Bernard Horn's Polaris Global Value Fund 2020 Annual Report

Discussion of markets and holdings

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Sydnee Gatewood
Mar 05, 2021
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Dear Fellow Shareholder,

No one could have expected 2020 to be the year of a pandemic, replete with country lockdowns, rising unemployment, trade wars, political turmoil and volatile oil prices. Yet, each of these developments rippled through the global economy, with investor optimism souring as the first effects of COVID-19 took hold. Governments and central banks initiated unprecedented monetary and fiscal policies, hoping to boost industries hardest hit. Still, many companies cratered in the first quarter of 2020, falling into bear market territory, only to begin their slow climb out of the trough in the second quarter. The third and fourth quarters heated up. For the year ending 2020, the MSCI World Index (the "benchmark") rose 15.90%, while the Polaris Global Value Fund (the "Fund") was up 6.68%. Underperformance was attributable to lackluster results in the overweight financial sector, as well as notable losses in energy, consumer staples and industrials. At the country level, the portfolio outperformed in Canada, France, Finland, Belgium, Norway and Austria; yet these modest weightings did little to absorb the underperformance and underweight in a robust U.S. market. While full year performance was underwhelming, we are pleased to have markedly outperformed in the fourth quarter; we believe that the Fund is well positioned for the fits and spurts of a 2021 recovery.

We would be remiss in not mentioning that 2020 was one of the worst years in history for value stocks, as world markets were driven by high flyer stocks and FAANGs (Facebook, Amazon, Apple, Netflix and Google), shunning the fundamentally strong but less glamorous sectors like materials, industrials and financials. In this context, the Fund outperformed the MSCI World Value Index, which was down -1.16%.


At the beginning of the COVID -19 crisis, we conducted an intensive research effort, selling richly valued companies and raising cash in anticipation of a market downturn. We sold Wesco International (

WCC, Financial), Infosys (INFY, Financial), Hewlett Packard (HPE, Financial), L Brands (LB, Financial), JM Smucker (SJM, Financial), Kone OYJ (OHEL:KNEBV, Financial) and a number of other companies on valuation, making space for more than two dozen buys. Some of the cash was redeployed starting in late March to invest in higher quality companies with more upside potential. Immense volatility brought the likes of Crocs Inc. (CROX, Financial), Antofagasta (LSE:ANTO, Financial), Bunzl (LSE:BNZL) and Laboratory Corp. of America (LH, Financial) into the "value" price range.

Many of the new purchases were centered in the consumer discretionary sector, including CROCS, Tapestry (TPR), Zhongsheng Group Holdings (HKSE:00881), Dometic Group (OSTO:DOM) and Darden Restaurants (DRI). Crocs was one of the biggest contributors to overall portfolio performance, up more than 100% as management indicated a faster than anticipated recovery in certain regional stores, with record U.S. sales revenues stemming from Crocs' direct-to-consumer (digital) platform. The footwear company also outlined its COVID-19 safety efforts at distribution centers, while shoring up balance sheets and reducing capital expenditures in the near term. Tapestry Inc. (the parent company for Coach, Kate Spade and Stuart Weitzman brands) increased revenue, expanded gross margins, and accelerated e-commerce sales. Zhongsheng Group, one of the largest Chinese car dealerships, cited great secular tailwinds in luxury car sales, aftermarket products and dealer services. Darden Restaurants, the parent of Capital Grille, Olive Garden and Longhorn Steakhouse restaurant chains, noted positive sales trends in its takeout/ delivery service and slowly began re-opening brick-and-mortar sites with much success. Climate control and convenience products maker for recreational vehicles (RVs), Dometic Group, capitalized on the RV travel craze as consumers sought vacation alternatives. Dometic's aftermarket sales held up well, while its cost cutting and efficiency measures improved margins. In the third quarter of 2020, Dometic and Darden were sold at a healthy profit, as each reached Polaris' valuation limits. U.K. homebuilders detracted from sector gains. Taylor Wimpey PLC (LSE:TW.) and Bellway PLC (LSE:BWY) went into the crisis in great shape, with good control of inventory, build rates, selling prices and financing. The subsequent U.K. lockdown shut down construction sites, with the homebuilders announcing fewer completions due to COVID-19 distancing restrictions. This short-term headwind is expected to reverse course in the second half of 2021; in fact, homebuilders were already showing upward momentum as of the fourth quarter 2020.

Most of materials sector holdings were in positive territory, led by new portfolio additions, Antofagasta PLC and HeidelbergCement AG (XTER:HEI). Favorable supply-demand metrics boosted Antofagasta, a leading Chilean copper and gold miner. Demand for cement remained relatively stable, per Germany supplier, HeidelbergCement. Canadian methanol producer, Methanex (TSX:MX), posted steady gains as methanol prices recovered from second quarter 2020 lows. The company referenced improving methanol demand within Europe and Asia, specifically in China. The fundamentals (resumption of building in China, increased industrial demand) underscoring the rise in commodity prices may translate into strong performance in other material sector companies in a post COVID-19 world; therefore, the Fund maintains an overweight position in materials.

In information technology, Samsung Electronics (XKRX:005930) and SK Hynix (XKRX:000660) both logged 30%+ annual returns as DRAM chip prices trended higher. A replacement cycle in data servers, Chinese inventory rebuilding and a recent Micron (MU) fab disruption were the primary drivers for this chip price projection. Additionally, SK Hynix's purchase of Intel's NAND business may bring better supply discipline, taking one competitor out of the industry. In other news, Samsung cited its television division as a strong revenue generator due to stay-at-home mandates. Plans to scrap its QLED/LCD televisions have been backburnered while Samsung capitalizes on demand. Arrow Electronics (ARW), a recent addition to the portfolio, added to gains as the company capitalized on demand trends in Asia.

With inklings of a COVID-19 crisis unfolding in the months of December 2019 and January 2020, we identified medical testing companies as critical in diagnosing potential spread of the virus. We added to our long-standing investment, Quest Diagnostics (DGX), and purchased Laboratory Corp of America, Germany's Fresenius SE (XTER:FRE) (supply chain of essential drugs and mask purification methods) and Alexion Pharmaceuticals (ALXN). All of the new buys were up more than 25% for the year.

Industrial sector returns formed into a barbell, with three 2020 purchases, Bunzl PLC, Ryanair Holdings (RYAAY) and Valmet OYJ (OHEL:VALMT) up in excess of 40%, while Babcock International (LSE:BAB) and Trevi Finanziaria (MIL:TFI) detracted. Bunzl reinstated dividends after reporting higher pre-tax profits in the first half of 2020, as its grocery and cleaning/safety divisions rose. The company also announced two acquisitions. Irish low-cost airline, Ryanair Holdings PLC, dropped precipitously as travel halted at the beginning of the pandemic; Polaris snapped up this cash-flow heavy company on the expectation of participating in a rebound. Polaris subsequently sold the company's stock after a healthy gain. Trevi, the Italian engineering and foundation driller, underwent a complete financial and operational restructuring. The stock jumped more than 150% in the second quarter as one of the Fund's top performers, but relinquished some of this gain in the third quarter. Trevi may face some near-term headwinds, as governmental infrastructure spending is postponed in deference to immediate COVID-19 related needs of citizens. Babcock International, the U.K. engineering services firm that supports local defense, emergency services and civil nuclear sectors, noted declining profits due to new distancing requirements on ship repair worksites. The stock price slipped further after Babcock announced the end of its long-term contract with Britain's Nuclear Decommissioning Authority.

With a large overweight and modest underperformance, financials detracted most from returns during the year. Substantial flows into the safest debt instruments drove interest rates, from Treasury bills to 30-year government bonds, to less than 1% on March 9, 2020. In an effort to coordinate central bank rates with these extreme market rates, the U.S. Federal Reserve cut interest rates to essentially zero and launched a purchase program, buying Treasuries and mortgage-backed securities whose prices were subject to potential drops in value. Bank stocks declined sharply on expectations of lower interest margins and higher credit losses due to higher unemployment and companies likely entering financial distress. By July and August, financials recovered modestly, with September bringing another dip on increased COVID-19 cases. Many banks encountered lower net interest margins and slower loan growth, while concerns swirled about stimulus running dry, raising the risk of defaults. To counteract these issues, banks set aside large reserves and capital to absorb potential losses; many had the highest capital ratios and loan loss reserves in more than 20 years.

By the fourth quarter, U.S. banks gained on news of vaccine approvals and renewed government stimulus, staving off concerns about loan losses and bankruptcies. Several banks reduced loan loss provisions and reported fewer loan deferral balances and non-performing loans, propping up Webster Financial (WBS), Ameris Bancorp (ABCB) and Puerto Rico-based Popular Inc (BPOP). The Federal Reserve also completed its 2020 bank stress testing, indicating banks were sufficiently capitalized; this may signal the resumption of capital return policies and buybacks for larger U.S. institutions like Capital One Financial (COF) and JPMorgan Chase (JPM). Nordic banks, including DNB ASA (OSL:DNB) and Svenska Handelsbanken (OSTO:SHBA), performed well as local regulators decided to soften their dividend payouts stance. Bancolombia (CIB) recovered most of 2020's lost ground with a sharp gain in December on the back of a Moody's rating affirmation and a stronger Colombian peso. Overall, it was gratifying to see the recovery in financials, as we remained resolute in our financial models and analysis, even as the banks tumbled earlier in 2020 amid emotional investor selling.

Few industries were more impacted by COVID-19 than travel and leisure, from airlines and hotels to restaurants and entertainment venues. Cineworld Group (LSE:CINE) was down 30% in October as it shuttered all of its theaters in the U.S. and U.K. By December, Cineworld's stock partially recouped declines, gaining 68%, as the company refinanced debt with 10% dilution to shareholders. While streaming platforms are now popular by default, we believe consumers will embrace the theatrical experience when lockdowns are lifted as has been the case in countries like China and Japan.

The following table shows the Fund's asset allocation at December 31, 2020.


We recognize that we are not "out of the woods" yet with the COVID-19 pandemic, as the next waves and strains of the virus cause country lockdowns. So far in 2021, we have already seen a moratorium on social activities in the U.K. until mid-February; Canada is hinting at stronger enforcement measures; France instituted a 12-hour curfew; and Germany posted harder restrictions across all 16 federal states. The U.S. isn't far behind, with many states mandating stay-at-home orders. Yet, we don't believe that any lockdown scenario will have the same gravity as it did in the first quarter of last year. Vaccines are in distribution, global citizens have dealt with the virus for nearly a year and most public companies learned to adapt to the new working condition, focusing on e-commerce and operational restructuring. When economies turn the corner, many highly-efficient businesses will be positioned for impressive growth. We are making every effort to build a Fund portfolio of these types of companies; we expect admirable performance (like that of the fourth quarter 2020) to follow.

We express our heartfelt sympathy for the many people who have suffered and/or succumbed to the COVID-19 virus. We recognize and give high praise to the many health care professionals and other essential workers worldwide across many industries, who made heroic efforts to save other people's lives.

As always, we welcome your questions and comments.


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. These risks are greater for emerging markets. Options trading involves risk and is 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.

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I am the editorial director at GuruFocus. I have a BA in journalism and a MA in mass communications from Texas Tech University. I have lived in Texas most of my life, but also have roots in New Mexico and Colorado. Follow me on Twitter! @gurusydneerg