Saxo Morningstar Moat Portfolio Q3 2017 Commentary

Instruments traded:Stocks
Asset Classes:Global Equities (excluding Emerging Markets)
Investment Style:Fundamental analysis focused on quality and value
Quarterly Return:4.07% (net of fees)
Q3 2017 daily return volatility:0.82%


Market Overview

The market landscape in the third quarter of 2017 (Q3) was dominated by North Korean tension, a Brexit deadlock, central bank murmurs and a series of U.S. policy oscillations, all of which are influencing asset markets but have failed to materially budge market optimism. Predominately, currency markets are feeling the brunt of the political developments, with sterling and the euro rebounding against both the US dollar and Japanese yen and having a meaningful impact on returns.

While the durability of European optimism is subject to debate, it would seem supportive on the data front – at least for now. The U.K. undoubtedly faces bigger challenges though. Many questions remain over the Brexit deadlock, with the policy direction under scrutiny amid early signs of an economic slowdown. Such a dynamic also puts a lot of pressure on the Bank of England, as they are hopeful to raise rates despite GDP annual growth being revised down to a 4-year low.

Despite the political tension and currency drag, it was another positive quarter for equities in general. Emerging markets delivered stellar results once again, outperforming developed markets over the third quarter (although September saw a partial reversal and the breaking of an 8th month streak). Japanese equities were notable laggards, clearly hampered by concerns over North Korea.

Such divergence was also evident at both a country and sector level too. China, Russia and Brazil have been buoyed by the strength in the energy and materials sectors, whilst US technology companies continued to attract investor attention despite lofty valuations.

Against a backdrop where central bank stimulus in being gradually unwound, fixed income markets were generally flat. However, on a look-through basis there were some noteworthy developments, with emerging market debt continuing to outperform developed market debt and corporate debt outperforming government debt. Moreover, with corporate defaults hovering near historical lows, corporate bond yields have narrowed further relative to government bond yields.

Portfolio Performance

July-0.4%
August-0.3%
September4.8%

Best performing positions

  • Allegheny is one of the largest manufacturers of diversified speciality materials in the world. Late July, the company released its earnings results for Q2, which were in line with Morningstar Investment Management’s expectations and the stock price moved sharply higher. The company has consistently hit expectations in recent quarters and carries strong momentum in the remaining period of 2017. Profit was taken on the portfolio at quarter end and the position closed.
  • SINA Corp is a leading online media company in China. Its services include Sina.com (portal), Weibo (social media) and Sina mobile (mobile portal and mobile apps). The stock continues to perform well, having also been a top performer in Q2, driven largely by the monetisation of Weibo.  The position was trimmed at Q3 quarter end is held into Q4 2017, having revised up its fair value and the market price remaining at a discount.
  • 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. The stock price jumped late August, given that the refine was out of the path of Hurricane Harvey and stands to benefit from the strengthening product margins. We still believe the stock is undervalued and is held into Q4 2017.

Worst performing positions

  • Vocus Group’s key asset is its infrastructure network, consisting of 1,900 kilometres of fibre in nine metropolitan cities in Australia and 4,600 kilometres of inter-city fibre covering New Zealand. Vocus has incurred a number of mergers in quick succession, and incurred a AUD 1.5bn impairment of goodwill on the balance sheet.  The position is held into Q4 2017 as the stock price is trading at a discount to its fair value, despite the fair value being revised downward by Morningstar Investment Management.
  • Smart Sand Inc. is among the top four public frac sand proppant suppliers, which collectively are expected to supply 58% of all proponent demanded in 2020. The company is distinguished among the producers by its large reserves of preferred fine mesh sand, which is critical for slickwater fracturing. However, the announcement of news frac sand mines has meant increased supply, negatively impacting stock prices. Mid-term, the fair value price has been revised down and at Q3-end the stock was removed from the portfolio.Sabre Corp has the number-two share of the air global distribution system market and its share is expected for this to increase over the next few years. That said, costly investments, higher expenses and lower IT Solution sales (another business channel) weighs on the stock price in the near term. The position is maintained into Q4 2017.

Outlook

Going forward, Morningstar Investment Management believe we face an interesting situation whereby market optimism appears pegged to one of the longest (but slowest) economic expansions in history. With strong historical asset price performance behind us, this leaves a challenging opportunity set. On the one hand, there are pockets of opportunity that appear to warrant investor attention, however the danger is that the broader market optimism could easily unwind.

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