Below is Lauretta ‘Retz’ Reeves’ first letter to investors in the Treasure Harbor Folio, an international dividend portfolio.
What a difference a month makes! As investors digested the withdrawal of central bank stimulus and an apparent slowdown in China, international markets – and especially emerging markets – gave back in January almost everything they had gained in the last quarter of 2013.
The Treasure Harbor Folio was launched on October 1, 2013. Treasure Harbor is an international dividend Spoke Fund®, focused on international equities that have above-average dividend yields. Treasure Harbor invests in ADRs (American Depository Receipts) and other U.S.-traded versions of internationally-traded shares.
While MLPs (Master Limited Partnerships) and REITs (Real Estate Investment Trusts) are common investment vehicles for income here in the U.S., both are rare in international markets – and the international real estate companies that do exist typically pay out far less of their earnings than their U.S. counterparts.
As a result, building an international dividend portfolio like Treasure Harbor was a painstaking process to say the least. Nonetheless, I strongly believe it will be worth it. I designed Treasure Harbor to provide excellent diversification for U.S. and other international income-producing assets.
Even with its focus on yield, Treasure Harbor provides diversification across various sectors and countries. Approximately 23% of the portfolio is in Financial companies; 17% is in Energy, Technology and Utilities each; 10% is in Materials, and 7% is in both Medicine and Staples. Geographically, the ADR-friendly U.K. makes up approximately 32% of the portfolio (although about half of these companies are dually domiciled in the Netherlands, Hong Kong or Australia); 18% is in Canadian companies; 15% is in France; 8% is invested in Germany and 7% is in Switzerland.
Treasure Harbor also invests in stocks of companies headquartered in Australia, New Zealand and Norway, which combined make up 8% of the portfolio. In addition, emerging market stocks in Africa, Brazil, China, and Russia make up 12% of the total. Treasure Harbor also has a large capitalization and value bias, with a Price/Earnings ratio of 12.7, Price/Sales of 1.08 and yield of 4.4%.
Consistent with other IIM portfolios, Treasure Harbor represents a unique approach for sophisticated investors. For instance – we haven’t been able to find an appropriate ADR benchmark including high yields stocks selected exclusively from all the countries outside of the U.S., so we created our own blended benchmark to best compare the performance of Treasure Harbor. That blended benchmark consists of an 85% weighting in the iShares International Select Dividend ETF and 15% of the iShares Emerging Markets Dividend ETF.
In its first quarter, Treasure Harbor declined 1.64% after fees versus a decline in the benchmark of 1.58%. In general, Emerging Market stocks were a drag on performance. Mobile Telesystems ADR, the leading provider of telecommunication services in Russia and the CIS, retreated from a five year high in October, despite reported improvements in 9 month cash flow and its debt profile.
MTS is facing slowing cellular demand but still has plenty of opportunity to expand broadband penetration, ARPU (Average Revenue Per User) and profitability. Its Russian domicile does warrant extra scrutiny, but MTS is actually rated by S&P as Russia’s most transparent company. In the meantime, cash flow is expected to cover debt obligations and the dividend, which should continue to generate a yield greater than 5.0%.
Another detractor to performance in the quarter was the Norwegian company Seadrill Ltd., one of the world’s largest and fastest growing deep-water drillers. Seadrill’s research shows that deepwater and ultra-deepwater discoveries will become a larger part of produced volumes, and the company is using unique financing options – combining debt, sales and leasebacks – to generate cash for its aggressive expansion of technically capable rigs and to pay a growing dividend, both top company priorities.
The combination of high leverage, a disappointing third quarter report and an unintuitive rise in the third quarter dividend at Seadrill created investor jitters. As noted in a January presentation, Seadrill increased its dividend based on confidence in its growth prospects – management sees EBITDA increasing 80% from 2013 to 2016, which should support assets, earnings and dividend growth.
Diversification in the portfolio across the telecom sector acted as intended. Deutsche Telekom (DT) showed positive performance as the company reported revenues, operating profit and free cash flow above consensus in its 2013 third quarter report.
DT has focused on improving its return on capital by merging its U.K. operations with France’s Orange, where it is now the largest wireless operator, and merging with Metro PCS in the US, where it is adding revenue and subscriber growth and focusing on costs throughout the company. DT’s cash flow should fund its projected .50 euro dividend for next year – based on current price the resultant yield would be over 4.0%.
The French asset manager, retail and investment bank BNP Paribas was one of the best performing securities in the portfolio. In addition to France, BNP has a very competitive position in the U.S. and Belgium, where it earns good returns on capital, and a wide banking presence in Italy as well. BNP has a very strong capital base which can help it expand into other regions, while its European business should benefit from the recent favorable Bank for International Settlements (BIS) revised leverage ratio proposals. In spite of the recent rise in share price, BNP’s yield is expected to be greater than 3.5% this year, and the dividend is expected to rise over 20% in 2015.
Studies have shown that investing in stocks that pay good dividends can enhance equity returns partially due to the dividend itself and partially due to management’s disciplined use of the capital required to pay those dividends. Companies that pay high dividends, however, may be more volatile. As such, although the outlook for MTN and Seadrill remains positive, I reduced their position sizes in the portfolio, as well as that of the U.K. utility SSE, to reduce volatility and harvest some tax losses. I also broadened the portfolio’s exposure in telecom throughout the period via investments in Vodafone and Telecom Corp of New Zealand.
If January is any indication, international markets may be volatile throughout the year – but keep in mind that with volatility comes opportunity. I intend to capitalize on these opportunities by visits I will be making to Europe in March to current and prospective Treasure Harbor and Frigate companies. I will provide further investment updates following this trip. In the meantime, thank you for investing with me, and I welcome any comments or questions you may have.
About the Treasure Harbor Folio
The Treasure Harbor Folio is an innovative, investor-friendly alternative to the traditional actively managed mutual fund. It’s built on a model we call a Spoke Fund®.
Spoke Fund® is a group of separate investor accounts linked to a portfolio containing a significant portion of the net worth of the portfolio manager. IIM created and owns this trademarked and proprietary approach to better transparency and integrity in investing other people’s money.
Fees for Treasure Harbor are 1.25% of assets annually, assessed on a monthly basis. Turnover, taxes and trading are minimized in the fund, which uses a long-term income-focused international value investing strategy.
For more information, visit our website.
The above in no way constitutes investment advice. It is for educational and informational purposes only. Nothing contained here should be construed by anyone as an invitation or solicitation to buy or sell any security. It does not contain personalized legal, tax, investment, or financial advice.
Historical performance data contained above represent performance results as reported by the portfolio listed. The performance results are for illustration purposes only. Historical results are not indicative of future performance. Positive returns are not guaranteed.
Individual results will vary depending on market conditions and investing may cause capital loss. The customized ADR Index used for comparison purposes above may be less volatile than the holdings of the portfolio listed. The performance data is net of all fees reflecting the deduction of advisory fees, brokerage commissions and any other client paid expenses. The performance data includes the reinvestment of capital gains and dividends.
The publication of this performance data is in no way a solicitation or offer to sell securities or investment advisory services.