Value Investing

Polaris Global Value Fund 3Q15 Investors Letter: Glencore Top Holding

Polaris Global Value Fund letter to investors for the third quarter ended September 30, 2015.

Dear Fellow Shareholder, October 6, 2015

The Polaris Global Value Fund (“the Fund”) underperformed the MSCI World Index, net benchmark in the quarter, at -8.80%, while the Index dropped -8.45%. The quarter was marked by volatility in commodity prices, which had a negative short-term effect on some materials and energy companies. Ultimately, we believe lower oil prices will have a positive effect on consumer purchasing power worldwide; however, we must first weather this current spate of volatility.

Polaris Global Value Fund

Polaris Global Value Fund

A number of U.S. financials, including The Chubb Corp., Astoria Financial Corp., Ameris Bancorp and BNC Bancorp contributed positively to the Fund’s performance. Banks were buoyed by the expected Federal Reserve rate hike in September. The Fed’s decision to postpone the increase left banks lower at the end of the quarter. India’s IT company, Infosys, Ltd., had double digit gains after announcing impressive quarterly results and projected growth that triggered revised upward guidance. A more recent portfolio addition, Kia Motors Corp., benefited from new car model launches and top safety ratings from J.D. Powers and Associates. These gains could not offset losses elsewhere in the portfolio, including energy stocks WorleyParsons, Ltd., Marathon Oil Corp. and Maurel et Prom. Perennial outperformer, Canada’s Methanex Corp., saw methanol prices drop more than 30% due to lower commodity prices. Lower prices of coal used to produce methanol in China also impacted the stock. One of the Fund’s largest holdings, Greencore Group, was down modestly this quarter due to labor cost pressures in the U.K. and one-off start-up charges for its U.S. facilities.

On a year-to-date basis, the Fund continued to exceed the MSCI World Index, net, at -3.27% vs. -6.04%. We are pleased with the out-performance YTD, as well as our benchmark-beating performance over all longer time periods as reflected below.

Polaris Global Value Fund

Polaris Global Value Fund – Investment Portfolio

The Chubb Corp., a property and casualty insurer in the U.S., was the top individual stock contributor this quarter. Zurich-based ACE offered a 30% premium to buy The Chubb Corp. and form a global property and casualty insurance leader with a shared culture of disciplined underwriting. Activist investor Basswood Capital reported a 9.2% stake in Astoria Financial Corp., citing opportunities to boost shareholder value. BNC Bancorp posted better-than-expected second quarter results, after successfully integrating recent acquisitions. This initiative expanded in August, when BNC Bancorp agreed to purchase South Carolina-based Southcoast Bank for $95.5 million. German reinsurer Hannover Re posted strong interim results and raised full year guidance, despite industry competition. Both Hannover Re and Munich Re had fewer catastrophic claims to pay out in 2015, benefitting their respective balance sheets.

U.K.-based Standard Chartered faced pressure in three different geographies. The company was impacted by rising impairment levels in India, significant exposure (loans and credit lines) to commodity traders in Europe and lesser emerging-market lending. In the face of these headwinds, Standard Chartered management felt it prudent to halve dividends to ensure sufficient capital on hand. Norway was no longer impervious to slumping oil prices, as evidenced by rising unemployment (to about 3.8%) and a slowing economy. The country’s biggest bank, DNB Bank, beat second quarter profit expectations, but increased loan loss projections through the end of the year. DNB Bank management expressed caution about 2016 and the likelihood of increasing impairment losses linked to oil-related activities.

ALLETE Inc. had double digit returns, due to robust taconite sales. Taconite is used in the production of steel, the demand of which has increased with higher car sales and infrastructure/building activity. Hong Kong water utility Guangdong Investment, Ltd. intends to deploy capital to acquire further earning assets from its parent company, including toll roads and water treatment facilities. Investors were excited about the prospects for the water treatment plant, which is a burgeoning theme in water-constrained China.

Information technology company Infosys, Ltd. was among the top contributors for the quarter, as it announced stellar quarterly results and notable growth rates. Issues that previously plagued Infosys, Ltd. dissipated. Attrition declined due to targeted measures by management to provide employees with better training and salaries. Legal battles over the visa program concluded, with no findings of misuse by Infosys, Ltd. The stock price responded, up approximately 20% during the quarter. Sector gains were essentially negated by Samsung Electronics Co., Ltd., which has yet to turnaround the market share declines in the smart phone division.

Deutsche Telekom’s stock price ticked up, after reporting double-digit growth for the second quarter of 2015. Net revenues rose by more than 15% and free cash flow improved to nearly $1.6 billion. Deutsche Telekom’s retail broadband customers increased in Germany and subsidiary T-Mobile U.S. continued to outpace peers in capturing new subscribers.

Among consumer staples stocks, The JM Smucker Co. was boosted by its FY15 acquisition of Big Heart Pet Brands and the first quarter U.S. retail launch of Dunkin’ Donuts K-Cup pods. Asahi Group Holdings, Ltd. experienced a tangential boost from news of a possible merger of two of the world’s biggest beer makers, AB InBev and SABMiller. Should monopoly issues arise with the merger, a spin-off of certain beverage lines might occur. Asahi Group Holdings could capitalize on this action, picking up overseas assets for continued growth. Greencore Group (as referenced above) was the sole detractor in the sector.

Consumer discretionary holdings, Kia Motors Corp., Duni AB and the majority of British homebuilders, were in positive territory for the quarter. Duni AB, a Swedish supplier of paper goods and table settings, was up on earnings news. The company noted increasing net sales for the 3- and 6-month periods ending June 2015, as well as decreased net debt. Duni AB shuttered the hygiene production business, and reinvested capital to upgrade paper machines for increased capacity. The on-going initiatives contributed to better profitability of operations. Homebuilders experienced consistent sales progress in a more favorable regulatory environment than we have seen in years, which allowed the stocks to hold up in a volatile market. Chinese lottery company REXLot Holdings, Ltd. was the main sector detractor, as the trading suspension continued due to accusations of accounting irregularities. REXLot Holdings also faces bond repayment demands due to the suspension in its stock trading and reported limited cash flow availability from its China operations.

Polaris Global Value Fund

Commodity price declines understandably hindered the global energy market. At the portfolio level, we sought to diversify holdings amongst both oil exploration/production (E&P) and refining businesses. Companies in refining, like Thai Oil and Marathon Petroleum Corp., proved a good hedge of lower oil prices. Yet many other companies suffered, including Maurel et Prom, which had operational issues that obstructed its ability to export oil. Like many of its competitors, Marathon Oil Corp. reduced its capital expenditure budget for next year. WorleyParsons, Ltd., an Australian engineering and design company, saw slowing customer demand as its business is largely comprised of E&P companies.

At a base level, the materials sector was the largest detractor to Fund returns this quarter, partially attributable to a 13% weighting in the portfolio. However, further analysis indicated that the Fund’s holdings outperformed the sector benchmark. Relative outperformance can be attributed to better performance from companies whose products ultimately sell into more defensive end markets, like German flavors and fragrance producer Symrise and beverage can supplier Rexam. Less than half of the materials holdings rely on cyclical end demand. Underperformers amongst materials companies included Methanex Corp. (as referenced above), Yara International and Solvay SA. All three stocks have been among the Fund’s top performers in prior reporting periods; each was uniquely impacted by lower commodity prices this quarter. Norwegian nitrogen giant Yara International faced increasing competitive pressure from Chinese low-cost producers of urea. Early in the year, global urea prices fell to multi-year lows below $260 a ton, and China continued a torrid pace of urea exports. Although Solvay SA reported admirable second quarter earnings and margin improvement, the stock dropped based on weak results in the company’s Novecare business line. Three of Solvay’s four main business lines executed well for the quarter with increased sales and volumes, yet all focus surrounded Novecare. The contraction in the U.S. oil and gas industry supply chain dampened Novecare’s sales. Demand diminished for stimulation, drilling and cementing activities. In a case of inopportune timing, Solvay announced just prior to the earnings release that it had recently built a state-of-the-art oil and gas lab in Singapore intended to internationalize Novecare’s business.

Polaris Global Value Fund

Polaris Global Value Fund – Investment Environment and Strategy

Our outlook remains constructive over the medium term. From a corporate perspective, the reset of commodity prices at lower levels will make it difficult for higher cost materials and energy producers, but will usher in a wave of disruptive technologies and lower-priced, efficient competitors. At the consumer level, lower gasoline prices may ultimately have a positive effect on purchasing power. There is clear evidence of this trend in the U.S. with record car sales and solid housing demand. In Japan, lower prices have encouraged spending even in the face of Japan’s consumption tax hike. India imports roughly 85% of its oil. Cheaper oil prices helped to lower India’s chronically high inflation rate and, given large government energy subsidies, aided the country’s fiscal position.

Lower commodity prices were a short-lived boon for China, as cheaper raw materials spurred on transportation and building projects. However, commodity demand has since lessened in the country. Data suggests a significant and continuing slowdown in China’s fixed assets investments and manufacturing, especially in heavy industries and capital goods. Taxes eroded the full benefits of lower gasoline prices in Europe. Unraveling the recent fiscal crises and faced with modestly rising unemployment in countries like Greece and France, Eurozone inflation fell to -0.1% by September. The European Central Bank has indicated a willingness to increase its stimulus program to ward off deflation.

We believe that deflation is far more present in the global economy than most investors, companies and central bankers like to believe. We don’t consider this a negative trend. The deflationary elements in the economy continue to keep interest rates down, which is impeding bank interest margins, but is also helping to dramatically improve credit quality among borrowers. Business that cut costs or are low-cost producers may thrive in a deflationary environment. “Deflation beaters” can promote productivity, while typically avoiding excess capacity and holding low debt levels. A pillar of our investment strategy has been to retain “deflation beaters” or similar companies that have the potential to prosper in a lower price environment and thrive in a market recovery. In the coming quarters, our research team will continue to evaluate individual companies to ensure they remain good values backed by strong fundamentals (free cash flow, notable management, etc.). In doing so, we seek to achieve long-term benchmark beating performance, as we have accomplished to date.

Sincerely,

Bernard R. Horn, Jr., Shareholder and Portfolio Manager