For the three months ending September 30, 2021, the iMGP International Fund was down 0.56%, while its benchmarks MSCI ACWI ex USA Index NET and MSCI EAFE Index NET declined 2.99% and 0.45%, respectively. The average peer in Morningstar’s foreign blend category fell 1.87% for the quarter.
Over the trailing one-year ending September 30, 2021, the fund is up 37.19%, beating the ACWI ex US index (+23.92%) and the EAFE index (+25.73%). This trailing one-year performance placed the fund in the top 2% of Morningstar’s foreign blend peer group. Shareholders may recall the fund’s performance had suffered when the pandemic hit because it entered 2020 with a strong cyclical-value exposure, driven by the fund subadvisors’ bottom-up stock picking. It was therefore good to see the fund rebound the way it has post the vaccine announcements.
Since its inception December 1, 1997, iMGP International has returned 7.11%, annualized. Over the same time period, MSCI ACWI ex USA Index NET and MSCI EAFE NET and Morningstar Foreign Blend category have generated an annualized return of 5.68%, 5.33% and 4.57%, respectively.
Performance quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the funds may be lower or higher than the performance quoted. To obtain standardized performance of the funds, and performance as of the most recently completed calendar month, please visit www.imgpfunds.com.
Manager Changes and Outlook
In our reports since the pandemic began we have been writing about our ongoing search for a growth-oriented manager. That search was completed during the third quarter.
We added Polen Capital as a sub-advisor to the iMGP International Fund effective September 30, 2021. Concurrently, we removed Pictet Asset Management and Evermore Global Advisors. We believe Polen will be an excellent addition to the fund. We believe these changes help the fund achieve the desired investment style balance in line with its core international mandate. The fund had taken on a much stronger cyclical-value orientation than we intended. Both Pictet and Evermore have been great partners during their tenure as sub-advisors and we sincerely appreciate the care and diligence with which they have guided us through a very challenging macro environment—including the aftermath of the European debt crisis, trade wars, and the pandemic. We thank them for their contributions to the Fund.
Our analysis shows that not having a dedicated growth sleeve has been one of the primary drivers behind the fund’s disappointing performance the past several years, and especially around the pandemic. The Fund’s cyclical bias greatly hurt when the global economy virtually shut down. We have seen strong recovery in cyclical names over the past year and are now hearing from managers that the opportunity set looks more balanced in terms of value vs growth and cyclicality vs quality.
In Polen we believe we are getting both quality and growth. The portfolio managers, Todd Morris and Daniel Fields, are executing a proven philosophy and approach that has generated strong risk-adjusted returns over a long period. They invest in companies they believe are financially sound and competitively advantaged that they can own for many years and that in their view offer the best odds for attractive and sustained earnings growth. They bring a risk-management and value-conscious mindset. They have always managed relatively concentrated portfolios, and we believe they are ideally suited to running a iMGP International mandate of typically 15 stocks or less.
Polen joins our two other managers—David Herro of Harris Associates and Mark Little of Lazard Asset Management. We have known both investors for decades and have a very high level of confidence in them. Their performance since their respective inception dates on the Fund—Herro’s going back to the Fund’s inception in December 1997 and Little’s to February 2013—has been very strong. They have executed the Fund’s concentrated mandate in an excellent manner. Herro is a value-oriented manager. Little is an all-cap eclectic blend manager. With Polen as our quality- and growth-oriented manager we believe the Fund is now very well balanced in terms of style. This combination we believe will result in a focused yet diversified low-turnover portfolio of 40 to 50 stocks. Our analysis shows this mix of three managers improves the fund’s overall diversification. We also believe it increases our odds of generating great performance.
The fund entered 2021 with over $63.4 million in loss carryforwards. At the end of the second quarter the fund had $40 million in loss carryforwards and after the portfolio manager transitions, the fund had $12.8 million .
We continue to believe that skilled stock pickers who focus on only their highest-conviction ideas and on generating great long-term performance, without worrying about shorter-term volatility and tracking error, will outperform indexes and their peers. This was the original premise of iMGP International Fund, launched in December 1997. We thank our shareholders for their continued support.
Brief Discussion of Performance Drivers for the First Quarter and Portfolio Positioning
It is worth remembering the fund’s overall positioning is driven by managers’ stock picking. As a result, stock selection is always the main driver behind the fund’s absolute and relative performance. Attribution analysis over a given period may however show other factors that also explain relative performance.
In the third quarter stock selection was the primary driver behind the fund’s outperformance versus MSCI ACWI ex US index. Sector allocation was a slight negative.
Stock selection was particularly strong in the communication services, a sector where the fund had a relatively large overweighting during most of the quarter. We have discussed in the past how the holdings in communication services are diverse in nature with specific risk drivers. Several of the holdings in this sector performed well, such as Informa, Vivendi, Bollore, and Nordic Entertainment. Within the utilities sector, China Longyuan Power Group (discussed below) rose over 40% to become the fund’s top contributor to performance. Stock selection within the materials sector was a positive driven by Glencore and Incitec Pivot.
Looking at regions, an overweighting to Europe added value while an underweight to Japan detracted slightly from performance.
| Sector Weights* | Fund | iShares MSCI ACWI ex- U.S. as of 9/30/2021 |
|---|---|---|
| Communication Services | 11.1% | 6.3% |
| Consumer Discretionary | 16.5% | 12.6% |
| Consumer Staples | 3.9% | 8.5% |
| Energy | 0.0% | 4.9% |
| Finance | 25.0% | 19.1% |
| Health Care & Pharmaceuticals | 7.4% | 9.5% |
| Industrials | 8.3% | 12.1% |
| Information Technology | 13.9% | 13.1% |
| Materials | 3.9% | 7.9% |
| Real Estate | 0.0% | 2.5% |
| Utilities | 4.6% | 2.9% |
| Cash & Other | 5.4% | 0.5% |
| 100.00% | 100.00% |
| Regional Allocation | Fund | iShares MSCI ACWI ex- U.S. as of 9/30/2021 |
|---|---|---|
| Africa | 0.4% | 0.9% |
| Australia/New Zealand | 1.6% | 4.5% |
| Asia ex | 6.3% | 25.6% |
| Japan | 0.9% | 15.2% |
| Western Europe and UK | 78.6% | 41.3% |
| Latin Am | 1.6% | 2.2% |
| North America | 2.2% | 7.8% |
| Middle East | 3.0% | 2.0% |
| Cash | 5.4% | 0.5% |
| 100.00% | 100.00% |
Quarterly Market and Portfolio Commentary from Managers
David Herro, Harris Associates
Global equity prices were mixed in the third quarter as concerns mounted over how supply chain disruptions, inflation pressures and the lingering Delta variant may impact global growth. Several underlying positives are helping offset these concerns including continued global monetary stimulus, low interest rates, slowly rising employment, and improving consumer and corporate balance sheets. In addition, there are many who believe (as we do) that the headwinds cited above will become less significant over the next 12-24 months. As we enter the fourth quarter, we believe the underlying positives will eventually prevail and gradually improving economic conditions ought to create a positive backdrop for global equity prices.
We established two new positions in the quarter: Prosus and EXOR. Both are holding companies that contain businesses we think are attractively priced. The position in Prosus was established as part of an exchange offer for Naspers shareholders (Naspers is the holding company for Prosus). We elected to make this exchange as we believe Prosus offers a better domicile (the Netherlands), more liquidity, and a better tax position. EXOR is a holding company for several businesses including CNH, Stellantis, PartnerRe and Ferrari. We believe EXOR is attractively valued on a sum-of-the-parts basis. Since the beginning of the year, the companies we own have reported largely favorable earnings and cash flows as the global economy began to emerge from the pandemic. While the coming quarters may experience more mixed fundamental progress, due to supply chain disruptions and increasing inflationary pressures, we think the overall trend remains positive over the next 12-24 months.
Mark Little, Lazard Asset Management
The third quarter of 2021 saw international equity markets broadly flat. The Delta variant slowed the reopening momentum in some markets and led to lockdowns in some Asian countries that had previously been more successful at restricting cases.
Meanwhile, supply chains remain disrupted and poorly supplied, putting downward pressure on volume availability and upward pressure on prices – natural gas and electricity in particular. Meanwhile, the data from China continues to slow in the face of new COVID lockdowns and a property sector under pressure from the demise of Evergrande and generally tight financing restrictions. Sector wise, energy stocks followed oil prices higher, while growth technology stocks benefited from some easing of cyclical enthusiasm. Banks were surprisingly strong given falling rates and economic concerns. On the negative side, consumer discretionary companies fell on concerns over China and over volume shortfalls. Consumer staples were weak after several companies highlighted rising raw material pressure on margins. Utilities fell as governments started to intervene to offset the impact on consumers of rising energy prices.
Top 10 Individual Contributors as of the Quarter Ended September 30, 2021
| Company Name | Fund Weight (%) | Benchmark Weight (%) | 3-Month Return (%) | Contribution to Return (%) | Country | Economic Sector |
|---|---|---|---|---|---|---|
| Bollore | 4.15 | 8.64 | 0.49 | France | Communication Services | |
| China Longyuan Power | 1.83 | 43.45 | 0.83 | Hong Kong | Utilities | |
| CTS Eventim | 1.12 | 21.23 | 0.29 | Germany | Communication Services | |
| Glencore PLC | 1.76 | 13.41 | 0.28 | UK | Materials | |
| Incitec Pivot Ltd | 1.39 | 13.85 | 0.2 | Australia | Materials | |
| Informa PLC | 4.28 | 6.91 | 0.29 | UK | Communication Services | |
| Israel Discount Bank Ltd | 2.25 | 11.42 | 0.21 | Israel | Financials | |
| Nordic Entertainment | 2.64 | 24.59 | 0.77 | Sweden | Communication Services | |
| Vivendi SE | 4.65 | 10.41 | 0.51 | France | Consumer Discretionary | |
| ZIM Integrated Shipping | 1.18 | 31.32 | 0.4 | Israel | Industrials |
Edited Commentary from the Respective Managers on Selected Contributors
BNP Paribas (David Herro)
- BNP Paribas possesses a dominant retail banking franchise as well as a diversified business base, which allows for cost of funding, liquidity and scale advantages versus its smaller peers.
- BNP has recently improved its risk profile by exiting riskier business lines and increasing its capital level; this has worked to further strengthen its balance sheet, resulting in a common equity Tier 1 ratio that exceeds regulatory requirements.
- In our assessment, BNP generates an ample amount of capital and realizes strong growth of its tangible book value per share owing to its ongoing pre-provision profitability.
- Management has opportunistically used free cash flow to engage in value enhancing mergers/acquisitions, as well as to consistently issue dividend payments.
BNP Paribas shares gained during the quarter as investors reacted to an earnings report and multiple acquisitions. In July, the company announced it had received the necessary approvals to finalize the acquisition of Exane (investment company). BNP later sold Hello bank! Austria to BAWAG Group and acquired FLOA, a leading payments company in France, for EUR 258 million. The company’s second-quarter earnings report was positive, in our view. First-half revenue grew 4.6% year-over-year, driven by 5.2% growth in domestic markets and 4.3% growth in commercial and investment banking. Overall, we like that BNP is a large, diversified financial institution that generated relatively high levels of profitability over time, including multiple crises. Although below-normal interest rates, one-time costs and a weak economic environment are pressuring earnings, we believe the company is positioned to recognize upside potential over the long term.
CTS Eventim (Mark Little, Lazard Asset Management)
CTS is the dominant European ticketing platform with over 60% share in all of its core markets. They are the second largest ticketing operator globally, and the third largest event promoter globally. CTS Eventim has strong network effects, industry leading margins, good financial productivity with an ROE over 30% and a net cash balance sheet even after a year and a half of no events. The company operates two business divisions: Ticketing (32% of Sales and 77% of earnings before interest, tax and depreciation/amortization – EBITDA) which makes money from booking fees and servicing costs (12-15% on the ticket price), and Live Entertainment (68% of Sales and 23% of EBITDA) where they organize shows and own promoters.
Our thesis is predicated on a recovery in earnings and we see EBITDA 20% ahead of 2019 levels driven by the strong event schedule, strong consumer demand driving ticket price inflation, and an accelerated online shift. Consumers have been spending more on experiences as evidenced by the fact that the global live music market has grown by 4% CAGR until 2020. Post Covid, demand for experiences remains strong evidenced by low refund rates (5-10%). We see two very strong years of recovery in 2022 and 2023 driven by more shows and ticket price inflation. Artists want to get back to touring, as they make 80% of their income from touring and the pandemic has therefore materially impacted their income. In the U.S. there are usually 25-30 tours a year but now that is trending towards 50 tours for 2022 and 2023. The company expects to see similar trends in Europe where reopening has lagged.
Consumers are also willing to pay up for experiences and the company expects high single digit ticket price inflation. Additionally, the shift to online magnifies revenue growth and Covid has accelerated shift to online. Online ticketing generates roughly seven times as much revenue compared to when a ticket is sold offline. CTS Eventim currently sells 80% of tickets online and we expect this to jump to 90% in the next 3 years. We see margin expansion given operating leverage in ticketing business. The strong balance sheet with a net positive cash balance sheet puts them in a strong position if reopening is pushed out.
Glencore (David Herro, Harris Associates)
- We like that Glencore is run by smart, hyper-competitive and value-focused managers with a focus on improving asset returns.
- In our estimation, Glencore differentiates itself from other miners with its trading business that provides high returns and cash flow with low cyclicality and significant barriers to entry.
- We appreciate the company’s leading market positions in attractive commodities and believe existing mining operations will benefit from normalized prices, higher volumes, lower costs and the move towards a low carbon economy.
Glencore continued to outperform expectations in the third quarter, benefiting from rising commodity prices and a disciplined cost program. Copper, the company’s most important commodity, is benefiting from rising production and lower costs. Copper demand is currently quite strong and, in our assessment, should continue to remain robust due to 1) broad infrastructure investment in China and elsewhere; 2) continued global industrial recovery; and 3) copper needed for environmentally favorable purposes, such as grid investment, renewables and mobility electrification. At both current and normalized prices, Glencore generates a significant amount of cash flow, in our view. Lastly, we like that the company is run by smart, hyper-competitive and value-focused managers incentivized to improve asset returns and return capital to shareholders.
China Longyuan (Mark Little, Lazard Asset Management)
China Longyuan designs, constructs and manages wind farms which sell electricity to power grid companies. They currently have approximately 8% market share of wind in China. They also have a coal power segment that operates coal power plants which also sells electricity to the grid. China is targeting aggressive capacity expansions as they aim to hit the newly announced 2060 net zero carbon climate targets. China Longyuan is an opportune investment on that growth with targets to double capacity over the next five years. Coal is still 60% of China electricity and needs to be substituted. Wind power is only 5% of the total. The runway for growth is very long. Demand growth for total power has grown 6% CAGR from 2015-2019. Renewables (wind & solar) have been taking 1% market share each year while installing 50-65GW of capacity each year. Other alternative sources of power (nuclear & hydro) are unlikely to take much share in China and therefore wind and solar are the likely share gainers.
To keep up with normal demand and also gain share, Longyuan intends to increase their growth from 2GW per year of capacity additions to 4GW as they look to increase their capacity from 20GW to 40GW over the next 5 years. All this is happening at a time when the subsidies for onshore wind power are disappearing due to being cost-competitive with the grid. This changes the margin profile, and thus the valuation, which is now more steady and predictable than the boom/bust cycles influenced by subsidies previously. Ultimately, this is a utility and so returns are not large and their minimum IRR target is 7% but we believe their returns are comfortably ahead of this. The accounting points to 10% ROE; while not incredible, relative to their low WACC and given their low volatility as a utility, this is value accretive. A valuation of 14x 2022 PE for 16% EPS CAGR looks inexpensive, especially compared to peers trading at twice the multiple.
Top 10 Individual Detractors as of the Quarter Ended September 30, 2021
| Company Name | Fund Weight (%) | Benchmark Weight (%) | 3-Month Return (%) | Contribution to Return (%) | Country | Economic Sector |
|---|---|---|---|---|---|---|
| Atlantic Sapphire ASA | 1.22 | 0 | -57.96 | -1.07 | Norway | Consumer Staples |
| Siemens Gamesa Renewable Energy SA | 1.64 | 0.03 | -23.58 | -0.45 | Spain | Industrials |
| Tencent Holdings Ltd | 1.82 | 1.33 | -21.18 | -0.42 | Hong Kong | Communication Services |
| Grupo Televisa ADR | 1.23 | 0 | -23.11 | -0.37 | Mexico | Communication Services |
| Nexon Co. Ltd. | 1.13 | 0.04 | -27.4 | -0.35 | Japan | Communication Services |
| Naspers Ltd | 1.16 | 0.23 | -21.15 | -0.33 | South Africa | Consumer Discretionary |
| Universal Music Group | 0.29 | 0.01 | -9.06 | -0.32 | Netherlands | Communication Services |
| Allianz SE | 2.4 | 0.35 | -9.46 | -0.22 | Germany | Financials |
| Carlsberg A/S Class B | 1.63 | 0.06 | -12.26 | -0.2 | Denmark | Consumer Staples |
| Montana Aerospace AG | 1 | 0 | -10.62 | -0.17 | Switzerland | Industrials |
Edited Commentary from the Respective Managers on Selected Detractors
Naspers (David Herro, Harris Associates)
- We like that an investment in Naspers provides a cheaper way to invest in Tencent via the former’s roughly 30% ownership stake in the latter. Tencent is the creator of WeChat and QQ, the two largest social platforms in China. In particular, the WeChat platform is used by the vast majority of Internet users in China and is a critical aspect of everyday life due to its multitude of product and service offerings.
- Importantly, high levels of user engagement allow Tencent to monetize its user base more easily and more frequently relative to a single-use application.
- Additionally, Naspers owns stakes in multiple Internet businesses including OLX (No. 1 in online classifieds in multiple countries), Mail.ru (No. 1 social networking site in Russia), and Delivery Hero (No. 1 food delivery company in several countries), among others.
Naspers’s stake in Tencent caused its share price to decline in July as technology companies faced increased scrutiny and regulations from the Chinese government, including requiring Tencent Music to eliminate exclusive music licensing agreements. In August, Prosus and Naspers completed a share swap in which Prosus purchased about 45% of Naspers shares for a 49% stake in total. For Naspers, this share swap reduces its market capitalization and its weighting in the Johannesburg Stock Exchange, which we view as a positive. We spoke with the company regarding the increased regulation in China and its impact on Tencent. While the cost of complying with these new regulations will be higher going forward and the environment has clearly changed, Naspers does not believe the changes materially impaired Tencent and thinks it will continue to prosper over the long term. Later, Prosus entered into an agreement to purchase BillDesk (online payment gateway based in India) for about $4.7 billion. Overall, we continue to believe the valuation for the company remains attractive, offering a compelling reason to own.
Carlsberg (Mark Little, Lazard Asset Management)
Carlsbergis a global brewer domiciled in Denmark with an attractive portfolio of brands and strong market share in Europe and Asia. Over the last several years that we have owned the stock, our thesis has evolved from a restructuring and margin improvement story to a compounder with a strong capital allocation framework. In our view, the market overlooks the Asia business, which we see as the crown jewel of the company. It accounts for 40% of earnings before interest, taxes, depreciation, and amortization, and has over 50% market share in western China. During the second quarter, the company reported a strong start to the year with broad-based volume strength and continued strength in Asia reinforcing our conviction that the business is best-in-class and pushing the overall company toward a structurally higher growth and profitability range. However, the stock gave up some of those gains as investors fretted over the health of the Chinese economy and some official anti-alcohol comments, though in the context of beer, these fears look overdone to the portfolio team. Given the growth the company is experiencing in Asia, the valuation remains very attractive, in our view.
Grupo Televisa (David Herro, Harris Associates)
- Even though Grupo Televisa is the world’s largest producer of Spanish speaking content, pay television and broadband has reached only about half of these respective markets in Mexico, which we believe positions the company to realize growth and enhanced earnings going forward.
- We find Televisa’s target audience in Mexico and the U.S. provides an attractive opportunity, as the population is young and growing and this demographic is increasing wealth at a healthy rate.
- We like that Televisa’s ownership of its distribution helps to both better protect content and save on distribution costs.
Early in the reporting period, Grupo Televisa delivered headline second-quarter earnings figures that showed healthy growth, although we found the results to be relatively weak as the most important business segment – cable – experienced a significant reduction in growth. The company attributed this to a difficult comparison versus the year-ago period and a higher unemployment rate in Mexico in the first half of 2021. However, management expects stronger performance in the second half of the year on improving macro conditions. Later, Live Nation entered into a deal to purchase Grupo Televisa’s 40% stake in OCSESA Entretenimiento. Despite its recent share price performance, we appreciate that a key aspect of Grupo Televisa is its ownership of its distribution, which we believe helps the company protect its content better while saving on distribution costs. In addition, even though Grupo Televisa is the world’s largest producer of Spanish speaking content, pay television and broadband has reached only roughly half of these respective markets. We believe this positions the company well to realize growth and enhanced earnings going forward.