After two years of solid investment performance, 2018 has been more challenging for us at FIM Group. We believe the weakness reflects investor reaction to higher interest rates and a mixed global economic picture rather than any wide-scale deterioration in the fundamental quality of our holdings.
We remain fully committed to our core investment philosophy. The key tenets of this are: (1) structure and manage portfolios thoughtfully to meet real client needs, (2) independently seek good value wherever we can find it (across geographies, asset classes, company sizes, and sectors), and (3) invest only when price and quality levels meet our standards.
Our portfolios remain well-positioned for an uncertain future. Defensive core stock and bond positions are complemented with select exposures to deeply discounted, more cyclical holdings. Market volatility has also afforded us opportunities to take overall portfolio quality to the highest levels in years.
On October 25, FIM Group’s investment team hosted a Q&A style webinar to discuss recent market volatility, portfolio strategy, and other client questions. A summary of the discussion follows. To access a full replay of the webinar, please request a link or visit our website (www.fimg.net).
Q: My portfolio value is down so far this year, yet all I hear is good news about the U.S. economy. How can that be?
After two above-average years of performance, 2018 has certainly been more challenging for our core investment strategies. Most accounts (as of mid-October) show modestly negative returns since January. For clients who haven’t been with us long, it is important to note that periods of soft performance like this are not unusual. We manage our strategies on multiyear time horizons and with balanced, global mixes of stocks, bonds, and cash. Our portfolios will rarely, if ever, resemble an all-U.S. stock portfolio. This means that our performance, both up and down, will almost always show a different pattern of returns, compared to stock market indices like the S&P 500.
We believe that higher interest rates and weak investor sentiment toward most asset classes is behind the drop in our portfolio returns this year, rather than any widescale deterioration in the fundamental quality of our holdings. Here in the U.S., tech stocks like Microsoft, Google, and Amazon continue to attract momentum investors. These stocks have been the primary engine for the broader U.S. market. Outside of tech, U.S. stock market performance has been far more muted. We’ve been concerned about the valuation levels of momentum-driven U.S. tech stocks and therefore have chosen to largely avoid investments in this area.
A stronger dollar and angst around trade tensions and economic conditions outside the U.S. have depressed both investor sentiment and returns abroad. Many of the equity markets that our portfolio companies call home are down double-digit so far this year. In bond-land, the solid performance of the U.S. economy has helped push interest rates higher and, conversely, bond prices lower. For much of the year, we have made the conscious decision to dial back our exposure to traditionally higher-yielding parts of the fixed income world, including securities with greater credit and interest rate risk. This move has meant lower overall portfolio income, but we think it is the right one that gives us more “dry powder” to deploy, once bond investment prices improve.
When looking at the portfolios from the bottom up, we find that most of our holdings are reporting operational progress in line with or better than our expectations. The stocks of some of these companies, like the Finland-based telecom equipment maker Nokia and the Singapore-listed owner of the Tiger Balm brand, Haw Par Corp, have performed well, despite negative investor sentiment in their home markets. Others, including the Hong Kong–listed conglomerate CK Hutchison and the Belgium-listed diaper-maker Ontex, have detracted from returns. As a result, many of these holdings trade at levels meaningfully below our estimates of their underlying fundamental value. We expect that these undervalued stocks will eventually be recognized in the market and that our patience with them will prove fruitful.
Undervaluation can be swiftly remedied in markets, even when public sentiment toward a given sector or region has gone sour. Two of our commercial real estate–related holdings – an area many have deemed too risky, amid global interest rate uncertainty – were taken private this year at premium prices that more accurately reflected the private market value of their assets. The Finnish office real estate owner Technopolis was bought by Kildare Partners, while U.S. industrial and office REIT Gramercy Property Trust was acquired by Blackstone. Although we had hoped for even higher return realization with these holdings, both were successful investments for us.
Q: In light of this year’s performance thus far, has the FIM team considered changes to its investment philosophy?
While we continually work to improve our investment process, we remain fully committed to our core investment philosophy. The key tenets of this philosophy are: (1) structure and manage portfolios thoughtfully to meet real client needs, (2) independently seek good value wherever we can find it (across geographies, asset classes, company sizes, and sectors), and (3) invest only when price and quality levels meet our standards.
The first tenet – to manage individually customized portfolios that meet real client needs – seems so obvious that it need not even be stated. Most of you aim to maintain or grow your portfolio’s purchasing power over long time-horizons, or to control the rate of its depletion so that it’s there for you and others who depend on it throughout your lives. Each of you also bring unique objectives around the magnitude and frequency of portfolio contributions and withdrawals, tolerances for temporary downside, capacity for permanent loss, and tax efficiency, among others. To meet these objectives requires portfolios that are thoughtfully balanced with a mix of holdings managed to withstand, through a complete cycle, a variety of unknown future political, economic, and market scenarios
Even though U.S. stocks, especially tech ones, have stood apart from other global markets so far this year, there is a much broader universe to choose from. Some 85% of global economic output takes place outside the U.S., and nearly 70% of listed companies are based abroad. Investor sentiment and business conditions can, of course, vary dramatically across different parts of the world. With a flexible, global approach, we can take advantage of these cycles.
Widening our net far beyond the S&P 500 enables us to stay invested when a U.S. stock-only portfolio would pose far too much risk. We scour the planet for risk-adjusted bargains, often in niches too hard to access for the large institutions that increasingly dominate the investment landscape today. A current portfolio example of such value is NZX Ltd, the company that runs New Zealand’s Stock Exchange.
NZX is tiny, by the standards of most listed stock exchanges. With an annual revenue of only $50m and a market value under $200m, it is dwarfed by the big, listed exchange companies here in the U.S. Most institutional investors are simply too big to invest in such a niche company, despite economics that are as compelling as (if not better than) those of the larger, “more investable” peers. The table below shows a few selected financial and valuation data points for both NZX and the leading listed U.S. exchanges. On pretty much every measure, NZX offers a more compelling proposition. NZX runs a net cash balance sheet while its peers have net debt, it has superior return on equity (a measure of profitability), it features a similar operating profit growth profile, and it offers three times the dividend yield and trades 20% cheaper relative to its earnings.
Our decision to invest in a company like NZX also reflects the third key tenet of our core investment philosophy: to invest only when a security meets our quality and valuation standards. This is the opposite of two popular forms of investing today: passive index investing (that is, owning everything in the reference index, regardless of price or composition of the index) and momentum investing (where investors jump on the hot trends of the day, again regardless of price or underlying business quality). We have no plans to change our “price and quality matters” philosophy merely because index fund providers like Vanguard and BlackRock are gathering assets at record pace. Nor will we change and try to join the party that investors in cash-burning companies like Netflix seem to be enjoying on the view that there will always be another partygoer ready to buy their shares (see Netflix comparison table below with Disney, a stock we own in select portfolios, to see the massive difference in market valuation today). Over the decades, we’ve observed the bubbling and bursting of strategies that, time and time again, leave price and quality considerations behind. We see no reason to believe that today’s apparent market fascination with low-cost indexing and hot stock momentum-chasing will enjoy any other fate.
Q: How are you positioning today to responsibly grow my portfolio, given all the uncertainty in today’s markets?
As noted above, we remain committed to our core tenets of managing for real client needs, seeking value across a broad potential investment universe, and investing only when we can satisfy our price and quality standards. We recognize that, broadly speaking, things look quite good for the U.S. economy from a “rear-view mirror” perspective. U.S. corporate earnings growth has been solid, employment trends look healthy, consumer confidence is high, and inflation is only modest. The risk for investors, however, is that these good conditions already seem to be reflected in the prices of many U.S. stocks and corporate bonds. Should the economic and corporate profit cycle show signs of peaking, markets will likely adjust to reflect a less-rosy scenario ahead.
Other parts of the world, while still doing all right economically, are clearly facing rising anxiety around the strong dollar, trade tension concerns, and region-specific issues (like Italy’s fiscal situation and the U.K.’s BREXIT plan in Europe, as well as China’s attempts at more-balanced growth in Asia). Financial markets in these areas have already begun to reflect these uncertainties and to trade at lower valuations accordingly. The figure below shows the basic math of how compressing or expanding valuations and starting dividend yields can drive quite different total return outcomes. It simply takes recent average price/earnings ratios for the U.S. and international stock markets and illustrates how a theoretical stock would perform if these valuation levels reverted to 20-year averages (assuming that earnings stay constant). This is by no means a market or portfolio return forecast, but we hope it reinforces the point that investing in assets already priced for some degree of uncertainty (low-valuation assets) is a more risk-aware strategy than investing where such uncertainty is insufficiently priced (high-valuation assets).
As of this writing, our portfolio strategies are generally structured with a core position in demand-defensive global stocks – in other words, in companies that offer products and services where demand is relatively constant regardless of economic conditions. These core positions include companies involved in healthcare like Merck (pharma), Medical Properties Trust (hospital real estate), and Roche (pharma and diagnostics); in consumer staples like Hanes Brands (T-shirts, socks, underwear); in Cott Corp (water and coffee delivery services); and in Ontex (diapers), as well as in mission-critical infrastructure and services like Verizon (communication services), CK Hutchison (communication services, ports, health and beauty retail), and Kennedy Wilson (office and apartment real estate).
Complementing these core positions are select exposures to more cyclical, growth-driven companies whose stocks are already heavily discounted. Holdings in this area include conglomerate/investment companies like Pargesa (Switzerland), Investor AB (Sweden), and Softbank (Japan), plus materials companies like Nucor (U.S. steel) and Borregaard (Norway, plant-based specialty chemicals). The global stock market weakness is providing opportunities for us to elevate aggregate portfolio quality. We’ve been doing so throughout the year, taking gains and losses in certain holdings to make room for increased allocations to our highest-conviction stocks. As a result, we believe that the fundamental quality of our stock holdings is the greatest it’s been in years.
On the bond side, we are also taking a core defensive positioning, with relatively high allocations to U.S. Treasury securities. It seems reasonable to expect that the Fed will continue raising short-term interest rates as long as U.S. economic conditions look OK, so we are keeping our basket of U.S. Treasuries weighted toward shorter maturities. Longer maturities are much more price-sensitive to higher interest rates (see figure below), and we are keeping our allocations to these fairly light. We are complementing this U.S. Treasury bond basket with select exposures to closed-end funds that invest in areas including senior, floating rate loans and international debt. The volatility jump in early October has pushed some of the closed-end fund prices that we monitor to attractive levels. Buying at these prices gives us a better margin of safety if the economy softens and promises significant total return potential if market jitters subside. We are patiently waiting for further opportunities to add to these higher-returning parts of the bond markets.
As always, we encourage you to reach out if you have any questions about the positioning and performance of your accounts. From its founding, FIM Group was designed to give you direct access to the decision-makers on your accounts. We invest in the very same strategies that we manage for you – and we never take for granted the trust you place in us.
The Medicare Open Enrollment Period is the time during which people with Medicare can make new choices and pick plans that work best for them. Each year, Medicare plan costs and coverage typically change. In addition, your healthcare needs may have changed over the past year. The Open Enrollment Period is your opportunity to switch Medicare health and prescription drug plans to better suit your needs.
The Medicare Enrollment Period began on October 15 and runs through December 7. Any changes made during Open Enrollment are effective as of January 1, 2019.
During the Open Enrollment Period, you can:
Now is a good time to review your current Medicare plan. As part of the evaluation, you may want to consider several factors. For instance, are you satisfied with the coverage and level of care you’re receiving with your current plan? Are your premium costs or out-of-pocket expenses too high? Has your health changed, or do you anticipate needing medical care or treatment?
Open Enrollment Period is the time to determine whether your current plan will cover your treatment and what your potential out-of-pocket costs may be. If your current plan doesn’t meet your healthcare needs or fit within your budget, you can switch to a plan that may work better for you.
Beginning in 2019, Medicare Part D Prescription Drug Plan participants will no longer be exposed to a coverage gap, referred to as the “donut hole.” Due to changes made by the federal Bipartisan Budget Act of 2018, Part D participants will see a reduction in their out-of-pocket costs for brand-name drugs from 35% to 25% – a reduction that was originally scheduled to take place in 2020. The gap in coverage for generic drugs will not be closed until 2020. In 2019, Part D participants will pay 37% of the cost of generic drugs.
Also, in 2019, the Medicare Advantage Disenrollment Period will be replaced by the Medicare Advantage Open Enrollment Period. The Medicare Advantage Disenrollment Period, which ran from January 1 through February 14, allowed you to drop your Medicare Advantage Plan and return to Original Medicare (Parts A and B), and it also allowed you to sign up for a Medicare Part D Prescription Drug Plan. In 2019, a new Medicare Advantage Open Enrollment Period will run annually from January 1 through March 31. If you’re enrolled in a Medicare Advantage Plan, you’ll have the opportunity to switch to another Medicare Advantage Plan, switch to Original Medicare Parts A and B, sign up for a stand-alone Medicare Part D Prescription Drug Plan (if you are covered by Original Medicare), or drop your Medicare Part D Prescription Drug Plan.
Determining what coverage you have now and comparing it to other Medicare plans can be confusing and complicated. Pay attention to notices you receive from Medicare and from your plan, and take advantage of help available by calling 1-800-MEDICARE or by visiting the Medicare website, medicare.gov.
Generally, if you did not sign up for Part D coverage during your initial enrollment period, and you don’t have other creditable drug coverage (at least comparable to Medicare’s standard prescription drug coverage) for at least 63 days in a row after your initial enrollment period, you may have to pay a late enrollment penalty. The penalty is added to your monthly Part D premium. Your initial enrollment period is the seven-month period that starts three months before you turn age 65 (including the month you turn age 65) and ends three months after the month you turn 65.
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