Polaris Global Value Fund commentary for the third quarter ended September 30, 2016.
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Dear Fellow Shareholder,
Global markets advanced notably this quarter, with the MSCI World Index returning 4.87%. The third quarter followed a tumultuous June quarter with highs and lows triggered by the Brexit vote. Investors fled to safety, and punished companies with a Brexit connection, like U.K. homebuilders. Over the ensuing three months, Brexit’s impact was downgraded, with residual concerns mitigated by global macro-economic growth initiatives. The Bank of England cut interest rates in early August and the Bank of Japan unveiled a 28 trillion yen fiscal stimulus package. Meanwhile, the U.S. economy showed satisfactory progress, with the Federal Reserve intending to tighten monetary policy. The expectation of higher U.S. interest rates had a positive impact on returns for U.S. financial and cyclical stocks; conversely, defensive companies declined.
The Polaris Global Value Fund (“the Fund”) was up 9.17% for the quarter, surpassing the MSCI World Index by a significant margin. We are pleased with the outperformance, attributable to absolute gains in seven of 10 sectors and more than 80% of individual stocks in positive territory. Contributors included materials companies LANXESS AG, Showa Denko and Solvay SA. Consumer discretionary stocks such as International Game Technology PLC and British homebuilders Persimmon, Bellway PLC and Barratt Developments also added to returns. U.S. bank stocks rose, with the exception of recently-sold Astoria Financial Corp. In industrials, Finnish crane equipment dealer, Konecranes Oyj, and U.S.-based electronics distributor WESCO had double-digit returns. Detractors from portfolio performance included Carter’s, Inc., The J.M. Smucker Co., Indian IT outsourcer, Infosys, as well as several U.S. utility and telecom companies.
Polaris Global Value Fund – Portfolio Review
Ameris Bancorp, Independent Bank Corp., and International Bancshares led performance in the financial sector. Ameris announced healthy quarterly metrics, with increasing revenue, higher net income from mortgage and Small Business Administration backed loans, organic loan growth and successful acquisition conversions. Independent Bank reported decent second quarter earnings, highlighting commercial loan and core deposit growth. The Fund exited Astoria Financial as it was the subject of a takeover by New York Community Bancorp. Sale proceeds were used to purchase Puerto Rico-based bank Popular, Inc. We believe the Commonwealth’s largest bank is undervalued due to the local debt crisis, which may be addressed by the recently-passed Puerto Rico Oversight, Management and Economic Stability Act.
All of Polaris Global Value Fund’s materials sector stocks were up, with the majority posting double-digit returns during the quarter. The market approved of LANXESS’ recent strategic acquisitions, including the purchase of Chemours’ clean/disinfect chemical unit and Chemtura, a lubricant and flame retardant business. The company is making in-roads in specialty chemicals, while seeking to dispose of assets from its less-profitable rubber business. Showa Denko’s petrochemical division raised earnings estimates on higher ethylene spreads; the hard disk drive media business showed positive results; and the company (in cooperation with JX Nippon Oil & Energy) agreed to purchase LyondellBassell’s joint venture stake in polypropylene producer SunAllomer. As a result, Showa Denko and JX Nippon enlarged their market share of this high-demand polymer used in packaging, textiles, plastic parts and automotive components.
In the consumer discretionary sector, International Game Technology had solid second quarter results, backed by higher lottery sales in Italy and North America. The company achieved three consecutive quarters of growth, while simultaneously paying down the up-front costs for Italian lotto concessions. U.K. homebuilders referenced positive industry trends, with 10% or more increases on post-Brexit reservations. We bought additional shares of the homebuilders on the second day after the Brexit vote. Carter’s, Inc. underperformed, as it revised down sales and guidance due to weak wholesale and international business. Lower margins were due to increasing capital expenditures related to expansion, technology and marketing. In consumer staples, The J.M. Smucker Co. encountered deflationary headwinds in the core foods segment. According to the Department of Labor, the “food at home” index dropped 1.9% over 12 months; the price index for meat, poultry and eggs was down 6.5% during the same period. This put pressure on J.M. Smucker, which was relying on its acquisition of pet food business, Big Heart, to make up the difference. However, Big Heart’s volumes and sales were down in the second quarter.
Within the industrials sector, Konecranes’ stock rose more than 35% after it received approval from U.S. and E.U. antitrust regulators to purchase the materials/port solutions unit from U.S. equipment maker Terex Corp. The approval is conditioned on the divestment of Konecranes’ STAHL CraneSystems. The company also announced improved profits on the back of cost savings efforts. U.S.-based WESCO International, Inc. confirmed full year guidance, referencing good construction end market demand that offset weakness in its energy business. Andritz, a previous Fund holding, was repurchased. The Austrian supplier of plants and services for hydropower, pulp/paper and metals appeared attractive because of its recurring service-based revenue streams, solid balance sheet and acquisition track record.
In the IT sector, Samsung Electronics advanced, notwithstanding the lithium battery problems late in the quarter. It reported its biggest operating profit in two years on strong Galaxy S7 sales, as the company increased its cellphone market share. The stock price rose further on news of management’s proactive restructuring efforts to avoid tax and/or share count issues in a changing regulatory environment. Conversely, Infosys declined after lowering its annual sales forecast. The entire IT outsourcing industry is facing competition from customizable internet-based/cloud software. Telecom sector stocks detracted from performance, including U.S.-based Frontier Communications and Verizon Communications. Frontier announced second quarter earnings that incorporated assets from its recent wireline acquisition. Revenues on a consolidated basis were below expectation, but Frontier raised its estimate of integration savings from $700 million to $1.2 billion. Verizon detailed subpar earnings, with lower total operating revenues. However, the company executed complementary acquisitions, including Yahoo’s core web assets, workforce management company, Fleetmatics, and IoT solutions company, Sensity.
Investment Environment and Strategy
Our unwavering value philosophy, focused on identifying companies with free cash flow and conservative balance sheets, directed our investment process. This discipline proved fruitful over the past quarter, and has contributed to long-term outperformance through the quarter ended September 30, 2016. We continue to seek out stocks that may enhance the valuation profile of Polaris Global Value Fund and lead to satisfactory returns. Over the past year, attractively valued companies have been predominately focused on two sectors: financials and materials, and a few countries: Japan, the U.S. and other Asian economies. Analyst travel has ensued. We look forward to sharing our findings in the months ahead.
Bernard R. Horn, Jr., Shareholder and Portfolio Manager
The Fund invests in securities of foreign issuers, including issuers located in countries with emerging capital markets. Investments in such securities entail certain risks not associated with investments in domestic securities, such as volatility of currency exchange rates, and in some cases, political and economic instability and relatively illiquid markets. Options trading involve risk and are not suitable for all investors. Fund performance includes reinvestment of dividends and capital gains. During the period, some of the Fund’s fees were waived or expenses reimbursed. In the absence of these waivers and reimbursements, performance figures would be lower.
On June 1, 1998, a limited partnership managed by the adviser reorganized into Polaris Global Value Fund. The predecessor limited partnership maintained an investment objective and investment policies that were, in all material respects, equivalent to those of the Fund. The Fund’s performance for the periods before June 1, 1998 is that of the limited partnership and includes the expenses of the limited partnership. If the limited partnership’s performance had been readjusted to reflect the second year expenses of the Fund, the Fund’s performance for all the periods would have been lower. The limited partnership was not registered under the Investment Company Act of 1940 and was not subject to certain investment limitations, diversification requirements, and other restrictions imposed by the 1940 Act and the Internal Revenue Code, which, if applicable, may have adversely affected its performance.
As of September 30, 2016, the Fund’s largest equity holdings and the percentages they represent in the Fund’s portfolio market value were as follows and are subject to change:
The MSCI World Index, net dividends reinvested measures the performance of a diverse range of global stock markets in the United States, Canada, Europe, Australia, New Zealand and the Far East. The MSCI World Index is unmanaged and does include the reinvestment of dividends, net of withholding taxes. One cannot invest directly in an index. The views in this letter were those of the Fund manager as of September 30, 2016 and may not reflect the views of the manager after the publication date. These views are intended to assist shareholders of the Fund in understanding their investment and do not constitute investment advice.
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