The IVA Worldwide Fund Class A (NAV) ended the quarter on September 30, 2019 with a return of -2.21% versus the MSCI All Country World Index (Net)(“Index”) return of -0.03% for the same period.
Volatility accelerated in the third quarter in what proved to be a bumpy ride for global markets with major price fluctuations. In the U.S., the Fed lowered interest rates by 25 bps twice – first in July (the first rate cut since the financial crisis) and then again in September. Other central banks followed suit and have been even more aggressive with long-term interest rates falling below zero in some cases.
Quantitative easing and low interest rates have resulted in very rich valuations. All this has made it increasingly difficult to be a value investor in today’s environment. Value stocks have endured a prolonged, brutal period of underperformance lagging their growth counterparts for almost a decade. As we’ve noted, the divergence between value and growth has been particularly sharp this year.
Despite a nice rebound in September, our equities once again lagged those in the Index for the quarter and returned -4.0%. In the last 12 – 18 months, our stock performance has not been as solid as it usually is. While we believe this is temporary, it does require an explanation. Part of the discrepancy comes from value increasingly underperforming growth as discussed above. Another part of the discrepancy comes from a widely recognized situation: investors believe, perhaps rightfully so, that the longest economic cycle in the U.S. in recent financial history is nearing its end. As a result, many cyclical companies have been pummeled and unduly punished to levels similar or worse than in 2009. Our portfolio today has a much more cyclical tilt to it than in the past as this is where we have been finding true value.
By sector, Consumer Staples was the top contributor adding 0.2% led by Nestle SA. Health Care, another defensive sector, was the second largest contributor adding 0.1%. On the downside, two cyclical sectors, Financials and Industrials, detracted most from return for a total of -1.3%. Our best performance by country was Japan with a contribution of 0.2%. In fact, Japan was the only country in our portfolio to post a gain. Ireland was the worst performer by country with our one name there, Allied Irish Bank, another top ten holding, detracting -0.7%.
Allied Irish Bank (AIB) is the one stock that is hurting our performance most so far this year. When the news came out that Boris Johnson became Prime Minister in the U.K., the stock fell almost 40% the following seven weeks. We believe the market has grossly over-exaggerated the impact Brexit may have on that bank (U.K. exposure is limited to roughly 10% of AIB’s loan book), and we have taken advantage of the price decline, which we view mostly as a temporary loss. For the most part, we have avoided European banks as many of them remain undercapitalized and operate in a very fragmented and competitive marketplace. We think AIB is different. One, you have a highly consolidated market in Ireland. Second, the bank is able to charge mortgage rates that are much higher than in the rest of Europe, partly because it is not legally allowed to take fees, but partly also because the Irish market is consolidated. Third, we believe the Irish mortgage market is about to grow again as the Irish economy is in a better position than most in Europe and new residential construction is booming, leading to renewed growth in mortgage originations down the road. We believe the market misunderstands how overcapitalized the bank really is. Close to 20% of its shareholders’ equity might be deemed surplus and it is very likely that in a few months the Irish regulator will allow them to distribute its excess capital to shareholders. The stock at EUR 2.55 per share trades at roughly 60% of tangible book, offered a 6.6% dividend yield, trades at a P/E of 7x in 2018, and potentially higher if earnings normalize down due to what has been happening to the yield curve on the euro and renewed provisions for nonperforming loans.
Our fixed income names were also down this quarter and detracted -0.2%. Our exposure to high yield remains minimal and unchanged at 2.3%. Gold returned 3.6% and added 0.2% to performance for the quarter. Our total gold exposure came down from 6.2% to 5.4%. However, the underlying mix has changed as we invested in three gold mining stocks during the quarter, so we now have 3.5% in bullion and 1.9% in miners. We estimate that the sensitivity, or leverage, of these gold mining stocks to be a little less than 3:1. So basically, 1.9% in gold mining stocks might be compared to 5.7% of a supplemental allocation to gold bullion, which is actually an increased exposure over the quarter to around 9%. We like the fact that more often than not, gold is inversely correlated to stocks and bonds, providing a nice hedge in a portfolio. If a recession does hit, it is likely in our opinion that long-term interest rates in the U.S. could fall more, potentially triggering gold appreciation in what is likely to be a difficult equity market. Mutual funds have to deal with an IRS rule when it comes to investing directly in commodities, including gold. To simplify, the tax rule says that in any given fiscal year, any $1 of realized gain taken on bullion is deemed to be bad income and requires $9 of good income (dividends, interest, capital gains, FX hedging, etc.) to offset it. We would not want to see the price of gold increase precipitously and then not be in a position to reduce gold because of these arcane tax reasons. For now, we increased our overall gold exposure this quarter as policymakers appear to become more and more desperate in the face of a global economic slowdown.
Our currency hedges added 0.2% to return as the U.S. dollar strengthened against most other currencies. Our hedges remain relatively unchanged at: 40% Australian dollar, 52% British pound, 10% euro, 25% Japanese yen and 50% Korean won.
Our equity exposure came up slightly from 59.8% to 60.7% at quarter-end. We are actively looking to add to positions or find new opportunities that are non-cyclical yet trade at much lower multiples than, say, food and beverage. These recently included health care related names in Japan and software in the U.S. Additionally, we’re trying to identify misclassified or misunderstood businesses that are less cyclical. Cash exposure came down marginally from 31.8% to 31.6%.
Our analysts continue to scour the globe for value and we are excited by the opportunities we are uncovering and by the overall discounts to intrinsic values. We do not believe the extreme discrepancies in price between value and growth will last forever. The pendulum has started to swing our way and if the trend continues, we believe this will be quite beneficial to our shareholders. In the meantime, we remain patient, vigilant and focused on protecting your capital.
We appreciate your confidence and are very much grateful for your continued support.
Past performance does not guarantee future results.
The views expressed in this document reflect those of the portfolio manager(s) only through the end of the period as stated on the cover and do not necessarily represent the views of IVA or any other person in the IVA organization. Any such views are subject to change at any time based upon market or other conditions and IVA disclaims any responsibility to update such views. These views may not be relied on as investment advice and, because investment decisions for an IVA fund are based on numerous factors, may not be relied on as an indication of trading intent on behalf of any IVA fund. The securities mentioned are not necessarily holdings invested in by the portfolio manager(s) or IVA. References to specific company securities should not be construed as recommendations or investment advice.
