Global equity markets made solid, but halting progress in local currency in the second quarter in the face of slowing global growth, escalating trade tensions, political upheaval in Italy, rising concerns about Brexit, and continued monetary tightening. As we write, the developed markets have largely clawed their way back from the losses experienced in the turbulence of late January and early February. The US dollar also strengthened against all major currencies during the quarter, putting added pressure on unhedged international equity and emerging market returns. With the exception of the Global Value Fund II, whose currency exposure is unhedged, we made financial progress in our other three Funds. Ironically, Global Value Fund II, which produced a modestly negative return during the quarter (-0.64%), was our best relative performer, besting its benchmark by 60 basis points.
Our flagship Global Value Fund was aided by its currency hedging policy during the quarter, which helped to protect the good local currency returns earned by the Fund’s international holdings. While it trailed its hedged benchmark, it produced a positive return of 2.40%, which was 364 basis points better than the MSCI EAFE Index in US dollars (-1.24%).
Returns for the quarter were led by strong results in the oil & gas and industrial segments of the Funds’ portfolios. This included robust returns in the Funds’ two fully integrated oil companies (Total and Royal Dutch) as well as in their exploration & production companies (Devon and Conoco) and oil service companies (Halliburton and MRC). In the industrial segment, aerospace company Safran continued to advance, as did the UK-based security company, G4S, and Teleperformance, the French customer servicing and employee outsourcing company. The Funds’ portfolios also benefitted from solid returns in consumer products companies such as Nestle, Diageo and Unilever, and from their internet-related investments, Alphabet and Baidu. In addition, media investments WPP and the Daily Mail were up nicely, as was Antofagasta, the sole mining investment in the Funds’ portfolios.
While many of the Funds’ holdings finished in the black for the quarter, there were also a number of holdings that finished in the red, including the Funds’ Korean auto holdings, Hyundai Motor and Hyundai Mobis. The share prices of these companies suffered when management shelved a group-wide restructuring of the Chung family ownership structure. Despite the short-term excitement that had been created by this plan, we believe it was detrimental to minority shareholders like the Funds, and that its postponement may open the door to fairer and more favorable moves in the future — which we believe, over time, should provide support to the share price. These auto holdings are also suffering from the prospect of a 25% tariff in the US, which would likely have extremely negative consequences for Korean, European, and most Japanese manufacturers. Our view is that sustained 25% tariffs are unlikely and probably impractical, and that an arrangement will be found that creates a fairer competitive landscape for all manufacturers, US and foreign alike. In the meantime, we believe the Hyundai group remains attractively valued and is doing all the right things by strengthening its product range, from SUVs to electrical cars, and by initiating a more sustained dialogue with investors. Decliners for the quarter also included Warren Buffett (Trades, Portfolio)’s Berkshire Hathaway, Axel Springer, Henkel, 3M, Ebara, Johnson & Johnson and Novartis, among others. The pharmaceutical sector continues to be buffeted by President Trump’s continued calls for lower drug prices, and hiccups in drug pipelines.
While President Trump continued to apply pressure on the Saudis and OPEC to increase oil production, oil prices (Brent crude) climbed into the mid to high seventies during the quarter, jumping up in late June when OPEC decided to boost output somewhat less than anticipated by market participants. This contributed in part, together with continued strong demand for oil and the possibility of supply disruption (Iran and Venezuela), to the strong results in our Funds’ oil & gas related holdings. As we write, oil prices have become somewhat more volatile, buffeted by the President’s repeated calls for lower prices and growing concerns about possible increases in near-term supply. While the share prices of energy related companies are likely to remain quite volatile in this environment, we believe that continued strong demand for oil, together with more disciplined capital allocation by oil companies, and the possibility of supply disruption, should provide ongoing support for oil prices over the longer term.
In terms of portfolio activity during the quarter, newly established positions included Hankook Tire Worldwide, a holding company that has a controlling interest among other investments in Hankook Tire, and the French flooring company, Tarkett. Hankook Tire, by far the largest tire company in Korea, has become a cost leader in its sector by patiently assembling an optimized worldwide manufacturing footprint, investing in product development, and developing a visible distribution and retailing network in key geographies. By purchasing holding company Hankook Tire Worldwide’s shares, we were able to essentially buy Hankook Tire in the Funds’ portfolios at a significant discount from our conservative estimate of its underlying intrinsic value. Tarkett (XPAR:TKTT, Financial), which is owned and controlled by the Deconinck family, is a global flooring company based in France. It designs, manufactures and distributes carpet and vinyl for commercial and residential use. While its business is somewhat economically cyclical, 80% of Tarkett’s end demand is driven by renovation and just 20% by new construction. In our view, Tarkett has a good, cash generative business that has consistently earned 20% returns on tangible invested capital. At purchase, it was trading at roughly 8 times normalized EBITA (earnings before interest taxes and amortization) and had approximately a 9% owner’s earnings yield (net operating profit after tax). In addition, it has paid a dividend yield of approximately 2.3%, and the founding family recently purchased a small amount of company shares at higher prices. We sold our remaining shares of long time holdings, Richemont, the Swiss luxury retailer; Daetwyler, the Swiss industrial company; Nitto Kogyo, the Japanese switchboard component company; and Siegfried, the Swiss pharmaceutical ingredients company. All four of these companies produced substantial gains over the years for the Global Value Fund and had reached our estimates of intrinsic value. In addition to these purchases and sales, we also took advantage of trading opportunities to add to and trim a number of other positions in our Fund portfolios.
Year-to-date and in contrast to 2017, it has been an up and down year for most global equity markets (in local currencies). As a group, they have for the most part treaded water, held back somewhat by high valuations, rising interest rates, escalating trade tensions, and a host of other macroeconomic worries. These concerns together with a strengthening US dollar, have presented significant challenges for emerging markets. While valuations on the whole remain elevated, we have been encouraged by the pickup in market volatility since late January, which has produced a number of bargain opportunities for our Fund portfolios such as WPP, Inchcape (the UK based auto distributor), Hankook Tire Worldwide, and Tarkett, as well as a number other ideas under current consideration.
Thank you for investing with us and for your continued confidence.
Tweedy, Browne Company LLC
William H. Browne
Thomas H. Shrager
John D. Spears
Robert Q. Wyckoff, Jr.
Managing Directors
Dated: July 2018
