Global Equity Fund

• Overview
• Manager
• Performance
• Holdings
• Commentary

October 2008

You know the story by now.  Global stock markets have not been kind to equity investors.  The MSCI World Index fell over 11% in the third quarter.  The larger markets of the U.K. (-12%), France (-9%), and Germany (-9%) all declined (returns are in local currency).  Many European  markets have fallen more than 20% so far this year.  Japan hasn’t fared any better (down 16% in the quarter and 26% year-to-date), and the emerging markets have fallen significantly as well.  Closer to home, the S&P 500 dropped 8.4% in the quarter and has shed 22% over the past year.     

The Global Equity Fund lost 7.4% for the three months ended September 30th.  Over the past year, the fund is down 22.1%.

September in particular was an extremely volatile month.  Between the collapse/rescue of a number of high profile financial insitutions and the unprecendented scale of the U.S. government’s bailout package, markets were whipsawed.  Intra-day price movements were enormous and investor confidence was extremely fragile. 

The fund’s defensive tilt helped in the quarter, but the strengthening Canadian dollar and difficulty with a few energy and technology holdings prevented the fund from advancing.  The manager, Edinburgh Partners Limited (EPL), has favored health care and telecom stocks over the past few quarters due to their strong balance sheets and cash flows.  This strategy is starting to pay dividends.  Several pharmaceuticals advanced in the quarter, including GlaxoSmithKline (+10%), Sanofi-Aventis (+10%) and Novartis (+5%).  With a few exceptions, telecoms also held their ground, with France Telecom (+9%) leading the way.
     
The other notable component of the portfolio, financial stocks, showed some signs of improvement, but these are the stocks that continue to keep the manager up at night.  As we have previously written, the greatest reward/risk opportunities lie in this sector.  Valuations are extremely compelling, yet the opportunities are countered by a crippled lending market and lingering short-term uncertainty that continues to weigh on the financial system.

EPL’s strategy in the sector is to diversify their bets across the risk spectrum, meaning they own both the strongest banks (i.e., those with the greatest capital strength) and those that have a weaker capital ratio, but greater potential for significant price appreciation.  HSBC and Intesa Sanpaolo are examples of banks that have weathered the storm well due to their capital strength, while Irish Life and Royal Bank of Scotland have suffered because of their weaker position.  On a positive note, while there was plenty of downbeat news and restructuring in the quarter, there was also some nice rebounds, notably Bank of America (up nearly 50%) and Isbank (+34%).    

The fund’s energy holdings weighed on performance.  Whereas in recent quarters the sector seemed to be the only place in which investors showed any interest, the falling price of oil and natural gas led to a pullback in the third quarter.  Gazprom was hit particulary hard (-47%), while CononcoPhillips (-22%) and ENI (-19%) also retreated.  The portfolio remains light in energy stocks as the manager is finding better value elsewhere.

As noted, some of the fund’s technology holdings also had a tough quarter.  Dell, Intel and TomTom lost ground.  EPL added to these holdings on price weakness and also increased the fund’s position in Cisco Systems.  These businesses represent compelling long-term value, even though the manager has factored into their forecasts more weakness in the sector.

Two stocks were added to the fund in the quarter, Deutsche Telekom and Unilever.  Deutsche Telekom is a large fixed line provider with a strong mobile division.  The company is a defensive holding that generates a huge amount of cash and pays an attractive dividend.  Unilever, a household products giant (brands include Sunlight, Vaseline and Dove), is a business that EPL has long followed but was disappointed with its management and strategy.  A major restructuring initiative and a cheap share price were the drivers for adding the stock to the portfolio. 

On the sell side, AIG, HBOS and Lagardere were removed from the fund.  EPL’s estimate of AIG’s value was crushed by the Fed’s terms of rescue, which wiped out any shareholder value.  With HBOS, the stock sale was triggered over concerns about the company’s liquidity position and the troubled U.K. economy.  Both stocks were sold at a loss.  As for Lagardere, EPL lost confidence in management’s ability to return value to shareholders.    

With the bear making its rounds, many good investment opportunities are developing.  While it’s been a painful ride to get to where we’re at, the low valuation of the portfolio has the manager more upbeat about its medium-term return expectations.  Given that Steadyhand’s employees are the fund’s largest unitholders, this has us enthused as well.