Innholdet på denne siden er markedsføring
Opportunities amid the turmoil
2016 has so far been a bumpy ride for investors with weak oil prices and fears over China causing ripples of anxiety across the world economy and a fall in risk appetite. Although stock markets have recovered some of their steep losses from the start of the year, the first two months have been clouded by economic uncertainty and ensuing market volatility.
This uncertainty has been a double-edged sword for investors; while portfolio values have fallen, the potential rewards have increased. For those, like SKAGEN, who invest long-term and with a strong emphasis on valuation, the indiscriminate sell-off across equity markets has been frustrating as share prices haven't reflected company fundamentals. However, it also provides a rich vein of opportunity to invest in strong but unpopular companies at attractive prices. Both SKAGEN Global and SKAGEN Kon-Tiki have used recent market weakness to selectively increase exposure to existing holdings at attractive valuations, with the funds' top 35 holdings currently containing potential upside of 47% and 66%, respectively, up from 30% and 46% a year ago.
Unpopular pockets
Perhaps the largest and deepest pocket of unpopularity is emerging markets where according to the most recent BofA Merrill Lynch Fund Manager Survey, investor sentiment is now at rock-bottom. Although few would dispute that many emerging market countries face problems – debt levels have steadily risen while margin squeeze has caused return on equity to fall below that of developed markets for the first time in fifteen years – the long-term demographic and technological forces driving their advancement remain compelling.
Emerging market valuations close to record lows
There are also signs that cyclical winds could be changing. Commodity prices, to which emerging markets are very sensitive, appear to be stabilising and valuations indicate that we could be close to the bottom of the current trough. On a Price / Book multiple of 1.3x, the MSCI EM index trades at its lowest level since the financial crisis (see chart) and you have to go back as far as the dotcom collapse to find a lower multiple (1.2x). Over the history of the emerging markets index we have seen that when emerging markets have traded below 1.4x, the subsequent 12-month period has delivered average annual performance of almost 50%[1]. The SKAGEN Kon-Tiki portfolio is cheaper still and currently trades below book value.
Clearly emerging markets should not be seen as homogeneous and some countries are currently more unpopular than others. Turkey, once the poster child for developing market reform, is now a source of investor pessimism; its debt-to-GDP ratio has increased by 40 percentage points since 2010 and a weakening Lira combined with increasing political tensions contributed to its stock market losing a third of its value in 2015. Currently 7.5% of SKAGEN Kon-Tiki is invested in Turkey, mainly in Sabanci Holding which is the fund's fourth largest position. We retain our conviction both in Turkey's long-term economic prospects and the deeply undervalued conglomerate and have used recent share price weakness to increase our holding, which has been one of the fund's best performers year-to-date.
As well as regions and countries, certain sectors are currently out of favour with investors. Energy and commodities are deeply unpopular, hurt by fears over the impact a slowing Chinese economy might have on global growth. Financial Services have also de-rated, driven by investor concerns over potential credit defaults by energy or commodity companies and the difficulties experienced by banks and insurers attempting to make money when interest rates are low (or negative). SKAGEN Global currently has just under a quarter of its portfolio invested in Financials, which are diversified by geography and across banking, insurance and real estate. A benefit of stock-picking is that we have used recent share price weakness to increase our position in Citigroup, the fund's second largest position, and also redeploy capital from Nordea into our other Financials holdings where we see attractive long-term return prospects.
Stay disciplined
Another feature of market volatility is that companies which generate reliable cash-flows and a predictable return on capital become increasingly sought after and therefore expensive. For example, although emerging market valuations are generally undemanding, the shares of market leaders such as Unilever Indonesia or Nestle India currently trade at over fifty times their earnings[2], arguably offering considerably more downside-risk for investors than upside potential.
Being selective and disciplined helps to avoid such mispricing which is an obvious flaw of passive investing where investors' exposure to popular companies grows in line with their index weighting. We believe a more attractive route to gain exposure to the growing numbers and wealth of emerging market consumers is often through less fashionable developed market-listed companies such as Spanish retailer DIA which has stores throughout South America and China but trades on a P/E ratio of less than ten times[3].
A positive aspect of volatile equity markets is that it can provide opportunities to trim or exit holdings at attractive prices, with positive company news often translating into immediate share price strength as the market's focus becomes increasingly short-term during periods of stress. While we are long-term investors – the holding period for SKAGEN Global and SKAGEN Kon-Tiki is around four years on average – it is important to remain disciplined and redeploy capital if target share prices are reached and better opportunities become available elsewhere. Our funds have taken profits in several holdings this year with SKAGEN Global trimming its exposure to Tyson Foods, Alphabet, Excel Energy and Dollar General while SKAGEN Kon-Tiki has reduced its position in Indosat and exited Bidvest completely following strong share price performance.
Periods of market mayhem can be demanding for the fund managers who keep an especially close eye on the holdings and their share price performance against our targets, while also evaluating alternative opportunities in the market. At the portfolio level they also monitor the impact of volatility on position sizing within the fund to maintain sensible risk weightings across companies, geographies and sectors.
Arguably the key during periods of volatility is to remain disciplined in sticking to our successful investment philosophy of selecting the best undervalued companies from around the world with identifiable triggers for a significant long-term re-rating. While our clients will be understandably concerned about the market volatility and its impact on their own investments, we believe they will be rewarded for taking a similarly longer-term view.
----------
All figures as at 29 February 2016.
[1] Source: MSCI, ShortSideOfLong.com
[2] Source: Bloomberg
[3] Source: Bloomberg