Bernard Horn’s Polaris Global Value Fund 2014 Letter
Dear Fellow Shareholder, January 12, 2015
Global equity markets returned to positive territory in the last quarter of 2014, as evidenced by the 1.01% return in the MSCI World Index (net). The positive result for the quarter was almost exclusively due to the 4.6% U.S. gain, partially offset by losses in nearly all non-U.S. markets. By comparison, the MSCI EAFE Index, net returns were 1.8% in local currency; however, the return in U.S. dollars terms was -3.6% due to the decline in most currencies versus the dollar.
The Polaris Global Value Fund (“the Fund”) outperformed the MSCI World Index, net benchmark in the quarter, up 2.39% while the Index advanced 1.01%. Notwithstanding declines in all energy and some materials companies, overall results were driven higher by solid earnings results in a number of companies.
At the start of 2014 we reflected on the strong equity market returns in 2012 and 2013 and felt investors should be pleased if equity markets advanced in 2014, and if so, single-digit returns should be appreciated. In fact, the MSCI World Index, net advanced 4.94% in 2014, while the EAFE Index, net dropped -4.9% in 2014, due to foreign exchange rate declines relative to the dollar. For the year 2014, the Fund was up 3.68%, lagging the MSCI World Index’s return of 4.94%. The Fund’s underweight positions in the U.S. and overweight in Europe were primarily responsible for the annual result.
In the fourth quarter, the Fund’s top 10 contributors were diversified across country and industry. Positive contributions were realized from companies including Greencore Group PLC (LSE:GNC), an Ireland-based producer of convenience foods; U.S. utility Allete (ALE); two U.S. banks; two U.K. homebuilders; Duni AB (OSTO:DUNI), a Swedish tabletop paper products supplier; U.S. based UnitedHealth Group (UNH); MEIJI Holdings (TSE:2269), a Japanese dairy products company; and Symrise AG (XTER:SY1), a German maker of ingredients in the beverage, food and fragrance industry. Detractors were more concentrated among energy and material sector stocks impacted by the commodity price declines, including Sasol Ltd (SSL), Maurel et Prom (XPAR:MAU) and Tullow Oil PLC (LSE:TLW), as well as Canadian methanol producer Methanex Corp (MEOH).
Eight of 10 sectors were in absolute positive territory, headed by consumer discretionary, consumer staples, financials and information technology. The majority of the consumer discretionary holdings produced robust returns because of good earnings. Encouraging sales and profit numbers at Duni (OSTO:DUNI) were attributable to organic growth, recent product launches, the completion of a recent acquisition and efficiency programs that have effectively strengthened margins. The four U.K. homebuilders in the Fund announced healthy results, on increased demand due to improved mortgage availability. Land bought inexpensively during the recessionary period is now coming into production, which should result in higher-margin house sales in the coming quarters. French tire maker Michelin (XPAR:ML) was added to the consumer discretionary sector during the quarter. With lower gas prices, increased driving mileage may boost the demand for replacement tires.
Consumer staples holding Greencore (LSE:GNC) reversed course from last quarter’s decline, adding double-digit gains after reporting results that reflected its participation in food-to-go (FTG) business, the fastest growing segment in UK grocery sales. The company also announced plans to build out its U.S. FTG business with the acquisition of Lettieri’s LLC and new site construction in Rhode Island and Washington State. In Japan, MEIJI Holdings Co Ltd. (TSE:2269) reported healthier margins and rising profitability. The integration of the 2009 merger of its dairy and pharmaceutical divisions is finally achieving better results. The company has successfully reorganized the business, implemented structural reforms and increased overseas operations. With an aging population eating more probiotics, MEIJI’s dairy division more than offset Japanese drug price cuts impacting the pharmaceutical division. We expect that the decrease in oil prices will have a beneficial effect on disposable income, leading to further consumer demand in Japan, and in all non-oil producing countries.
All of the Fund’s U.S. financial holdings were in absolute positive territory this quarter. The end of the Federal Reserve quantitative easing program signaled the potential for higher interest rates (and possibly improved net interest margins) in 2015; many investors looked favorably on this prospect. However, this trend has yet to materialize, with several banks still reporting stagnant net interest margins at the end of 2014. Increasing loan balances and decreasing loan loss provisions buoyed net income at financial institutions over the past few quarters. In addition to these metrics, U.S.-based BNC Bancorp (BNCN), Ameris Bancorp (ABCB) and Independent Bank Corp (INDB) capitalized on recent acquisitions or realized synergies from integrations. U.S. reinsurer The Chubb Corp. (CB) posted satisfactory returns, due to better renewal pricing and fewer catastrophic losses. In similar fashion, German reinsurer Hannover Re: announced fewer catastrophe losses in 2014, while gaining subscribers to its life and health business. During the quarter, the Fund’s position in Univest Corp of Pennsylvania (UVSP) was sold as it reached its valuation limit.
Norwegian banks, Sparebank 1 SR (OSL:SRBANK) and DNB Bank ASA (OSL:DNB), declined on oil-related concerns, although neither institution holds more than 10% of loan books in direct oil- and gas-related businesses. We believe that the stock price drops are more magnified than warranted. Although Norway is an oil-producing country, it has a very different structure for oil proceeds. In most OPEC countries, oil is the only resource and money from oil revenues is spent on current government programs. In Norway, oil revenues collected by the government are sequestered in an oil fund, which is explicitly banned from use to bolster the domestic economy. In our opinion, the Norwegian economy is fairly insulated by declines in oil prices, but might be affected at the margins.
Seven of eight information technology stocks were up, as many reported respectable earnings for the September 2014 quarter. Hewlett-Packard Co. (HPQ) was the sector’s top performer, after announcing plans to split into two publicly traded companies: one that will focus on enterprise technology, storage, service and cloud platforms and one that will focus on consumer-driven products and printers. In an effort to reposition itself in the business-to-business space, Xerox Corp. (XRX) struck a deal to sell its information technology outsourcing business to France’s Atos for $1.05 billion. At Samsung Electronics (XKRX:005930), Lee Jae Yong has taken the reins of the company since his father’s hospitalization. During his short tenure, he has already proposed a $2 billion buyback and disposed of stakes in chemicals and defense businesses. The market is optimistic that such restructuring will also lead to better corporate governance and a renewed focus on core markets, including consumer televisions, smartphones and smart home software. We look to new cell phone models from Samsung’s research & development labs to lead its low-cost competitors.
All utility sector holdings had double-digit returns for the quarter. Allete (ALE)’s third quarter earnings were up, due to cost recovery revenue related to wind energy expansion and retrofit of an electric unit. In addition to capital expenditure projects coming to fruition, the company announced strong demand from its important industrial customers in the region. Hong Kong water utility Guangdong Investment Ltd. (HKSE:00270) renewed its contract to supply water to Hong Kong, with higher-than-expected tariff increases of approximately 6% per year for