Dear Fellow Shareholder, April 10, 2018
Global markets were volatile during the first quarter of 2018. Markets rose in January on the back of tax reform, synchronized global growth and consumer spending. By February, U.S. stock indices experienced the largest decline since August 2011. Investors were concerned that rising inflation would force interest rates higher, and erode profitability for companies already trading at elevated valuations. Fiscal tightening was signaled by the European Central Bank and Bank of Japan, leading to similar company-level worries. In March, trade wars between the U.S. and China shifted sentiment. Amid these geopolitical risks, the Polaris Global Value Fund returned -2.49% for the quarter, lagging the MSCI World Index, which dropped -1.28%. The Fund continues to experience the headwinds of growth stocks outperforming value stocks although there are signs this is reversing.
Gains in financials, information technology (IT), utilities and energy were offset by losses attributable to consumer-driven sectors. Puerto Rican bank Popular Inc. showed resilience in the wake of Hurricanes Irma and Maria. U.S. banks, Ameris Bancorp and Colony Bankcorp, announced good results, with new loan originations, more deposits and improved asset quality. Nexon Co., Ltd, Infosys Ltd. and Microsoft Corp. were standouts in IT. Marathon Petroleum Corp. noted improving gross refining margins on the back of robust U.S. fuel demand. Detractors included select consumer staples stocks, U.K. homebuilders and U.S. clothing/fashion retailers.
Although lagging the benchmark this quarter, the Fund continued to outperform over all periods longer than one year, as indicated below, and was a recent recipient of two 2018 Thomson Reuters Lipper Fund Awards. The Polaris Global Value Fund posted the strongest trend of returns in the global multi-cap value fund category for the 5- and 10-year periods through November 30, 2017. In the Lipper Universe, a total of 58 funds over a five-year period, and 37 funds over a 10-year period, were eligible for this category distinction. The Fund has been recognized with Lipper Awards many times in the past, including 2014, 2015, 2016 and 2017.
Japanese video game company, Nexon (TSE:3659, Financial), rose more than 13% after posting its highest-ever quarterly sales, leading to good year-end results. Nexon upped its sales and operating profit forecast for the first quarter of 2018, as the company expects high margin business from its widely-popular Chinese game, Dungeon & Fighter. Nexon also improved the monetization of its subscriber base. IT consulting company, Infosys, continued its turnaround by posting stable quarterly earnings under the watchful eye of new CEO Salil Parekh. Infosys’ employee utilization increased to an all-time high of 84.9%, and attrition rates decreased as Mr. Parekh promoted professionals internally. SK Hynix Inc. benefitted from supply/demand dynamics in the DRAM market. The South Korean memory semiconductor supplier raised prices over the last few quarters; the favorable pricing trend continues unabated. We continue to watch trends in this cyclical and fast moving sector.
Microsoft Corp. (MSFT, Financial) also boosted IT sector gains. Commercial cloud offerings fueled growth, as Microsoft posted greater revenues and operating income. The company’s various platforms, including Azure, LinkedIn, Microsoft 365 and Dynamics 365, are also advancing. Strategic initiatives were broadcast at quarter end, as Microsoft sought to unify its artificial intelligence and core Windows into one team; a similar combination was expected between product and office business solutions. Japanese online social networking company, Mixi Inc., and U.S.-based Web.com Group Inc. were the only notable sector detractors. Mixi (TSE:2121, Financial)’s net sales and operating income declined on a quarterly and yearly basis, with fewer growth drivers in play. Sales of flagship game, Monster Strike, were lackluster and the Ticket Camp business was closed after the government effectively outlawed secondary ticket sales. Web.com Group (WEB, Financial) noted solid fiscal year results in line with expectations; however, this news was muted by ongoing subscriber losses in the retail segment yet to be offset by full-suite solution sales to corporate accounts.
Puerto Rico continued to navigate through the hurricane aftermath, restoring power to nearly 70% of residents. Monetary stimulus, in the form of Federal aid and insurance proceeds, also helped the Commonwealth. In this environment, Popular Inc. delivered upbeat quarterly results. Consumer loans picked up on the back of auto demand (some replacement from the hurricanes) and provisions were halved from the third quarter of 2017. Popular acquired Wells Fargo’s auto finance business in Puerto Rico for $1.7 billion, procuring a high-yielding portfolio with modest credit quality risk. With an improving net interest margin, dominant market position, heavy presence in auto trade and a strong capital base, the bank should be able to handle ongoing territory challenges.
With a foothold in the thriving Singapore economy, United Overseas Bank (UOB) (SGX:U11, Financial) recorded impressive fourth quarter results. The bank cited higher profits than last year, pointing to increased mortgage pricing, greater fee-based income and fewer non-performing loan provisions. Many analysts took note, upgrading UOB due to a better operating environment. Shares of Bancolombia SA rose during the quarter, as the Peso appreciated against the U.S. dollar, hitting its strongest level versus the greenback since November 2015. Bancolombia (CIB, Financial) also noted a number of cost savings, ranging from tailoring back loan loss provisions in its Panama-based banks, reducing bonus expenses and lowering taxes. Hannover Re declared solid earnings, with premium volumes and prices surpassing previous year metrics. The German reinsurer had limited exposure to catastrophe claims from the spate of hurricanes in the Caribbean and U.S. The stock was up more than 8%, as the street speculated about issuance of a special dividend in 2018. Fellow reinsurer Munich Re reported earnings that bested guidance, but were generally unremarkable. True recovery may depend on Munich Re’s execution of restructuring plans. Russia’s largest bank, Sberbank, had a strong quarter with solid revenues, strong net interest margins, lower loan loss provisions and an improving efficiency ratio. Backed by a healthy balance sheet, Sberbank may issue a substantial dividend payout in 2018.
In the U.S., Ameris Bancorp (ABCB, Financial) announced good results, with 20% organic loan growth, greater deposit base and improved asset quality. Ameris’ acquisition of Hamilton State Bancshares also met with investor approval, as this deal will enlarge Ameris’ footprint in Atlanta. Colony Bankcorp (CBAN, Financial)’s earnings were impacted by the one-time write down of deferred assets, per the newly-enacted Tax Reform Act. Excluding the one-time tax adjustment, earnings were 33% higher than the prior year, boosted by increased net interest income/noninterest income and a reduction in loan loss provisions. Although Colony (along with numerous other banking institutions) was impacted this quarter by the one-time expense, the lower tax rate may be positive for future earnings. The stock rose more than 15% during the quarter. Conversely, Franklin Resources declined after declaring a special dividend that failed to impress the market. At $3.00 per share, this was a 10% yield payout on a dividend basis; however Franklin could have realistically paid 3x to 4x that amount. Speculation was rampant as to why the financial services firm didn’t execute a more robust payout.
In industrials, General Dynamics’ (GD) earnings call highlighted backlog in its defense business and strong order intake from Gulfstream. These were critical metrics showing accelerated industry demand after nearly two years of stagnant sales/orders. During the quarter, GD announced the acquisition of IT contractor CSRA for $9.7 billion. According to big data analytics firm Govini, the post-merger combination of GD and CSRA will supplant market leader Leidos as the U.S. government’s largest IT provider. Conversely, Loomis AB sold off as investors overlooked its excellent results in the U.S. (7% sales growth and improving margins) and focused on the 0.8% decline in European margins. Declining European and international sales were mainly due to the end of the note/coin exchange program in Sweden and competition in France. In energy, U.S. oil refiner Marathon Petroleum improved gross refining margins, due in part to rampant U.S. fuel demand, buoyant exports and planned maintenance shutdowns of competitor refineries. The company also completed the dropdown of refining logistics assets and fuel distribution services to its general partner, MPLX, in exchange for $8.1 billion.
Shares of Japanese beer brewer Asahi Group Holdings were up after the company released 2017 numbers that showed healthy operating profit. The company noted strong volumes in Europe and good headway in the domestic market, as consumers adjusted to price hikes. In contrast, Irish convenience food producer, Greencore Group (LSE:GNC), plunged during the quarter. Although the company’s fourth quarter 2017 sales grew in both the U.K. and U.S., concerns arose about the U.S. business. Greencore was unable to cultivate new U.S. customer relationships, as evidenced by single-digit volume growth and underutilized facilities in Rhode Island. The company plans to restructure its U.S. network to match capacity to its commercial pipeline. Due to the delayed timing of this rationalization, Greencore expects U.S. profits to remain stagnant for the first half of 2018. Tyson Foods reported strong year end results. However, cost burdens impacted labor and logistics, as a shortage of truck drivers pushed freight rates higher. Until Tyson passes these costs through by raising prices, the stock might be pressured.
In consumer discretionary, L Brands, owner of Victoria’s Secret (VS) and Bath and Body Works, noted positive year-on-year comparable sales growth. Yet gross margins at their brick-and-mortar VS stores were lower than expected due to product mix and promotional activity. Carter’s Inc. was up almost 40% in 2017 on the back of huge sales increases. The company promised to share the benefits from tax cuts with employees, authorized a $500 million share repurchase program and upped its quarterly dividend by 22%. Yet, the stock fell after the company’s 2018 profit guidance fell short of market estimates. U.K. homebuilders, Bellway and Taylor Wimpey, dropped during the quarter, although all indications were positive. Recent trading updates alluded to higher revenues/volumes, attractive average selling prices and new land plots under contract. Declines were likely due to profit taking, after homebuilder stock prices rose markedly in recent quarters.
Teva Pharmaceutical (TEVA) continued to face headwinds, with sluggish generic product introductions and pricing pressures. With a new CEO at the helm, Teva launched a comprehensive restructuring plan to shore up its balance sheet. The company enacted layoffs and plant closures, optimized its generics portfolio and reviewed of its R&D and drug pipeline. Consistent with this agenda, Teva announced the termination of its CGRP migraine drug discovery and development pact with Sosei. The company also renegotiated some of its debt at much higher interest rates than previous. Neither of these actions was well received by the market. German telecom reseller Freenet AG reported mid-single digit increases in both sales and profitability within its TV and media business. Average revenue-per-subscriber was stable in its core mobile communication business, which added subscribers at the margin. Yet, analysts were skeptical about the momentum of the core mobile business, due to longer handset life cycles and lower market churn. The stock trended down nearly 18% during the quarter.
Investment Environment and Strategy
Positive momentum continues in nearly all global economies, both developed and emerging. Recent company meetings echoed this drive, pointing to good business demand, inventory restocking and new purchasing trends. Raw material/commodity prices are rising, and supply-demand metrics are proving favorable, especially in electronics and tech components. As a result, select IT companies remain on our radar, as do financial, consumer discretionary and industrial sector stocks. Generally speaking, we already have a healthy weighting in many of these named sectors or applicable sub-sectors; therefore, we may seek to replace current portfolio holdings with more attractively-valued companies at opportune periods. Regardless of sector, the majority of undervalued, but fundamentally strong, companies remain centralized in Asia (China, Japan, Korea, Taiwan) and the U.S. We benefit from a globally diverse analyst team, all of whom conduct on-the-ground research, meet with companies/competitors, visit manufacturing plants, and carefully analyze prospective companies using local and global accounting standards. We continue to believe in the merits of this bottom-up investment philosophy, and strive to improve the valuation and risk profile of the Fund.
Sincerely,
Bernard R. Horn, Jr., Shareholder and Portfolio Manager
The Fund invests in securities of foreign issuers, including issuers located in countries with emerging capital markets. Investments in such securities entail certain risks not associated with investments in domestic securities, such as volatility of currency exchange rates, and in some cases, political and economic instability and relatively illiquid markets. Options trading involve risk and are not suitable for all investors. Fund performance includes reinvestment of dividends and capital gains. During the period, some of the Fund’s fees were waived or expenses reimbursed. In the absence of these waivers and reimbursements, performance figures would be lower.
On June 1, 1998, a limited partnership managed by the adviser reorganized into the Fund. The predecessor limited partnership maintained an investment objective and investment policies that were, in all material respects, equivalent to those of the Fund. The Fund’s performance for the periods before June 1, 1998 is that of the limited partnership and includes the expenses of the limited partnership. If the limited partnership’s performance had been readjusted to reflect the second year expenses of the Fund, the Fund’s performance for all the periods would have been lower. The limited partnership was not registered under the Investment Company Act of 1940 and was not subject to certain investment limitations, diversification requirements, and other restrictions imposed by the 1940 Act and the Internal Revenue Code, which, if applicable, may have adversely affected its performance.
Past performance is no guarantee of future results. The Thomson Reuters Lipper Fund Awards are based on the Lipper Leader for Consistent Return rating, which is a risk-adjusted performance measure calculated over 36, 60 and 120 months. The fund with the highest Lipper Leader for Consistent Return value in each eligible classification wins the Lipper Fund Award. Lipper scores for Consistent Return reflect funds' historical risk-adjusted returns relative to funds in the same Lipper classification and include each fund's expenses and reinvested distributions, but exclude sales charges. Consistent Return values are calculated with all eligible share classes for each eligible classification. Thomson Reuters Lipper is a global provider of mutual fund information and analysis to fund companies, financial intermediaries and media. Additional information is available at www.lipperweb.com.
