Saxo Morningstar Moat Portfolio Q1 2017 Commentary
|Asset Classes:||Equities (excluding Emerging Markets)|
|Investment Style:||Fundamental analysis focused on quality and value|
|Quarterly Return:||6.35% (net of fees)|
|Q1 2017 daily return volatility:||0.80%|
The first quarter of 2017 passed without any major disruptions for equity markets. Financial market volatility was the lowest for a decade and investment performance reflected this after a quarter of strong gains. Supporting this were a series of strong data releases globally – including upbeat corporate profitability announcements as well as cheerful surveys of economic confidence. This more than offset the potential headwinds of political uncertainty and delicate central bank tightening.
The U.K. also commenced its official divorce from the European Union by invoking Article 50, while European contagion risk temporarily settled following the failure of the populist movement in the Dutch elections.
This positivity has prompted action from some central banks, with the Federal Reserve hiking rates in the U.S. for the third time since the financial crisis. China also joined the tightening camp, with a similar hike at the end of the quarter.
Given this favourable backdrop, it should not be a surprise that risk assets performed best over the first quarter, with equities comfortably outperforming bonds. Emerging market equities topped the table, posting near-double digit gains, while developed markets also produced healthy mid-single digit returns (in US dollar terms). Underlying the strong gains were a muddying of the ‘value revival’ seen during the second half of 2016, with energy companies dropping following a 9% fall in crude oil prices, while technology and healthcare rallied strongly.
Best performing positions
- Vertex Pharmaceuticals discovers and develops small-molecule drugs for the treatment of serious diseases. The company is well-supported by lengthy patent protection and being one of the first-movers into the lucrative cystic fibrosis (CF) market. Vertex’s stock soared over 20% following positive results from the company’s pivotal trials. The recent favourable news both de-risks Vertex’s CF franchise and sets the foundation for the firm’s penetration into harder-to-treat CF populations. The position is maintained into Q2 2017.
- Millicom International Cellular is a telephone company that mostly operates in smaller, less congested markets, or in less developed countries with lots of opportunities for subscriber and revenue growth. Millicom shares have gained since discussing and later announcing it has agreed to merge its Ghanaian operation with Bharti Airtel's into a 50/50 joint venture. Millicom maintains an economic moat due to cost advantages and efficient scale, and remains in the portfolio into Q2 2017.
- Skyworks Solutions produces semiconductors for wireless handsets that are used to enable wireless connectivity. The share price gained over the quarter, notably in response to strong earnings results. Positive earnings particularly benefitted from healthy ongoing radio frequency chip demand from Apple for its latest iPhone 7 launch, but also from several leading Chinese smartphone manufacturers. An economic rating is maintained, based on the competitive positioning of its technology used in many 4G-enabled smartphones. At end- Q1 2016, profit has been taken and the position is now closed.
Worst Performing positions
- Valeant Pharmaceuticals is a global specialty pharmaceutical firm with a focus on branded products for the dermatology, gastrointestinal and ophthalmology markets. Its stock price declined in Q1 2017, driven predominantly by earnings being reported below expectations, and also due to negative sentiment from specific hedge funds. A significant portion of Valeant's assets deserve an economic moat, but Morningstar continues to assess this carefully into Q2 2017, given the firm's poor debt situation.
- HollyFrontier Corp is an independent petroleum refiner that owns and operates five refineries serving the Rockies, midcontinent, and Southwest of North America. It is supported with an economic moat due to advantageous positioning of its refining assets and for its feedstock cost advantage. In Q1 2017 the stock price declined following poor refining market conditions in the fourth quarter of 2016, including weak product margins due to high inventories and narrow crude spreads. It remains in the portfolio into Q2 2017.
- Tesoro is engaged in the refining and retail marketing of refined petroleum products. Its refinery plans and feedstock improvement should see improving margins and returns-on-capital over the next five years, which Morningstar believes warrants an economic moat. A fall in the oil price in the latter half of the quarter, plus a slight cooling-off after strong returns made in early February, has meant Tesoro’s stock price has drifted lower since February-end. The position remains in the portfolio into Q2 2017.
Looking forward, many investor participants are citing the separation between political uncertainty and market volatility as a noteworthy development. While this is undoubtedly important in the lead up to the French elections, Morningstar suggests investors instead focus on what can be more clearly identified, moreover an increased focus on the sustainability of asset price gains relative to their ‘fair value’.