SIM Global Financial Feeder comment - Mar 16 - Fund Manager Comment02 Jun 2016
March was a good month, with the fund gaining 11.7% (in US$) but whilst outperforming the MSCI World Financial Index over the month and quarter, it is still down 4.2% year to date.
This highlights the extent of the January/February sell-off and I would like to repeat two paragraphs we wrote last month:
History shows that when companies get this mispriced investments generate significant returns over the next few years. I can’t recall when last the fund had such attractive franchises at such beaten down valuations. Despite all the macro negativity we are very optimistic about potential for excellent returns over the next few years. A repeat of 2003-2007 and 2009, 2010 when the fund generated excessive returns is very possible.
True, the environment remains tough and our recent company visits confirmed this. However, our company visits also confirmed that the actions undertaken by various companies’ management are having an effect and they are growing shareholder value.
Most pleasing was the fact that emerging markets came through strongly. Credicorp (Peru) gained 37% during the quarter whilst Yes Bank in India (+18%) and Moscow Exchange (+25%) and Sberbank (+22%) helped the fund to outperform. [Performance figures in USD]
The list of double digit fallers (prices that declined more than 10% during the quarter) is big and proves why I felt it necessary to repeat the paragraph from last month. Shares like Bank of America, Intesa (Italy), Axa (France) have been sold down 20% and many have been sold down 33% since January 2016. At the risk of sounding like a stuck record: yes, the environment is tough but the benefits of management actions over the past six years can be seen in the increasing dividend payouts and growth in shareholder value. It just doesn’t make sense for the abovementioned companies to trade at the current discounts to net asset value.
During the quarter the fund sold its Brazilian banks as we feel the market is overreacting to the positives of a possible Rousseff impeachment. The cash was used to increase the fund’s holdings in European insurers now trading on 5% dividend yields after their significant price falls.
SIM Global Financial Feeder comment - Dec 15 - Fund Manager Comment16 Mar 2016
The MSCI Global Financial Index declined by 3.4% in 2015 compared to the fund's 11% decline. This disappointing performance was mostly due to the fund's investments in emerging markets where record outflows caused significant currency depreciation (with the Brazilian real weakening by 49% and the Turkish lira and Russian ruble by more than 20%). These outflows also caused significant share price falls.
Besides the currency induced losses the largest share price declines were PRA Group and Encore Capital, two debt collection companies in the US with very long (and good) track records. New tough rules, making debt collection difficult, were imposed by the regulator causing investors to take flight and sell them aggressively. Despite company managements stating that they have adjusted collection methods, the market has remained skeptical. Due to the record of both managements in consistently growing shareholder value over many years we have maintained our investment, believing that the higher collection cost is now reflected in the valuations of both companies.
Even in the negative environment we had a large number of our investments that performed very well (and some exceedingly so): - In the UK: small caps Arrow Global, One Savings Bank and Novae (+16%, +64% and + 49%)
- Our European holdings: Ageas (+45%), Intesa (+27%
- ) and Raiffeisen (+8%
- ),
- In the US: AIG (+10%, one of our top 3 holdings) and JPM (+5%),
- In emerging markets: Sberbank (+45%
- ), Moscow Exchange (+54%) and Dewan Housing in India (19%).
The list shows how winners and losers in the financial sector were spread among large caps and small caps, as well as emerging and developed markets.
What did we learn?
My own formative years were post 1989 (South African banks) and post 2000 (EM crisis).
In these post-crisis periods, investment returns were generated by selecting financials that were mispriced and especially those that operated in growth environments. Small caps with good managements that were undiscovered did particularly well. This philosophy worked in 2015 (Arrow Global, One Savings Bank, Novae, Dewan and Moscow Exchange), but these were exceptions. Generally speaking, 2015 was a year in which outperformance was generated by avoiding risk: currency risk, regulatory risk, but also "crowded trade" risk.
It is likely that a risk avoidance strategy will continue to be the best in H1 2016, but over the long term this leads to below-average performance.
Quo vadis 2016?
A few factors continue to make markets dangerous:
- The commodity super-cycle has created excesses that haven't been worked out of the system yet.
- Governments like Brazil, Turkey and South Africa have yet to grasp that generating growth through spending is not sustainable and can only be maintained while easy funding is available.
- Worse, China thinks it can continue fighting its lower growth rate by indebting itself even more while Spanish, Portuguese and Greek electorates (to name a few) continue to fight austerity without having plans to increase government revenues.
The combination of these (and a few other) factors will most probably continue to put a damper on growth and keep interest rates low while also increasing the risk of social unrest.
Our DNA has always been to search for good companies that are mispriced, and our track record in 2015 (and since the inception of the fund in 1999) shows that we did that well. Over time, share prices reflect shareholder value growth and in 2015 the shareholder value growth of our average investment exceeded 10%. As said, it was mainly the currency markets that did most of the damage. However, eventually currency depreciations do bring about lower import levels and hence improves the trade balance. Besides, it can be argued that the US$ has been too strong. In a weaker $ environment the increased shareholder value growth will be recognized by the markets that are now significantly underweight non-US$ assets and the companies we are invested in could re-rate sharply. Until that happens we know that the companies are well managed. Besides, they are trading at levels considerably below both their intrinsic values and historic valuation levels.
- The price movements reflected in brackets are the 12-month share price moves, the actual performance in the fund was higher due to the shares having been bought during the year after large share price falls, and similarly sold when prices had run strongly.