a 0% allocation to energy companies but ended the year over 7.5%. Energy stocks were some of the worst hit in the March decline, and the Frank Value Fund initiated positions in three of the strongest balance sheets in the industry. Both oil supply and demand are highly uncertain, even with a vaccine on the horizon, but when your company has no debt, you can outlast your competition. Numerous energy companies are declaring chapter 11 bankruptcy, and instead of restructuring, liquidations result, permanently eliminating competitors. Those with high debt levels that are still solvent are drastically cutting their capital expenditures, ensuring oil supply will be scarce in the future. As a bonus, the S&P 500 is only 3% energy stocks, and due to the immense asset base and market cap of component issues, increasing energy to 6% of the S&P would result in multiples of upside in energy stocks.
A similar dynamic has already played out in gold and silver mining, with strong companies surviving a tough cycle and then reaping the rewards. The results were spectacular for Frank Value Fund holdings. Demand for gold in 2020 came from central banks and other large institutions looking to protect themselves against increases in money supplies around the globe. Meanwhile, since industry capital expenditures for gold discoveries has dropped in recent years, lower supply and increased demand drove gold prices higher which caused cashflow windfalls for gold miners. Free cash flow at Newmont Mining, one of the Frank Value Fund’s largest holdings, more than doubled in 2020, while the stock price was “only” up about 75%. Quarterly dividends also increased from 14 to 40 cents or 185%. The current dividend yield is over 2.5% which is about 40% higher than the dividend on the S&P 500 index. Newmont has plenty of room for more stock appreciation, dividend increases, and continued cash flow. Compared to the average S&P 500 valuation, Frank Value Fund gold miners are still extremely undervalued. As the frenzy for technology stocks raged in late 2020, opportunities also arose in select dividend-paying companies.
The Frank Value Fund added a position in H&R Block (NYSE: HRB) in the fourth quarter. At our average buy price, the dividend yield is over 6%. Comparing this to yields today, as well as the company’s history of a dividend between roughly 2% and 4%, HRB is attractively priced. Besides the high-dividend and low-valuation, our research focused on the company’s new approach. The board hired Jeffry Jones as CEO in 2018, and Jones has moved franchises from promotional activities to brand and relationship building. H&R Block acquired Wave Financial, a software-as-a-service bookkeeping company that will expand scope and customer acquisition. H&R Block will build out its tax relationships and add small business accounting and consulting, instead of offering the promotions and gimmicks of years past. Meanwhile, Jones kept tax preparation fees flat for several years for both in-person and do-it-yourself products, while competitor Turbo Tax aggressively raised prices. H&R Block is now cheaper to use than its competition and has room to raise prices in 2021 when tax returns filed are expected to be flat to down. We are confident this new approach for H&R Block will resume revenue growth and increase profitability. Should that occur, the stock could trade at a premium to its historical ranges, and more in-line with the S&P 500. Meanwhile, our shareholders get paid over 6% in dividends to wait. Opportunities like this are still scarce but adding just a few will benefit shareholders while we wait for sanity to return. We are always on the hunt for more.
How Bubbles End
When will the madness end? Wall Street, with its insatiable greed for fees, is accelerating the endgame by increasing the supply of equities. As mentioned above, the number of IPOs and SPACs (and fees!) are exploding higher. Each of these newly public companies absorbs demand for stocks while creating future needs for additional capital through negative cash flows. Eventually the music stops, just like in 1999-2000, when a deluge of IPOs soaked up all the speculative capital. Adding to the speculators’ coffers are US stimulus payments, but we believe these payments are ultimately deflationary as they are financed by government debt.
Stimulus checks are clearly popular with Americans, but these payments also accelerate the end of the everything-bubble. Most of these checks are being spent on consumer goods and other items that do not produce cashflow. Since the US government is running a deficit, payments to citizens must be financed by debt. Essentially, the US government is buying groceries, rent-payments, electronics, furniture, and other non-cash producing, depreciating assets with debt that requires interest payments indefinitely. This is inflationary over the short-term and deflationary over the medium and long-term. Eventually these payments end, and the inflation and economic growth will disappear. Neither inflation nor deflation are good for asset prices!
As interest rates rise in 2021, we notice asset prices failing to build on their highs. Rising interest rates mean asset prices deserve to decrease because higher rates increase financing costs. This means more company cashflow going to interest payments instead of shareholders. Additionally, with record amounts of corporate debt outstanding, higher interest payments increase default risk. A small rise in interest rates on a large pile of debt means big payments! Looking at it from a bond-buyers perspective, increases in interest rates lower the value of debt. Simply, when a bond’s interest rate goes up, the bond’s price goes down. All outstanding corporate and government debts are held by someone, whether a bank, an institution, or a private individual. Declining values over this heap of debt create collateral issues and other deflationary effects. To balance investment portfolios, institutions may sell equities to buy more bonds. The equity selling is also deflationary! You can see how a system burdened with so much debt is extremely fragile. Rates at zero are bad because it encourages speculation with deflationary risks. Rates going up are bad because it causes defaults and bond deflation. It’s a trap! With the ballooning of the Fed’s balance sheet and money supply, when does inflation come in to play?
Once an uncomfortable amount of deflation exists, central banks panic and start buying the falling debt with newly created money. What we saw in March 2020 was just a glimpse of how afraid and aggressive central bankers are when it comes to deflating debt values. We believe the Fed will eventually control yields on the longer-dated US bonds, as well as asking Congressional approval for direct Federal Reserve spending in the US economy. The Fed potentially creating money to buy risk assets is inflationary, and if the Fed’s balance sheet is declared spending money, wild inflation will terrorize the United States. Therefore, our belief is deflation causes inflation. Either way, these scenarios destroy the “Goldilocks” low-inflation environment the US has been enjoying since 2009. Fed actions in 2020 knocked Goldilocks out cold in her porridge. This shift boosted the Frank Value Fund portfolio and we are prepared for the next steps.
History shows deflation and inflation are unkind to stock valuations. The global financial crisis of 2008 was deflation in action, and stocks plummeted to levels more than 66% lower than today. The double-digit inflation in the 1970s also caused a decline in stock valuations, with a P/E near 10x compared to over 30x today. Just note, a decline from a 30x P/E to 10x is also 66% lower. Thus, you can share in our disbelief when investors cheer interest rates rising as inflationary and reflective of a strong economy. Understand debt to protect your portfolio.
For now, we are content watching how far the rockets can rise before they run out of fuel. We are pleased to generate an acceptable return in 2020, but we are prouder of how little drawdown the Frank Value Fund suffered in the first quarter, especially when compared to our peers and the market averages. We believe March 2020 was just a test-run. Eventually the Fed will lose control and a painful reset will result. The Frank Value Fund is positioned to minimize pain from a return to normal but also invested in companies that can generate returns while we wait. 2020 finally moved the game to where we had been positioned, and we are eager to continue creating value for our shareholders through opportunistic investing and informed protection from the Federal Reserve and other speculators.
Frank Value Fund Lead Portfolio Manager
|Performance as of 12/31/20||Total Return||
Average Annualized Total Returns
|YTD||1 Yr. %||5 Yr. %||10 Yr. %||Since 7/21/04 %|
|Frank Value Fund*||13.10||13.10||3.20||6.70||6.32*|
|Russell Midcap Value||4.97||4.97||9.73||10.49|
|S&P 500 Total Return||18.40||18.40||15.18||13.86||9.95|
* Represents an estimate based on the performance of the Fund’s Institutional share class, adjusted for fees.
Please see our website for distribution information: www.frankfunds.com/distribution-history. 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 January 11, 2020 and are subject to change without notice.