April 8, 2020
Dear Fellow Shareholders:
The longest economic expansion in US history, along with one of its longest bull markets, has come to an abrupt end. Its early demise wasn’t due to overheating or a bursting credit bubble, but the introduction of a particularly contagious and severe virus to the human species. SARS-CoV-2, better known as the coronavirus and its resulting disease, COVID-19, has thrown our world into a crisis.
Lethal respiratory viruses have been with us at least as long as domesticated animals. The 1918 flu epidemic was a global catastrophe and killed tens of millions; coronavirus will almost certainly take fewer lives. But what we haven’t seen before is the impact of a serious pandemic on a modern economy, one that is more interconnected, service-oriented, and mobile—and thus more fragile in certain ways—than the one a hundred years ago.
No one, including us, knows for sure what’s going to happen next, but there are few things that we feel relatively confident about:
- The economy is in a standstill, which some describe akin to a medically induced coma to save a dying patient. The estimates vary widely, but the economy will likely contract by roughly 25–35%, though the exact amount almost doesn’t matter. It’s bad, really, really bad. There has been nothing like it in American history.
- There will eventually be an effective vaccine. It could take two years before it’s widely administered, but the overriding scientific consensus is that we’ll get there. Scientists regularly create vaccines for similar viruses, and there’s nothing uniquely challenging about this virus’s structure that suggests that won’t happen here. Almost the entire world’s scientific community is focused on solving this as quickly as possible.
- Once enough people are vaccinated to achieve herd immunity and the virus fades away, things will look pretty similar to the way they did before. Sure, governments will be more prepared for the next pandemic, people may use more hand sanitizer or wear face masks more often, and this will be a generational-defining event for our culture, similar to 9/11. But people will travel again, eat at restaurants again, and go about their daily lives.
What we don’t know is what the world will look like between now and then. We know that things won’t be completely normal. The current sheltering restrictions will ease up a bit when new cases peak and warmer weather possibly helps slow the virus’s spread, but the restrictions won’t go away completely. As of now, it doesn’t look like this coronavirus will mutate quickly into a “mild” version and dissipate like flu viruses tend to do, and as long as there is a disease reservoir somewhere and no vaccine anywhere, we are likely to see recurring resurgences across different geographies. The virus seems to be especially contagious in large, enclosed groups, so it’s hard to see church services, concerts, cruises, and sporting events (at least with fans in the stands) returning to full force. Restaurants could open, but tables may have to be spaced six feet apart. Schools, historically one of the main vectors of infectious disease transmission, may not reopen for a long time. Commuting to work could resume, but international leisure plane travel might be unthinkable. We don’t really know.
Our main concern is how the global economy will be affected if this purgatory extends for a long time. If it’s only a few months, even a very sharp cessation of economic activity wouldn’t do much lasting damage. You could think of it as an unexpected, unpleasant, and unpaid vacation. If we discovered a therapy soon that could hold down the fort while we trial a vaccine, this could happen. But if the pandemic and on-again-and-off-again lockdown measures persist for a while, small and medium businesses will fall apart en masse, and all that organizational capital vanishes. That doesn’t get put back together easily. New restaurants and autobody shops would eventually replace the shuttered ones, but that rebooting process would be long and messy. Government programs will help, but unlike in financial crises, the organizations in need are far too disparate to help as effectively.
This could be a painful but short experience or a long, difficult one, and we’re uncertain as to which one it will be. We are not going to try to time when the stock market will recover; we don’t think that’s possible. We are going to avoid companies that might not make it through a prolonged downturn. We are going to take advantage of large drops in the market to buy companies that will do well in either scenario and are attractively priced. We’ve already added two, S&P Global and UnitedHealth, which we describe below. We are going to adjust our portfolio as the market fluctuations create better opportunities. Almost all of our holdings are hurt by this, but we do expect most of them to make it through just fine while maintaining—and in some cases expanding—their competitive positions. Google’s advertising revenue will be hit, but will recover just fine. Internet usage will keep growing, and businesses need to get in front of those users. Union Pacific’s rail traffic will come back at some point, and in the meantime, no one is going to build another railroad. Visa and Mastercard will process fewer transactions in the coming months than we would have hoped at the beginning of the year, but the transition from cash to card is only accelerating. Our goal over the next few months is to find more of these types of businesses at compelling prices when the market offers them up.
Total Returns as of March 31, 2020
| 1st Quarter | 1 Year | Annualized 3 Years | Annualized 5 Years | Annualized Since 9/30/10 Inception | |
| Bretton Fund | –22.25% | –7.52% | 5.76% | 4.96% | 9.27% |
| S&P 500 Index | –19.60% | –6.98% | 5.10% | 6.73% | 11.28% |
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. Current performance may be lower or higher than the performance data quoted. You may obtain performance data current to the most recent month-end here or by calling 800.231.2901.
All returns include change in share prices, reinvestment of any dividends, and capital gains distributions. The index shown is a broad-based, unmanaged index commonly used to measure performance of US stocks. The index does not incur expenses and is not available for investment. The fund’s expense ratio is 1.35%.The fund’s principal underwriter is Rafferty Capital Markets, LLC.
Contributors to Performance
We underperformed in the quarter, returning –22.25% versus –19.60% for the S&P 500, mostly because of our bank investments, which were the biggest hit to the fund. Bank of America had a –2.3% impact, followed by Wells Fargo at –2.2% and JPMorgan Chase –1.9%. The banks will see an increase in loan defaults, though they are well capitalized for that. The bigger concern is the near-zero rates that look like they will last a while. NVR’s impact was –1.8%, and Carter’s –1.8%. They will see sharp revenue declines, but we expect the coronavirus to have little long-term impact on houses or baby clothes.
The only bright spots in the quarter were Progressive, which added 0.3% to performance, and new holding S&P Global, which also added 0.3%, as we bought on a market dip.
Portfolio
| Security | % of Net Assets |
| Alphabet, Inc. | 9.9% |
| Mastercard, Inc. | 6.8% |
| Union Pacific Corp. | 6.5% |
| The Progressive Corporation | 6.1% |
| Microsoft Corporation | 5.7% |
| Ross Stores, Inc. | 6.0% |
| Visa, Inc. | 5.6% |
| The TJX Companies, Inc. | 4.9% |
| Canadian Pacific Railway Limited | 4.9% |
| NVR, Inc. | 4.6% |
| AutoZone, Inc. | 4.4% |
| Bank of America Corp. | 4.3% |
| American Express Co. | 4.2% |
| JPMorgan Chase & Co. | 4.1% |
| Berkshire Hathaway, Inc. | 4.1% |
| Carter’s, Inc. | 3.3% |
| Wells Fargo & Company | 3.1% |
| S&P Global, Inc. | 2.9% |
| UnitedHealth Group Incorporated | 2.5% |
| Discovery, Inc. | 2.3% |
| Armanino Foods of Distinction, Inc. | 1.8% |
| Cash* | 2.4% |
*Cash represents cash and cash equivalents less liabilities in excess of other assets.
We exited Continental Building Products in the quarter as its acquisition by Saint-Gobain finalized in February. Our total return was 50.2%, 18.5% on an annualized basis.
S&P Global
S&P Global is a financial information conglomerate comprised of four businesses, each of which participates in a tight oligopoly:
- Ratings. A bit less than half of S&P’s revenue comes from the ratings business, a wonderful example of mission creep. Founded at the dawn of the Civil War as a source of unbiased information for railroad debt investors, S&P (along with rivals Moody’s and Fitch) became a critical source of ratings for companies looking to sell debt. As corporate debt has exploded, fewer and fewer investors have had the time to analyze specific offerings, and the entire debt investing landscape has become fully dependent on the major firms’ ratings. If companies do not pay for a S&P rating, they cannot access the investor base that relies on S&P ratings—which is the overwhelming majority of the investor base, including pension funds and the Federal Reserve. Crucially, the companies need to continue to pay to maintain the rating. That reinforcing dynamic makes it tough for new entrants to break in; indeed, the core three players have remained unchanged for over a hundred years.
- Indices. The most lucrative part of the business, S&P Dow Jones takes a royalty from every fund looking to access its indices, including the various permutations of its most famous index, the S&P 500. This business has grown rapidly, and unlike the ratings business where more business requires more work, the index business scales astonishingly well.
- Platts. The major source for commodities information (e.g., oil prices, Platts both publishes price indices and provides consulting services.
- Market Intelligence. The business formerly known as Capital IQ, Market Intelligence is a financial information platform that sells data to capital markets participants, similar to Bloomberg and Refinitiv.
S&P Global has many of the attributes of what we look for in great businesses: a long runway of growth combined with a structural competitive advantage. It’s slightly more expensive than our typical acquisition, but the downturn gave us a compelling buying opportunity.
UnitedHealth
UnitedHealth is the behemoth of the American healthcare system, generating $240 billion in revenue from services that touch more than one in three Americans. Readers who follow American politics may be aware that healthcare payment is handled differently in the US than in other developed countries, and a brief overview is useful to understanding UnitedHealth’s role.
Contrary to popular assumptions, developed countries have widely varying healthcare systems, even within Europe. The UK has a single, public provider; Canada and Taiwan have a single payer but private providers; Germany and the Netherlands have private insurance; France and Australia have blended systems of basic single payer and broad supplemental insurance. The US has elements of each of these systems: a single provider (Veterans Administration), a single payer (Medicare), private insurance, and blended gap coverage.
What distinguishes the US from other systems is that doctors and hospitals are free to set prices as they wish. Providers (e.g., doctors, hospitals) typically earn about 50% more in the US than in other countries. The counterbalance to this situation is that American healthcare features the concept of “networks.” A payer (e.g., an insurance company, Medicare) contracts with doctors to accept a specified rate, and either will not pay at all for services rendered outside this network or will only pay its own contracted rate, leaving the patient exposed to the difference. Note that these are intimately linked: a system of unlimited pricing authority can only survive if the payer can reject payment.
Providers have a perishable resource—their time—and like other vendors of perishable resources, such as airlines and hotels, they often sell the same product at different prices to different people. Many doctors will see Medicaid patients at a very low Medicaid rate, Medicare patients at the modest Medicare rate, and commercially insured patients at a high rate. Patients with commercial insurance will be offered more attractive appointment times; Medicaid patients will find only the slots the doctor would not otherwise be able to fill.
UnitedHealth uses its role as the broadest, highest quality network to have a leadership position providing “administrative services only” services to large, self-insured customers. These large industrial concerns do not need someone else to bear the financial risk of health insurance, but they do need someone to manage a network and process claims. Over 19 million Americans get their health coverage through UnitedHealth in this fashion. Another 8.5 million receive coverage through small- to medium-sized business insurance where UnitedHealth bears the financial risk of claims.
Beyond these customers, about 15.5 million Americans who are enrolled in government health plans actually work with UnitedHealth, split relatively evenly between Medicare Advantage (where the government pays UnitedHealth and UnitedHealth pays members’ expenses), Medicaid (similar concept, except the federal government pays the states and the states pay the carriers), and Medicare supplemental insurance, where someone has traditional fee-for-service Medicare and then uses UnitedHealth (co-branded with AARP) to address uncovered expenses.
UnitedHealthcare also operates two non-insurance businesses under the “Optum” umbrella: , a pharmacy benefits manager, and OptumHealth/OptumInsight, which provide health analytics. The pharmacy benefits business may be the most Byzantine niche of the healthcare system, and it thrives on the high rebates paid by drug manufacturers that want high list prices for their drugs. Regulation will eventually dig into this profit pool. OptumHealth and OptumInsight are fantastically profitable, growing vendors of health information and analytics.
Investing in a health insurance business during the largest pandemic in a century may seem odd, but we think the impacts will be transitory. One one hand, health insurers benefit from the direct impact of the coronavirus: expensive elective procedures have been canceled as medical system capacity is repurposed to care for the virus. On the other hand, the negative impact to UnitedHealth is the significant job loss created by the ensuing recession. We expect large corporate employment to hold up better than small business, and Medicare and Medicaid will add subscribers. At $250/share, we own UnitedHealthcare for about 15 times its earnings and about a 7% free cash flow yield.
As always, thank you for investing, especially in these volatile times.
Stephen Dodson Raphael de Balmann
Portfolio Manager Portfolio Manager