This shareholder letter is part of the Bretton Fund 2012 Semiannual Report. Here’s the full report (pdf).

August 17, 2012

Dear Fellow Shareholders:

The Bretton Fund’s net asset value per share (NAV) as of June 30, 2012, was $19.19, and the total return for the fund for the quarter was 1.21%. Over the same period of time, the total return for the S&P 500 Index was -2.75%, and the total return for the Wilshire 5000 Total Market Index was -3.13%.

The fund’s returns over the past year continue to compare favorably to the overall market and other equity mutual funds, with Lipper again ranking, based on total return, the fund’s performance of 17.31% for the one year ending June 30, 2012, as #1 out of the 299 funds it categorizes as “multi-cap value.” The average multi-cap value fund returned -2.47% over the same period of time.

Total Returns as of June 30, 2012

2nd Quarter1 YearSince Inception -
Annualized (A)
Bretton Fund1.21%17.31%15.88%
S&P 500 Index (B)-2.75%5.45%12.98%
Wilshire 5000 Total Market Index (C)-3.13%3.96%12.59%

(A) Since Inception returns include change in share prices, and in each case, include reinvestment of any dividends and capital gain distributions. The inception date of the Bretton Fund was September 30, 2010.

(B) The S&P 500 is a broad market-weighted average dominated by blue-chip stocks and is an unmanaged group of stocks whose composition is different from the Fund.

(C) The Wilshire 5000 Total Market Index is a market-capitalization-weighted index of the market value of all stocks actively traded in the United States.

Performance data quoted represents past performance. Past performance 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. All returns include change in share prices, reinvestment of any dividends, and capital gains distributions. Current performance may be lower or higher than the performance data quoted. Indices shown are broad-based, unmanaged indices commonly used to measure performance of US stocks. These indices do not incur expenses and are not available for investment. You may obtain performance data current to the most recent month-end here or by calling 800.231.2901. The fund’s expense ratio is 1.50%. An investment in the fund is subject to investment risks, including the possible loss of the principal amount invested.

Contributors to Performance

The largest impact on the fund’s performance was JP Morgan Chase & Co., which took 1.1% off the fund’s NAV when its stock price dropped 28% during the quarter. The bank estimates, at the most recent and unfinished tallying, it lost $5.8 billion in a series of botched trades on the creditworthiness of various large companies.

Oddly, the trading group responsible for the losses had as part of its mandate the goal of protecting the bank from losses if large companies defaulted on their loans. The traders of this previously obscure group typically accomplished this by buying agreements, basically insurance policies, that paid out if certain companies stopped paying their loans. The thinking was that because JP Morgan’s core business of making loans exposes the company to losses when companies default, it made sense to buy some protection in the event that a lot of them defaulted at the same time. All of this seems reasonable enough, but the devil hides in the details. The $5.8 billion (and counting) snafu started early in the year when top company managers deemed they had too many of these agreements, the costs of which can add up if companies do not end up defaulting, and ordered these positions trimmed. Instead of just selling their positions, the traders, whose motivations and thought processes are as yet unknown to the public, engaged in further trades that they believed offset their prior ones, essentially hoping that the new trades would balance out the existing ones. But these agreements were too complicated, too numerous, and the two sides weren’t perfect mirror images of each other. When that became clear to JP Morgan senior managers, it was too late. The positions were too complex and too large to be wound down gracefully with minimal losses.

This is exactly the type of thing that terrifies bank investors. The trading operations of banks are like mysterious black boxes that either spit out or suck in money. I’d prefer if JP Morgan kept its trading to a minimum, but considering Bretton Fund owns 0.0001% of the outstanding shares, our influence is somewhat limited. Yet, put the loss in perspective: Six billion dollars, give or take a few hundred million, is real money, but it’s what the rest of JP Morgan typically earns in a couple months before taxes. I.e., the biggest trading loss in JP Morgan’s history, a mistake CEO Jamie Dimon called “egregious,” cost the company only two months of profits. Its core engine of earnings has not been impaired.

The risk to us is that the trading losses are a sign of excessive risk-taking and/or a harbinger of further, larger losses. That’s possible, but from what I understand of management and the rest of the business, I believe future trading losses will pale compared to its other earnings. I’m not predicting that JP Morgan won’t incur an even larger loss in the future; I am predicting that the income from the rest of JP Morgan—the interest from its loans, the fees for its services—are so significant compared to even a major trading loss that I believe investors will do quite well over the next few years considering how low its stock price is.


Security% of Net Assets
Ross Stores, Inc.11.3%
The Gap, Inc.10.5%
CSX Corp.8.3%
Aflac, Inc.7.6%
Norfolk Southern Corp.5.1%
Carteru2019s, Inc.4.8%
Wells Fargo & Company4.6%
American Express Co.4.5%
JP Morgan Chase & Co.4.2%
New Resource Bank4.0%
Union Pacific Corp.3.9%
CapitalSource, Inc.3.3%
SI Financial Group, Inc.2.8%
Standard Financial Corp.2.7%
Peoples Federal Bancshares, Inc.2.6%
Apollo Group, Inc.2.5%

*Cash represents cash equivalents less liabilities in excess of other assets.

For another quarter, the fund neither added nor eliminated any companies from the portfolio. We continue to sit on our hands (and cash) until something overwhelmingly compelling comes along. In the meantime, I’ll keep turning over rocks.

“How about tech stocks?”

I started my career as a junior investment banker arranging financings for telecom service providers, followed by a stint in venture capital, investing in early-stage technology companies. I’ve programmed in Java and built websites (including I live in San Francisco, and a meaningful number of my friends and contacts work in technology, including some at Facebook, Apple, Netflix, and Google; others have started tech and Internet companies.

Now, given this background and potential comparative advantage over the typical mutual fund manager, one might think the fund would have significant technology investments. Yet, the fund doesn’t own any, and you could even say the fund—with investments in railroads, banks, and retailers—looks like it’s run by a 19th-century robber baron.

Why would I not invest in tech companies given my familiarity? It’s because of my familiarity with technology that I don’t, at least not at current prices. My reasons:

  • Tech companies are going public later than they used to, leaving less growth for public investors. Greater regulation has made going public less attractive, and venture capitalists with larger funds can provide any needed interim financing. Apple went public at a valuation of under $1 billion; Facebook went public at over $100 billion.
  • Shareholder-centric companies in general are hard to find, but they’re even rarer in technology. Some seem to view their public shareholders less as partners and more as dumping grounds for employee stock options, and some take an almost hostile stance to shareholders, constantly diluting shareholders with stock issuances for acquisitions and options, or unilaterally cutting shareholders’ rights after going public. There’s often a greater motivation by management to work on cool stuff and being perceived as a “hot” company. Sometimes this can translate into shareholder value; but sometimes it doesn’t.
  • A huge percentage of publicly traded tech companies, probably most, don’t have competitive advantages that last very long. Especially among makers of low-end hardware, there are scores of companies that don’t earn their cost of capital, having to constantly spend enormous amounts of money just to stay afloat from obsolescence. The forces of creative destruction are more powerful in tech and happen on a compressed timeline.

    Due to low switching costs and rapid change, startups often have an inherent advantage over incumbents, and there are plenty of smart, motivated entrepreneurs, with access to capital, who take advantage of this. A friend of mine and fellow investor puts it this way: “If you were tinkering in your backyard and came up with a clearly better bleach, it would take you forever to take a bite out of Clorox. If you came up with some sort of super search engine that had, say, 10% better results—better being defined as ‘I just found what I was looking for when I typed in my search’—my guess is you’d have a third of the search-engine market within two years. It tips immediately.”

    There are only a few tech companies whose entrenched positions give them a structural advantage. Few of the leading tech companies of 1990 were leaders in 2000, and the same thing happened from 2000 to 2010.

  • All that being said, there are some truly outstanding tech companies, businesses with wonderful growth prospects, thoughtful management, and entrenched advantages. The problem is everyone knows it. Their great prospects are obvious, and their share prices reflect that. I’ve found the best investments come from either companies with nonobvious growth prospects (e.g., Ross, Union Pacific) or distressed situations (e.g., JP Morgan, Wells Fargo). I’d love to buy Apple at the price of RIM, but that opportunity isn’t available right now.
  • Most important, it’s hard for me to predict with precision what earnings will be years from now. It may be a safe bet that Apple will sell more iPhones and iPads five years from now, but what will the average price be? The first iPod sold for $400, and today I can get a much better iPod from Apple for $130 and a pretty good one for $50. Verizon Wireless, AT&T, and Sprint currently subsidize the cost of the iPhone, resulting in an out-of-pocket price to customers of around $300, but it’s not certain they’ll continue to do that. Would Apple sell as many phones if consumers had to pay the full $750 price? Would more people then buy older models instead of the new ones, or maybe buy new models less frequently? Would Apple reduce its prices?

    Maybe; I don’t really know. And that’s the important thing to recognize. Investing more than almost anything else comes down to being good about knowing what you have the ability to predict and what you don’t. I may have a greater than average familiarity with tech companies, but that doesn’t mean it’s a sufficient level of knowledge to be investing people’s money in them. I’m more confident predicting rail traffic will grow at roughly the same rate as the economy and prices will increase a few percentage points each year. I have greater confidence the new stores Ross opens up in Illinois and eventually New York will look like the ones in California. Some of the technology companies I look at today will turn out to generate exceptional returns for their investors. I’m just not sure which ones.

A Little More Press

Reuters’s Beth Pinsker Gladstone interviewed me and two other fund managers with strong recent performance about possible market volatility this summer and the opportunity it would create:

As the summer wears on, however, all are ready to dive into other tech stocks, or whatever company presents itself as an opportunity.

“If there is a catastrophe or major market pullback, it will be a good thing,” Dodson said. “It’s in those market panics that you can find the best opportunities.”

No one knows if there will be a major stock crash this summer. I know we’ll try to take advantage of it if that happens.

Thank you for investing,

Stephen J. Dodson
Bretton Capital Management