For professional investors and advisers only
Schroder Global Equity Income Fund
Quarterly Fund Update
Covering First Quarter 2017
Overview
The fund delivered a positive absolute performance in the first quarter, but lagged behind the wider market.
Portfolio review
UK supermarket Tesco detracted from returns in the first quarter. Tesco has worked hard to address the widespread view that in the
past it didn’t offer the best deals to its customers, its employees or its suppliers. The main components of CEO Dave Lewis’s
turnaround strategy for the business he joined in July 2014 have been to reduce prices, re-engage colleagues and reset the group’s
relationships with its suppliers. Evidence from customer and employee satisfaction surveys and supplier rankings suggests the
strategy is working on these fronts and this is feeding through into a better business – and a better investment for our clients.
This is exactly why we pay such close attention to whether a company’s governance is appropriately aligned and why we are so
attuned to potential stakeholder risks. If we find an ESG-related (environmental, social or governance) issue that we think is
unsustainable, we will make an appropriate adjustment to a business’s normalised earnings which will ultimately bring down our fair
value of that business.
Once we have initiated a position we continually monitor developments and will engage with businesses where necessary. When
Tesco announced its acquisition of wholesaler Booker in January 2017 we were concerned that the high price being paid for Booker
would be value destructive. We favour private constructive dialogue with companies and raise any concerns we have directly with
management. In this case we expressed our concerns to Tesco management that it is paying over 23 times Booker’s peak operating
profit, a multiple which will make the creation of shareholder value extremely challenging. Following extensive communication with
management, we took the unusual step of writing formally to the board of Tesco and going public in March 2017 to re-iterate that we
believe the risk of the deal does not carry proportionate reward. We will continue to work to ensure that the actions of Tesco’s
management are in the interests of long-term shareholders.
Education business Pearson weighed on fund performance after lowering its 2017 profit forecast and announcing a dividend cut. Its
North American higher education division is being negatively affected by falling higher education enrolments and a growing trend of
students renting, rather than buying, textbooks. Management has adjusted the strategy to tackle these issues head-on. Pearson has
already taken steps to move away from paper-based literature and testing, with over 60% of sales coming now from digital and
services. It is increasing digital investment to accelerate the shift to digital education sources, reducing e-book rental prices and
launching its own print rental programme. The result of these measures is likely to dent revenues and profits in the near term, but
they are important steps in Pearson’s recovery process and shareholders should be well rewarded for their patience.
Abu Dhabi based real estate firm Aldar Properties detracted from fund returns following a mixed set of fourth quarter results.
However, the group’s balance sheet remains healthy and the dividend yield is attractive. Aldar retains a landbank of around 77 million
square metres, of which around 25 million square metres could potentially be monetised in the short to medium term.
Department store chain Kohl’s Corporation was another detractor after the company lowered its full-year earnings guidance after
weak sales in November and December and lower gross margins. However, costs appear to be under control. We established our
position in Kohl’s in July 2016. We note that much of the group’s capital expenditure is focused on technology spend targeting
efficiency measures such as streamlining the fulfilment of online orders.
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Covering First Quarter 2017
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On the positive side, Kulicke & Soffa was the leading individual contributor to fund returns. The semiconductor equipment group
released an encouraging set of quarterly results, with revenues up 38% year-on-year. The market can on occasion overreact to the
ebbs and flows of quarterly results, in what is a volatile industry. We have a positive long-term view as we feel the company can
continue to generate meaningful capital.
Another leading individual contributor to fund performance was Samsung Electronics. The group launched its new flagship S8
smartphone and the shares have also been supported by strong sales of memory chips and flat panel displays.
Education and media conglomerate Graham Holdings was among the top contributors to fund returns in the wake of well-received
results. The company has taken steps to restructure its education business Kaplan. The business is starting to show the fruits of this
restructuring, with improved operating results in 2016 compared to 2015. There is further scope for recovery, and the group’s robust
balance sheet provides a solid foundation while we wait for this recovery to come through.
Key portfolio activity
We have built a new position in Russian gas giant Gazprom. We are cognisant of potential political and corporate governance risks
and so this will remain a modestly-sized position in the portfolio. The business makes most of its profits in distribution, which is a
relatively cost-light, asset-light sales division. We feel the balance sheet is sufficiently robust and note that Gazprom has a good track
record of converting net income into cash and paying dividends to shareholders.
We have initiated a new position in Apple. Clearly this is a business that has enjoyed strong growth over the past decade or so.
However, we feel the market is currently valuing the shares too cheaply, even when using very conservative sales and profit margin
assumptions. The balance sheet is strong and the dividend is growing, with pressure from investors likely to see the dividend to grow
further. Products that have seen significant growth, such as the iPhone, are supported by the extensive ecosystems that surround
them (the app store, iTunes, etc), which means customers are reluctant to switch to competitors.
We have sold out of software security provider Symantec, due to a deteriorating balance sheet. Symantec sold its Veritas data
management business last year and has spent the proceeds – and more – on new acquisitions. The firm has also undertaken a share
buyback and dividend.
Another sale was US for-profit education provider Apollo Education, on the completion of the bid to take the company private. This
is a disappointing outcome. When we bought our holding, we felt that Apollo’s financial prospects were significantly better than the
market believed, and the group had a robust financial position. We remain of the view that there was substantial upside in the
business for long-term investors who were prepared to be patient, like ourselves. By selling the company at a depressed valuation,
Apollo’s board did not allow time for this upside to emerge.
We have trimmed the holding in US bank JP Morgan, taking profits as the position size had increased significantly on the back of
strong performance.
Outlook
Value, back from the dead …
The story is now well-known. By mid-2016 value had underperformed growth for the longest period on record and was trading at its
widest discount to growth since the dot-com bubble in 2000. Value then enjoyed a partial rebound through to the end of the year.
… or is it?
Value’s resurgence appears to have stalled in the first quarter of 2017, giving rise to the question, is the value rally over? When posed
this question, we look to history for guidance. The analysis of periods of global value outperformance shows that this would be the
shortest and smallest value rotation in 40 years if it stopped here. The level of value’s underperformance to growth remains at the
level last seen during the dot-com bubble in 2000. Value underperformed growth for a decade and it will take much longer than a few
months to unwind this (see chart below).
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Source: Schroders, Thomson Datastream, 31 March 1987 to 31 March 2017.
It is highly unlikely that value’s recovery versus growth will go in a straight line. Value investing is a marathon, not a sprint. Value is a
very good indicator of long-term performance, but it tells you nothing about investment returns in the short term. What we can say,
is for those willing to be patient the outperformance on offer from a true deep-value portfolio is the most attractive opportunity
available to equity investors today.
Investors must eschew short-termism to reap the long-term rewards
The average holding period for equities has fallen tenfold since 1950, and there is plenty of evidence to suggest short-termism can
lead to higher costs and lower returns. There is one benefit of this trend however, and that is the more short-term the broader
market becomes, the greater the potential benefit to those who are able to adopt a more patient, longer-term investment strategy.
This could be termed our “behavioural edge” – that is our patience amid market hyperbole and the long-term mind-set that we
steadfastly adhere to. This way of thinking is in stark contrast to most other market participants, who tend to myopically focus on the
next quarter’s financial results of the companies in their portfolios. By having a genuine 3-5 year time horizon we are able to invest in
businesses that others are simply unable to pursue, and in doing so we can reap the long-term rewards.
Avoid the illusion of control in the short term
The trade-off to the superior returns that can be achieved by following a value-based approach is that we never know how long it will
take for the market to recognise the value of our investments. Investment results in any one month, quarter or year are more or less
random. We avoid commenting on short-term performance because it gives the false impression that our results over such periods
can be definitively explained. Remember that the performance of a skilful investor is likely to look very similar to that of a lucky
investor in any given quarter – the difference between the two only emerges over the longer term.
We look for businesses with the capacity to suffer
As long-term investors, we have learned that trying to second guess short-term trends, and using these to position portfolios, seldom
delivers returns. Valuation spreads (the difference between the cheapest and most expensive companies) remain wide throughout
the world. In this environment, your portfolio is characterised by significantly undervalued cyclical businesses with robust balance
sheets that will provide us a margin of safety in a wide range of inherently unknowable future economic scenarios. Given a history of
relatively long value cycles, your investment in a true deep-value portfolio should deliver significant outperformance on a 10-year
view.
For more insight from the Fund Managers please visit www.thevalueperspective.com
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Important Information: For professional investors or advisers only. This material is not suitable for retail clients. Past performance is not a
guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors
may not get back the amount originally invested. Matt Hudson has expressed his own views and these may change. The data contained in this
document has been sourced by Schroders and should be independently verified before further publication or use. This document is intended to be for
information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the
purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or
investment recommendations. Information herein is believed to be reliable but Schroder Unit Trusts Limited (Schroders) does not warrant its
completeness or accuracy. No responsibility can be accepted for error of fact or opinion. Reliance should not be placed on the views and information in
the document when taking individual investment and/or strategic decisions. Risk factors: The fund can be exposed to different currencies. Changes in
foreign exchange rates could create losses. Equity prices fluctuate daily, based on many factors including general, economic, industry or company
news. In difficult market conditions, the fund may not be able to sell a security for full value or at all. This could affect performance and could cause the
fund to defer or suspend redemptions of its shares. Failures at service providers could lead to disruptions of fund operations or losses. The
counterparty to a derivative or other contractual agreement or synthetic financial product could become unable to honour its commitments to the
fund, potentially creating a partial or total loss for the fund. A derivative may not perform as expected, and may create losses greater than the cost of
the derivative. The fund uses derivatives for leverage, which makes it more sensitive to certain market or interest rate movements and may cause
above-average volatility and risk of loss. Issued in February 2017 by Schroder Unit Trusts Limited, 31 Gresham Street, London EC2V 7QA. Registered No:
4191730 England. Authorised and regulated by the Financial Conduct Authority.
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