Portfolio Manager’s Report

Hansa House View

Pinning the tail on the donkey


Market backdrop

The rapid ascent that stock markets experienced in the latter part of last year continued into 2017. Buoyed by a cocktail of an improving economic outlook across the globe, an anticipated stimulation package from the Trump administration and tentative signs of better company profitability, market prices moved higher.


Global equities in Pound Sterling terms rose by some 5.2% in the first quarter of 2017 with the US, UK, Europe and Japan returning 4.4%, 3.4%, 6.7% and 2.9%, respectively. More surprisingly, emerging markets have also started to perform well. Initially, following Donald Trump’s surprise US election victory, emerging markets fell sharply.  Investors reacted cautiously to a more US-centric policy with threats of greater protectionism, higher interest rates and a rising dollar; all usually negative for emerging markets. Of late, though, markets have chosen to ignore these concerns and instead have focused on the positive impact of stronger global growth, with emerging markets typically a geared play into this, while also benefiting from more attractive valuations, and ongoing strength in many commodities which provides a boost for commodity-exporting nations. The region as a whole has returned 9.7% in the first quarter, taking its 12 month return to 34.5%, with notably strong performance from Asia Pacific (ex-Japan) which returned 11.0% over the quarter, and India, which rose by 15.3%.


In contrast to the strength experienced in equity markets, bonds have been more muted.  Anticipated stronger economic growth combined with the greater use of fiscal policy are serving to accelerate the expected path of interest rate rises in the US.  Even in Europe, investors are starting to anticipate the eventual end of the current loose monetary regime.  Overall, for the quarter, global government bonds generated a meagre 0.5% return, investment-grade credit was flat, and high yield produced a slightly higher 1.6%.


Elsewhere, commodities represented a mixed picture. Industrial metals continued to be robust, up 5.9%, helped by the improved global growth environment, whereas the oil price has weakened sharply, with Brent crude falling by 6.4%. The latter’s underperformance likely represents a pause for breath following a period of strong performance. Partly this reflects investors reassessing OPEC’s commitment to oil production cuts and, importantly, the ability of shale oil producers to influence future oil supply by rapidly turning production on and off.







Pinning the tail on the donkey

With many stock markets hitting all-time highs and the current bull market reaching its eighth anniversary it is worth pausing for a health-check. 


At Hansa Capital we view stock markets through the lens of the business cycle, with markets typically following a fairly pre-defined sequence of events. All cycles are different, with their own quirks and nuances, but almost without exception they comprise the familiar stages of despair, hope, growth and optimism.






The challenge, of course, is to determine where we stand within the cycle and which idiosyncrasies this particular cycle will exhibit. Like pinning the tail on the donkey you have a sense of where one stands but it is impossible to be completely certain. What we can do, however, is gauge where a number of key metrics are to help us improve the odds of identifying the correct point.  Important metrics to consider regarding the business cycle include: the macro backdrop, corporate profitability, valuations, policies and other factors such as geopolitics.


Working through this list the macro picture has undoubtedly improved. The path of growth in this cycle has been muted compared to previous recoveries and different regions have experienced different growth rates, with the US and the UK leading the way and Europe being a clear laggard.  Recent surveys suggest growth is improving albeit it is still below that which would have been expected historically.  What is less clear is how successful President Trump will be in implementing his spending and tax plans and how this will feed through to global growth.  His intentions are clearly to boost growth, at least in the US, but such efforts often have long lead times, and the early signs of his Presidency are not encouraging regarding his ability to successfully negotiate the US political system.  Autocratically managing a private US real estate firm is one thing but it is by no means clear that this approach will work at the government level, where a degree of finesse is required!



Linked with the macro backdrop is corporate profitability. Like economic growth, company earnings have been muted this cycle and estimates have been persistently downgraded. Again, a multitude of factors lies behind this but central, in our opinion, was the global financial crisis and the subsequent central bank policy of zero interest rates. These served to dampen corporate confidence and subsequent investment with many companies preferring to engage in corporate engineering through share buy-backs. Furthermore, many companies that should have died, and so freed up capital for more productive uses, were kept alive in this process. The net effect of this has been low productivity and a stock market recovery that has been driven by rising valuations rather than improving profitability.


Higher valuations are perhaps our biggest concern. At the beginnings of cycles, when valuations are low, markets have the capacity to rise even in the face of negative news flow. One would then normally expect there to be a point when corporate profitability starts to improve, such that markets continue to rise but are no longer being re-rated, at least initially. As mentioned above, this cycle has been unusual in that corporate profitability has been muted and as a result stock market valuations have risen more quickly than is typical.  Again central bank policy has played an important role in this.  By forcing down interest rates, government bond yields fell to multi-decade (even century!) lows. This had the dual effect of forcing investors to move up the risk spectrum, into asset classes such as equities in order to achieve their income and return requirements, and also making assets such as property and equities look attractive from a relative valuation perspective.  The net impact of this is that almost all assets now sit above their historical valuation averages. Whilst valuations are not in fact particularly good predictors of short-term future market returns, they are very important over the longer term. Historically, when equity markets have stood at current levels (with the US Shiller P/E at 29.5x), they have typically been followed by negative real equity returns over the next five years.




 Hence if we update our scorecard we find:

Chart 6: Key metrics within the business cycle






Very Good


Macro Backdrop




Getting better

Corporate Profitability














Fiscal positive, monetary deteriorating

Other (Geopolitics)


Swing factor?



Pulling all of this together and reflecting back on the stock market cycle, we can draw a number of important conclusions. Clearly the global financial crisis and subsequent policy actions have made this an unusually elongated cycle. This is important, although we also note that stock markets rarely die of old age. Combining this with high valuations, and with policies starting to shift to a tightening phase, we are inclined to believe that we are in the latter stage of the cycle.  Our sense is that we have moved from the growth to the optimism stage (arguably this started in 2016).


Typically the optimism phase lasts a couple of years in the US and about half that in Europe. This phase of the cycle can be quite powerful and is often dominated by momentum investing (i.e. people do not worry much about valuations).  It is also a rather dangerous phase with rising volatility, and the absence of a valuation buffer makes the market vulnerable to disappointing news flow.


As for idiosyncrasies, clearly the geo-political backdrop has considerable scope for extending or contracting this cycle. Europe has huge potential for disappointments, either from the Brexit negotiations or from one of the several elections in 2017. President Trump is also a wildcard. If he is successful in his growth-push this would likely extend the current cycle (although in our view it would also increase the downside in the next downturn). Conversely any failure of his plans for growth will not be taken well by the markets, and neither would any signs that his more maverick views on protectionism and foreign policy are coming to fruition.


In conclusion, we are inclined to continue riding the current cycle with market optimism often quite a powerful stage of the business cycle. We do, though, acknowledge that the risks are rising, with markets having had no meaningful pull-back for quite some time and as a consequence we are ever ready to increase our allocations to more defensive assets if we see further signs of excess or if the risk/reward balance becomes increasingly unattractive.


Portfolio review and activity

Your Company has returned 23.4% over the financial year and 2.8% for the quarter. This compares to 3.3% and 0.8% for the benchmark, respectively. This strong performance was driven in large part by the returns generated by Ocean Wilson Holdings and its position in Wilson Sons Ltd, which are discussed below. The Trust’s net asset value per share rose over the quarter from 1,250p at the end of December to 1281p at the end of March. This compares to a level of 1,065p at the beginning of the financial year in March 2016.



Core regional funds

Reasonable performance has been generated in the regional silo over the last year, although the range of returns has been wide. This diverging performance has been a major feature of markets over the past 12 months, with many active managers struggling to generate outperformance. Partly this reflects the major rotations discussed in previous reports, in particular with emerging markets, cyclical companies and commodities all bouncing strongly following multiple years of disappointing performance. 


The strongest performers included Vulcan Value, the US equity manager based in Birmingham, Alabama. The portfolio manager, CT Fitzpatrick, follows a value approach and whilst this style has struggled in recent years, it performed strongly during the past 12 months and quarter (the fund was up 33.1% and 5.8% over the respective periods). Findlay Park American, another of our US equity managers, also performed well, returning 3.5% over the quarter and 19.3% over the year whilst the portfolio manager continues to express his relatively cautious view on equity valuations by maintaining a high cash position in excess of 15%.


Strong performance was also generated by Schroder Asian Total Return. The Fund rose 35.0% over the year, with performance driven by stock selection, as the manager focused on strong franchises and resilient cash flow generation.  


The main area of disappointment has been the performance over the past 12 months by some of the managers that have been among the largest contributors to performance in recent years. Most notably, Odey Absolute Return Fund and Adelphi European Select Equity Fund were material detractors. The Odey fund saw a number of stock specific challenges as well as being poorly positioned during the sector rotation, whilst Adelphi’s investments reported strong or stable underlying earnings, but were de-rated by the markets. We watch these funds carefully, but recognise that it is not normally sensible to sell good investment managers following a period of poor performance. 


Eclectic and Diversifying

During the last 12 months we have been introducing a number of more defensive investments into the portfolio. This reflects our belief that whilst equities remain the favoured asset class, there are risks in being fully invested in equities as the business cycle becomes mature and valuations rise. It is very early days but we have been pleased with the performance of a number of the names, especially in the global macro hedge fund space. Macro funds have been under pressure in recent years with limited investment opportunities in a flat interest rate environment. 2016, however, has provided a more fruitful backdrop with interest rates starting to diverge and macro events becoming more plentiful. 


One underperformer during the quarter and over the past 12 months was the investment in Argentière. The fund declined 1.8% during the quarter and has fallen modestly over the past 12 months.  The manager seeks to capitalise on spikes in realised equity market volatility by building option positions with convex return profiles. Unfortunately the fund failed to capitalise on the increased volatility surrounding the Brexit referendum and the US Presidential election. 


UK Equities

Cape reached an agreement to settle with Insurer PL Litigation, with the maximum amount payable being settled from the Group’s existing cash resources, thus removing a significant risk to the business, and the distraction of a likely protracted appeals process, thereby enabling the management to focus on the development of the core business.  Cape announced a strong set of final figures, and the decision to halve and re-base the dividend is constructive, as it clearly signals the desire to continue executing the growth strategy now that the main asbestos litigation threats have been settled.  Higher growth prospects for lower risk have duly been rewarded with a higher share price.


Hargreaves Services announced that it has received planning approval in principle for 1,500 new homes on part of a 392 acre site situated less than 15 miles from Edinburgh city centre.  This is the first phase of a wider master plan for more than 3,200 homes to be developed over the next 12-15 years, an important milestone in achieving the target of delivering £35-£50m of new value from the overall property portfolio over the next five years.  Hansteen Holdings successfully crystallised the value of its German and Dutch property portfolios, selling them for €1.28bn (7% yield), a 6% premium to the December FY16 valuation and 30% above FY15, as the European assets hit cyclically high occupancy and rents, combined with a favourable exchange rate.  The net effect will be to remove £1bn of property and £400m of debt, resulting in £600m of cash, with the intention to return a substantial proportion of net cash to shareholders.  The company also plans to sell £35m of Belgium and French properties.  The remaining UK-weighted business is well placed to deliver attractive returns, comprising £677m of property yielding 7.3% (with a vacancy rate of 7.7%), which is in a sweet spot for rising occupational demand and late-cycle yield compression.


NCC Group has a dominant position in the UK cyber-assurance market, counting most of the FTSE 100 and Fortune 500 companies and the British Government among its customers.  The company warned that earnings before interest, tax, depreciation and amortisation would be 20% lower than the bottom of its previously forecast range of £45.5m-£47.5m after a disappointing third-quarter performance.  Rob Cotton stepped down as Chief Executive, and Jonathan Brooks, Chief Financial Officer of ARM Holdings from 1995 until 2002 has been appointed as a non-executive director.  Hilton Food announced a strong set of final figures and a 17.1% dividend increase, and continued to generate significant cash during 2016, enabling the Group’s net cash position to grow from £12.7m at the end of 2015 to £32.3m at the end of the year.  As well as having the cash available to fund new projects in Australia and Portugal, the company is in a good position to take advantage of other opportunities as they arise.


Ocean Wilson Holdings

The end of March saw the release of the Wilson Sons fourth quarter results. The Brazilian economy has endured a very difficult period, and the result of the US election has led to further uncertainty for the country and other Emerging Markets.  Despite this backdrop, the company has benefited from efforts to diversify its portfolio and improve efficiency and productivity, and the full-year profits of $85.1m were significantly ahead of the $31.4m achieved in 2015  The company is continuing to focus on improving cash flow, operational efficiencies and maximizing the use of the installed capacity across of all of its businesses.  In the first quarter of 2017, the company’s two container terminals, Rio Grande and Salvador, took receipt of $40m and $4.9m worth, respectively, of new crane equipment, which will contribute significantly to improved productivity at the terminals. The three new ship-to-shore cranes at Rio Grande will be the largest such cranes currently in operation in Brazil.


The Brazilian currency remains much weaker versus the US Dollar than it has been for most of the past five years, but its strength over the course of 2016 meant that the average exchange rate in the quarter was 14.3% higher than in the prior year.  This contributed to general increases in costs, but was positive for the minority of revenues denominated in dollars. This benefited Container Terminals revenue, which was up 12.0%, but the division’s EBITDA declined by 9.5%. Although there was volume growth in imports, partly driven by solar panel imports, export volumes at Rio Grande declined, mainly owing to the cancellation of some ships.  The Towage division continues to benefit from the expanded fleet, as well as from lower costs as fewer tugs are rented, and its EBITDA grew by 9.4%. The Offshore Vessels joint venture experienced strong growth in revenues and EBITDA, and was boosted by the commencement of operations of two long-term contracts for the two largest vessels in the fleet.


The Ocean Wilsons Investment subsidiary was valued at $238.9m at the end of December 2016, which was an increase of 0.8% from 31 October 2016. The end of year valuation is 2.3% below the 31 December 2015 value of $244.4m, although during this period $3.75m was withdrawn from the portfolio to contribute to the dividend paid by the parent company. The portfolio continues to be biased towards equities, both public and private, reflecting its long-term nature.


The share price performance of Ocean Wilsons Holdings has been strong since June last year. However, the share price fell back at the beginning of January, and despite a partial recovery, it produced a return of -0.73% in Pound Sterling over the first quarter. This brings its return over the last twelve months to 35.3%, or 42.7% on a total return basis taking into account the dividend of 43.7 pence per share that was paid in June last year. The share price represents a discount to the look-through NAV of 29.7%, based on the market value of the Wilson Sons shares together with the latest valuation of the investment portfolio.


Alec Letchfield

April 2017


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