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Chou's straight talk is more reassuring than feel-good reports

00:00 EDT Thursday, September 02, 2004   

The purpose of those fancy annual reports your mutual fund company sends you is to make you feel good about your choice of money manager.

The usual fund company annual report can be summed up as saying: We have the strategy, we have the expertise and we have the experience. If things aren't working out right now, don't worry because they will.

There are exceptions to this pattern of vacuity and when you come across one, the impulse is to savour it because it's unique. Example: the annual and semi-annual reports from Chou Associates Management.

Widely respected by those who really know mutual funds, the Chou family is all but invisible to most fund investors because it does no marketing and pays only negligible commissions to investment advisers. Adding to the Chou fund family's obscurity is the fact that you need $10,000 to open an account.

You buy into the Chou family for the outstanding long-term consistency of manager Francis Chou (full disclosure: I'm a unitholder). You'll find your choice of fund family is validated when you read the firm's annual reports, but not in the same way as most other fund families.

On plain white paper, Mr. Chou gives you straight, unvarnished talk about his results, the markets and the business of running a fund. By comparison, most standard fund industry annual reports have the feel and depth of insight you usually see in new car brochures.

Mistakes, Mr. Chou's made a few. What's more, he'll tell you about them. In the annual report issued in April, Mr. Chou talked about a misadventure in buying the subordinate debt of a distressed company called Fleming Cos. for the Chou Associates fund. "In retrospect, we clearly overestimated management's ability to restructure its debt obligations," Mr. Chou wrote. "The move cost the fund roughly 3.5 per cent."

Mr. Chou also examined a broader strategic shortcoming of his, which is to be too inflexible on the price he pays for a stock. "When we examine our past mistakes, we find that we have lost a lot more by missing or buying an insignificant amount of a stock, because we would not pay a dime more for an obvious bargain, than by buying a stock that has gone down substantially from our purchase price."

Take a moment to think about how often you've read about a regular fund company talk about its missteps. Most times, you'll find the Kremlin under Stalin was more forthcoming.

The long-term results of the two older Chou funds, Chou RRSP and Chou Associates, are excellent. Chou RRSP, the firm's second-largest fund with a paltry $136-million in assets, has a 10-year compound average return of 17.6 per cent, while the average Canadian equity fund made 8.3 per cent.

If you're a unitholder expecting an encore performance in the next 10 years, Mr. Chou has a corrective dose of cold water that shames the typical fund company's delicate attempts to keep unitholder expectations in check.

He explains in the April annual report that the stock market is not cheap as measured by common valuation methods such as price-earnings ratio and premium to book value. Whereas he could find undervalued sectors when the markets peaked four years ago, now he finds all sectors overvalued. Money can still be made, he added, but there are major risks.

"We feel it would also be irresponsible to extrapolate the fund's three-, five- and 10-year return into the future," Mr. Chou writes. "Those returns will be virtually impossible to duplicate over the next 10 years."

Mr. Chou was a little less gloomy in his semi-annual report issued recently, but he also cautioned unitholders that he will not chase stocks to keep the fund's numbers comparable to those of the benchmark stock indexes. In fact, Mr. Chou makes it clear that he is at least as concerned with protecting capital as he is with boosting it.

"If given a choice . . . we would prefer to lose half of our unitholders rather than half of our unitholders' money," he writes.

The Chou fund family's annual reports accomplish exactly what mainstream companies set out to do in their own documents, which is to make unitholders feel they've made a wise choice. The difference is that Chou does it with forthrightness, while the other companies do it with salesmanship.



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