Mackenzie Ivy Team
- Over the first quarter of 2017, the global market finished strong, continuing the trend that started last fall. Far East markets outperformed the US and European markets; this is the opposite of what was observed in Q4, when Far East markets lagged their global counterparts. European markets also posted strong performance. US markets achieved new all-time highs. The U.S. Federal Reserve raised the federal funds rate again in March 2017, after the hike in December 2016, citing higher home prices, low unemployment rate and improving economic confidence.
- The MSCI World Index returned 5.6% over the first quarter of 2017. The rally was quite broad-based, with most sectors having positive returns except Energy. On a country basis, the index was generally positive, led by winners like Spain, Singapore and Hong Kong clocking in +13.6%, +12.4% and +12.3% in CAD terms, while the bottom contributors like Norway and New Zealand turned in +0.4% and +1.0% in CAD terms respectively.
- The S&P/TSX underperformed relative to global markets in the first quarter but continued its upward climb, touching new highs in February. The gains in the TSX were widespread with the exception of energy. The Ivy Canadian Equity Fund increased roughly in line with the TSX and the most significant positive contributors to Ivy’s performance in the quarter were Richemont, Oracle and Brookfield, while the key detractors were consolidated around our energy holdings.
- One of the main contributors to performance was Richemont, a Swiss-based luxury goods company that was held across all Ivy funds. Richemont owns a collection of strong jewellery and watch brands such as Cartier, Van Cleef & Arpels, Jaeger-LeCoultre, and Vacheron Constantin. Having great brands is a good starting point, but it is equally important to be a good manager of brands, sustaining the necessary investment in marketing and distribution to ensure the brands remain valuable well into the future. Richemont excels at this, with a long-term orientation that reflects family control. One of the defining characteristics of the luxury goods industry is the importance of Chinese buyers, both at home and at prime tourist destinations. This customer segment can account for 40% or more of a luxury company’s total revenues. Entering 2016, there was a concern about weakness in the Chinese customer base, which led to a steep decline in the share price of Richemont. This year has seen the opposite situation, as signs of a resurgence in Chinese demand has led to gains in the shares of luxury good companies, Richemont included. Investors often over-react to both good news and bad, particularly if they have a shorter-term time horizon. We have maintained our long-term view about the value of Richemont, which led us to reduce our position last quarter.
- Samsonite (a holding in Ivy Foreign Equity, Ivy Global Balanced, Ivy International Equity and International Growth funds) saw significant share price appreciation in Q1; this was due to a combination of a) stronger than expected Q4 F2016 results, and b) a discounted valuation prior to the results announcement. Samsonite’s business performance was helped by improved performance in Hong Kong and China, as well as good progress with the recently completed TUMI acquisition. The Company signaled that synergies from the TUMI deal could be significant, even after accounting for higher brand and distribution investment; Samsonite continues to take a measured approach to integrating and growing the TUMI business.
- Pearson was a very weak performer, and was removed from the Ivy portfolios after a six year holding period. Pearson is a global leader in educational products and services, which traditionally meant textbooks but has been shifting over time to things like digital instructional materials, testing services, and management of online educational programs. The original thesis was that Pearson had recognized the industry shift to digital earlier than others, had invested significantly behind it, and had the necessary elements to ultimately succeed in this market. At this point, that thesis appears to be wrong. We still believe they have the opportunity and resources to succeed, but underestimated the difficulty of re-organizing the company and re-orienting the culture to adapt to industry changes. We had reduced our position in Pearson substantially in past years as worries began to mount, so it was a small position entering 2017, but nevertheless it was a mistake and it detracted from fund performance.
Outlook & Strategy
What are the key opportunities you see?
- We initiated a position in Brambles in the Ivy International and International Growth funds during the quarter. Brambles is an Australian-listed supply chain equipment pooling company; it owns and operates the largest pool of wooden pallets globally. Its pallets are used to transport Fast Moving Consumer Goods through various parts of the manufacturing and retail supply chain. Brambles also owns and operates a pool of reusable plastic crates (used in the produce supply chain), and various other industrial containers (automotive, bulk commodities, oil and gas equipment). We believe Brambles has a strong competitive advantage in its core pallets business, supported by economies of scale, a vast warehousing and distribution infrastructure that has been built over a number of years through significant investment, and well-developed equipment tracking techniques. We had identified Brambles as a high quality business quite some time ago, however we were deterred by its lofty valuation and optimistic market sentiment. More recently, the share price has come under significant pressure due to a combination of cyclical and operational issues – Brambles announced in mid-January 2017 that its H1-2017 results were weaker than expected and that it would not be able to meet full year guidance. The company is also in the midst of a planned management change. We used this opportunity to build a position in the company – we believe the company continues to offer an attractive customer value proposition, retains a strong competitive advantage, and will be able to navigate through these pressures over the long-term. Our initial assessment of new management is also favourable – newly appointed CEO Graham Chipchase oversaw an impressive turnaround at Rexam PLC, and will be taking a prudent approach to growth and capital allocation at Brambles.
- We also initiated a position in Techtronic Industries in Ivy Global Balanced in Q1, and increased our position in the Ivy International and International Growth funds. Techtronic’s share price had come under significant pressure since August 2016, as its reported H1-2016 results were not strong enough to meet the market’s aggressive expectations; the stock further weakened following the results of the US Presidential Election in November 2016 due to concerns about the impact of protectionist trade policies on Techtronic’s China-centric manufacturing model. This opened up a window to accumulate shares at an attractive price in early Q1. The weakness that had been observed since August has now almost completely reversed, following Techtronic’s strong H2-2016 results, along with some calming messaging from management about the company’s flexibility to reallocate some production to North American facilities if needed. Techtronic continues to execute its stated strategy, which is based on technological leadership and innovation, brand building, high levels of customer service, and efficiency.
- Seven & I’s share price also came under some weakness during Q1 – we used this opportunity to increase our position across the various Ivy funds. The business performance has been steady and in-line with our expectations, since our initial purchase in July 2016.
- During the quarter we initiated a new position in Gildan Activewear in Ivy Canadian and Ivy Canadian Balanced. Gildan manufactures basic apparel (i.e. t-shirts, socks, underwear) for distribution into the wholesale and retail channels. Under the stewardship of its founder and CEO Glenn Chamandy, Gildan has consistently generated attractive returns, grown earnings and reinvested in its low cost manufacturing capabilities, while maintaining a conservative balance sheet. Gildan’s low cost position has allowed it to gain market share by offering a compelling value proposition of high quality at a low price to its customers. We expect this competitive advantage will support the company’s next leg of North American and international growth. Gildan benefits from open borders and a favourable tax status, but unfortunately both policies are outside of the company’s control, presenting key risks to our outlook. In addition, demand for some of its product is cyclical so we would expect higher earnings volatility through an economic downturn. Despite these risks, we believe that the high quality of this business in combination with our expected through cycle return justifies the position.
What are key risks that need to be managed?
- Our future portfolio returns will be influenced by a large number of external non-company specific factors, some of which we recognize will likely be of importance and some which will occur and will remain unknown to us until they do. The most important of the ones we recognize are probably central bank ideology and actions and Chinese Communist Party (CCP) ideology and actions. An interesting juxtaposition we think. In both cases, the recognition that change of direction is required and secondly, the institutional capacity to undertake change may ultimately define the paths the two dynamics take. Also in both cases we see unelected officials encouraging increasing amounts of financial leverage in order to provide a short-term growth elixir while they grapple with what it is about their ideological economic model that isn’t working as hoped. In the case of China, CCP leaders appear to have some ability to reflect on the dynamic at play in an intellectually honest manner, something we find completely lacking from the ideologues at the Fed, ECB, and JCB among others. Maybe it’s just harder to blame something or someone else in a planned economy and maintain legitimacy – the whole idea is not to allow the buck to be passed anywhere other than to the Party. But the institutional capacity for change in communist China is potentially limited and more difficult. Central bankers have lots of people to blame and have shown an inability to attribute undesirable outcomes to their own behavior. We believe the lengths Central bankers will pursue to defend their intellectual honor and ideology will continue to be extreme and that a change of course will likely only occur after an extremely negative outcome. However, the institutional capacity for this change does exist in the proven construct of Western democracies. Stay tuned.
- We believe the most significant risks facing global markets are a) reversal of ultra-loose monetary policy, including potential unwinding of the Fed’s balance sheet, b) impact of excess leverage in various pockets of the global economy (Chinese corporates and Japanese government are two examples in Asia), and c) reduced optimism around the actual impact of policies of Donald Trump and his administration.
How are you positioning portfolios in response to this outlook?
- From our vantage point, we believe valuation risk has become increasingly prevalent in the Canadian market despite significant underperformance relative to the US and global markets since the crisis. However this is not to say that this environment cannot persist for an extended period. On a net basis, our cash position increased to 14% at the end of March from 10% at the end of December, reflecting our view that the opportunity set, in aggregate, is a bit less attractive than it was three months ago. As always, we construct a thoughtful, diversified and concentrated portfolio of high quality businesses. We will continue to monitor our holdings and watch list with the aim of capitalizing on opportunities in a disciplined manner.
- For the Far East specifically, we remain ‘underweight’ Japan relative to most benchmarks, as we believe valuations for most high quality businesses are expensive. We have relatively high exposure to Hong Kong, as we have identified several high quality businesses that we believe are trading at attractive valuations – even after the recent strong market performance. We do hold a number of ‘cyclical’ Far East stocks, but these are companies with attractive valuations, strong balance sheets, and good long-term growth prospects – we are happy to own companies like this through a cycle, and we balance these holdings with cash and other defensive businesses.