Fund Manager Monthly Report - March 2015
View the latest portfolio and market commentaries from our range of fund managers.
Aberdeen Asset Management (Asia) - Hugh Young
In March, the fund gained 4.61% in sterling terms, marginally underperforming the FTSE World – Asia Pacific Index’s 4.64% gain.
The underweight to China was one of the main reasons for relative underperformance. The rally in Chinese stocks was, in our view, not supported by improving fundamentals, but hopes of looser monetary policy in response to a substantially slowing economy. In terms of stock selection, our core holding China Mobile lagged on concerns over weak mobile revenue growth and average revenue-per-user trends. We remain positive about the company as there is potential upside from the sharing of tower assets with other domestic telcos and further monetisation of its 4G subscriber base. Furthermore, the stock’s valuation remains cheaper than regional peers. PetroChina also lagged as weak crude prices continued to dampen sentiment. Its recent results met expectations; the disappointment arose from the view that capital expenditure reduction for 2015 did not go far enough.
Where we added value was stock selection in Japan. Robot maker Fanuc plans to better engage investors by setting up a shareholder relations department, something that management is just starting to focus on. The decision was made in the wake of the government’s new corporate governance rules. Furthermore, the company is considering returning more cash to shareholders from its ample reserves. Retailer Seven & i was lifted by hopes that consumer spending might pick up on wage rises and lower oil prices. Canon’s share price did well on expectations that the camera market has bottomed.
Aberdeen Asset Management – Jamie Cumming
In March, the fund gained 1.54%, trailing the benchmark’s return of 2.51%, largely owing to negative currency impact and stock selection in Brazil.
Vale and BHP Billiton were among the fund’s weakest performers as the iron ore price touched new lows. However, both miners continue to streamline their assets to focus on their core businesses. Shares of Brazilian lender Banco Bradesco also underperformed in tandem with the local benchmark. Sentiment in Brazil was weighed down by expectations of a recession this year and the unfolding Petrobras corruption scandal.
Conversely, Japanese robot maker Fanuc was a key contributor to performance. Its shares rose after management announced plans to set up a shareholder relations department in the wake of the government’s new corporate governance rules. We welcome the company’s efforts to better engage investors. Standard Chartered also aided relative performance as investors acknowledged the bank’s efforts to restructure and refocus its business, as well as its series of top management changes.
In portfolio activity, we introduced TJX Companies, a US-based discount apparel and home goods retailer. Supported by a robust balance sheet, the business is well-positioned to further expand its footprint domestically and across Europe. Against this, we sold UK utility company Centrica, owing to increased regulatory and political interference. We also added to BG Group and pared Jones Lang LaSalle on valuation grounds.
Artemis Investment Management – Adrian Frost & Adrian Gosden
UK & International Income
Equity markets were becalmed in March with volatility confined to fretting about the timing and scale of rate rises and the prospects for the oil price. We regard the former as not particularly material to longer term equity prospects as our current view is that interest rate rises are likely to be measured and miniscule. The oil price is of more significance because whilst the trading range is unpredictable, the fact that the price seems to be “capped out” at a materially lower level than last June is likely to be an enduring positive. With that in mind, we used periods of strength to sell the remainder of our BG Group holding and to make a further reduction in Shell. Other than that transactions were just increments or reductions to existing holdings.
A number of commentators feel that the UK market ought to be taking fright (flight?) in the face of electoral uncertainty. Undeniably there are some stocks and sectors with a degree of specific risk but the international nature of the UK markets is a constant source of forgetfulness.
Artisan – Dan O’Keefe & David Samra
Global Managed & Global Unit Trust
The MSCI All Country World Index declined 0.4% in March (all returns in local terms, unless otherwise noted). On the surface, it was the US market that dragged down the index, falling 1.5% compared to a gain in Europe and Japan of 1.3% and 1.9%, respectively. While the weakness in European currencies was particularly acute in March, this is a trend that has been playing out globally since the middle of last year. Since June 2014, the euro has devalued 27%, the Japanese yen has weakened 18% and the British pound has declined 15% (all versus the US dollar).
Among the largest contributors to performance during the month were Samsung Electronics and Arch Capital Group. Samsung shares rose 6.2% on optimism around the launch of the Galaxy S®6, the company’s new high-end smartphone. There was no company-specific news that drove the 4.1% increase in Arch shares.
Among the largest detractors from performance this month were Royal Bank of Scotland (RBS) and Applied Materials. RBS declined 7.4% after the company announced further restructuring—including plans to significantly shrink the size of its investment bank. The new plan should allow the bank to release large amounts of excess capital that is currently supporting the investment bank, and accelerate the company’s transformation into a simpler and highly valuable retail and commercial banking franchise. We believe that the shares, which are priced at a discount to tangible book, represent an excellent value. There was no company-specific news that drove the 9.9% decline in the shares of Applied Materials.
We made no new investments during the month, and exited our position in TSB Banking Group after it announced an agreement to be acquired by Banco de Sabadell at a price above our estimate of intrinsic value.
We continue to find valuations generally unattractive, and therefore our cash positions remain near their maximum levels. In times like this, it is paramount for investors to resist the urge to “do something”—adjusting their investment discipline (consciously or unconsciously) to the market environment. Our investment process is focused on identifying undervalued securities based on a bottom-up evaluation of business quality, balance sheet and management. In the absence of investment opportunities that meet these criteria, we are perfectly happy to be patient and wait.
AXA Framlington – George Luckraft
Diversified Income & Allshare Income Unit Trust
Equity markets weakened during March led by the commodity based sectors. The portfolio benefitted by being underweight in these areas. In addition good rises in stocks such as Hilton Foods, Clarkson, Cineworld and HellermanTyton helped performance.
During the month new holdings were purchased in Eurocell and VPC Speciality Finance. The holding of Game Digital was sold while those of Cineworld and Redefine were reduced after good share price rises.
The UK election will dominate the market in the short term. Whatever the result interest rates should remain at a very low level for a sustained period which will mean that investors will continue to seek income producing assets.
Babson Capital – Zak Summerscale
International Corporate Bond
March was a tale of two halves for global senior secured bonds, with the market ending the month effectively where it started albeit with some intra-month movements. The first half of March saw high yield soften due to increased volatility in the price of oil and the equity markets, combined with heavy primary supply and retail money outflows. This trend was reversed in the latter half of the month as more stability returned to markets, and global senior secured bonds bounced back from their mid-month low. As we moved through March, a firm bid for the Energy sector resurfaced as oil prices started trending upwards. Also, U.S. interest rate rises are expected to be delayed, which boosted high yield assets. These factors coupled with retail inflows accelerating and primary market supply subsiding contributed to the end of the month recovery.
New issue volume remained strong over the first quarter as issuers continued to take advantage of favourable market technicals. In Europe, senior secured bond issuance was healthy, with in excess of 45% of European issuance year-to-date falling into this category. High yield issuance in the U.S. continued to be driven by M&A activity, whereas Europe saw refinancings taking a more active role, especially during March. We expect the level of primary issuance to remain robust, with the demand for high yield assets overall contributing to a positive technical environment. The top portfolio contributors for March included names such as Heinz, an American food processing company; and Takko, a German fashion retailer. Negative contributors during March included names such as Vue Cinemas, a UK-based cinema chain; and Essar Steel Algoma, a Canadian integrated primary steel producer.
The European high yield market outperformed the U.S. in March, with Quantitative Easing providing a positive tailwind for risk assets in Europe. With the benign rate environment in the U.S. combined with global corporate balance sheets remaining in good health, we would expect global senior secured bonds to remain an attractive investment option in the current low-yield environment. As such, the SJP International Corporate Bond Fund will continue to take advantage of primary and selective secondary market opportunities, ensuring a diversified combination of robust senior secured credits with attractive yield profiles.
BlackRock – Luke Chappell
UK & General Progressive
UK equities rose during the first quarter as the European Central Bank’s programme of quantitative easing (QE) improved investor confidence coupled with positive economic surprise in European economic indicators. In the US, data continue to show reassuring economic growth, although there are some signs that growth is moderating. Divergence in central bank policy has impacted currencies with dollar strength and euro weakness. Lower oil prices have led to capital spending plans within the oil sector being revised lower, whilst evidence of a boost to consumer spending has been mixed.
The Fund began 2015 with positive relative performance driven by holdings in Shire, which delivered strong revenue growth and beat market profit expectations and Wolseley, given its significant exposure to the stronger US economy and currency. Sky rose despite paying significantly more than expected to secure the majority of the 2016-2019 English Premier League broadcast rights, whilst easyJet upgraded its profit forecast for its half year to 31 March due to favourable short term currency movements and “yield” improvement and reaffirmed its intention to further increase capacity.
The main detractors to fund performance included Johnson Matthey, which fell following concerns around the impact of lower oil prices on its process technologies business and miner Rio Tinto, which announced strong results, but underperformed as a result of the continued fall in iron ore prices. Not owning GlaxoSmithKline hurt relative performance as the shares outperformed. The group completed the complex series of transactions with Novartis, which saw Glaxo sell its oncology business and add to its existing operations in Consumer Healthcare and Vaccines.
US economic activity remains strong, in contrast to Europe where activity remains subdued. The announcement of QE in Europe has improved investor sentiment, but evidence of its real economic impact is not yet visible and we see a divergence of monetary policy between Europe and the US in 2015. In addition to the timing of interest rate increases in the US and UK, the uncertainty surrounding the number of potential outcomes of the General Election may provide a further source of volatility for UK equities.
Inflation expectations are expected to remain modest aided by a lower oil price, whilst economic growth in the US, UK and Asia and the potential for recovery in Europe, is a positive backdrop for corporate earnings and equity valuations.
In this environment we continue to focus more on the specific drivers of individual companies and the ability to determine their future rather than relying on a specific macro outcome.
BlackRock – Nigel Ridge
UK Absolute Return
The anticipated policy divergence between US tightening and European QE was supplemented by unexpected rate cuts by a number of emerging markets nations. The most notable economic improvement was somewhat surprisingly seen in Europe given the aforementioned QE. This helped drive eurozone equities significantly higher. Elsewhere, the US dollar continued to strengthen and a bounce in the oil price reflected the ongoing level of uncertainty in the energy complex.
The Fund made a very encouraging start to the year with gains seen in March comfortably over-riding initial weakness. These gains have primarily come from a number of core long-term positions with stock specific news flow contributing to the return rather more than any macro-level dynamics. Short positions have detracted overall with the pair book making little impact. Our long-term core holding in Essentra was the largest contributor to returns where the company comfortably beat earnings expectations supporting our confidence in management to deliver further progress across the business. Notable gains also came from Betfair in the consumer services space. Shares in the online betting exchange platform have enjoyed significant gains as the business momentum continues with investment into marketing spend translating into good customer traction. UK Food Retailers have remained in the headlines and a short position in the industry was the largest detractor in the period. Following a slightly better than expected Christmas trading period, shares in the listed supermarkets experienced some respite even though like for like sales growth remains negative. We believe there is more pain ahead for the sector arising from the long term structural changes in consumer behaviour. A further short in a technology company also detracted with shares benefitting from a buyback programme despite weak operating results being announced in the period.
The net exposure was held within a 15% to 25% range over the period with gross exposure operating between 120% and 132%. Attention is increasingly shifting towards the first interest rate rise in the US, expected in the summer, and the UK General Election. While a number of equity markets have hit new highs, bond yields in many markets are pointing to a period of deflation and central bank deposit rates creep further into negative territory. The advantage of an absolute return strategy is the ability to deliver a return stream from equities that is largely independent of the level of the equity market. The investment backdrop continues to support the SJP Absolute Return Fund’s fundamental bottom up approach targeting exactly that.
First State – Jonathan Asante
Global Emerging Markets
We continue to try to find good quality companies at prices that will allow us to make a reasonable return over the long-term, not an easy task at the moment given current valuations in many stock markets.
At a stock level, Chubb Corp (US: Financials) performed well due to continued momentum from positive results across commercial, personal and special insurance. Markel (US: Financials), a speciality insurer which continues to be managed sensibly and conservatively, performed well. Standard Bank (South Africa: Financials) climbed as it announced good results from its African operations.
On the negative side, Tiger Brands (South Africa: Consumer Staples) declined as the operating environment remained difficult and Tullow Oil (UK: Energy) fell as the weak oil price forced the company to cut capital expenditure. Unilever (UK: Consumer Staples) was lacklustre on no particular news.
Invesco Perpetual – Paul Read & Paul Causer
March was a challenging month for high yield corporate bond investors, with yields in aggregate higher than the previous month end. The key event was the start of the European Central Bank’s (ECB) Quantitative Easing (QE) programme. Between its announcement and implementation in early March corporate bond markets in general tended to rally. However, post its implementation there has been some profit taking resulting in higher yields by month end. This pattern of returns was more pronounced in bonds that have a low sensitivity to interest rate changes, with bonds of the lowest credit quality underperforming the most.
Data from Merrill Lynch showed the European Currency High Yield bond market returning 0.1% with BB bonds returning 0.1% and CCC and below -1.3%. European investment grade corporates returned 0.0%. Peripheral European sovereigns benefitted from the ECB’s bond purchases with both Italian and Spanish sovereigns returning 1.1%. (All returns sterling hedged.) Supply in European high yield was active with Barclays estimating issuance of €14.3bn, a factor which put further upward pressure on yields.
In terms of positioning we are defensive. Our exposure is skewed toward higher quality, well established high yield issuers. Many of our holdings are in the financial sector, which we think have the type of defensive qualities we are seeking while still achieving a reasonable level of yield. The fund also has a sizable allocation to liquid assets, including cash as well as short dated securities. This positions the fund to react quickly as market opportunities arise. We also hold sizable positions in peripheral Europe as we seek to benefit from a further tightening of the yield spread over German Bunds.
In a busier month of trading we bought new issues in HSBC 6.375% 31/12/49 (Bank), Obrascon 5.5% 15/03/23 (Construction) and Valeant 4.5% 15/05/23 (Pharmaceuticals). We also added to our exposure in the AA PLC by participating in its new 5.5% 31/07/22 issue (Service). We continued to take profits from our position in EDF 5.875% 22/07/49 (Energy).
Invesco Perpetual – GTR team
During March, performance for the fund was marginally negative. In the interest rates space, our Japanese curve flattener idea performed well as the low yield available on near-term government debt was encouraging local pension companies and foreign investors to buy higher yielding, long-term debt. Our long position in Swedish government debt relative to the Eurozone also moved into profit for the month after the Riksbank announced a surprise interest rate cut and an expanded bond buying programme. This move also led us to close out the idea. In addition, despite some weakness in the second half of the month, US dollar strength against the euro and Canadian dollar boosted returns. On the downside, the same US dollar strength proved a headwind for US large cap stocks, which underperformed compared to more domestically focused small cap stocks, going against an idea we have in the portfolio preferring US large cap stocks over their small cap peers. The perceived potential for interest rate rises in the US saw emerging market (EM) debt sell-off during the month, hurting our selective EM debt idea.
J O Hambro – John Wood
UK & General Progressive
There is a generally accepted view that central banks printing money is fantastic for financial assets but that the withdrawal of monetary stimulus is not. The actions of the European Central Bank have, in recent months, prompted a reflex reaction by investors, with money pouring into European bonds and equities. In contrast, the timing of the inevitable rise in US interest rates is debated endlessly, the view being that it will be bad for financial assets. Indeed, given the role of the US dollar as the global reserve currency, it will be bad for ALL financial assets, regardless of their geographic location. A debate then usually ensues as to where the ripples of the rising interest rate policy will cause most damage: emerging market debt and equities, corporate bonds, 'bond proxy' equities, etc.
There is, then, seemingly a general acceptance that a financial tsunami is coming. But, for now at least, the investment community appears happy to slap on the sun cream and soak up the last rays of sunshine.
At a fundamental investment level, the "party past midnight" mentality is represented by investors clamour for shareholder returns via dividends and buy-backs, regardless of whether these are covered by earnings and cash flows. This has led investors to demand distribution over investment in the companies. A recent report by Citigroup strategists argued that 2014 saw a recession-like cut in corporate investment but a boom-time increase in shareholder pay-outs. For UK companies, the authors calculated that in 2014 investment fell by 9% yet shareholder distributions rose by 17%. Rising uncovered dividends unsupported by investment to protect (and grow) the long-term value of a business is a disaster waiting to happen.
We are leaving the sun cream behind and heading for higher ground. We will return to the beach to trawl through the wreckage after the financial tsunami has done its damage.
Loomis Sayles – Kenneth Buntrock
Investment Grade Corporate Bond
Economic activity remains sound; growth could be somewhat above potential in 2015.The rate-hike cycle due to start this year has been priced out by many. Inflation has fallen well under the BoE's targeted 2% given oil prices. Our house expectation is for one hike (from current 0.50% policy rate to 0.75%) in the next twelve months. Monetary conditions are set to remain loose, until inflation and wage growth take hold. Housing cooled during the second half of 2014 and is not currently an outsized risk to the economy. We are mindful of risks and volatility around the May 7th elections. Although, we expect the BoE to begin raising rates in the next 12 months, we are not looking for dramatic rate increases and should remain a rate friendly environment for corporations. Desynchronized recoveries among major economies should cause the global economic recovery to be more drawn out, and keep inflation low.
After posting strong returns in January 2015, UK Corporate bonds reversed course in February. However, both investment grade and high yield issues outperformed UK Gilts on a duration-matched basis as the yield curve faced upward pressure and yields reverted close to where we started the year on lower demand for safety and improving inflation expectations. We have a favourable outlook towards spreads. In fact, the recent spread widening has largely been a buying opportunity, in areas where credit fundamentals are supportive. There are risks to this view due to changes in US Federal Reserve and Bank of England hiking plans, oil price volatility (especially to low side), EU concerns, and decelerating revenue and margin growth.
An overweight allocation to Corporate bonds added value as the segment outpaced quasi-government issues. The underweight exposure to the Financial sector detracted in terms of relative performance as the industry has been relatively resilient in 2015. Selections among banking names contributed to perform well, as did those from Services and Media. Perpetual bond spreads tightened throughout the month, which had a material impact on relative results.
The UK Gilts curve saw yields across the belly to the long end of the curve. While we maintain a neutral to benchmark duration, there was modest underperformance from slight mismatches in select key rate buckets in the longer end.
Majedie – James de Uphaugh
UK Growth & UK & General Progressive
Your portfolios outperformed a falling market during March, returning -0.3% vs an index of -1.7%, despite the FTSE 100 momentarily breaking through the 7,000 barrier for the first time.
The positive economic data being recorded at home and in Europe has been countered by signs of the US economy cooling, uncertainty remains over Greece’s future in the EU and Russia has renewed its aggression in Ukraine. All this, coupled with an election round the corner, makes for jittery markets.
We have been increasing our exposure to the UK banking sector over the quarter, where we feel stronger, leaner businesses are emerging, with a clear line of sight to generating attractive returns, with good dividend potential. However, RBS announced poor results in February, which were generally not well received, despite the fact that these are a backward looking measure and, to us, there are clear signs – job cuts and a reduction in investment banking activities – that point to a management team which is making progress. This was the major detractor during the month, although Bus and Rail operator First Group continued to struggle in the face of further contract losses and widespread investor apathy, and so also detracted from performance.
On a positive front, companies benefiting from the increase in economic activity gave your portfolios the greatest boost. Marks and Spencer continues to be rewarded for its stock management restructuring and has rectified its online woes; clothing sales are even on the rise! Carnival, too, has seen its share price re-rate as, led by a new CEO, it recovers from a series of cruise disasters and benefits from a much reduced fuel bill. Ryanair is another beneficiary of the low oil price and favourable sentiment from the sell side.
In terms of portfolio activity, we have recently been adding to HSBC, a stock we have eschewed in recent years due to its emerging market exposure. The regulator has forced many of HSBC’s competitors to retrench to their core or traditional businesses, leaving the bank as one of the few genuinely global players, and now trading on an attractive valuation.
Your portfolios continue to see evidence of a consumer-led recovery in Europe, and are positioned accordingly, with an eye on the potential for a sell-off in US equities and a continuing slowdown in China.
Majedie – Chris Read
Your portfolio produced a return of -0.2% in March, outperforming the FTSE All-Share index fall of 1.7%.
The largest driver of performance during the month was our holding in TSB which received a bid approach from the Spanish bank Sabadell. The bid was well received by the market with the share price increasing nearly 30%. We have since sold out of the position of the back of the increase. Our position in Man Group was also a big contributor to performance as the turnaround story there continued to play out.
The negative side was dotted with a few commodity companies including Rio Tinto and Vedanta. Rio Tinto posted a negative return at a time when the iron ore price weakened and despite being the lowest cost producer in its industry the share price suffered. We feel the company has a strong balance sheet with a management that is committed to delivering dividends to investors; it remains one of our top ten positions. We hold Vedanta because of the operational improvements we see in the business and despite weak performance this month we believe the operational turnaround is gaining momentum and that the CEO, Tom Albanese, is making a real impact. We are conscious that not much movement has occurred on the debt front, despite the company generating cash; we will continue to monitor this carefully.
This is a stock picking portfolio, where the focus is on companies undergoing a cycle of improvement, and paying a healthy dividend to their investors while this plays out; various stocks in the General Financials sector fit into this theme at present.
Manulife – Paul Boyne & Doug McGraw
Global Equity Income
Stock selection in the materials and telecommunication services sectors contributed to the strategy’s performance. Individual contributors to performance included Samsonite International S.A., Roche Holding AG and Bridgestone Corp. For the fifth consecutive year, Samsonite announced double-digit growth in revenue and earnings before interest, taxes, depreciation and amortization. New sales reach a record US$2.35 billion. February data suggests an acceleration of growth for Roche’s key franchises. Bridgestone’s share price rose on positive global auto demand.
Stock selection in the consumer staples and health care sectors detracted from performance. Individual detractors included British American Tobacco PLC, Philip Morris International Inc. and Mattel, Inc. British American Tobacco’s and Philip Morris’ share prices fell as investors took advantage of share price strength. Mattel’s share price fell in response to uncertainty about the company’s strategic direction following the departure of its CEO.
During the month, we added Nestlé SA, The PNC Financial Services Group, Inc. and McDonald’s Corporation to the strategy, and eliminated the position in Mattel. We believe Nestlé has sustainable top-line growth, strong cash flow generation, good capital allocation and strong management. In our view, PNC is a quality U.S. bank with solid capital and a strong financial position. McDonald’s has a strong balance sheet and has experienced solid free cash flow improvement under a new CEO, who has successfully turned around the company’s U.K. operation.
Oldfield Partners – Richard Oldfield
Tesco topped the list of contributors to performance during the quarter, following our increase in the size of the holding in the last quarter of 2014 and the strong recovery since then: in the quarter, the share price rose by 28%. We believe that the new management is grasping the nettle in the two essentials: price competition and staffing. The effects of price discounting appear to be being felt in some early signs of stabilisation of the market share. Staffing has been increased by 6,000 in stores to reverse the far too radical cuts of the Leahy era. The product range is being simplified. The number of products had increased by 31% over a year before the arrival of the present management, an extraordinary move probably reflecting the use of promotional payments by suppliers on new products to bolster Tesco’s revenues, resulting in inefficient stores and unhappy customers. The closure of 43 unprofitable stores and some restructuring of the property portfolio are steps in the right direction.
Other major contributors were Nintendo, MUFG, Lukoil and Kyocera. Nintendo announced that it would form a joint venture with DeNA to provide its games on smartphones. We had hoped for this for some time. A year ago some such change seemed to be on the cards when the president, Mr Iwata, made clear his judgement that the company’s current strategy, based on production of consoles and hand-held devices with the games to go with them, was not working. We had, in fact, begun to despair when after nearly a year there had been no further change, and had reduced the holding. This recent announcement, which may follow some nervousness within the company on the forthcoming vote for re-election of directors, is a game-changer.
Among the under-performers were Hewlett-Packard, Staples, Rio Tinto, ArcelorMittal and Microsoft. The Staples fall, 9% during the quarter, follows the large rise last year when Staples provided the largest positive contribution to performance with the announcement of its plans to merge with Office Depot. This merger, hugely beneficial in terms of cost reduction, seems likely to take place as planned although it is dependent on approval by the FTC: meanwhile a lull is not surprising or worrying.
Weakness in Rio Tinto (down 5%) and Arcelor (down 3%) reflects concern about iron ore prices in both cases and steel prices in the case of Arcelor. Even with a very cautious view of iron ore prices (we are using $55 per tonne and a 45% profit margin, both below what we would expect in the medium term) we have a value for Rio Tinto which is well above the current share price. In the case of Arcelor, the position is more complicated. We need to see large upside given that the level of gearing is high and that interest is covered little more than two to three times at current levels of profitability. We are concerned that steel prices in the US, impacted by exports from China and Brazil, may have further to fall, converging with the price levels in Europe and elsewhere. We have reduced the position and are reviewing actively the remaining holding.
Microsoft and Hewlett-Packard reacted, as did many other US companies, to the effect of the strengthening dollar on their profits. In both cases our valuation targets provide substantial upside, and we have increased the holding in Hewlett-Packard.
Performance over the last 12 months has been well below benchmark, with resource companies the leading under-performers. During the 12 months, Barrick Gold was down 29%, Arcelor 24%, Tesco 15%, Rio Tinto 13%, and Eni 6%. We continue to believe that, given the activities of central banks over the past five years, the gold price is likely to be significantly higher in two to three years’ time. As John Plender wrote in the Financial Times, while gold “is often thought of as a hedge against inflation, it is more of a hedge against central bank incompetence and monetary dysfunction, which includes deflation.” Gold mining shares remain unprecedentedly cheap in relation to gold bullion. Barrick Gold is the lowest cost producer of the majors and is focussed on reducing its debt level through sale of assets and improvement in operating performance, in which there has been notable progress over the last year.
In relation to BP and ENI, we believe that the current level of the oil price is unsustainably low in view of likely growth in demand in the coming years, particularly as a result of car sales. The currently lower oil price has self-correcting aspects in that demand is stimulated (petrol consumption in the US was 6.2% higher in January 2015 than the year earlier, and the highest in any January since 2008) and capital spending by oil producers is cut back. On our base case scenario of a medium term price of oil of $70, there is considerable upside.
The positive contributors over the year included Staples, Japan Airlines, Toyota, MUFG and Kyocera. In spite of the weakness of the yen four of the top contributors were Japanese. In each case the management is focussing on profitability and value for shareholders, and there has been a significant gap between price and value.
We sold Renault during the quarter. The share price had reached our valuation target and on review we were concerned that the position in Russia did not justify an increase in our assumptions for operating profits. Russian car sales held up well during the last few months of 2014 as people were anxious to replace roubles with hard assets; but in January and February sales have fallen dramatically. Renault in its core business has been quite reliant on Russia – at one point we estimate that 25% of its operating profits came from Russia. In addition to its own operations there, it has a stake in AvtoVaz which in the six months to September 2014 made a loss of €182 million, and it will not have got better.
In terms of outlook, we remain concerned about the level of valuation of the US market. Of the major markets, the US is the only one to have a Shiller price-earnings ratio above the level at the peak in the autumn of 2007; indeed, the US Shiller p.e. is now not far short of double its level at that time. The average return over the following ten years for markets with a Shiller p.e. as high as the current level in the US is only marginally positive in real terms, whereas from the current Shiller p.e. levels for the rest of the world the average return per annum in real terms has been around 6%. The Shiller p.e. is useless as a short term indicator but there is good evidence that in projection of probable returns over an ensuing decade it has been reasonably reliable.
In Europe there are grounds for greater optimism about economic trends, with improvements in retail sales and purchasing manager indices, and also in lending; there are also massive uncertainties, about Greece and Eurozone stability.
In Japan, even though there too there are large uncertainties – demographic and the size of government debt – we have the clearest picture, with many more positive features than negative ones. Over the years there have been many periods in which company managements have talked about raising dividend yields or targeting higher returns on equity, but nothing much has happened. Now a combination of, first, long-term pressure resulting from a miserable economy, second, government policies and influences, and third, pressure from outside in the form of both foreign and domestic shareholders, the emphasis on return on equity looks serious. The new JPX Nikkei 400 index has as its main criterion for inclusion a high return on equity. This has influenced companies to buy back shares. Whereas in the US such buybacks are increasingly frequently done with borrowed money, in Japan these buybacks are being financed by companies’ large cash piles – the inefficient balance sheets which we as western investors have long criticised Japan for. Last year, the volume of share buybacks in Japan, at nearly ¥4 trillion, was twice the level in any previous year. Institutional Shareholder Services, the world’s largest proxy voting advisor, includes in its 2015 guidelines a provision that they will recommend voting against the top executives of companies posting a return on equity of less than 5% in each of the previous five fiscal years. We have seen evidence of the impact of this emphasis. In the portfolio, MUFG has been buying back shares; Toyota has for many years been a vigorous buyer-back of its own shares with surplus cash; Kyocera has bought back shares, though not recently; Nintendo has had the game-changing announcement, reflecting concern about profitability, referred to above; NTT has had large buybacks. For many years there has been a gap between price and value in Japan, but too little attention by managements on seeing the value recognised. We have much greater confidence that this is now changing. Consequently, we have a third of the portfolio in Japan.
Despite concerns about the market background especially given US valuations, we feel that the portfolio has good value, with an average 32%, currently, to our valuation targets. The price-earnings ratio averages 13, the price-cash flow ratio 7, and the price-book ratio 1.4.
Orchard Street – Chris Bartram
Property Unit Trust
The portfolio valuation as at 31st March 2015 was up 1.4% month on month.
We have completed the acquisition of a 50% interest of New London House in the City (the other 50% already owned by SJP L&P fund) for a purchase price of £25.2m showing a net equivalent yield of 5.98%. Post acquisition we have completed a new 10 year lease on the 4th floor with rental income significantly ahead of ERV.
At Richmond Riverside we completed three new leases on a total of 77,000 sq ft of office space to eBay UK Ltd. This significant transaction extends and secures their occupation whilst adding 13% to the asset value during March.
We completed a lease surrender on Unit A4, Stuart Road Industrial Estate, Altrincham with a premium of £60,000 paid by the tenant to the fund. Simultaneously, we granted a new 5 year lease to another existing tenant on the scheme at a rent well ahead of ERV.
The portfolio vacancy rate is 3.1% compared with 8.5% for IPD and the initial yield on the portfolio is 5.2% which compares with 5.3% for IPD.
Property Life and Pension funds
The portfolio valuation as at 31st March 2015 was up 1.1% month on month.
We completed the acquisition of St George’s House West in Wimbledon for £59.1m reflecting an initial yield of 4.5%. The 85,000 sq ft multi let office building is located 100m south of Wimbledon station.
At Richmond Riverside we have completed three new leases on a total of 77,000 sq ft of office space to Ebay UK Ltd. This significant transaction extends and secures their occupation whilst adding 13% to the asset value during March.
Following the refurbishment of Old Jewry in the City we completed two new 10 year leases, without breaks, on the 2nd and 7th floors. Three of the remaining four floors are currently under offer.
We have completed a new 10 year lease on the 4th floor of New London House in the City with rental income significantly ahead of ERV.
At Queens Road Retail Park, Sheffield, we have signed an agreement for lease with Netto Ltd, guaranteed by J Sainsbury plc on 10,500 sq ft of retail space. The 10 year lease has a rental income above ERV.
The portfolio vacancy rate is 8.8% compared with 8.5% for IPD and the initial yield on the portfolio is 4.8% which compares with 5.3% for IPD as at 31st March 2015.
SW Mitchell Capital – Stuart Mitchell
Continental European, Greater European & Greater European Progressive Unit Trust
We made a significant new investment in the French retailer Carrefour, whose sales are currently split 47% France (17% market share), 26% other Europe, 19% Latin America and 8% Asia. The company has faced a traumatic past few years, with returns on capital falling from 12% in 2003 to 7% in 2013. France has been especially difficult with Carrefour losing 3.5% market share to the aggressive price competitor Leclerc. We have, however, been very impressed by the success of the restructuring plan launched following the appointment of Plassat as Chief Executive in 2012. Management firstly raised €3.5bn through asset sales thus reducing the debt to a manageable €5.3bn and encouraging S&P to raise its rating from BBB to BBB+. Plassat also re-invested heavily in group’s hypermarkets, recognising that they had been ‘clearly underinvested in’ over many years, as well as very successfully introducing ‘click and collect’ into industry. The hypermarket and small store supply chain have also been more closely brought together yielding significantly lower delivery costs. Carrefour, furthermore, have recently announced a ground breaking deal with Cora to cooperate on purchasing. Overall organic revenue growth accelerated to 3.9% in 2014 with the operating margin rising from 3%to 3.2%. Most notably in France, organic revenues and EBIT rose by 1.2% and 6.1% respectively in 2014.Trading on 15 times 2016 earnings the share appears compelling considering the opportunity for further substantial margin improvement on France (4.5%), recovery in Spain and lower losses in Italy. We funded the purchase with the sale of our investment in RWE where it seems increasingly unlikely that an energy capacity market will be introduced in Germany.
We made a further two significant new investments over the past few months. We reinvested in the French optics company Essilor after almost two years of marked underperformance relative to the market. The share is now trading at some twenty times prospective earnings which is near to the lower end of its long term valuation range. The share price had suffered as organic growth dipped to only 2% in 2013 from the longer term 4-6% average. Essilor were hurt by Hoya’s actions to re-load a plant that had been closed down following a flood in 2012. In the last few months the organic growth rate has recovered to some 4%. The long term growth opportunity for Essilor remains very significant. It is thought that some 4.3bn people have defective vision but that only 1.8bn wear glasses. This is especially true in the emerging world where growth rates are running at above 10% per annum. The population is also getting older driving sales of progressive and anti-UV lenses. At the same time, myopia is developing quickly due to the increased use of tablets and computers. Essilor dominate the industry with a 37% and rising market share. The company has minimal debt and an impressive 19% operating margin. We also purchased a significant new position in Airbus whose sales currently split 67% Civil Aircraft, 22% Defence and Space and 11% Helicopters. We first became interested in the group in 2012 when new management dramatically changed the corporate governance of Airbus by dissolving the government-led shareholder pact and creating a more typical corporate governance scheme. At the same time the company bought back 15% of the shares and increased the free float from 49% to over 70% today. We believe that Airbus should be able to significantly narrow the profitability gap between themselves (6.6% operating margin) and Boeing (10.9% operating margin). The Defence and Space business is being dramatically restructured (‘a bit like open heart surgery’). At the same time the Helicopter product range has been refreshed and the shares in Dassault progressively divested. More importantly, the earnings of the group have been depressed by development costs in the A350 and A330 NEO. The recent weakness in the euro relative to the dollar will also drive profitability sharply higher. The share could be trading on 6 times 2020 earnings with 30% of the current market cap paid out in dividends.
Wasatch Advisors – Ajay Krishnan
Emerging Market Equity
During March, currency movements impacted the returns realized by the portfolio in Brazil, Turkey and Colombia. Depreciation in the currencies of those countries cut the value in British pounds of the portfolio’s holdings.
Nevertheless, weakness in the Colombian peso helped our cement company, CEMEX Latam Holdings S.A., by making it unprofitable for a competitor to continue importing cement from a nearby country. Although CEMEX detracted from portfolio performance in March, we think the company is positioned to exceed analyst expectations in coming quarters.
Kasikornbank Public Company Limited provides personal, commercial and investment banking to customers throughout Thailand. The company’s 2014 financial results were well-received by investors, and it was one of our top contributors to performance for the month.
The information contained herein represents the views and opinions of our fund managers and not those necessarily held by St. James’s Place Wealth Management.
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