The primary objective of the BlueAlpha BCI Global Equity Fund is to offer investors a high long term total return by investing across global equity markets.

Global Markets
Following the spike in volatility around the unexpected Brexit referendum result at the end of June, average volatility through the 3rd quarter was surprisingly low. Global equity markets drifted upwards over the period - supported by expectations of additional monetary accommodation and stable global economic data.

While there remains continuous fretting regarding the timing and extent of US interest rate hikes, we would be inclined to argue that the inevitable rate increases are bound to be both moderate and slow. Emerging markets (+9%) and non-US equities led the upward move in global equities. Regional price performance was strongest in Asia (+10%), Japan (+7%) and Europe (+5.8%). The US, by contrast, lagged the World Index, gaining 3.8%. After a very strong first half of the year, both commodities (-2.7%) and gold (-1.8%) drifted downward through the quarter.

It appears that most of the developed world is currently in the mid- to latestage of economic expansion. Having said that, global growth is still slow and inflation is subdued. Policy driven stabilization in China and a reduction in inventories has helped emerging market economic activity. A substantial and lasting acceleration in China seems unlikely though, given the private sector’s excess capacity and debt levels.

The Chinese banking system remains as opaque as ever, and the risk of bad loans coming out of the woodwork should not be underestimated. Given the low growth environment and cheap cost of funding, it is no surprise that large merger and acquisition activity persists. This is particularly evident in the US and European pharmaceutical, hospitality and tech industries. The primary aim of consolidation is to grow and protect both market share and profits by increasing economies of scale, reducing costs and competition, while leveraging off cheap debt. While markets will inevitably shudder and attract a lot of “headline” risk, as investors adjust to a move up in rates, we take a fairly sanguine view on this.

What is most likely, at this juncture, is an extended period of sustained and generally low rates. We believe this will provide fertile ground for making rewarding investments in high quality businesses that have an attractive growth path. While many investors are grappling with whether or not to chase the cyclical rally, or alternatively “hide” in gold, we think a far more moderate path makes as much sense as ever. In the long run, companies which are proven good-quality growers are a better store and creator of wealth.

Accordingly, the best and most sensible investment option, in our view, is to keep searching for, and investing in, durable high-quality businesses with the ability to generate real earnings growth and economic value.

Portfolio
The fund returned 5.8% in US$ over the quarter, almost 1% ahead of the World Index. Given the strength in the Rand over the period this translated into a 1.1% decline in local terms. Exposure to technology and consumer discretionary added to performance, while telecommunications and healthcare detracted from returns. At a stock level, our top contributors to performance were Priceline (+18%), Biogen (+30%), Apple (+19%) and Samsung (+16% - in spite of the exploding phone saga). These are all longstanding investments in the portfolio. Detractors from performance were McKesson (-10%), EasyJet (-10%), CR Bard (-5%) and Starbucks (-6%).

Over the quarter, we sold our investments in the first 3 companies and added to our position in Starbucks. One of the challenges of investing in high quality companies is not to get “trapped” by seemingly attractive valuations as a result of a change in the growth trajectory. Last quarter we discussed the fallout in EasyJet as a result of labour strikes and Brexit and considered these to be one-off in nature and outside the company’s control. On further analysis, it appears that the headwinds the company is facing challenge medium-term growth considerably.

Notwithstanding a very temping valuation, we decided to exit our investment. Post our sale, the company has indeed confirmed the extent of the difficult climate they are facing and issued a profit warning. Other changes during the quarter included selling Bank of America, Gilead Sciences, Skyworks and Walt Disney. In each case, we based our decision on a review of subdued growth prospects. New positions added during the quarter include investments in Amazon, CBS, Delphi Automotive, Marriot International, SS&C Technologies and Service Now. These companies all generate high returns on invested capital and have high growth expectations as a result of scale, market dominance or being at the forefront of their particular technology set.

The last year has been challenging in relative terms – partly as a result of style underperformance, given no exposure to lower quality cyclical companies or emerging markets, and in other instances, it has been self-inflicted - where we have tolerated a slowdown in growth for too long and seen high quality companies decline in spite of undemanding valuations.

Nonetheless, September marked the 2 year anniversary since the strategy launch, over which period the fund is placed in the top quartile of peer performance. As always, we strive to position the portfolio towards high quality businesses with good growth prospects.

A new position
CBS is a US domiciled network operator that is a market leader in TV content. It owns several banner brands through which it transmits and distributes its products such as Showtime, CBS Sports and the CW. It owns the rights to several hit shows such as NCIS, Big Bang Theory and Homeland, from which it generates the highest advertising rates in the industry and will earn annuity income for decades to come, once these shows are syndicated. CBS Sports Network is underpinned by the rights to distribute the NFL, which is the holy grail of sports coverage in the US in terms of advertising and viewership.

CBS is in the process of significantly increasing its international distribution, which should sell at higher rates than the US and generate higher margins in constant currency terms. This will be augmented if it succeeds in re-merging with Viacom - roughly ten years after it was spun out as the weaker sibling, and now returning as the dominant partner. The merger will allow for significant cost savings and give CBS access to the one ingredient that it lacks – its own studio network via Paramount Pictures and its related library.

This merger is not without risk, as Viacom (particularly Paramount Pictures) has performed poorly with significant losses under its previous leadership team. In contrast, the management of CBS have been the architects of a significant transformation within the company – driving it to become the market leader in viewership numbers across the US. At the same time, average ROIC has more than doubled and ROE over the last 5 years has averaged 26% versus a less than 10% average 5 years earlier.

The risk from OTT players (Netflix, Hulu, and Amazon) has also been significantly reduced via the launch of CBS All-Access, meaning that these OTT players are now significant customers of CBS.

Global Macro
The MSCI World Index ended the quarter marginally down, greatly disguising the degree of investor angst through the quarter with equities declining 11.8% to mid-February before staging a similar sized rally into the quarter end. Equity markets were driven by large swings in sentiment and risk appetite through the period. A key driver of sentiment at present is the oil price, with global equities moving in step with the short term directional moves in the oil price.

Given that the current decline in oil prices has been driven by a surge in supply, rather than a collapse in demand, the low prices should on-balance be considered positive, as energy consumption costs for both industry and consumers decline across the world. The flip side to this gain is the unquantified effects that may be realised in financial markets with oil-producing nations facing significant declines in revenues. The growth in global oil production has also been linked with a significant formation of Oil and Exploration related debt, held both by investors and banks. Some estimates suggest that the total debt outstanding has tripled in 10 years from 1 to 3 trillion US$, highlighting the potential financial risk that remains in the industry.

Regional performance was almost a complete reversal of the previous quarter, with Japan falling 13% following a strengthening in the Yen. Both Europe and the UK lagged the World Index - the latter caught up in growing fears and uncertainty regarding a possible exit from the Eurozone. The US market was slightly ahead, while Emerging Markets showed the most strength for the quarter.

While commodities rallied 7% (CRB Index) during the quarter, this appears to be more tactical in nature than a change in cycle, given the oversold levels they rallied from and because global growth still appears fairly modest, while earnings revisions are trending downwards.

Growth concerns were mirrored by Fed comments regarding the pace of future interest rate hikes, matched with a rally in the 10 year bond yield from 2.3% down to 1.7%. Our focus remains on high quality businesses and stable growers that have an ability to generate real earnings growth and economic value.

Portfolio Performance
The fund returned -8.4% for the quarter vs -5.9% for the Benchmark. For the last 12 months, the fund returned 13.1% vs. 17.7% for the Benchmark.

The portfolio had a challenging quarter, lagging the World Index by 3% in US$ terms and Rand strength further detracted from investment returns. This was a reversal of the outperformance in the prior quarter and is attributable to having no Emerging Market exposure; and our investment strategy, which focuses more on high quality, stable growers. This approach tends to direct our portfolio toward healthcare , consumer and technology companies - which did relatively poorly - and away from defensives and cyclicals which did relatively well during the quarter.

At a stock-specific level, we saw a reversal, with some of our best performers of the prior quarter being our worst performers. Fuji Heavy Industries, the manufacturer and exporter of the Subaru automotive brand, fell 20% off the back of Yen strength. Pharmaceutical business Mylan fell 18% on slightly disappointing earnings and the announcement of a high-priced acquisition of Swedish drug maker Meda. Post the announcement of this deal, we decided to exit our investment.

Top performers during the quarter were management and technology consulting business, Accenture, which raised guidance based on strong digital services demand; Samsung Electronics; and FedEx, after beating earnings expectations. During the quarter, a new investment was made into Broadcom, a semiconductor business. There has been a significant drive by tech companies to take advantage of the opportunities afforded in Cloud-based technologies.

This has seen strong capital spend on this technology, with Broadcom being one of the largest beneficiaries. The recent merger between Broadcom and Avago Technologies has created the 3rd largest pure-play semiconductor company in the world, giving it leading market positions across all of its core offerings. A combination of scale benefits and cost reductions should support high returns and growth for the foreseeable future.

We continue to position the portfolio towards high quality businesses with good growth prospects.