Dear investor,
Firstly, on behalf of the BESTINVER team, I would like to thank you for your continued trust.
During the first quarter of 2018, we have been witness of the signs that volatility has returned to the markets. We would like to tell you how our portfolios were prepared for that return, as well as to share what our reaction has been as a consequence.
“Be Fearful When Others Are Greedy and Greedy When Others Are Fearful”. That quote from Warren Buffett (Trades, Portfolio) is undoubtedly one of the best pieces of advice for any investor. 2018 is proving to be a complex year for value investors. High quality companies undoubtedly have very well-adjusted valuations, whilst very attractive companies from a valuation perspective have insufficient quality in many cases. For this reason, in 2018, being greedy for us means being prudent and patient.
The market suffered significant fluctuations during the first few months of the year. The Dow Jones index suffered the greatest point fall in its history, dropping by more than 1,100 points. After months of inertia, its volatility soared by 116% in just one session, leading to the liquidation of derivative products and, as a result, significant losses for the institutional portfolios holding those exposures. The bet made by those portfolios was very risky: that calmness and complacency would continue in the markets over the short term.
Nevertheless, the effect of those and subsequent market decreases on our portfolios has been very limited. As you know, at BESTINVER, we do not place bets nor do we put all of our eggs in one basket with complex products. For us, the key is to look for the best returns over the long term by managing the risk appropriately. Our philosophy has not changed and we are continuing to do what we have always done: find good businesses at good prices.
How do we deal with these events?
In our letters in the past, we have shared our opinion about the importance of being prepared in the face of adverse events and/or when tension returns to the markets. In the end, during the first few months of this year, we saw a major correction in the market. This correction, which is reasonably unusual, served to remind us that whilst investing in equities over the long term can be tremendously profitable, it is not an activity that is exempt from complications in the short term. It is here that the management of portfolio risk and the patience of investors become key pieces in the puzzle.
At BESTINVER, we are convinced that there are three essential conditions for maintaining resolve in less favourable environments:
- Firstly, we do not assume risks that we are not familiar with. Quoting W. Buffett again, “Risk comes from not knowing what you are doing”. We avoid assuming unknown risks that could lead to permanent negative results, and we focus on the circle of competence of our team of analysts who have extensive experience.
- Secondly, not assuming unnecessary risks or excessively concentrated positions on few stocks in a specific sector. This way, we diversify the assets of the portfolio, keeping 34% in companies in the industrial sector, where the spectrum of opportunities and sub sectors is very broad. This sector is followed by that of retail, where we have close to 30% of our assets invested. Finally, we invest 15% in the financial sector and 11% in technology and media.
- Thirdly, we build robust portfolios. Our shopping list is always ready; we know what companies we like and the price at which they offer value. But more importantly, we have a strong preference to avoid badly managed businesses or those with excessive debt which exposes us to suffer significant permanent losses of capital.
For us, these three conditions can only materialize from the detailed and constant study on the part of an investment and analysis team as varied and as experienced as we have at BESTINVER. Capacities that allow us to get to know the business very well and measure the risks we are ready to assume.
What are we doing with our portfolios?
In these first months of the year, we have tried to associate market movements to opportunities to find undervalued companies and strengthen our portfolio. This way, we have bought companies where we have seen great potential after being unfairly penalised, and on the other hand, we have sold the companies that have reached our target price, providing us with significant capital gains along the way.
Thanks to the success factors mentioned previously, and the management and rotation of different positions, the three-year return of the international portfolio exceeds the European index by more than 13% and the five-year return by more than 24%. While short-term results are poor indicators and do not reflect a solid image of long-term performance, in this quarter we have tried to mitigate market disruptions, and the performance of the international portfolio has been -3.3%, while the reference index has fallen a further point (-4.3%).
As a result of recent events and portfolio movements, we highlight two key aspects of our management:
- Sales of stocks with strong gains that have limited their upside potential.
The Finance Director of one of the companies in the portfolio has called us periodically over recent years to see if we were interested in selling him a tranche of shares for its treasury stock. In February, we contacted him because we wanted to sell the position and we discovered that he was no longer interested in buying. Therefore, we had to find a buyer in the market, but for us this was another signal that indicated that we had made the right decision in selling the position.
The movements of a company or its directors with their shares provide us with important clues for our analysis. For example, in 2017, the management teams of most British property developers sold most of their shares, showing a very clear negative signal. It is not a good sign when those immersed in the day-to-day of the business cash out. And vice-versa.
Among the sales of the quarter, we took advantage of the strong start of the year in raw materials to sell our shares in mining companies BHP and Rio Tinto, which constituted 5% of the portfolio and assume positions with much greater potential, such as FLSmidth, a supplier of the raw materials sector.
We have also reduced our exposure to retail companies in Brazil, most of them controlled by the French company Casino. Our investment in these companies came from the attractive valuations, but at current prices the discount has disappeared and we do not want to bet on the future performance of Brazilian retail. For example, we have completed the sale of the Brazilian company Via Varejo at 28, which we bought at 10.
We have also reduced our position in companies that have been subject to corporate movements. For example, the British company GKN (LSE:GKN, Financial), reached record highs after a purchase offer from Melrose. Our analysis indicated that only the sum of the aerospace and car industry businesses alone offered a very high revaluation potential. Others in the market have now discovered this value.
- Differentiate winners from losers
During the first quarter, it has become evident the importance of analysing each business model well and differentiating winners from losers. For example, the financial sector has contributed to our portfolios in an essential way, thanks to positions such as Standard Chartered, and not having companies that would have represented an unnecessary risk, such as Deutsche Bank. We have also bought ING again, taking advantage of the fact that the market had gone on to look for banks that would benefit most from a rise in interest rates.
In terms of internet companies, we remain positive on food delivery companies, a very attractive sector where we expect consolidation. In the portfolio we currently have Grubhub, Delivery Hero and JustEat, where we remain positive despite recent falls in light of very specific negative news concerning their results.
Within the Iberian portfolio, we took advantage of the perfect storm experienced by Siemens Gamesa to take positions in the company. We also added Telepizza, where we believe the market has not appreciated the value of the agreement reached with Yum Brands.
Finally, we have also invested in ACS (XMAD:ACS, Financial). In the middle of the operation to take control of Abertis, we thought that the market was putting a price on the destruction of value, when the negotiation with Atlantia was already well advanced, which didn’t correspond to the reality. This operation has worked very well since the acquisition.
What will we continue doing?
While many investors are concerned about the return of volatility in the short term and they reduce their exposure to the market, at BESTINVER we continue looking confidently towards the future, and are convinced that we can achieve just as good results over the long term as we have in the past.
Faced with market turmoil, we remain steadfast in our work which, from afar, may seem boring, but it’s something we’re passionate about: analysis, analysis and analysis. Finding good companies, setting the target price and waiting for the market to offer opportunities to buy and sell.
For us, your long-term commitment is essential. This allows us to invest the way we do and obtain the returns we obtain.
Thank you for your continued trust in BESTINVER.
Beltrán de la Lastra
Presidente y Director de Inversiones
BESTINVER
