The economic environment we find ourselves investing in is extremely abnormal. Financial repression has caused all asset prices to rise with little regard for fundamentals (for equities these would include cash flows, earnings and dividends). This cannot continue indefinitely but while it does, we continue to practice caution in our investment: We will only invest where we see attractive medium term absolute returns and will not compromise our valuation discipline simply to stay fully invested. Our aim is to deliver attractive medium term absolute returns. If there are insufficient opportunities that will deliver this then we are happy to be patient and wait for ‘the fat pitch’. It is our experience that markets oscillate over time and provide opportunities to invest at compelling valuations at times. Today is not one of those occasions and while we continue to look for ‘special situations’ that we believe will deliver attractive returns there tend to be fewer of these opportunities at any one time.
However, this does not mean that there are no opportunities for investment – rifle-shot investing in specific companies with a compelling investment case and valuation over the long term is still achievable especially if the company in question is facing a short term ‘issue’. In the past few months we have had the opportunity to invest in the following companies (among others):
Amex has a strongly spend-centric model with high attractive returns; and is a key beneficiary of both economic recovery and the network effects stemming from the structural shift from cash to electronic payments. Amex dominates the affluent customer segments, where its cardholders are high spenders and highly attractive to merchants. No doubt competition for these shall increase, but we attempt to control for that in our forecasts. Amex management have demonstrated the ability to adapt to a changing environment with new initiatives, e.g. to boost acceptance for its existing operations or even in entering new areas e.g. prepaid cards, while keeping control over costs to generate operating leverage. This is a high quality company where we believe the risk-reward is skewed to the upside.
In addition to aggressive cost cutting and rationalisation to reposition the business for a tougher trading environment, HAL announced that it will merge with the number three player in the market, Baker Hughes. The combination of these two businesses will afford the group the opportunity to substantially narrow the competitive gap with its main competitor, Schlumberger. Despite being similar sized (both in terms of geographic exposure and product / service lines) to Schlumberger post the merger, the combined HAL / BHI has margins well below the industry leader (around 1,000bp lower in the ex-US business). This margin differential is largely a function of scale benefits at Schlumberger and over time the merged Halliburton / Baker Hughes should largely close this margin gap. This ‘self-help’ potential is not currently being recognised by ‘the market’ which remains fixated on the near-term challenges of 2015.
We have also sold a number of positions in the past few months largely as a result of share price appreciation and the company in question reaching our intrinsic value. Such sales include Fiserv, Citigroup and Allergan. The consequence of equity prices rising ahead of fundamentals is that holdings are more likely to reach our intrinsic value and therefore be sold. We retain our valuation discipline on selling as well as on buying and therefore sell when a company attains our target price.
Dependent on opportunities for purchase, such selling may lead to higher cash weighting in the Nedgroup Investments Global Equity Fund and over the quarter, this is exactly what has occurred with the cash level in the fund ending the quarter at just over 10%.
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