Dear investor,
First and foremost, I would like to thank you on behalf of the Bestinver team for the trust you place in us.
Allow me to start this letter with a summary of 2018 to date, which, as you will remember, began with a rise in the volatility that we had been talking about, and which continued in a more intermittent way over the subsequent months. At the end of the third quarter, the return on the international portfolio is -2.5% and on the Iberian portfolio is 2.11%. Given the noise in the market, the key to investing is to have a long-term perspective, a vision of time that allows us to avoid taking erroneous decisions in the short term. Our international portfolio has accumulated a return of 25% over 3 years and of 55% over 5 years, compared with the European market’s performance of 13% and 45%, respectively.
To achieve these figures, it is crucial that we focus on the analysis and leave our emotions to one side, both in terms of trends, and irrational fears. We are following our own path, with determination, and full conviction in our philosophy, which means that we have a very different portfolio from those of the benchmark indices. That is reflected in the active share index, which in the case of our international portfolio amounts to 92% (the closer to 100%, the more different a given portfolio is from the index portfolio). We know where we want to be and how to get there, and we will not be thrown off course during our journey together with you.
Separating the wheat from the chaff
During 2018, we have read lots of headlines that have thrown up a plethora of sources of uncertainty: the escalating tension regarding the nuclear threat; the trade war between the USA and China; the trade war between the USA and its neighbours, Mexico and Canada (which has been resolved in the last few weeks); the re-appearance of populist policies in Europe, with the new government in Italy; and the crises being experienced in emerging countries such as Turkey, Argentina and Brazil.
At Bestinver, we do not take it upon ourselves to predict the next geopolitical surprise, but we do seek to differentiate the fleeting from the pivotal, the superfluous from what really could cause a permanent loss of capital. Reducing that risk is the basic rule that underlies the basis of long-term performance. With this conviction, we place all of our sense and dedication into building solid and robust portfolios.
In our opinion, the most important factor at play in 2018 is what is happening with interest rates in the USA, which represents a very important change for investments. For a whole decade, the value of money in that country has been zero, but the situation has changed and it is no longer free. Interest rates have been rising, slowly but surely, since the Federal Reserve began the upward cycle at the end of 2015, and they now stand at 2% over the short term and at more than 3% for 10-year bonds.
It is a common belief that a rise in interest rates ends up causing decreases on the stock markets. The basis for that argument is that the discount rate applicable to the dividends that we will receive in the future rises, which causes a decrease in their present value. But, that is not always the case. If we are able to isolate ourselves from the noise in the market and understand the reasons for the decisions taken by the central banks, we may reach a somewhat different diagnosis: monetary policies are normalising given that our economies no longer need them. The global economy and companies’ profits are continuing to display robustness, at the same time as inflation is starting to return after a long period of absence. By way of example, the recent decision by Amazon to increase its minimum wage in the USA and United Kingdom to $15/hour, and inflation will end up arriving. Put simply, central banks are withdrawing the auxiliary engines from economies that can now operate on their own. That is not bad news for the investor.
Which companies could suffer in this environment of normalising interest rates? On the one hand, those known in the market as “bond proxies”. In other words, those that trade at high multiples because they are considered in a similar way to the safest bonds (which in our opinion are also overvalued). On the other hand, very indebted companies that need to refinance and which are going to be forced to do so at higher costs. Many will manage to move ahead with their operations, others will not, but, in any case, the rise in interest rates will not help any of them.
At Bestinver, when we analyse companies, we normalise the cost of debt in our valuation models (except for in the case of financial companies), and so we already take into account this change in the panorama. And that means that we prefer companies with healthy balance sheets, which normally have cash in the bank.
If we focus on good businesses, and we buy them at good prices, then we will not be very concerned if the multiple that the market assigns the profits rises or falls in the short term. Shares offer us long-term performance due to the growth of corporate profits, not only due to the rise in the multiples at which they trade.
The key to success in this context is the quality of the capital (a long-term vision shared between investors and managers), the adequate management of risk (not taking shortcuts) and the capacity and dedication of our team of analysts. The hours dedicated to analysis by people with plenty of qualifications and experience, the meetings and contacts with companies, competitors, suppliers and clients help us understand their businesses in the utmost detail and whereby take advantage of the opportunities offered to us by the market.
What are we seeing in the market right now?
Focusing on companies, what are we finding in the market:
- Very expensive good companies
High-quality companies, with sustained profit growth, which tend to do well in adverse environments, but for which you have to be willing to pay the high prices at which they are trading.
We could also include many large technology companies here, for which very high prices are being paid, but where there is also a great capacity to generate profits. No resemblance to the past, like the dot.com bubble.
In fact, for many of them, such as Amazon, Google and Facebook, the risks are now coming from a different direction: they have grown so much that their management is becoming increasingly complex and they also face major regulatory threats.
- Cheap companies….which could be even cheaper
Not all of the firms that have seen their share prices fall are attractive. There are some companies, such as the traditional TV and telecoms players, whose business models are in serious risk of becoming obsolete, of being devoured by technological disruption. A horizon plagued by value traps, in which technological giants such as Amazon could enter and wipe the floor.
- Good businesses with high growth potential and margins of safety
Finally, and very importantly, we are finding companies that have been hit very hard by the concerns surrounding world growth, the turbulence mentioned above, but where we see that the business and activity are continuing to grow. We are focused on identifying these types of securities.
In our opinion, Konecranes (OHEL:KCR, Financial) reflects the inefficiency in the market that we are pursuing. The share price of the leading crane operator for industry and ports has decreased, despite on-going efforts to continue to integrate Demag and whereby benefit from the associated cost synergies. The order book is growing, margins are expanding and profits are rising. But the share price is suffering because of a general uncertainty surrounding the sector, caused by the tariff war between the USA and China. In these cases, our duty is to ensure that our investment hypotheses are well founded and that the decrease in the share price does not represent a decrease in the company’s value. If the price decreases, but the value remains, then the growth potential and margin of safety increase.
It is in these types of Industriall companies, such as the cases of Andritz and Boskalis, which we already talked about in the previous letter, where the market is offering us numerous opportunities to transform the noise into music.
Great potential to invest in value in specific sectors
There are also other areas of the market where investment in value still has great potential, where we have taken advantage of approximately one third of the liquidity cushion that we used to have to take positions during decreases. We have added new names such as Valmet and Renault, as well as others that used to be in our portfolios in the past.
And we continue to be prepared to take advantage of more opportunities. Although we have reduced the liquidity of our portfolios, it still remains at 12%. That leaves us in a clear position to enter a series of good businesses that we have analysed on the shopping list. In those cases, we are just waiting for the market to offer us the appropriate prices to take positions with a sufficient margin of safety.
An attractive environment over the long term
It may seem counter-intuitive, but we see this market, which is so complex and which has so many distortions in terms of the prices of certain assets, with great confidence. Although it is an uncomfortable environment with occasional turbulence, it is going to offer us interesting opportunities to buy good businesses at good prices, which is the basis for making lots of money over the long-term.
To handle the challenge of making an investment with the aim of generating returns, we must first have an investment philosophy that is valid in its fundamentals and of proven use in reality. Moreover, we have to be able to define and execute an investment process that is capable of capturing the philosophy and turning it into an investment portfolio. And finally, we must have the necessary resources available to put all of that into practice. At Bestinver, we have those three ingredients: philosophy, processes and resources. And the result is returns over the long term.
Our commitment continues to be to dedicate all of our efforts to obtaining the best results for our investment over the long-term. Only then shall we be capable of continuing to be worthy of your trust.
Beltrán de la Lastra
President and Director of Investments
BESTINVER
