Half-year letter 2H2023

Theme and Background

This chapter is the first part of Azvalor’s second-half 2023 investor letter, reviewing the fund’s annual performance, analyzing the market environment and valuation starting point, and identifying three major market risks. The report emphasizes the non-linear nature of equity returns and, based on the fund’s trading price-to-intrinsic value ratio (approximately 55%), expects future long-term annualized returns between +10% and +20%.

Core Views

• Current valuation starting point determines future returns: The fund trades at approximately 55% of its value, a level historically corresponding to long-term annualized returns above +10% but below +20%.
• Equity return distribution is highly non-linear: Over the past 150 years, the S&P 500’s real annualized average has been +6/7%, but 36% of the time it posted losses, 44% of the time it saw double-digit gains, and only 20% of the time did it approach the mean.
• Market consensus poses three major risks: The AI boom echoes the internet bubble (NASDAQ once fell 80%), index investing appears diversified but is actually concentrated (the top 7 S&P 500 weights approach 30% with elevated valuations), and economic vulnerability rises exponentially when developed economies’ public debt-to-GDP exceeds 100%.

Key Arguments and Data

1. Historical Returns and Valuation Relationship

Valuation Level (Fund Price/Value)	Scenario at the Time	Realized Real Annualized Return
70% (June 2007)	Market peak	Below +10%
30% (2009 low/COVID low)	Market panic	Above +20%
55% (Current, end of 2023)	Discounted state	Expected +10% to +20%

2. S&P 500 150-Year Return Distribution

Return Range	Probability of Occurrence
Loss (negative return)	36%
Double-digit gain (≥+10%)	44%
Close to long-term annualized average (+6/7%)	20%

3. Quantification of Three Major Risks

• AI Boom: The internet changed the world in the late 1990s, but the NASDAQ index plummeted 80%, requiring 15 years for buyers to break even.
• Index Concentration: The top 7 companies in the S&P 500 account for nearly 30% of the weight (e.g., Apple, Microsoft, Google, Amazon), with elevated valuations.
• Debt/GDP: When developed economies’ debt ratio exceeds 100%, the economic vulnerability index rises exponentially, a risk not yet fully priced by the market.

4. Azvalor Iberia

• Net asset value grew +13% in the second half of 2023, with current potential return (price/value gap) at 80%.

5. Azvalor Managers

• Portfolio companies subject to acquisitions total 18, portfolio P/E is 8x, free cash flow yield is 18%, and the discount to the market is 65%.

Companies/Assets Involved

Fund Name	Mentioned Holdings Changes or New Additions	Role/Key Data
Azvalor Iberia	Main holdings: Tubacex, Técnicas Reunidas, Prosegur Cash; Positive contributors: Tubacex, Elecnor; Drags: Técnicas Reunidas, Prosegur Cash	Potential 80%, NAV +13%
Azvalor Internacional	New additions: Imperial Tobacco, Vale, Mobico Group; Main holdings: Barrick Gold, NOV, Endeavour Mining	Potential 92%, NAV +10.1%
Azvalor Blue Chips	New additions: Whitehaven Coal, Mobico Group; Main holdings: Barrick Gold, Noble, Tullow Oil	Potential 89%, NAV +9.6%
Azvalor Managers	New managers: 3D Capital, SouthernSun, FountainCap (Hong Kong, investing in 35-40 Chinese companies)	Cumulative return +51.6%, Portfolio P/E 8x, FCF Yield 18%
Azvalor International Sicav Lux	New addition: Tenaris, sold Vale; Positive contributor: JD Wetherspoon	Potential 95%, NAV -0.02% (Benchmark +4.24%)

Additionally, the report notes that from March 2003 to the end of 2023, patient investors saw returns grow 13x (annualized +13%), experiencing two 50% declines along the way.

Investment Implications

• Current valuation implies high returns but requires enduring volatility: With a fund price/value ratio of 55%, expected long-term annualized returns are +10% to +20%, but returns are non-linear, and investors should mentally prepare for a 36% probability of losses.
• Beware of three major market risks: AI bubble, index investment concentration, and high debt vulnerability. Azvalor hedges through deep stock selection and discounted purchases, but the market as a whole has not priced these risks.
• Specific directions: Azvalor Iberia has the highest potential at 80%, followed by Azvalor International SICAV Lux at 95%, though the latter underperformed its benchmark in the second half of 2023. The portfolio is concentrated in natural resource stocks like Barrick Gold, NOV, and Tullow Oil, benefiting from inflation and supply constraints; the newly added Chinese manager FountainCap positions in discounted Chinese assets.
• Avoid chasing trendy indices or AI concepts: Focus on buying discounted companies rather than following the index.

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Theme and Background

This chapter serves as the concluding section of the report, containing only acknowledgments to investors, an invitation for investor relations, and two technical footnotes on internal valuation models. This section does not involve any investment analysis, market judgment, or company discussion.

Core Viewpoint

None. The original text does not contain any investment thesis.

Key Arguments and Data

None. The original text only mentions that the valuation calculation method is "the difference between the estimated value of the underlying assets in the investment portfolio and the current market price," without providing any specific figures.

Companies/Assets Involved

None.

Investment Implications

None. This section is a compliance closing statement and offers no insights for investment decisions.