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CONNECTIONS www.kl-communications.com - September 2015

T. Rowe Price’s Levenson expects December rate hike as Fed chair Janet Yellen decides against move

Hermes EOS calls for VW overhaul Hermes EOS is calling for an

overhaul of management at

Volkswagen, following this

month’s emissions scandal.

The US EPA revealed VW sys-

tematically cheated emissions

tests of some 500,000 vehicles

with diesel engines it sold in

the US. This led to CEO Martin

Winterkorn’s resignation and

the exit of other executives.

Porsche CEO Matthias Müller

was named the new CEO.

Hermes EOS director Dr Hans-

Christoph Hirt comments: “The

supervisory board’s choice of

corporate insiders as CEO and

chair-elect raises real doubts

whether the key shareholders

have recognised the need for

fundamental reform and a real

new beginning.

“The new CEO and the incom-

ing chair should overhaul VW’s

corporate governance, includ-

ing the composition and effec-

tiveness of its supervisory

board, and create a corporate

culture which ensures the trust

of customers and society will

never again be jeopardised.”

After many months of intense con-

jecture, the US Federal Reserve this

month decided against hiking inter-

est rates for the first time in almost

a decade.

In the much-anticipated 17 Septem-

ber decision, the Fed kept rates at

the near zero level that has been in

place since December 2008.

Despite deciding to hold fire on a

rate hike, Federal Reserve chair

Janet Yellen still expects movement

by the end of the year.

“I anticipate that it will likely be

appropriate to raise the target

range for the federal funds rate

sometime later this year and to

continue boosting short-term rates

at a gradual pace thereafter as the

labor market improves further and

inflation moves back to our 2% ob-

jective,” Yellen said in a speech later

in the month.

While the US economy has been

continually improving, recent pro-

gression appears to have been

trumped by increased market vola-

tility, moderating global growth and

continued concerns about below-

trend inflation.

“The Committee continues to see

the risks to the outlook for econom-

ic activity and the labor market as

nearly balanced but is monitoring

developments abroad,” the FOMC

statement read.

CONTINUED ON PAGE 3

Fed ‘errs on side of caution’ and delays hike

P2 THE RUSSIAN FOOD

RETAIL REVOLUTION

S. W. Mitchell Capital’s Alexis

Mathieu discusses one of the

‘catch-up’ trends on offer in

Emerging Europe.

P3 VALUATIONS AT BEST

LEVELS FOR THREE YEARS

Evenlode’s Ben Peters talks

to www.investorvlog.com

about the recent volatility in

equity markets.

P3 ARDEVORA’S FITCHEW

NAMED A RISING STAR

Ardevora’s Ben Fitchew has

been named in Financial

News’ 40 under 40 rising

stars in asset management.

P4 ARE ABSOLUTE RETURN

FUNDS WORTH IT?

Argonaut Capital’s Barry

Norris looks at whether

absolute return funds are

worth paying for.

“We see this as being a very slow and moderate process,

perhaps taking a few years before normalisation occurs”

– Neuberger Berman’s Thomas J. Marthaler

2

Tapping into the Russian food retail revolution The late 1950s and early 1960s

heralded a golden age of food retail

in Europe.

Spearheaded by companies such as

Sainsbury’s and Tesco in the UK and

Carrefour in France, the large self-

service store concept changed gro-

cery shopping. Today, organised

retailers dominate the market. In

France, the modern retail format

represents 80% of the food retail

market; in Germany, the figure

reaches 88%.

We are now, finally, seeing this

trend in Russia.

As the ‘revolution’ unfolded in

Western Europe, the USSR food

retail market was served through a

range of state stores. Goods short-

ages and extensive queues were

common. After the Cold War and

the liberalisation of the economy,

this channel disappeared to make

way for independently-operated

stores. These were small, but a

rising entrepreneurial spirit com-

bined with capital availability meant

organised chains could develop.

This year, for the first time, modern

formats have overtaken traditional

peers as the largest sub-segment,

with a 53% share of the food retail

market. Representing just 21% in

2006, chains have gained an aver-

age of 4% per annum – and there is

no reason the progress in conver-

gence should stop here.

Thanks to prosperous market condi-

tions (15% compounded annual

growth in the past nine years), al-

ternatives such as traditional stores,

street kiosks and open markets also

expanded. There was space for

everybody.

Now things may get tougher. A

challenging economic outlook

means continued market growth is

not assured. In the competition for

the consumer’s wallet, proximity to

customers and flexibility in assort-

ment and hours may not be enough

to fend off bigger newcomers. Pro-

fessional competitors, improving

their operations thanks to econo-

mies of scale in areas such as logis-

tics and suppliers’ terms, can deliv-

er lower prices with little impact to

their financial results.

Modern players have emerged

mainly through the rollout of new

stores. An example of the pace of

expansion is market leader Magnit,

which opened its first convenience

store in 1998 and by 2005 had a

network of 1,500 locations.

As of the end of 2014, it had 8,344

convenience stores, 190 hypermar-

kets and aimed to open a further

1,200 stores in 2015 alone. Yet

Magnit only holds 7% market share.

In the next decade, we see further

growth for organised players – part-

ly to the detriment of traditional

channels. Consolidation among

large players should also occur

when the returns on investment on

marginal new selling space fall to a

level where M&A is an appealing

alternative. Magnit and its four

largest competitors hold 19% of the

market. In Western Europe, the top

five players hold around 70%.

We expect a small number of com-

panies will dominate the space.

Robust long-term structural trends

can offset potential cyclical head-

winds, and market leaders can de-

pend on multiple levers of growth:

market expansion, a shift towards

organised retail, and consolidation.

We invest in Eastern Europe to take

advantage of this type of trend: the

‘catch-up’ phenomenon, which

provides exceptional long-term

investment opportunities – not just

in food retail, but also banking/

insurance, internet services, and

transportation.

Alexis Mathieu runs the SWMC

Emerging European Fund

CONNECTIONS

T. Rowe Price, the $773bn global

asset manager, has launched an

emerging markets equity strategy

to tap into the contrarian value

opportunities on offer in the devel-

oping world.

The T. Rowe Price Emerging Mar-

kets Value Equity Fund, managed

by Ernest Yeung, will typically hold

between 50 and 80 stocks. Lever-

aging T. Rowe Price’s extensive

research capabilities, he will look

for stocks not actively followed by

other buy or sell side analysts.

This helps Yeung populate a portfo-

lio away from the many crowded

trades found across the emerging

market equity universe.

At launch, the Emerging Markets

Value Equity Fund has large expo-

sures to Romania, Russia, Brazil,

South Africa, China, South Korea,

and Taiwan. At a sector level, the

portfolio currently favours finan-

cials, telecommunications services,

and consumer discretionary.

Yeung says the emerging markets

asset class still offers many diverse

opportunities.

“In many markets, information can

be hard to access and a crowd men-

tality can be a significant driver of

stock prices in the short term. For

us, opportunities arise when stock

prices diverge from company fun-

damentals,” he says.

“We are contrarian and invest in

forgotten stocks because they often

exhibit a wider margin of safety on

valuation. Their cash flows or divi-

dend streams can be significantly

mispriced. They also tend not to

have much associated investor

selling, which provides another

measure of downside risk manage-

ment, making the risk/reward rela-

tionship more favourable.”

While there are plenty of cheap

stocks on offer in emerging mar-

kets, Yeung says being cheap is not

good enough.

“Many such stocks have proven to

be value traps. To avoid these traps,

our approach focuses on finding

companies where some sort of

change is taking place that could

drive returns higher,” he adds.

“Or alternatively a company may be

a leader in an unloved industry, and

have solid corporate governance

and sensible capital allocations.”

T. Rowe Price unveils value-biased EM equity fund

Ernest Yeung - T. Rowe Price

“We invest in Eastern Europe to take advantage of this

type of trend: the ‘catch-up’ phenomenon”

Alexis Mathieu - S. W. Mitchell Capital

3

CONNECTIONS

‘Valuations now at the best levels in three years’ It will not have escaped your atten-

tion that equity markets have taken

something of a southerly turn over

the last few months. As long-term

valuation-based investors, a natural

question for us to ask in this envi-

ronment is: has there been any long

-term value that has emerged out

of the short-term market moves?

Market levels are down quite a bit

on a few months ago. So are we

seeing better value? The answer is

yes – by our estimates the valuation

on offer is the best we have seen in

perhaps three years on an absolute

basis. But within the companies

that we look at there are better

value and worse value opportuni-

ties, and we are looking to capture

the best value that we can. So has

the relative opportunity set moved

significantly for us?

The answer, really, is no. The sec-

tors where we saw the best value

previously are still the sectors

where we see best value, and that

includes global large companies

with some exposure to emerging

markets.

One area of the market that has

been stubbornly high – and has

arguably been the ‘defensive’ area

of the market – has been the mid-

cap space. We have seen some

companies move toward more in-

vestable levels, but by and large the

opportunity has not fully emerged

in that sector. I can think of special-

ist distributor Diploma as a compa-

ny that has come down in price, but

not quite towards a level where we

are comfortable investing for the

long term.

In the meantime we wait patiently.

In the short term we could get

more market jitters as macro fac-

tors remain, but we are waiting

patiently and our portfolio is, we

believe, well-positioned in terms of

quality and in terms of the value

that is on offer.

Ben Peters is investment director

at Evenlode. He was speaking to

www.investorvlog.com

Ardevora’s Fitchew named in 40 Under 40 Rising Stars Ardevora partner Ben Fitchew has

been named by Financial News as

one of its 40 Under 40 Rising Stars

in Asset Management. In its fifth

year, the annual awards celebrate

the brightest and most promising

men and women in the European

wholesale financial industry.

Financial News comments: “Fitchew

joined boutique Ardevora from

Liontrust Asset Management as one

of four partners at its launch in

2010 and is involved in the manage-

ment of £1.1bn of the firm’s total

£1.4bn assets.

“With joint responsibility alongside

colleague Gianluca Monaco for

short allocations within Ardevora’s

£140m UK Equity Fund, he helped

the fund return 16.1% in the seven

months to August 2015, against

benchmark returns of 5.1%.

“Working closely with founders

Jeremy Lang and William Pattisson,

who take a behavioural finance

approach to investments, he has

developed a strong interest in psy-

chology.

“He also feeds into Ardevora’s stock

-picking approach as a co-manager

on Ardevora’s global long-only equi-

ty strategies and its Ardevora Glob-

al Equity Fund.”

Evenlode’s Ben Peters talks to www.investorvlog.com

Fed ‘errs on side of caution’ and delays (cont.)

FROM PAGE 1: Thomas J. Mar-

thaler, portfolio manager at

Neuberger Berman, says the

timing of the first hike is not as

important as the pace and

magnitude of future increases.

“We see this as being a very

slow and moderate process,

perhaps taking a few years

before normalisation occurs,”

Marthaler says.

“The decision to delay raising

rates shows its preference is to

err on the side of caution ra-

ther than jeopardise the econ-

omy's recovery, especially in

light of weakening growth in

many parts of the world.”

While T. Rowe Price chief US

economist Alan Levenson ex-

pected a rate hike, he still sees

movement in the short term.

“I still expect lift-off in 2015,

and I view December as being

far more likely,” Levenson

adds. “If the Committee is

concerned about the impact of

international developments in

general and of the July-August

tightening of financial condi-

tions in particular, September

data probably will not be suffi-

cient to sound the all-clear.”

Ben Fitchew - Ardevora

2000

2500

3000

3500

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2010 2011 2012 2013 2014 2015Source: Bloomberg

FTSE All Share Index

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CONNECTIONS

Why low volatility absolute return funds may not be worth paying for The argument for investing in abso-

lute return should be relatively

simple: a consistent delivery of

attractive returns, combined with a

risk profile offering diversification

from traditional long only funds.

However, much of the investor

attention surrounding absolute

return strategies overly focuses on

those funds displaying low volatility

characteristics, which we argue by

itself has no portfolio diversification

benefits.

We are concerned the emphasis on

low volatility in isolation often leads

too many funds to only deliver me-

diocre ‘cash plus’ returns – without

the actual safety of cash.

With approximately half of the

sector displaying a standard devia-

tion of less than 4%, are these ‘cash

plus’ returns worth the bother?

Cash is the ultimate low volatility

investment. Unlike low volatility

funds, cash never delivers a nega-

tive absolute return – unless in the

unlikely event of the bank becom-

ing insolvent. Therefore, the risk/

return analysis of cash as an asset

class is always consistently strong,

simply due to the absence of risk.

But by far the biggest limitation of

‘cash plus’ low volatility funds is the

absence of clear diversification

benefits.

An investor may believe they are

achieving diversification by se-

lecting a range of low volatility

funds, only to find all of the strate-

gies selected are highly correlated

to the stock market and/or each

other. The investor could likely

replicate the same return profile by

splitting assets between cash and

the market index, which would

probably be cheaper to replicate

after fees.

Are low volatility funds worth pay-

ing for?

While cash does not charge an an-

nual management fee, or perfor-

mance fee, this is not the case with

the universe of low volatility funds.

In fact, it is questionable whether it

is appropriate for many low volatili-

ty funds to even apply the com-

monplace AMC.

For example, if a fund has a stand-

ard deviation of 2%, is it really ap-

propriate for it to apply 75bp AMC?

Even in a year where the fund man-

ager has demonstrated skill in con-

verting risk into return, with the

delivery of an admirable Sharpe

ratio of 1, the AMC would likely

consume nearly 40% of the target-

ed return.

Our analysis of the IA Targeted

Return sector reveals approximate-

ly one quarter of funds have an

AMC of at least half of the standard

deviation. Even in a good year, this

suggests fees will eat away at least

half of the implied return.

Focus on low correlation and deliv-

ering returns

The most attractive risk characteris-

tic of an absolute return fund in our

view is not low volatility, but

achieving low correlation to risk

assets and delivering returns in all

market environments. After all, the

least difficult skill in investing is

providing a positive return at the

same time as the market and every-

one else.

It is clearly more difficult to deliver

positive returns at different times

to the market and peers, while still

displaying an attractive return pro-

file overall – given the tendency of

stock markets to deliver positive

returns over market cycles. This

requires investment in a non-

correlated asset – which for us at

Argonaut is a short book of equities

– and demonstrating skill in gener-

ating alpha on both the short and

long side of the book. It also re-

quires a net exposure to never get

too aggressive.

Our analysis of the IA Targeted

Absolute Return sector found only

three funds had a negative correla-

tion to the European stock market.

However, the overall return record

of these funds is poor. By contrast,

over half of the funds in the sector

had a correlation of more than 0.5

with the European stock market –

which suggests limited diversifica-

tion benefits. The sweet spot is in

the combination of an attractive

return profile and a low correlation

to the European stock market –

something we are proud to have

been able to achieve at Argonaut.

The IA Targeted Absolute Return

sector is filled with a variety of

different fund types: such as multi

asset strategies, or long/short bond

or equity vehicles. While this clearly

results in different risk and return

profiles, the framework for analys-

ing the attractiveness of these strat-

egies is the same.

Investors must take a closer look at

this heterogeneous sector to identi-

fy funds truly offering diversifica-

tion, as well as still provide value

for money.

Barry Norris runs the FP Argonaut

Absolute Return Fund 0%

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0-25% 25-50% 50-75% 75-100% Over 100%

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T: +44 (0) 203 137 7823

www.kl-communications.com

info@kl-communications.com

Barry Norris - Argonaut Capital

AMC vs Volatility in IA Targeted Absolute Return sector

AMC as % of Standard Deviation