IIM International Portfolios: Investor Letter for Q4 ’18

Skyfall

Chicken Little had a point in 2018 – for equity investors, whether in the U.S. or abroad, the sky fell!

Political turmoil, rising interest rates and a slowing global economy were credited for pushing the S&P 500 Index and the Dow Jones Industrial Index down  6.2% and 5.6%, respectively.  Digesting U.S. turmoil along with other woes such as Brexit, international markets fared even worse – the Morgan Stanley All Country World Ex-U.S. Index fell 14.2%.

Our International ADR Portfolio Frigate, focused on capital appreciation, returned a negative 9.05% in 2018, better than the gross return of the S&P ADR index of a negative 15.82%. Since inception on 7/1/2013, Frigate has returned a cumulative positive 13.23% versus 11.42% for its benchmark. Key detractors included Bayer, which, as discussed in previous letters, is having trouble digesting the its Monsanto acquisition along with the glyphosate litigation, which I am hopeful will be less onerous than previously expected. Perhaps due to uncertainly in its major American and Asian markets, Japan-based, Komatsu the second largest construction equipment manufacturer by revenue, also had a bad year, despite rising consensus estimates. French bank BNP worked against performance as expected provisioning increased in some marginal markets and unexpectedly in a specific area of its home market. I am expecting this pressure to abate and earnings return to a growth trajectory.

On the bright side,  Frigate captured a very nice profit in British telecommunications company SKY PLC, which we sold into the bidding war successfully won by Comcast.  Investors also approved of the turn-around progress made by Swedish telecommunications and equipment provider Ericsson, who also should benefit from the roll out of 5G. Indian software developer Infosys enjoyed good revenue growth and an improving share price.  Taking advantage of volatility, we sold luxury good maker LVMH when it became expensive in June and bought it back in Treasure Harbor after the price fell and the yield became attractive.

Treasure Harbor, our ADR portfolio focused on dividend yield, fell 8.99% in 2018 versus its blended benchmark’s return of a negative 10.21%. Since inception on 10/1/2013, Treasure Harbor has returned a cumulative negative 4.98% versus the return of its benchmark (15% SPDR S&P Emerging Market ETF, 85% SPDR S&P International Dividend ETF) of a negative 3.78%.  Brazilian brewer AMBEV and Spanish Bank Santander were negatively impacted by their exposure to Brazil, which struggled to come out of its two-year recession.  As of the third quarter, there was a moderate return to economic growth, which has underpinned improvement in their share prices. UK communication provide Vodafone  is transitioning from a wireless  provider to a converged player while simultaneously restructuring and trying to buy  assets from Liberty Global – a transaction that has been delayed by the European Commission.

Combining the uncertainty of shape of Vodafone’s future with that of the UK,  it’s not surprising that Vodafone’s share price was a big detractor to performance last year. Slightly offsetting our beer exposure,  Coca-Cola European Partners PLC continues to execute its expansion well and its share price appreciated accordingly.  Other good performers included: telecom company Spark New Zealand, which also will benefit from a roll-out of 5G and its economies of scale in a relatively small market , and Spanish-based utility Iberdrola, which has a global footprint and good investments in renewables.

Not surprising, Yellowtail, our international small/mid cap strategy was the most vulnerable to negative investor sentiment, falling 20.46% in 2018 versus a negative 18.61% percent for the benchmark (Vanguard FTSE All-World ex-US Small-Cap ETF).  Since inception on 12/1/2014, Yellowtail has returned a cumulative + 14.31% versus +8.59% for its benchmark. German-based Wacker Chemie was recovering from a September, 2017 explosion in its Charleston, Tennessee plant, but due to changes in Chinese solar policies suffered  from lower pricing and profits in its polysilicon division and the stock price continued to suffer.  The position in Wacker is currently under review as the company lowered 2018 earnings expectations this January due to questions over insurance coverage.

Sulzer, a provider of pumping solutions, rotating equipment maintenance and mixing technology to oil and gas, power and water markets,   lifted the cloud of sanctions by reducing the majority ownership of  Renova, chaired by Russian “specially designated national” Victor Vekselberg, below 50%. Still Sulzer’s share price languished as the year and volatility in the energy markets progressed.  With the terms of Brexit unresolved, the share price British- based staffer and recruiter Hays PLC suffered. Although the company reported a strong second-quarter ending in December, currency and Brexit uncertainty could be working against Hays in the future; I believe these scenarios have been discounted in the share price. Yellowtail also owns Spark, which was a bright spot in performance. Reporting good nine month growth in assets, fee income and premiums, Swiss Life’s share price also did well in 2018. London-based Bunzl, a global leader in supplying nonfood consumables, benefitted from outsourcing trends and smart acquisitions, and its share price was a positive contributor to 2018 performance.

Maybe the sky didn’t actually fall in 2018, but it sure got dark. Perhaps due to the abatement of tax-loss selling, there has been a rebound in some areas of the market, but there is still plenty of volatility and the sky is still dark. I expect the current shut down of the US government and the overhang of new tariff regimes will have a real economic impact on individuals, the economy and company earnings in both the US and abroad. In the meantime, the Brexit situation is reaching a dangerous impasse. The EU, Theresa May and the UK parliament cannot agree on the terms of Britain’s exit from the European Union and the deadline at the end of  March is fast approaching.   There are several possible outcomes: the UK could hold another referendum and stay in the EU or not,  the UK and EU could hammer out a gentle exit,  the EU could grant an  extension while details are worked out or the UK could “hard exit” which, among other things, could create a hard border between Northern Ireland and the Republic of Ireland.  I will keep you updated on our client message board. Please let us know if you need access to login.

We don’t know when any or all of these issue will be resolved and the sky will start to clear, but after their performance last year, I believe the markets have discounted the uncertainty and risks, somewhat.  In the meantime, “markets” are made of individual stocks managed by people and boards that incorporate risks into their plans. I will continue to test our holdings for their adaptability and prospects while looking for new quality companies whose share prices have been unfairly penalized by these clouds.

Thank you for investing with IIM along side with Cale and myself, and please reach out with questions and comments.

-Lauretta “Retz” Ann Reeves, CFA AWMA

About Retz Reeves

Portfolio Manager of the Frigate and Treasure Harbor Folios.
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