Blog: Cutting Through the Noise
Undexing, Diversification and the Global Equity FundPrint
Posted on October 23, 2012
By Tom Bradley
Our Global Equity Fund has had a rough three years. Nonetheless, it’s our view that foreign stocks will be an important contributor to client returns and portfolio diversification in the coming years. In this post, I’ll provide some background on the fund and outline how it fits into our balanced portfolios (including the Founders Fund).
Steadyhand has a defined investment philosophy we’ve dubbed ‘Undexing’. Our equity portfolios are (1) focused on absolute returns (as opposed to index-like returns), (2) concentrated in stocks where we have the highest conviction and (3) not constrained by company size or investment style. Because our funds tend to look significantly different than their comparable market indexes, they will also perform differently, sometimes for extended periods.
Our clients achieve diversity in their portfolios by having exposure to a mix of securities in different asset classes (i.e. U.S. stocks, corporate bonds, etc.) and having four managers working for them. While the equity managers all fit nicely under the undexing umbrella, they approach their mandates in different ways, and have unique views and strategies.
In this context, we should expect that the asset classes and managers will take turns leading the way. Not all parts of the portfolio will perform well at the same time. Indeed, if everything is working, it’s likely that the portfolio is not adequately diversified (i.e. all managers are pursuing similar strategies and themes).
In producing first quartile performance for our balanced clients over our first five years, the Steadyhand funds have taken turns carrying the load (and holding back the wagon). In 2008, we were pretty average overall, meaning everything was hit hard. There were no heroes. In 2009, the Global Equity Fund and Income Fund were the strongest performers, while the Equity and Small-Cap funds lagged behind the hot market. Since 2009, the Income Fund has continued to perform consistently and the Equity and Small-Cap funds, with their emphasis on high quality, less cyclical companies, have been big contributors. The Global Equity Fund on the other hand, has been a consistent burden on the portfolio.
Global Equity Fund
The fund has performed worse than the MSCI World Index since 2009 for a number of reasons. There is no doubt the manager, Edinburgh Partners (EPL), has had a cold hand which has resulted in some unfortunate stock picks (Nokia, Sony and Petrobras being examples). These stocks served to substantially offset the good selections they made (Samsung, Google, DR Horton and others).
But a more important factor has been EPL’s consistent view that predictable, growing companies were (and are) too expensive. While the fund has owned a number of these steady growers (GlaxoSmithKline, Walmart, Unilever, Sanofi), EPL has been tilting towards less steady, underperforming companies, which in many cases, are based in similarly troubled regions (most notably Japan and Europe). These companies trade at significantly lower valuations, reflecting their warts and cyclicality.
Unfortunately, the market’s preference for safe growth has persisted. Stocks fitting the bill have done well and less predictable companies have lagged behind. As a result, the valuation gap between the two has gotten more extreme. In a report published last week, EPL’s CEO Sandy Nairn worded it this way: “Our view is that investors’ desire for predictability has skewed valuations significantly.”
Sandy goes on to say, “In the long run, safety derives from valuation and as the US bond market arguably suggests, there may be little safety in the areas with highest predictability. Paradoxically, the greatest safety may well be found in the most unloved areas where expectations are lowest. This is an investment view which is commonly cited, but more often than not as an ex-post explanation. We believe that the level of skew in markets makes for an exciting absolute and relative outlook if you are prepared to follow the valuations.”
Going forward, it goes without saying that we can’t provide any guarantees (or even rough estimates) as to what returns will be, where they’ll come from and how the funds will do. My objective is for our clients to perform well under a wide variety of scenarios.
The Global Fund is positioned significantly differently than the other funds in our clients’ portfolios. The Income Fund (equity portion), Equity Fund and Small-Cap Equity Fund still have an emphasis on steady, predictable companies. The Global Equity Fund on the other hand, has more exposure to a recovery in Europe (Maersk, Aviva, ENI, Intesa, Royal Bank of Scotland), growing consumer spending in Asia (China Mobile, Genting Singapore, Dongfeng Motor, Bridgestone, Panasonic) and a renewed capital spending cycle (ABB, Applied Materials, Fujitsu, SAP).
Clearly, EPL is pursuing these themes with the idea of generating higher returns, but in doing so, it’s also providing our clients’ portfolios with diversification at this volatile, unpredictable time.