Passive success opens up opportunities
Like the majority of active managers, equity fund SKAGEN Kon-Tiki struggled last year. Looking ahead, portfolio manager, Hilde Jenssen sees lots of interesting opportunities for 2015.
What opportunities do you see for SKAGEN Kon-Tiki in 2015?
"We're fundamentally a value investor, so we're primarily looking for undervalued companies that offer investment opportunities rather than attempting to pick the right region or industry segment. This means that often we're bucking the consensus," emphasises Hilde Jenssen.
One example of SKAGEN going against the grain was when, before the end of 2013, most experts agreed that 2014 would be a weak year for "The Crazy Five," namely, Brazil, India, Turkey, Indonesia and South Africa. SKAGEN did not believe this to be the case and the prophesy did not come true. Brazil, which ended the year at -1 percent, was the exception while the four other markets gained 44, 30, 29 and 9 percent, respectively, as measured in euros.
Jenssen also paints a picture of 2015 where lower oil prices will finally start to benefit oil-importing countries, especially in Asia where many companies have strengthened their balance sheets in the prevailing low-interest climate. She believes that, on the one hand, the US will continue full steam ahead although it is becoming increasingly difficult to find bargains there, especially if higher labour costs start pressuring margins.
"On the other hand, Europe may turn out to be interesting hunting grounds – not least among the companies that are well-positioned to take advantage of an improvement in emerging markets," she notes.
Nirvana for risky assets
Hilde Jenssen and her Kon-Tiki team-mates are trying to ascertain where the prevailing consensus is wrong. They are working with various alternative scenarios to identify investment opportunities. As an example, Jenssen mentions how the analyst profession was expecting higher US 10-year bonds in 2014 than the 2.8 percent that prevailed in December 2013. Instead, interest rates fell. And in October, US bond interest rates reached their lowest level of 1.87 percent.
"The quantitative easing measures implemented by the United States, Asia and Europe represented a nirvana for many risky assets, including companies with credit market access. Many of these are in a far better financial state today, even though most often that's not reflected in their share prices," says Jenssen.
Best risk protection
With respect to future 'safe havens' that may counterbalance risk in SKAGEN Kon-Tiki's portfolio, Jenssen points to the fund's long-term time outlook of at least two-to-three years, which is the best hedge against poor stock allocations. Having a longer outlook can help in three ways: It increases the likelihood of unearthing undervalued assets; it reduces transaction costs; and it may turn volatility into an advantage for the fund.
"Studies show that analysts primarily focus on estimates for the current year and the next. That gives us a lot of scope to find companies that are mispriced relative to their long-term potential. Kon-Tiki's portfolio has a turnover rate of 20 percent per year. This is low in our business and is something that has contributed to our lower transaction costs. With our long-term perspective, we also have greater ability to adjust our investments when good opportunities emerge," she concludes.
2014 was a year in which active managers broke records – in a negative sense. It has been decades since so many underperformed their respective benchmark indexes. Some estimates go so far as to say that only 15-20 percent of active managers beat their benchmark index last year.
Investors were quick to put former cash cows out to pasture in favour of passive managers. According to the Financial Times, US equity funds witnessed an outflow of USD 92 billion, while passive funds had an inflow of USD 156 billion in 2014. Of the world's equity fund assets, managed funds currently represent 17 percent compared with 10 percent 10 years ago.
The final straw came when active fund manager legend Warren Buffet recently came out in favour of index funds.
To be or not to be... active
The question boils down to whether it is wiser to go with the flow and invest one's savings in a fund that invests passively, in order to capitalise on general, strong market growth while keeping costs down; or whether one should go with an actively managed fund whose goal, in the long term, is to outperform the average.
There are no right or wrong answers. But in our view at SKAGEN, opportunities for active value investors have improved in step with the higher reallocation rates into passive funds. Currently, the risk-reward pendulum seems to be swinging in favour of active investors. Not least because the ratio gives rise to price inefficiencies.
Hilde Jenssen, portfolio manager of emerging markets fund SKAGEN Kon-Tiki, also believes that the trend has resulted in what she sees as a long overdue clean-up in the industry:
"Even though 80-85 percent of so-called active managers underperformed their benchmark indexes in 2014, we should bear in mind that most of those managers are in fact "closet index managers" who charge high fees despite actually delivering returns close to the index. Few can match SKAGEN's 90 percent active share. It is only natural that people move capital out of closet index managers into index funds and ETFs that have lower fees. This opens up the market for bona fide active managers," she points out.
Active share refers to how much positions in a portfolio deviate from a given index – which is the whole point of active management. (If the active share is zero percent, the fund is identical to the benchmark index, while an active share of 100 percent means that there are practically no similarities at all.)
Macro scenario changed fundamentally
Many have also pointed out that a major issue for active managers relates to the central banks' actions since 2008. Low interest rates and quantitative easing have freed up a lot of liquidity, which has driven up share prices. Perhaps it is not surprising that active managers have been buffeted by headwinds.
These macroeconomic conditions are expected to change radically over the next year. The US Federal Reserve will cease their easing and will wind down their five-year long zero-interest policy. This will have a great impact on the global economy where nearly half of all transactions are performed in US dollars.
"Quantitative easing has primarily produced an upswing for US – and to some extent Chinese and now most recently Indian – shares. The remainder of the emerging markets haven't seen a multiple expansion to the same extent as the US. So, for us it won't make a big difference. Europe is weak and Latin America is being pulled down by oil producing countries such as Brazil and Venezuela. All else being equal, higher interest rate levels may normalise the high valuations in the US down towards a global level. Lower oil prices benefit economies that import a lot of oil, such as Japan, China and India," says Jenssen.
Some of SKAGEN Kon-Tiki's high conviction holdings
(1) Hyundai Motor
Among other things, Hyundai's launch of the new i20 Coupé, aimed at appealing to young customers with its distinctive design, is likely to increase margins. Hyundai Motor has also taken steps to improve corporate governance. SKAGEN Kon-Tiki holds preference shares in the company, which are traded at a discount of 22 percent relative to the ordinary shares and 5.3x 2015 P/E.
(2) Samsung Electronics
The South Korean electronics giant made news recently by announcing its intention to raise its dividends by 30-50% for 2014. This means that Samsung is finally fixing its overcapitalisation issue, which has been a main trigger for SKAGEN Kon-Tiki's investment case. The preference shares held by SKAGEN Kon-Tiki are 23 percent less expensive than the ordinary shares.
(3) Great Wall Motors
With the launch of new models and increased capacity, the Chinese SUV manufacturer is back on track. Higher sales figures for the top H9 segment show that the company can compete also in that market.
(4) State Bank of India
State Bank of India has improved both its cost structure and the quality of its assets. This has placed the bank at the top of the Indian companies that will most benefit from Prime Minister Nerendra Modi's reforms. There is still a lot of room for improvement but the bank should benefit further from its more than 400 million accounts-large distribution platform.