Cooper Investors’ CI Brunswick Fund commentary for the third quarter ended September 30, 2016.
“Men, it will not be long until there will be a mob assembling here to hang Senators from the rafters of the Senate. I have to determine whether I will stay and be hung with you, or go out and lead the mob” – Huey Pierce Long Jr., nicknamed The Kingfish, was an American politician who served as the 40th Governor of Louisiana from 1928 to 1932 and as a member of the United States Senate from 1932 until his assassination in 1935. A Democrat, he was an outspoken populist who denounced the rich and the banks, and called for “Share our Wealth.”
“A society that puts equality before freedom will get neither. A society that puts freedom before equality will get a high degree of both.” Milton Friedman.
“The Great Depression, like most other periods of severe unemployment, was produced by government mismanagement rather than by any inherent instability of the private economy.” Milton Friedman.
CI Brunswick Fund
CI Brunswick Fund – Market and Portfolio Performance
The ASX200 Accumulation Index performed strongly in the September quarter (+5%). This included a post Brexit recovery during the month of July followed by a small downward drift during August as investors digested a mixed set of company results.
Key contributions to portfolio performance during the quarter included iSelect (ISU) (good 2H 16 result with strong growth in new product verticals), Lifestyle Communities (LIC) (solid FY16 result), Equity Trustees (EQT) (new management and refocus of business), and Summerset (SUM) (strong 1H 16 result).
Portfolio stocks that performed poorly were TPG Telecom (TPM) (weaker than expected FY17 guidance driven by slower organic growth, increasing margin pressure from the NBN, and delays in realising IIN synergies), Washington Soul Pattison (SOL) (derating of TPM, its largest portfolio holding), Remgro (REM) (partly currency related, news of a rights issue) and Carindale Property Trust (CDP) (concerns that US bond rates will rise).
During the quarter the Reserve Bank of Australia lowered rates (again) by 25bps, bringing the cash rate down to 1.5%. The key reasons cited were:
- conditions have become more difficult for a number of emerging market economies and the underlying pace of China’s growth appears to be moderating;
- Australia’s terms of trade remain much lower than it has been in recent years;
- recent data suggests that overall growth is continuing at a moderate pace, despite a very large decline in business investment;
- other areas of domestic demand, as well as exports, have been expanding at a pace at or above trend;
- labour market indicators continue to be somewhat mixed, but are consistent with a modest pace of expansion in employment in the near term;
- inflation remains quite low;
- the most recent information suggests that dwelling prices have been rising only moderately over the course of this year, with considerable supply of apartments scheduled to come on stream over the next couple of years, particularly in the eastern capital cities;
- growth in lending for housing purposes has slowed a little this year. This suggests that the likelihood of lower interest rates exacerbating risks in the housing market has diminished.
In contrast, the US Federal Reserve continued to signal that an increase in rates is now more likely. In August, Fed Chair Janet Yellen stated that “…in light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months”.
As we have previously spoken about, the collective action of Central Banks across the globe is unprecedented. For example, the Bank of England’s current cash rate (0.25%) is lower than it has ever been over its 300-year history:
The ECB, BoE and BoJ have extended their asset purchase programs (quantitative easing) to include corporate debt and equities, in what can only be described as a large, unprecedented experiment.
Although we are bottom-up investors, the magnitude of this intervention by governments in financial markets is hard to ignore and has undoubtedly influenced asset prices and skewed the allocation of capital across economies. There is little doubt of the potential future risks to asset prices and performance of the portfolio, even though the end game remains uncertain.
We remain entirely focused on implementing our investment philosophy. Perhaps the most important part of this is finding and backing the best management teams, who will ultimately find a way to navigate whatever is ahead of us. These “best in breed” managers are often owner operators with a proprietorship culture, deep (nuanced) industry/ business knowledge, are passionate and above all honest.
We also believe that a number of secular growth opportunities will remain robust in almost any future scenarios and so we continue to focus our efforts around “clusters” of companies exposed to these trends. For example, the ongoing dynamic of our ageing population.
In addition, the portfolio remains well diversified across sectors, particularly relative to the ASX200 Accumulation Index which is much more concentrated in Banks and Resource companies (~40% combined).
The portfolio is also more diversified by market capitalisation, geography and by CI’s subsets of value definitions. Combined, we believe this is a key reason for the portfolio’s 87% hit rate of out-performance in down markets:
The portfolio remains positioned around six subsets of value:
- Stalwarts (19% of the portfolio) – sturdy, strong and generally larger companies with world class privileged market and competitive positions. (Wesfarmers)
- Bond like equities (12%) – stocks with secure, low-volatile dividends that can be grown and recapture inflationary effects over time. (ALE Property Group, Auckland Airport)
- Growth companies (36%) – growing companies with identifiable value propositions using traditional value metrics and run by focused, prudent and experienced management. (Vitasoy, Summerset and Ryman)
- Asset plays (13%) – stocks with strong or improving balance sheets trading at discounts to net asset value or replacement value. (Jardine Strategic, Soul Pattison, Remgro)
- Low risk turnarounds (11%) – sound businesses with good management in place and good balance sheets essential. We especially like spin offs and government to private turnarounds. (Clydesdale, Sims Metal)
- Cyclicals (3%) – stocks showing both upside and downside leverage to the cycle with experienced and contrarian managers who can allocate capital prudently. (Boral)
Currently the portfolio holds around 7% cash. The portfolio has around 13% of assets invested in overseas stocks that own businesses in Switzerland, South Africa, China, USA, Canada, UK, Singapore, Mexico and Hong Kong listed companies.
Portfolio attributes as at September 2016 are summarized below:
During the September quarter we added a couple of new stocks to the portfolio.
Following a large derating in its share price, we were able to purchase a stake in Regis Healthcare (REG) at what we believed was an attractive price. This followed a number of negative announcements relating to the government’s funding for the