From the UndergrowthJuly 2014 At a Glance as at 30 June 2014 Moat or Momentum? You can tell when there is a bit of heat in a market – everyone talks about it and wants Unit Prices ($) to be part of it. If the New Zealand share market is not hot, it’s certainly balmy. A New Zealand Growth Fund 5.3906 bunch of companies are planning to list in order to feed “buoyant investor demand” and investors are seemingly prepared to consider all and any IPO, regardless of the Australian Growth Fund 2.5674 company’s pedigree. Actually, that’s harsh, all companies have a pedigree. It’s just hard International Growth Fund 1.3674 to understand why investors get frothy about a company that hasn’t made any money or get excited about buying something when its owners are wanting to sell (if it’s that KiwiSaver Growth Fund 1.4678 good, why are they selling?). KiwiSaver Conservative Fund 1.2920 IPO enthusiasm is not unique to New Zealand – so far this year, there have been 144 Property & Infrastructure Fund 1.5769 IPOs in the US raising $US30 billion, making it the busiest year since 2000. Investors are excited about new companies coming to the market in New Zealand and in the US High Income Fund 1.0222 because both share markets have enjoyed good times for the past two or three years, and investors don’t want the good times to end. Net Performance (June 2014) Momentum investing is a centuries old phenomenon. It essentially involves backing winners – buying the sort of investments that have recently been successful, on the New Zealand Growth Fund 0.6% assumption that past trends will continue. However, while momentum investing has Australian Growth Fund 0.4% proven itself as a successful strategy in certain periods, it can also be costly because the momentum can end as quickly as it starts, and you don’t want to be the last International Growth Fund - 1.8% man or woman standing. In a recent investor bulletin, the Securities and Exchange KiwiSaver Growth Fund - 0.4% Commission described momentum investing as a “manifestation of magical thinking and herd behaviour”. While we wouldn’t go so far as to suggest magic, we do prefer an KiwiSaver Conservative Fund 0.1% investing approach that is grounded in logic and fundamentals, rather than emotion and Property and Infrastructure Fund 0.0% enthusiasm (especially someone else’s). That is not to say we don’t appreciate enthusiasm. We can get very enthusiastic, excited High Income Fund 0.3% even, when we find an investment that ticks the boxes and then goes on to be successful NZ50 Gross index - 0.7% as its investment thesis plays out. We have talked often about the sort of companies that we like – those with a sustainable competitive advantage or moat. Warren Buffett S&P/ASX 300 ($NZ) - 3.1% coined the phrase “economic moat” to describe a sustainable competitive advantage MSCI Global Small Cap Index ($NZ) 0.9% that a business possesses that makes it difficult for rivals to wear down its market share and profit. It can be likened to a water-filled moat that surrounded medieval castles - the wider the moat, the more difficult it would be for an invader to reach the castle. Moat and momentum investing may not be as polar opposite as one might think. To my mind, the difference between the two comes down to the eye of the beholder. A momentum investor wants to invest in companies that other investors love. A moat investor wants to invest in companies loved by their customers. If their customers continue to love them, then ultimately other investors will love them (and their profit growth) too. Now if only the momentum investors, in their rush to chase the latest hot thing, would overlook moat stocks, allowing us to buy them cheaply. Unfortunately, there is quite a bit of heat in moat stocks as well, all over the world. While we continue to find quality investments that get us interested, right now their share prices leave us cold. Thankfully our existing moat is wide enough to offer protection while we wait. Carmel Fisher, Managing Director Your Portfolios - what has been going on since we last spoke? New Zealand International The NZ Growth Fund’s net performance of 0.6% in June was Global equity markets moved higher in June despite ahead of both the broader market (NZ50G -0.7%) and the increasing tensions in Iraq and rising oil prices. The MSCI mid-cap segment (NZSEMCG -0.8%). World Index rose 1.7%, the MSCI World Small Cap Index bounced nicely in June rising 3.7% while Emerging Market The Fund’s outperformance relative to the market in June share markets continued their recovery with the MSCI can be put down to our high weightings and favourable Emerging market Index up 2.2%. share price movements in F&P Healthcare, Mainfreight and Ryman Healthcare, negated by the earnings downgrade The International Growth Fund was up 1.4% in US Dollar by Kathmandu due to a warm winter during this big sales terms but faced significant currency headwinds over the period. The 18.8% fall in the Xero share price (not owned) month. The Reserve Bank’s interest rate increase helped also helped relative returns. push the New Zealand Dollar close to 30 year highs against the USD. As a consequence the Fund was down 1.8% in Kathmandu advised the market that they expect its earnings NZD terms. for the 11 months ended 30 June will be down 10%-15% on the same period last year (down 0% to 5% on a constant The Fund’s underperformance relative to the MSCI currency basis). Kathmandu’s three sales periods (Easter, World and Small Cap Indices was largely due to the winter & Christmas) make up 60% of its total annual revenue, mild underperformance of some of our larger holdings. with the winter sale being key. These are stocks that have been key contributors to our outperformance over the last 12 months but sold off slightly We have owned Kathmandu for over four years and during June on no company specific news. Included in acknowledge and expect that periodically one of its sales this category are companies such as Brembo, Sarine periods will not go well and have reflected this factor into Technologies, Zodiac Aerospace and United Internet, all our portfolio weighting. Overall, however, Kathmandu is in a companies in which we continue to have strong conviction. favourable sector (adventure travel), has a good track record, Positive contributor’s over the month largely came from the robust growth prospects and is well run. healthcare sector with Sirona and Stratec performing well. The recovery in Stratec is pleasing. The company has Australia struggled over the last 12-18 months following a couple of profit warnings and the loss of a large contract. We recently The Australian Growth Fund was up 0.4% in June beating had the chance to visit their headquarters in Birkenfeld the broader market (S&P/ASX 300) which fell 3.1% in New in south-west Germany, meet with the CEO and take an Zealand dollar terms. June proved a tough month in extensive tour of their factory. The tour certainly helped us Australia. Consumer stocks struggled on a spate of profit appreciate the strong technology component in the design warnings as the sharp decline in consumer confidence of their analyser systems, the powerful value proposition and an unseasonably warm start to the winter weighed on this gives their client base and the significant moats the spending. Banks (-1.1%) and Resources (-1.9%) also offered business has as a result. We continue to believe Stratec little support. will deliver good returns, and this is reflected in the high portfolio weighting. The Fund’s solid June performance was encouragingly broad-based. As we anticipated Ingenia (+11%) recovered May’s underperformance quickly to reach record highs and Property & Infrastructure Nansonics (+7%) share price pleasingly began to reflect the positive emerging fundamentals we’ve been focused on for While the Property & Infrastructure Fund was flat for the some time. Retail Food Group (+7%) distinguished itself month, there were two key pieces of news flow from from consumer peers, a development we expected given portfolio companies. that the company should clearly benefit from financially stressed consumers trading down from more expensive Firstly, Port of Tauranga signed a 10 year deal with Kotahi (a discretionary items. joint venture between Fonterra and Silver Fern Farms) that effectively underwrites Port of Tauranga’s cost of dredging During June new portfolio manager, Manuel Greenland, its harbour for bigger ships to visit ($50m), and validates its started to imprint his influence on the Fund introducing recent purchase of 50% of PrimePort Timaru. three new companies with global footprints: Flight Centre (a unique travel specialist), Sonic Healthcare (a leading Kotahi in turn has committed to providing substantial export provider of medical diagnostic services) and CSL (a leader volumes to the Maersk Line (2.5m Twenty-foot Equivalent in the growing plasma therapies market). We also sold out Units or TEUs) over the next 10 years, which means that completely of Universal Biosensors. As indicated in last Maersk will commit to bringing larger ships (6,500 TEU’s month’s newsletter we lost confidence in the management of v 4,800 TEU’s currently) to Tauranga, once its harbour is the company and preferred to exit the investment. dredged to allow for these bigger boats (expected by the end of 2016). PrimePort Timaru will now be a strong feeder Manuel introduces Sonic Healthcare in this month’s Birds Eye port to Tauranga based on Kotahi’s committed volumes.