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Fund Manager Monthly Report - September 2014

22 October 2014

The latest portfolio and market commentaries from our range of fund managers.

Aberdeen Asset Management (Asia) – Hugh Young

Far East

The benchmark FTSE* World – Asia Pacific Index fell 2.22%. Against this, our fund held up slightly better but posted a decline of 1.58%.

Australia was the worst-performing market on the back of lacklustre economic growth and falling commodity prices, with the decline in the local market exacerbated by the weak domestic currency. The fund did well by being underweight to this area. In particular, we do not hold any of the Australian banks that underperformed on the prospect that the central bank might curb lending to investors.

India was more resilient than the broader region and our non-benchmark exposure was positive. Consumer, software and cement stocks in our Aberdeen Global – Indian Equity Fund outperformed the local market. 

Japan was a detractor, mainly because of negative asset allocation. We were underweight the local market, which did better than the benchmark. However, positive stock selection mitigated the losses. Shin-Etsu Chemical’s shares rose on strong demand for silicon wafer and polyvinyl chloride, while Unicharm reported positive sales for its high-margin diapers in China. Fanuc raised its full-year profit forecast amid higher sales of its products to the IT industry.

Korea was also a detractor. Samsung Electronics’ shares fell amid continued worries about the outlook for its handset division. While this unit may remain under pressure from rising competition, the memory division should be well positioned to benefit from any improvement in industry dynamics. We maintain the view that the company’s strong balance sheet provides a safety buffer against demand cyclicality and gives it the ability to invest in new technology to stay at the forefront of a hugely competitive industry.

Aberdeen Asset Management (Glasgow) – Jamie Cumming

Ethical

During the month, the fund’s value fell by 2.80%, underperforming the benchmark’s decline of 0.77% largely owing to larger holdings in poorer performing parts of the world.

Detracting the most from relative return was our overweight to Brazil through our holdings in Banco Bradesco, Petrobras and miner Vale. Brazilian equities tumbled and the real weakened after opinion polls showed President Dilma Rousseff’s re-election bid regaining lost ground. This lowered expectations that a more business-friendly administration will be elected to kick-start the flagging economy.

Conversely, Italian-listed specialist steel pipe maker Tenaris performed well as product pricing improved on the back of the US Commerce Department’s decision to impose anti-dumping duties on steel-pipe imports from end-July; Tenaris has operations in various countries including the US. Japan’s Fanuc was another contributor to performance: it raised its full-year profit forecast amid higher sales of its products in the IT industry.

In portfolio activity, we added to several holdings on the back of price weakness, including Atlas Copco, Ericsson, Linde and Vale. Against this, we top-sliced Vodafone, which faces pricing and regulatory pressures in key European markets, as well as Banco Bradesco and Petrobras on price strength.

Artemis Investment Management – Adrian Frost & Adrian Gosden

UK & International Income

September had everything. Heightened political uncertainty surrounded the Scottish independence referendum, continued international conflict on a number of fronts and … oh yes continued economic malaise in the usual regions. Thus far the market seemed to be calm, almost nonchalant about such matters, but in September it showed some emotion and fell by 2.8%. Within the market the multiple travails of the food retailers took centre stage. Although their fall from blue chip to wood chip all seems rather rapid, in reality it is the tipping point of accumulated pressures. Elsewhere, the sale of Standard Life’s Canadian business was positive news as it takes a further step to becoming less capital intensive and a more cash generative business.

We continued to reduce SSE because we are cautious about the valuation. We added to Vodafone sensing that data / 4G is having a more positive effect than many would anticipate.

If lessons can be learnt from recent company pronouncements it is that some have let levels of investment lapse, and are now having to backfill at the expense of cash flow. A further observation would be that where structural threat lurks, companies are compromised between ‘business as usual ‘and taking radical (often unpalatable) action to confront the threat. If nothing else the valuation of dependable, growing yield has been enhanced by recent events. 

Artisan – Dan O’Keefe & David Samra

Global Managed & Global Unit Trust

The MSCI All Country World Index declined 1.4% during September (all returns local). Developed markets declined, with weakness in the US and Europe mostly offset by a 4.8% gain in Japan. Emerging markets declined 4.2%.

The impact of currency overshadowed the movement in the markets during September. The US dollar appreciated against nearly every global currency, rising approximately 4% against the euro, 2% versus the British pound and 5% compared to the Japanese yen. 

The largest contributor to the portfolio in September was Novartis, which rose 9.5% during the month after announcing favourable clinical data for a medicine called LCZ696 – a potential new blockbuster drug used to treat chronic heart failure.

Among the largest detractors from performance this month were Tesco and Oracle. Tesco declined 19.1% after the company disclosed it had overstated first half profits due to an accounting error. Oracle’s shares fell 7.8% after reporting mixed first quarter results that showed good growth in software and cloud revenues, largely offset by continued declines in their hardware and services businesses. 

We added Citizens Financial Group and ABB to the portfolio this month. Citizens is a US-based regional bank with a strong presence in the Northeast and Midwest. The UK government is forcing Royal Bank of Scotland to sell Citizens as part of its 2008 government bailout. Citizens has an attractive core deposit franchise and opportunities to grow profits by adding new revenues on their existing cost structure. The balance sheet is well-capitalized with a Tier 1 capital ratio of 13%. Due in part to the presence of a forced seller, we were able to acquire the shares cheaply at a valuation of 0.95x tangible book value.

ABB is a leading capital equipment supplier to utilities, manufacturing and resources companies. The company has strong market positions in attractive industries like power, electrical equipment and industrial automation. The balance sheet is excellent and management has committed to returning most of the free cash flow to shareholders through a combination of dividends and a newly announced share repurchase program. We estimate our entry price was approximately 13x normalized cash earnings, which we view as attractive given the quality of the business and balance sheet. 

Over the past month, we have taken advantage of the market weakness to deploy some of our cash into equities. While we believe that stocks overall remain fairly valued, our team is starting to see more company-specific investment opportunities where valuations have become more attractive.

AXA Framlington – Richard Peirson

AXA Framlington Managed & Balanced Managed Unit Trust

The Scottish referendum on independence was the focus of attention in the UK, particularly after an opinion poll suggested a ‘YES’ victory. In the end the ‘NO’ victory was by a comfortable margin but not before a panic by the main political parties damaged their credibility and sterling. Geopolitical concerns were many
but international equities held up relatively well with the US helped by the dollar’s strength and Japan rallying following earlier weakness. UK equities were the weakest major region returning -2.8% while UK government bonds returned –0.6%.

There was no significant change in the shape of the portfolio. In the UK we sold Shire, currently being bid for by US company AbbVie, as a precaution in case changes in US tax rules caused the bid to be withdrawn. The proceeds were used to add to a number of existing holdings. We also sold Verizon Communications, a holding we received when Vodafone sold its stake in Verizon Wireless, taking advantage of a sharp rally in the dollar. In Japan we sold the plant engineering company JGC where we believe the attractions are too long term and reinvested in Don Quijote, a 24/7 discount store which is expending its range of merchandise and particularly focussing on foreign tourists.

Stock selection in equities and bonds was mixed; we outperformed in UK, Japanese, Pacific ex Japan and Emerging Markets but underperformed in Europe and US equities, while we marginally outperformed in UK gilts and underperformed in overseas bonds. In the latter area being underweight was helpful as returns from
the category were negative.

To concerns about Russia/Ukraine, Syria/Iraq and China/Hong Kong we have had to add the prospect (probably small) of an Ebola pandemic. Although such events are tragic and generate volatility they tend not to have a lasting impact on company valuations. Closer to home, recent economic data from Europe has been weak suggesting that the ECB will need to do more than rely on ‘zero’ interest rates to stimulate growth. We consider that global equities look no more than fair value based on historical valuation measures but look very cheap in comparison with government bond yields.

AXA Framlington – George Luckraft

Diversified Income & Allshare Income Unit Trust

Equity markets weakened in September as it became clear that European economies had weakened. Confidence has been affected by the unrest in Ukraine and by the evolving crisis of the Ebola outbreak in Western Africa. 

The portfolio outperformed despite a profit warning from Low & Bonar on the back of weaker European demand. Many of the shares in the portfolio trade on sub market ratings which provides a degree of protection. During the month the holdings of Imperial Tobacco and Vodafone were increased while that of GlaxoSmithKline was reduced.

Many valuations have fallen to levels where the yield is very attractive assuming that it can be maintained. At present the underlying economic background does not appear to be so bad to cause much concern. Inflationary pressures are falling as commodity prices especially oil fall. This should mean that the timing of the first rise in interest rates is delayed. The rising yield as share prices fall should lead to share prices being supported.

Babson Capital – Zak Summerscale

International Corporate Bond

The high yield market came under pressure in September as a strong month of new issuance led to investor indigestion in the markets. A trend of a somewhat reduced appetite for risk assets from selected investors contributed to markets being led lower with the European High Yield market outperforming its U.S. counterpart. The mid-month U.S. Federal Reserve Rates meeting and the Scottish referendum result did however provide some stability in an otherwise turbulent month. Modest outflows continued from Exchange Traded Funds, which put further pressure on the secondary market, although it was significantly less pronounced than in July.

Despite the challenging market conditions, September saw the strongest month of issuance in 2014 so far amidst the backdrop of muted investor demand and rising bond yields. Deals focused on corporate acquisitions led the way this month. However, year-to-date new issue activity continues to be dominated by corporate refinancing needs, although this was slightly lower this month. The top contributors for the portfolio in September included names such as RPG, a Czech real estate company that owns and manages a portfolio of commercial and residential units; and DomusVi, a French nursing home business. Whereas detractors included Premier Foods, a British food manufacturer; and Takko, a German fashion retailer.

As we look ahead, we see a strong corporate environment maintaining low default rates and we will continue to use periods of market volatility to selectively invest in attractive investment opportunities for the portfolio. In this continued environment of low interest rates and economic growth, the International Corporate Bond Fund remains well positioned to provide attractive risk-adjusted returns to investors.

Edgepoint - Tye Bousada

Global Equity

When we invest, we focus on key characteristics such as quality of the business, strength of the management team, defendable barriers to entry and of course an appropriate entry price. Most importantly, we ensure we have a proprietary idea about the business that isn’t recognized by others. In the last several weeks, we’ve reduced our exposure to companies where our proprietary view has been recognized by others.

A recent example is Dresser-Rand Group Inc., a leader in engineered rotating equipment solutions primmrily for the oil and gas industry. Seimens AG made an all-cash bid for the company at a price substantially higher than our purchase price. We always believed their large install base made them an acquisition target. Siemens take-over bid demonstrates its attraction to industry-leading equipment and a high-value service network that enticed our interest in Dresser 13 months ago.

Another example of where our thesis has materialized is Tenneco Inc. It’s one of the world’s leading designers, manufacturers and distributors of clean air and ride performance products and systems for the automotive, commercial truck and off-highway markets. As commercial sales volume and profit margins have increased, the market became excited about Tenneco’s future prospects and its stock price increased. As a result, we sold our position in Tenneco.

J O Hambro – John Wood

UK & General Progressive

As the US Federal Reserve approaches the end of its quantitative easing (QE) programme, everybody is suddenly worried that there is no economic growth. To us, that is easy to explain: the only growth was credit-induced; withdrawal of the drug leads to cold turkey. The only way for productivity-led growth is through investment. Funnily enough, special dividends and share buy-backs do not provide the productivity-led growth needed to sustain properly-functioning economies. 

Our focus continues to be on identifying companies that can generate above-average returns over the long term through compounding growth. Unfashionably, we seek to buy and hold stakes in companies characterised by high quality franchises that generate plentiful free cash flow and which have solid balance sheets marked by low levels of debt. High return investments are scarce in the low return environment now facing us, but we believe we can achieve attractive long-term returns through the patient process of holding stocks that regularly compound their growth over time.

Magellan - Hamish Douglass

International Equity

During the month of September we purchased a new holding in Home Depot and also added to our position in SAP. We reduced the size of our largest position, Lowe’s, and exited our small Adidas position given the level of uncertainty surrounding its golf and Russian exposures and better opportunities elsewhere. Finally,
we reduced the position in DirecTV, given some modest risk associated with the upcoming regulatory decision on AT&T’s takeover. 

As at 30 September 2014, the portfolio consisted of 27 investments, with the top-ten holdings representing 48.15% of the portfolio. The portfolio held 10.62% of its assets in cash at the end of the period.

The portfolio is currently positioned to take advantage of the following major ongoing investment themes:

• Technology/software: We believe that entrenched global software companies enjoy enormous competitive advantages and exhibit attractive investment characteristics.
• Internet/e-commerce convergence: There are a number of internet enabled businesses that have very attractive investment characteristics with increasing competitive advantages.
• The move to a cashless society: There continues to be a strong secular shift from spending via cash and cheque to cashless forms of payments, such a credit cards, debit cards, electronic funds transfer and mobile payments.
• US interest rates normalising: As the US economy recovers, the Federal Reserve will increase the federal deposit rate and begin to reduce the size of its balance sheet.
• US housing recovery: A recovery in new housing construction should drive a strong cyclical recovery in companies exposed to US housing and also provide a strong boost to the overall economy.
• Emerging market consumption growth: Through investments in multinational consumer franchises.

In September, the portfolio returned +1.05% in sterling terms, before fees, this compares with a benchmark return of -0.34%, giving relative performance of +1.39%. 

In sterling terms, the biggest contributors to performance were Target (+0.32%), Microsoft (+0.27%) and eBay (+0.26%). Meanwhile, the three largest detractors from absolute performance were Tesco (-0.82%), Oracle (-0.27%) and Nestle (-0.16%).

In sector terms, Consumer Discretionary (+0.82%), Health Care (+0.42%) and Financials (+0.33%) made the largest positive contributions, while Consumer Staples (-0.84%) was the only detractor. 

Geographically speaking, the United States (+1.84%), France (+0.16%) and Switzerland (+0.04%) made positive contributions to performance, while the UK (-0.80%), Germany (-0.13%) and the Netherlands (-0.06%) detracted.

Majedie – James de Uphaugh

UK Growth & UK & General Progressive

The fund produced a negative return of -2.3% in September, which was marginally better than the FTSE* All-Share index contraction of -2.8%. Global macro news and industrial data worsened during the month: at home the Scottish referendum made for jittery markets, in Europe the take-up in the first tranche of TLTRO
disappointed many; Chinese data has continued to worsen, and it now looks like the PBOC will no longer underwrite local government lending – a key driver of construction growth. The silver lining is the weak oil price which, coupled with a looser lending environment post the ECB’s bank stress testing, offers some
relief to the embattled European consumer. Although US small caps are showing the strain, the broader US indices bucked the trend, buoyed by encouraging economic data – Alibaba’s record $25bn float summed up the ebullient mood.

UK Food Retail has been a laggard for us, particularly Tesco, where the news went from bad to worse at the end of the quarter, but we feel the new management team now have a real mandate for change, so expect to see disposals and a refocusing of the business; Shire received a bid from AbbVie, a US pharmaceutical giant, which affected our relative performance as it is not held in the portfolio; speculation of a tie up between SAB Miller (also not held) and Heineken meant had similar results. On the positive side, BAE Systems delivered an encouraging set of H1 numbers that beat market expectations in July, with signs that the US had troughed and visibility on future earnings had improved; Carnival too announced price improvements and a pick-up in bookings, after a subdued 24 months, and our continued minimal exposure to the Mining sector spared your portfolio much fallout from the weak iron ore price.

In terms of positioning, we are still on a defensive footing, given that uncertainties abound, eschewing where possible emerging market exposure, but we have trimmed our exposure to Integrated Oils, in favour of airlines and one or two consumer stocks that we feel will benefit from a lower oil price, and added a little to banks.

Manulife – Paul Boyne & Doug McGraw

Global Equity Income

Stock selection within the energy and financials sectors contributed to performance. Individual contributors included Pearson plc, Johnson & Johnson and Raytheon Company. Stock selection within the consumer discretionary and industrials sectors detracted from performance. Individual detractors included Eaton Corporation plc, Mattel, Inc. and Amcor Limited. We added Koninklijke Philips N.V. and Whirlpool Corporation to the Fund, and eliminated the strategy’s position in Northern Trust Corporation as the stock reached our estimate of fair value.

Orchard Street – Chris Bartram

Property

Property Unit Trust

The portfolio valuation as at 30th September 2014 was up 1.1% month on month. There were no acquisitions or sales during the month. 

At Westhill Shopping Centre in Aberdeen we have extended two leases with a combined annual rent of £66,000 by a further 10 years. This is 4.2% ahead of the estimated rental value. They have attributed an increase of £400,000 to the valuation. Works commenced on 15th September, as planned on the new 15,000 square feet development.

Following completion of the landlord works associated with the new leases at St Andrews House Cambridge the valuation has increased further to £20.8m. 

The portfolio vacancy rate is 2.4% compared with 9.5% for IPD and the initial yield on the portfolio is 5.6% which is the same as IPD as at 30th September 2014.

Life & Pension Property Funds

The portfolio valuation as at 30th September was up 1.1% month on month. There were no acquisitions or sales during the month.

At the Blackthorne Road Industrial Estate in Poyle we have re-geared two leases with the largest tenant on the estate occupying 58,000 square feet. We have removed the 2015 break clause increasing the term certain to 6 years whilst simultaneously settling the rent review at £6 per square foot which is £1 above the estimated rental value. This asset management initiative has contributed to the valuation uplift of £1.35m.

The initial yield on the portfolio is 5.3% compared with 5.6% for IPD and the vacancy rate is 7.7% against 9.5% for IPD.

SW Mitchell Capital – Stuart Mitchell

Continental European, Greater European & Greater European Progressive Unit Trust

We remain optimistic on the outlook for European equities. Investors have been unsettled by the combination of a weak German services PMI in September, modest initial take-up of the TLTRO and continued low inflation data. At the same time, however, there is a wealth of data suggesting that the recovery is proceeding as we might have expected. Notably, the economies of the periphery continue to rebound. Spanish house prices, for example, are now rising for the first time in six years. Mortgage approvals also rose by an impressive 28% in July. In fact, dramatically improving construction confidence suggests that the Spanish economy could grow by some 3% next year. Credit conditions, furthermore, appear to be improving across the region. The TLTRO and purchases of asset backed securities and covered bonds should help lower bank funding costs, most notably, in the periphery of Europe. The recently published ECB lending survey was also very encouraging. The recent, almost 10%, fall in the value of the Euro relative to the Dollar should also help support the export sector. More importantly, second quarter earnings have tended to surprise on the upside. Our recent calls with managements have in most cases suggested that business is better than might have been expected. This has been confirmed by our extensive meetings with a broad range of companies over the past month. Our most upbeat management meetings have, interestingly, often been with those from the banking sector.

We are, as a consequence, confirmed in our long held view that recovery is gradually taking root across the region – as in Spain – especially in a number of economies which have embraced austerity. From a company earnings point of view, a mixture of recovering revenues combined with stringent cost control and strict capital discipline, should generate surprisingly strong earnings growth. This is at a time when expectations are still framed by fears of a ‘Euro crisis’, and valuations are at mostly at historically extremely compelling low levels. In fact, share prices currently imply that almost 50% of European companies will face declining ROCE’s in the future. Where high valuation levels still prevail, however, is among more internationally orientated companies. These still trade on ‘cultish’ valuations with many investors continuing to put their trust in continuing vigorous emerging market growth. Our company visits suggest, however, that the growth outlook from the emerging world has slowed significantly. We therefore remain committed to more Europe-centred, domestically orientated, companies. These now constitute almost two thirds of our investments. Companies from the periphery of Europe represent 30% of our investments. On a recovery basis, for example, the Italian media group, Mediaset, represents great value. The same holds true for our holdings in Intesa Sanpaolo and Banco Popular. Banks make up a further 25% of the fund. We still believe that the market has failed to appreciate the benefits of a rapid recovery in financial margins coupled with draconian cost cutting and easing regulatory pressures. We have focused on the strongest retail banking franchises such as BNP and Santander where we believe that returns should rather rapidly return to pre-crisis levels. Utilities now constitute a growing 26% of the fund including investments in Orange, RWE and Eiffage. Our favourite growth companies, such as Zodiac and Essilor make up the remainder of the portfolio.

Wasatch Advisors – Ajay Krishnan

Emerging Market Equity

Developments leading up to Brazil’s presidential election in October have been key factors driving financial markets in that country, which is the second-most heavily weighted in the portfolio. The Brazilian stock market rallied in August when it appeared that incumbent Dilma Rousseff was headed for defeat, only to give back those gains in September as polls showed Rousseff pulled ahead of centrist opposition candidate Marina Silva. With Brazil’s economy having slipped into recession earlier in the year, our view was that a change in leadership would boost investor sentiment and lead to less-intrusive, more-predictable economic policy.

Meanwhile, Russia’s economy appears headed for recession as well. With output and industrial production in decline even before the Ukraine crisis began, recent sanctions and uncertainty have worsened the already-weak structural situation. The portfolio currently has no investments in Russia, although we continue to monitor the country closely for potential opportunities. In India, the S&P BSE Sensex Index pushed to a new all-time high during September on continued optimism surrounding recently elected Prime Minister Narendra Modi. With the country’s surging equity market already discounting significant future improvement, we plan to use additional strength in Indian stocks as opportunities to book gains and cut back positions in the portfolio.

Woodford Investment Management – Neil Woodford

Income Distribution, UK Equity and UK High Income UT

The UK stock market suffered a setback in September amid increasingly volatile conditions. None of the factors suggested as potential causes of the retreat are new – the withdrawal of QE, financial conditions in China, stretched valuations, Eurozone deflation to name a few – but the market has suddenly become less complacent about the risks that they represent.

These issues have concerned us for some time and our strategy reflects them. Consequently, although the fund did post a negative return during September, it comfortably outperformed the wider market and its peers. A number of stocks contributed positively to performance during the month. AA continued to perform well. We are confident that the new management team can deliver on a clear long-term strategy of refining and strengthening the core roadside assistance business, as well as growing related businesses. 

Next disappointed, however, with an uncharacteristic warning towards the end of the month that, if the unseasonably warm weather were to continue throughout October, it may not meet current profit guidance. As long-term investors, however, we are not deterred by this weather-related blip and took the opportunity to add to our holding in what we continue to view as a very high quality, dependable retail business with an outstanding track record of delivering long-term shareholder value.

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.

* Source: FTSE International Limited (“FTSE”) © FTSE [2014]. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under licence. All rights in the FTSE indices and / or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and / or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

Some of the products and investment structures documented within this article will not be available to our clients in Asia. For information on the funds that are available please get in touch.

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