1. Zadig Quarterly Letter #27
September 28, 2012
The Manager’s Comment
Over the last quarter Zadig was up 4.8% whereas currency with all 27 countries reshaped into regions?
European markets, measured by the BE500 Index, were The answer is not financial: Europe Ltd is sound
up 7.1%. financially. But the vested interest of local politicians and
the rigidity of the cost of the welfare state make Zadig
Is debt expensive or equity cheap? 10 year Euro generic cautious about the future of the Euro currency. Our
government bonds currently yield 1.4%, whereas most portfolio is constructed to be resilient if the Euro were to
equities in our portfolio offer a Cash Flow Yield of 8% at collapse. Let's hope for all of us that the scary
current share prices. Pernod-Ricard for instance, with consequences of the Euro break-up will bring about
great international brands (Chivas, Absolut, Martell, courage, not austerity, that German idea for preserving
etc.) has 10 year debt yielding 3.5% whereas its Equity their investment in the Euro. Zadig has gone short in
Cash Flow Yield is 7.0%, 2x higher. This quarter, we several industrial companies which compete globally but
added Bic to the portfolio in order to increase our suffer structural cost disadvantage in sectors ranging
exposure to the Americas. Bic is typical of what we like from auto, capital goods and chemicals. Those will be
today: low valuation, defensive, growing thanks to tackled by Europe’s structural issues and should keep
geographical reach (less than 7% sales in France), pricing under performing until Europe reforms.
power to hedge inflation and conservative family
ownership. In the early 80s, investors bought equities for Zadig went to Greece three times in the last year on the
capital appreciation and they purchased government lookout for distressed investment opportunities. We
paper bonds for yield. Today it is the opposite. only found Folli-Follie, a retailer with stores mainly in
Asia, with high enough Risk Adjusted upside. In Greece
Zadig has sold its luxury stocks, mainly PPR and Swatch. the working population in public administration and
The Chinese real estate affordability ratio is today in defense is the same as it was in 2004 when none of us
excess of 10x (30x in Hong Kong, world capital for knew about the country's faults, and stands at 1 million.
luxury consumption). Paris, capital of luxury creation, is For comparison, Austria has a population of 9 million
at 12x. This compares to 3x in the USA and 5x in compared to 11 million in Greece, but only 300,000
Europe. Chinese banks have 10% of their assets as Equity public workers for a GDP 40% higher than Greece. The
capital. With 20% of their books in property, Chinese number of Greek public sector workers is up 4x from its
real estate could turn into a bubble. If it were to burst, 1981 level, when Greece joined the European Union.
the luxury industry (like contemporary arts and fine European money went into boosting the politicians'
wines), as second derivatives of real estate prices, would troops of public servants. With a working population of
collapse. 5 million, of which 25% are unemployed, the number of
people in private jobs is less than 3 million, only 25% of
At Zadig we have experience with property bubbles. Our the total population; this is similar to France where
journey took us through a Spanish housing frenzy. We Zadig is short some government related businesses. The
are still short Sacyr in Spain. Spanish construction and "47 percent on the tape" debate started by Mr. Romney
real estate loans grew from 10% of GDP in 1992 to 43% in the USA should go live in Europe.
in 2008, when Sacyr's share price reached 40 EUR, today
it trades at 2 EUR. The guilty party was politically In the words of the Austrian economist Ludwig Von
accountable, i.e. non-accountable: the Cajas. Those Mises: "The supporters of the welfare state are utterly
quasi-public sector banks went from 10% in 1962 to anti-social and intolerant zealots. For their ideology
nearly half of the Spanish loan book. Those banks are to tacitly implies that the government will exactly execute
blame for the credit bubble which led to Spanish what they themselves deem right and beneficial" and
unemployment rate jumping from 8% to 25%, and a instead advocate free market economy where the captain
dramatic 50% for those under 25 years old. A lost is the consumer. He wrote in 1929, long before the Euro
generation due to the non-accountability of the 20th existed: "There is no means of avoiding the final collapse
century's monster: the welfare state. of a boom brought about by credit expansion. The
alternative is only whether the crisis should come
The Euro crisis continues whilst new "E" names keep sooner, as the result of a voluntary abandonment of
popping up: EFSF, ESM, etc. As if these new infants further credit expansion, or later as a final and total
could help the ECB, the Euro currency and the European catastrophe of the currency system involved". His Liberal
construction. The answer to the problem remains views could move the economic debate into the 21th
political: do we want to build one Europe around one century over those of Keynes from the past 20th.
“This document is purely for informative purposes, and does not represent an offer or an invitation to
invest. All subscriptions must be made on the basis of the Funds issue Offering Memorandum or
Prospectus in effect at the time of the subscription. Past performance cannot guarantee future
performance in any way. Despite the fact that great care has gone into creating this document, errors
or omissions cannot be ruled out. Zadig Gestion (Luxembourg) S.A. accepts no responsibility in terms
of the full and accurate nature of the information contained in this document.”