international investor ISSUE
5
september 2012
Why Invest in the Technology Sector Why the tailwinds behind the technology sector are building
Quenching the World’s Thirst An Investor’s Perspective
Investment news
China’s One Child Policy
hanging Implications for the Chinese Economy
2 | International Investor SEPTEMBER 2012
Welcome to this edition of International Investor
Samuel Instone Chief Executive Officer AES International
In his inaugural speech, Pretoria, 1994, Nelson Mandela proclaimed, ‘Let there be work, bread, water and salt for all’. The eurozone debt crisis continues and since our last issue there have been many more sensational headlines as European governments and worldwide institutions labour to indeed provide both work and the proverbial bread. While elections convene, summits meet and compromises take shape, the individual investor searches for answers and looks to the future. With the correct knowledge, tools and advice our contributors establish that investors can still be optimistic with their financial planning.
I
n this issue, we bring you a feature article focusing on global water provision and the implications involved for both supranational organisations and the private sector as they look to meet the inevitable incline in demand for fresh water, a basic commodity needed by all worldwide. Additionally, we delve deeper into the world of technology looking at the underlying drivers behind recent industry and media excitement. The news of late has been inundated by the release of new phones and tablets; as technology is an essential strategy in the AES Model Portfolios, it is our aim to provide our clients with both the information and services you need to make informed decisions about your financial future. If an indicator of the power of modern-day technology was ever needed then the use of the Internet by the technologically-adept Chinese to voice their causes, in spite of the infamous authoritarian censorship, is certainly a significant example. At the time of going to print, Sino-Japanese relations are straining with protests taking place all over China. Baidu, the nation’s equivalent of Google, and other prominent Internet companies have also publicly expressed their patriotic sentiments and hosted prominent campaign banners. Our article on China’s one-child policy demonstrates another aspect in which Chinese social and technological attitudes and changes are affecting the wider world, both in the present-day and in terms of what the future may hold. We continue our commitment to keep you updated on the performance of the AES Model Portfolios as the AES Investment Committee shares its views on the past quarter. As ever, the fund managers also comment on the performance of their funds. Your financial future is of the upmost importance and even in these turbulent times, working together directly with your Private Client Adviser will ensure you continue to receive clear, comprehensive advice and customised service.
International Investor SEPTEMBER 2012 | 3
Table of Content
4
China’s One Child Policy: Changing Implications for the Chinese Economy
6 8
Why Invest in the Technology Sector Quenching the World’s Thirst - An Investor’s Perspective
10 12 16
Fund Manager UpdateS AES Portfolio Fund Manager Quarterly Updates
19
glossary
AES INvestment committee
Asset Allocation AES Model Portfolio Asset Allocation
4 | International Investor SEPTEMBER 2012
China’s One Child Policy: Changing Implications for the Chinese Economy The harsh realities of China’s one-child policy were brought into sharp focus last month, when disturbing photographs of a young Chinese woman and her forcibly aborted foetus swept the Internet. Forced abortion is not sanctioned under the policy – indeed it is illegal – but because local family-planning officials have financial incentives to keep abortion rates high, such interventions are not uncommon. The pictures, uploaded onto Sina Weibo (the Chinese equivalent of Twitter), have proved a rallying point for opponents of the policy within China. While many commentators have understandably focused on the human tragedy of this story and others like it, the debate has widened to encompass issues such as the growing gender imbalance (in a society where male children are preferred), as well as more general questions about human rights. But an increasing number of Chinese people, prominent business leaders and academics among them, have been voicing their concern over another aspect of the one-child policy – its changing implications for the Chinese economy.
International Investor SEPTEMBER 2012 | 5
James Chong, Portfolio Manager
W
hatever one might feel about the ethics of the policy, it is hard to deny its efficacy – or that its introduction was necessary. It was initiated in 1978 in an attempt to prevent the grave social and economic problems associated with overpopulation. In the 50s and 60s, Mao Zedong had encouraged Chinese couples to have as many children as they could, believing that a more populous nation was a stronger one. By the mid-70s, the resulting surge in population growth had already caused food shortages and put considerable strain on the nation’s education and medical systems. The spectre of high unemployment was also looming. In alleviating all of these pressures, the one-child policy has largely met its aims and has played an important role in the country’s remarkable economic progress. Although the policy was introduced more than 30 years ago, China has continued to enjoy a so-called ‘population dividend’. As the number of economically productive citizens has grown, the country has benefited from a vast supply of cheap labour, and established itself as the ‘workshop of the world’. But the demographic dividend is now fading. The Chinese population is ageing fast, and as more old people retire from the workforce there are fewer young people to replace them. Experts predict that China’s cheap-labour advantage will have disappeared by 2015. In fact, despite the current slowdown in the economy, some areas are already suffering labour shortages. There are also implications for China’s pension and healthcare systems, which must now be able to support an increasing number of elderly dependents.
Rather than simply continuing to churn out huge quantities of low-end, low-margin goods, Chinese companies are increasingly focusing on high-value-adding technological expertise. To help them achieve this, they have a vast pool of home-grown talent to draw on; young Chinese are better educated than ever. Parents from all social classes tend to place great store in academic success; having fewer children to support and more savings than their predecessors. Encouragingly for China – and for investors attempting to harness its potential – the country’s economy is ‘climbing the value chain’. Rather than simply continuing to churn out huge quantities of low-end, low-margin goods, Chinese companies are increasingly focusing on those that rely on high-value-adding technological expertise. To help them achieve this, they have a vast pool of home-grown talent to draw on; young Chinese are better educated than ever. Parents from all social classes tend to place great store in academic success; having fewer children to support and more savings than their predecessors, they are in a better position to let their child concentrate on studies rather than go out and find a job at the earliest opportunity. China now produces many more science and engineering graduates than the US each year. On top of this, no other nation allocates so large a proportion of its GDP to research and development. In the near and medium term, China’s shrinking but better-educated workforce provides great opportunities for investors. To take one example that is represented in our portfolios, certain factoryautomation companies are well placed to benefit as more and more manufacturers tackle the shortage of cheap unskilled labour by upgrading to automated production systems. There are similar opportunities, too, in the automation of agricultural processes. Looking further ahead, the insurance and healthcare industries stand to gain from the ageing of the population, as people increasingly buy long-term insurance products, pension protection, and so on, and the government upgrades
its creaking healthcare system. And because the children of one-child families tend to spend more and save less than their parents when they grow up, they will help shift the country’s economic structure further towards domestic consumption rather than government investment and export. Pension reform would also help this trend, by reducing the perceived need to save (the Chinese savings rate is currently the highest in the world). If China’s manufacturers are raising their aspirations, so are its consumers; companies that will benefit most include luxury brands and other providers of high-end goods. In many respects China is changing quickly. The rise of social media like Sina Weibo is facilitating public debate and even dissent in a way that would have been unthinkable five years ago. But although I expect the Chinese government to ease its one-child policy – indeed it has already been relaxed, with most couples who each have no siblings now allowed to have two children – the process will surely be a gradual one. And even if the policy were to be suddenly abandoned, the idea that having fewer children makes economic sense is now deeply ingrained among the Chinese people, so it is highly unlikely that there would be a baby boom of sufficient proportions to reverse the ‘greying’ of the population. It is all the more important, therefore, that China shake off its dependence on cheap, abundant labour and move its economy further up the value chain. The good news in this regard is that the world’s secondlargest economy is well equipped to do just that.
6 | International Investor SEPTEMBER 2012
Why invest in the technology sector The tailwinds behind the technology sector are building and there are three major themes that point to strong fundamentals within the technology sector: • IT spending growth rates are currently much stronger than the average levels seen over the past decade and this extra spending is being allocated to areas of innovation as companies strive to expand. • Excitement is growing over strong demand for new devices like smartphones and tablet computers. • Valuations in the technology sector remain attractive, particularly for companies with higher growth rates.
Greg Tuorto, co-portfolio manager of the JPM US Technology Fund
The return of IT spending For most of the last decade, technology spending has been severely restrained. Much of this is a hangover from the dotcom boom and the massive spending associated with Y2K preparations. With spending severely depressed, many promising technologies in networking and storage struggled to find traction. During this period of austerity, the mantra of the Fortune 500 Chief Information Officer was ‘do more with less’. This led to the development of a patchwork of proprietary technologies that didn’t talk to each other. As the purse strings loosened in 2006-2007 and spending increased, companies moved to integrate and
consolidate many of these proprietary technologies. However, although the overall level of spending rose, the net benefit to technology companies and to end users was negligible. This situation is now changing. Technology spending is not only increasing, but the biggest spenders are likely to come from a broad range of industries. We are already seeing signs that manufacturing, healthcare, media and pharmaceutical companies are embracing the new tools and modalities that are being made available by Cloud Computing1 to enable their workforces to drive sales growth, develop new products and services and improve the efficiency of the corporation. There is also a high correlation between the rise in IT spending and the rise in overall corporate revenues. We believe this
correlation is also positive for technology investors as it usually leads to outperformance from technology stocks. When companies add to their IT spend, we think it will benefit the growth areas of the technology sector. These are the types of technologies we like to invest in, as they are seeing inflection points in demand and adoption. Early corporate adopters of Cloud infrastructure services, efficient storage arrays and sales force enablement systems tend to see a rise in their market share as a result of being first to market and ahead of the competition.
International Investor SEPTEMBER 2012 | 7
transformation still in early stages
penetration rate
PC/Laptop 50%
Server Virtualization Smartphone Cloud Computing Desktop Virtualization Tablets Big Data
25%
time Source: Gartner Group, U.S. Department of Commerce, J.P. Morgan Asset Management estimates
mobility: we are in the early stages of smart phone growth
Valuations
Smartphone Adoption 1,000,000,000
smartphone sales
900,000,000 800,000,000 700,000,000 600,000,000 500,000,000 400,000,000 300,000,000 200,000,000 100,000,000 2007
2008
2009
2010
2011E
2012E
2013E
2014E 2015E
Source: Gartner Group and J.P. Morgan
We like the prospects for areas such as virtualisation, wide area network optimisation, tablet computing and enterprise wireless over the next twoto-three years. As already discussed, the Cloud (or the delivery of computing services over the internet) is also an increasing focus for us. The emergence of the Cloud is positive for technology investors, creating a host of opportunities. However, instead of trying to find companies that are ’pure plays’ on this theme, we are identifying companies that are participating in the semiconductor, storage, service provider and infrastructure trends created by the growth of Cloud Computing.
Increasing demand for mobility There are many aspects of the mobility theme that interest us. The advanced technologies in many new smartphone models and tablets have led consumers and businesses to question the need to purchase PCs or Notebooks. Apple, the runaway leader in the smartphone and tablet market, sold more than 26m iPhones and 17m iPads in the second quarter of 2012. This is unlike any other phenomenon we have seen in the technology space. We also have a number of challengers in the tablet and smartphone space which should be able to produce tablets and phones for consumers who are not interested in Apple products.
Cloud Computing allows companies to access databases or software hosted by a third party over the
1
internet. The technology can help companies integrate across global boundaries without investing in expensive IT infrastructure.
These dynamics will have a major impact on media consumption, social networking, e-commerce, mobile payments and collaboration. We have spent a lot of time identifying the potential winners in this space and feel that investors can capitalise on this trend in many different ways. The mobility trend is proliferating at a faster pace than most can comprehend. There are new models that pop up daily to take advantage of rich feature sets and multimedia capabilities. We have seen a few companies emerge in recent months to participate in the tablet/smartphone market and we expect many more to emerge in the future.
Currently the technology segment is trading at a discounted valuation level to the overall market. In fact, technology valuations remain near their cheapest levels going back to 1995. Even excluding the technology bubble years (1998-2001), technology’s current price to earnings ratio is more than 30% below its historical average and well under is historical premium to the market. As a result, technology earnings expectations could fall by as much as 30% and the sector would still trade at a discount to history, even excluding the technology bubble. Not only are valuations attractive across the technology market cap spectrum, but balance sheets are flush with cash and companies have plenty of financial flexibility. We believe technology companies should be able to expand their valuation multiples, supported by sustainable revenue growth rates.
Conclusion We feel we are entering a multi-year outperformance phase for the technology sector and are excited by the thematic and fundamental opportunities currently available. In particular, we think the amount of cash allocated to technology projects will rise faster than many expect. The strong demand for tablet computers and smartphones is also creating many peripheral opportunities in areas that are new to many investors. As a result, the technology sector may be entering a phase similar to the mid 1990s where innovation will be rewarded.
8 | International Investor SEPTEMBER 2012
Quenching the world’s thirst – an investor’s perspective UN and OECD studies highlight the need for better water provision Precious yet squandered. This is the precarious status of the world’s water resources, as revealed in a series of new studies by the UN and OECD. The reports, released to coincide with the World Water Forum in Marseille in March, predict that population growth and climate change could soon turn fresh water into one of the world’s scarcest commodities. industry by 20%, a huge rise for a sector that already consumes more than two thirds of the world’s useable water. The imbalance in demand and supply will be made worse by changes in the world’s climate. Shifts in rainfall patterns, the steady disappearance of glaciers and changing river flows will each have a negative effect on water supply, the UN says.
Paul Gaston, Head of Sales - UK, Pictet Asset Management
A
ccording to the OECD, with the world population set to increase by 2 billion to 9 billion over the next 40 years, demand for water can be expected to rise by more than 50%. Under this scenario, two in five people will be living in areas suffering ‘water stress’. Agriculture is the main reason that water demand will rise rapidly. To feed 9 billion people by 2050, farmers will have to increase food production by 70%. This, the UN says, will boost demand for water in the agricultural
Easing the strain – solutions from the private sector While bringing supply and demand into balance will be a difficult process, there are reasons to believe the picture will not be quite so bleak. Crisis is avoidable and the solution lies in finding ways to manage the competing demands of water’s heaviest users - farmers, energy producers and households. Supranational organisations like the UN and OECD, governments and public water utilities will obviously have a large part to play in ensuring the world’s water resources are efficiently managed. But these noncommercial entities are not equipped to solve such problems on their own – the
International Investor SEPTEMBER 2012 | 9
private sector will also have a major contribution to make. As an investment manager, Pictet Asset Management has always believed in private companies’ capacity to help solve some of the problems that threaten to stall economic progress. Such ingenuity and competence is in plentiful supply in the water services industry there are many firms that possess the management expertise, products and services that can help ease the strain on the world’s water resources. Just as importantly, these firms also have the necessary access to capital.
The world currently recycles just 20% of its used water – an unsustainably low level if it is ever to bring demand and supply into equilibrium. There is, however, evidence to suggest that the water treatment technologies being developed by private firms can have a significant impact on water re-use rates.
It is in the area of water recycling, an activity which will be crucial in reversing the world’s water shortage, where the skills of the private sector are being deployed to particularly good effect. The world currently recycles just 20% of its used water – an unsustainably low level if it is ever to bring demand and supply into equilibrium. There is, however, evidence to suggest that the water treatment technologies being developed by private firms can have a significant impact on water re-use rates. Chile, for instance, a pioneer in the privatisation of water services, now treats or recycles 90% of its urban waste water compared to just 8% some 20 years ago. In Sydney, the percentage is closer to 100%1. Such successes are likely to be repeated in other countries. Water recycling has become a focus for local and national governments in both the developed and developing world. And in response, many of the largest companies in the water services industry have made recycling a priority, investing heavily in the research and development of new wastewater purification techniques. But water recycling is just one of many areas where private companies are making a difference. The development of more
efficient irrigation techniques is another field where such firms are leading the way. Technological breakthroughs are also being made in the area of water desalination. Here, private companies are developing technologies that reduce both the cost of desalination and its impact on the overall environment.
An investment for the long term Overall, the world will need to invest $1 trillion per year through to 2030 to safeguard its water resources. It is against this backdrop that the water services sector can be expected to sustain its strong rate of growth, which is currently running at 6% per year. For investors, this presents an attractive opportunity: much of the industry’s expansion should come through the private sector. Private companies currently account for just 8% of the global water services market but this figure is expected to rise to 21% over the next decade, driven in large part by the outsourcing of water services worldwide. Having a stake in the companies that can help steer the world away from a water crisis can therefore be a rewarding endeavour for investors. Source: United Nations Water Report, 2012
1
10 | International Investor SEPTEMBER 2012
AES Investment Committee The second quarter was a tough trading environment but we are pleased nonetheless with the overall performance so far this year. On an absolute basis, all the portfolios finished the first half of the year in positive territory, with performances on average of 2.7%, 1.3% and 2.5% for the aggressive, balanced and cautious portfolios respectively. On a relative basis, all the portfolios beat the FTSE 100 for the first half of the year; they however struggled against their peer benchmarks. This underperformance was due to the overweighting of the energy and gold sectors relative to the benchmarks, covered in greater detail shortly. A Choppy Second Quarter The rally of the first quarter proved to be short-lived, as general market conditions in the second quarter marked a stark contrast against the results of the first. This was due to the market refocus on Europe, Greece and Spain in particular and weakening growth data coming out of the US and China. Looking at Europe, May brought about more uncertainties when Greece held the financial markets hostage as a result of its first round of attempted elections which failed to produce a governing coalition. Until mid-June, the markets were left pondering what the consequences would be if Greece were to exit the eurozone. With so much uncertainty and indecision resting on Greece, markets naturally started to look towards the next countries with problems: Spain, which possesses both a much larger balance sheet and banking system. With the spotlight now on them,
the Spanish government attempted to ‘kick the can further down the road’, with a â‚Ź100 billion injection into its banking system to temporarily satisfy markets. Although there is general concern over the predominantly reactive approach taken by many European policy makers, China, on the other hand, has been taking aggressively proactive moves. New initiatives to stimulate consumption are instilling confidence that the region can indeed meet its target 7.5% GDP growth. More positive news was received in mid-June with the Federal Reserve announcement that it will be taking measures to support the fledgling housing recovery with the idea of promoting household spending to pre financial crisis levels. Shortly after in late June, a European summit provided more encouraging news as a compromise was met between Germany, who wished to lend no more unless budget authority
was surrendered, and the most affected debtors, who were against further austerity measures. Such a compromise provided well-needed relief for troubled governments and markets reacted very positively.
AES Model Portfolios Performance Analysis: First six-month period of 2012 When reviewing the portfolios each quarter, if they have not performed according to our expectations, we study the reasons for any over- or underperformance. This helps us determine if any changes should be considered; for example, if a particular fund within one of our portfolios has over-performed expectations in a given quarter because the fund manager is, in our opinion, taking excessive risks outside the parameters of that portfolio, we will consider replacing that fund with another more suited to the risk level of the portfolio.
International Investor SEPTEMBER 2012 | 11
With this in mind, attribution analysis shows us that performance excelled in the technology, fixed interest, foreign exchange and lastly, inflation linked strategies. We feel that while absolute performance has not been at the levels we would prefer for the year-to–date, the fact we have outperformed the FTSE100 and that many of our funds performed positively reassures us on our strategy. Themes which detracted from performance were energy and gold. The energy strategy is vulnerable to price fluctuations of oil and short-term global growth figures, both of which have been particularly affected by lacklustre second
Portfolio
€
£
$
quarter economic indicators coming from the US. Such indicators revealed a weaker recovery than had been hoped for, which in turn put downward pressure on the price of oil and energy prices causing the energy sector to underperform over this period. Going forward we still believe energy, as both a sector and strategy, will outperform over the long-term as the fundamental need for energy only increases. The gold sector has been much less favoured this year by comparison due to the continued pressure on the price of gold. This, in our view, has been rather illogical mainly because gold companies are currently being priced at below 2008
Absolute Performance to mid September
Performance Relative to Benchmark to mid September
crisis levels while still enjoying, relative to historical gold prices, huge revenue levels. We also believe inflation fears, US$ hedging and central bank buying will help in increasing the value of this precious metal. Our closing thoughts rest on the future which is why when investing in stock market assets, we maintain at least a five year, or preferably a ten year plus, stance. As such, we would also advise our clients of the same, avoiding short-terms views on investment portfolios. The structure of the AES Model Portfolios follows this investment philosophy, selecting themes we believe take advantage of future long-term trends in the global economy. Absolute Performance Since Inception to July 2012
Maximum Drawdown
AES Euro Aggressive Portfolio
7.87%
-0.56%
-0.62%
-16.20%1
AES Euro Balanced Portfolio
5.23%
-0.72%
0.59%
-9.61%1
AES Euro Cautious Portfolio
3.44%
-1.39%
5.15%
-2.58%1
AES GBP Aggressive Portfolio
4.71%
-5.01%
-7.26%
-17.98%2
AES GBP Balanced Portfolio
4.70%
-3.53%
0.54%
-8.52%2
AES GBP Cautious Portfolio
2.55%
-5.21%
3.96%
-3.83%2
AES USD Aggressive Portfolio
9.29%
1.66%
-3.68%
-20.33%1
AES USD Balanced Portfolio
6.02%
0.66%
-1.20%
-12.61%1
AES USD Cautious Portfolio
4.26%
0.38%
3.70%
-4.01%1
¹ARC benchmarks as published by ARC Advisory Group. ²Adviser Fund Indices as published by Trustnet.
12 | International Investor SEPTEMBER 2012
AES Portfolio Fund Manager Quarterly Updates Our AES Model Portfolios aim to draw on some of the best fund management talent to provide you with a range of portfolios which can be matched to your risk profile and currency preferences. Each of our carefully-constructed portfolios includes a selection of funds, especially chosen to work in a complementary manner to enhance the performance potential of the portfolio and to even out fluctuations. In this section, you’ll find commentary from some of these managers on the last quarter’s performance of their funds and their outlook for the next quarter. They provide insights about some of the economic conditions that have affected and will continue to impinge on performance going forward.
Thames River
neptune
global bond FUND
Neptune Global Equity Fund
Q2 12 commentary
Q2 12 commentary
Peter Geikie-Cobb and Paul Thursby June, the fund returned +0.44% versus -1.37% for the index. Markets reversed some movements experienced in May with 10-year government bond yields rising by 9, 38, 16 and 2 basis points in the US, Germany, UK and Japan respectively. Spanish yields fell 25 basis points with news of the eurozone summit solution to funding of the Spanish banking system. Consequently, the US dollar fell 2% against the EUR and GBP and 5% versus the AUD as the month closed with investors favouring the ‘risk-on’ trade and the S&P 500 Index rallied by almost 4%. However, core economic data in the major economies showed signs of slowdown, much as it did in the first half of 2011. In the US, employment data disappointed and survey data came in weaker across the board, although housing data appears to have stabilised with signs of improvement. In the US second quarter GDP looks as though it has slowed to about 1.5%. In the eurozone and the UK, economic data continues to look fairly dire and with the oil price falling a further 2% in June, markets are concerned about the outlook for growth in the emerging world. We continued running short duration positions in both Germany and the UK. It is becoming increasingly apparent that Germany is far from a safe haven given its ultimate exposure to peripheral eurozone liabilities. In the UK, there is little political appetite for further austerity and therefore the poor growth outlook will do little to help the deficit. More quantitative easing may support gilts in the short-term but ultimately inflation is the only way out for the major governments’ deficits. We are already seeing decent wage inflation emerge in both Germany and France. In addition, we have maintained the long USD position and in fact added to it slightly over the month. It is interesting to note that any sell-off in the USD as a result of ‘riskon‘ periods does not last for very long.
Robin Geffen The second quarter of 2012 was dominated by rising levels of uncertainty. Once again, the eurozone was at the heart of this ambiguity, with the French and Greek elections and the sovereign stress in Spain being the main causes for concern. However in the US, economic data deteriorated slightly which triggered investor concern about the sustainability of US growth and weighed on equities globally. Our views on the global economy have remained consistent and we expect that Europe will eventually ‘muddle through’ and that sufficient firewalls exist to prevent global contagion. We also believe that the US economy will remain healthy due to its continued manufacturing revival and that consumers will start to benefit from lower gasoline prices. Accordingly, we did not make any significant moves in the portfolio. We did, however, take advantage of price weakness to increase exposure to the US consumer via quality operators, such as Starbucks, which also offer good exposure to emerging market consumption. These acquisitions were funded by selling the more defensively orientated pharmaceutical company Novartis, and by locking in profits made in HSBC. Despite having one of our largest weightings in the US since inception, we were still underweight versus the Index and this weighed on the fund’s performance in the quarter. Our overweight in energy also detracted from performance. However, our continued zero exposure to eurozone financials was a positive contributor throughout the turbulence. We maintain conviction in our positioning and are positive on the outlook for the remainder of the year despite the challenges faced.
International Investor SEPTEMBER 2012 | 13
JPMorgan Funds
BNY Mellon
US Technology Fund
Global Strategic Bond Fund
Q2 12 commentary
Q2 12 commentary
Greg Luttrell and Greg Tuorto The fund outperformed its benchmark for the month as strong stock selection in the semiconductors and both positive stock and sector selection in the IT services sector aided performance the most. On a stock selection basis, our exposure to semiconductor company, Mellanox Technologies, was the top contributor to relative performance for the month. Mellanox’s stock rallied due to stronger-than-expected Q2 results. Additionally a lack of exposure to Informatica, which declined for the period under review, also added value. Meanwhile, our stock selection in the datacom/telecom and hardware sectors proved disappointing. Among the top detractors to relative performance was our lack of exposure to Seagate Technology and Western Digital. Additionally, an overweight position in Nuance Communications also proved disappointing. The provider of speech recognition technology used in devices such as the iPhone reported solid Q2 earnings. However, its share sold off as the company’s organic growth rate declined.
Portfolio Manager Comments for the current quarter We maintain a positive view on the technology sector despite the macro uncertainty. We are keenly focused on real-time updates from spending surveys from global enterprises. The positive results we are seeing give us confidence that our positioning will allow us to see solid growth prospects for all of our portfolio companies. Over the course of Q2 we reduced our software holdings slightly. With the proceeds, we increased our positioning slightly in the hardware, semiconductor and internet segments. Our holdings are focused on some specific dynamic trends in software as a service, security and big data. None of these areas are seeing declines in purchasing intentions. We slightly reduced our bet on smartphones as there could be a pause in the near-term as the iPhone 5 is becoming the most hotly anticipated new product in electronics (since iPad 3).
Thant Han In Europe, there are limited signs of improvement, as economic growth across the region continues to disappoint. Peripheral eurozone countries, including Spain and Italy, are facing recordhigh levels of unemployment. Although we view the steps taken at the latest summit of European Union leaders as positive, our outlook for the region remains cautious. We believe that more significant progress towards solving the problem of excessive debt levels is needed. The recent improvement in US housing data is encouraging for future construction spending, and falling oil prices should continue to support consumer demand. In our view, the US economy will grow during the second half of the year, albeit slowly. Due to investments in currency, the fund performed well over most of the second quarter of the year. However, due to the European debt crisis, the fund’s exposure to the euro negatively affected the fund. Yet this was balanced out by having exposure to the US dollar, Mexican peso and Japanese yen. In May, our investment in high-yield bonds (effectively a loan to a company that pays a higher level of income) and eurozone government bonds had a negative effect on performance. During June we were able to counteract almost all of this underperformance by investing in stronger US dollardenominated company bonds and European government bonds. Against this uncertain backdrop, we will continue to seek attractive investment opportunities, particularly in the government bonds of emerging market countries and the debt issued by US companies.
The AES Model Portfolios are engineered to meet the global demands of today’s investors and fluctuating markets; by lending quality features of traditional investments with innovative ideas in the sophisticated fund selection process.
14 | International Investor SEPTEMBER 2012
invesco
Legg mason
Energy Fund
WESTERN ASSET GLOBAL Multi Strategy Bond Fund
Q2 12 commentary
Andrew Lees and Tyler Dann
Uncertainty caused by the eurozone
Q2 12 commentary
debt crisis, slowing growth in China
The fund increased by 1.17% in US
and lacklustre economic data in the
dollar terms in June and recorded
US caused stock markets to falter in
a gain of 0.61% over Q2 of 2012.
the second quarter, giving up first
Ian Edmonds
quarter gains. The energy sector was among the market laggards,
Performance was helped in June by the fund’s exposures to high-yield
corporate bonds, emerging market debt, and investment grade corporate bonds.
underperforming the broader market during the quarter. Additionally, the fund
This was partially offset by rising core government bond yields. Aside from the
underperformed its benchmark, predominately as a result of stock selection
Japanese yen, the fund’s non-US dollar currency exposure also contributed
and an overweight position in the oil and gas equipment and services sector,
positively to its absolute performance.
as well as in oil and gas exploration and production stocks. An underweight
On the downside, the fund’s underweight position in US dollar-denominated
exposure in integrated oil and gas stocks also negatively impacted fund
sovereign emerging markets debt and its underweight exposures to the euro and
performance. We believe the US Federal Reserve policy of quantitative easing
the Australian dollar were performance detractors over the month.
will ultimately cause a weakening of the US dollar. This, combined with secular
The manager remains comfortable with the fund’s overall level of interest
demand for crude oil in China and India, will continue to underpin US dollar-
rate risk.. As the absolute level of core government bond yields reaches record
denominated crude oil prices. We also believe long-term increases in demand
lows, however, it is felt that the marginal benefit of holding duration as a hedge
and limited production capacity offer the potential for long-term appreciation
against risk asset positions diminishes.
within the energy sector. Current reductions in supply will exacerbate future
The manager’s assumption that the global economy should continue to
supply constraints. Our stock selection continues to focus on companies that
expand at a moderate pace remains in place, but feels that the risks of a weaker
exhibit the ability to control costs and increase production profiles with new
outcome have risen significantly. The fund is positioned to benefit from the wide
discoveries, or by working existing assets.
risk premiums in investment grade and high-yield corporate bonds, as well as select emerging markets.
BLACK ROCK
Pictet
Q2 12 commentary
Q2 12 commentary
Markets reacted strongly to
The fund underperformed the
macroeconomic news in the second
benchmark during the second
quarter. The possibility of Greece
quarter. Global and sector allocation
gold and general & world gold funds
Evy Hambro
leaving the euro rattled confidence
and Spain became the fourth eurozone country to request a bailout, keeping
Euro Corporate Bond Fund
Frederic Salmon
contributed marginally to the underperformance owing to the risk
the EU crisis well-fuelled. China cut interest rates for the first time since
reduction at the end of first quarter. Our short duration explains the main part,
2008, a 0.25% reduction. For those who welcomed the monetary loosening,
while at the individual level Spanish and Italian names generated either excess
there were those, seemingly equal in number, who feared it would signal a
or under-performance depending on our exposure.
slower-than-anticipated growth rate in the world’s second-largest economy. A conclusive outcome to the Greek election and expectations of some constructive political policy from the EU summit laid the foundation for a relief rally in stock markets at the end of the quarter.
Market outlook The European crisis will keep on driving risky assets for the coming months, and the economic slowdown should not make investors feel any
The gold price took much of its direction from rhetoric around a third
better. We should face a new set of rating downgrades during this earnings
round of quantitative easing (in which billions of dollars in new money is
season, mostly within the cyclical issuers. Some of them should drop to the
created) in the US and, entwined with it, the strength of the US dollar. The
high-yield space. However, within this depressed environment, it is worth
price volatility was facilitated by some sharp moves in speculative positions
mentioning some positive factors such as the low-yield environment which is
in gold futures markets, in which traders bet on the likely future direction
pushing investors towards higher-yielding assets, the collapse in commodity
of prices. Data released during the period indicated, however, that the gold
prices, which eases margin pressures for the next quarter, and supportive
price appears to be underpinned by a solid ownership base.
measures to help the financial sector. Thus, the second quarter earnings season
Shares in gold-mining companies are trading at attractive valuations
will corroborate the negative perception. The question is how much bad news
on a number of variables. Strong profit margins in the gold-mining industry
has already been priced in? Even if we believe the slowdown is already priced
have enabled companies to deliver record earnings. Free cash-flow levels are
in for the largest companies, the current market stress prevents us from taking
high and dividends are beginning to increase, while rising dividends are set
too large a bias.
to increase the attractiveness of gold shares relative to their key competitor - gold Exchange Traded Funds (ETFs) - which track the price of bullion.
International Investor SEPTEMBER 2012 | 15
martin currie china
clareville
the pegasus fund
the china fund
Q2 12 commentary
David Yarrow and Angus Donaldson
Risk appetite reversed sharply in
Q2 12 commentary
Q2. April started well, the fund was
It was a weak quarter for the market,
+2.4% thanks to contributions from
as investors worried about slowing
two of our biggest short positions,
economic growth in the Greater
Supergroup & Man Group. However performance reversed in May, -2.2%,
James Chong
China region and the on-going debt crisis in Europe. The MSCI Zhong Hua
as sovereign debt concerns dominated. Within the context of the FTSE 100
index fell 3.4% in sterling terms during the quarter. The fund outperformed its
falling 7.3% this should be considered one of our better months especially
benchmark by 0.6%.
when we consider the fund was 72% net long going into May. Unsurprisingly,
Top contributors included Kweichow Moutai, one of China’s largest liquor
the short book did most of the work for us again. Of particular note was the
producers, which reported earnings ahead of expectations. Want Want, China’s
short in Man Group.
largest maker of rice cakes and flavoured milk, also helped performance. The
Also on the short side, Homeserve continued to disappoint. Homeserve
portfolio’s property holdings performed relatively well. Within the banking sector,
made its business, during the boom times, based on aggressive selling of
the shares of Bank of China Hong Kong rose on news that the Chinese government
appliance home insurance policies, typically boilers. The problem with a hard
will introduce new measures aimed at promoting the development of the offshore
selling, highly incentivised sales force is the need to sell can override the need
renminbi market in Hong Kong.
to adhere by the rules. It is not a surprise to us that the FSA have much to look
On the negative side, the portfolio’s holdings within materials detracted
at regarding Homeserve’s selling practices; it seems likely a fine will follow
from performance. The sector saw widespread earnings downgrades throughout
although the real damage is reputational. Thus far their overseas businesses
the quarter. Investment-holding company Tencent, which is not held within the
have been largely unaffected by the problems at home. We feel Homeserve will
portfolio, was another detractor from relative performance.
do well to keep it that way. June reversed a part of our outperformance in May. The fund was -1.5%
We maintain a cautious view of the market. We still firmly believe in China’s solid, long-term structural growth story, and, in particular, in those opportunities
against a bounce back in the All-Share index which was +4.5%. Given the
arising alongside the country’s social, financial and cultural reforms. That said,
reduced exposure we had as a result of our caution in May this should not be a
we also anticipate that economic recovery could take longer than expected, and
major surprise.
that this new round of loosening and stimulus is less likely to have the significant impact that it did last time.
AES International is able to offer clients a diversified investment proposition where overall risk control is achieved by the careful selection and combination of managers pursuing different investment disciplines across their respective asset classes.
16 | International Investor SEPTEMBER 2012
AES Model Portfolio Asset Allocation Euro Aggressive emx
KEY: Commodity & Energy | 28.76%
Money Market | 6.92%
North American Equities | 20.33%
European Equities | 3.95%
Alternative Investment Strategies | 14.00%
Other International Equities | 3.13%
Asia Pacific Equities | 9.69%
Global Emerging Market Equities | 2.50%
Global Fixed Interest | 7.52%
Other | 3.21%
Euro Balanced emx
KEY: Global Fixed Interest | 46.01%
Asia Pacific Equities | 2.97%
Commodity & Energy | 23.00%
European Equities | 2.80%
Money Market | 9.55%
UK Equities | 1.95%
UK Fixed Interest | 7.52%
Japanese Equities | 1.05%
North American Equities | 2.97%
Global Emerging Market Equities | 0.18%
Euro Cautious emx
KEY: Global Fixed Interest | 67.27%
North American Equities | 0.65%
UK Fixed Interests | 12.00%
UK Equities | 0.35%
Alternative Investment Strategies | 10.00%
Asia Pacific Equities | 0.24%
Money Market | 9.67%
Global Emerging Market Equities | 0.03%
Japanese Equities | 0.77%
European Equities | -0.96%
International Investor SEPTEMBER 2012 | 17
GBP Aggressive emx
KEY: Commodity & Energy | 26.13%
European Equities | 5.07%
Asian Pacific Equities | 20.72%
UK Equities | 4.58%
North American Equities | 20.55%
Other International Equities | 1.92%
Alternative Investment Strategies | 13.00%
Japanese Equities | 1.64%
Money Market | 6.23%
Global Emerging Market Equities | 0.18%
GBP Balanced emx
KEY: Global Fixed Interest | 47.97%
Asia Pacific Equities | 2.76%
Commodity & Energy | 20.33%
European Equities | 2.60%
Money Market | 13.22%
UK Equities | 1.81%
UK Fixed Interest | 5.57%
Japanese Equities | 0.98%
North American Equities | 4.62%
Global Emerging Market Equities | 0.17%
GBP Cautious emx
KEY: Global Fixed Interest | 35.67%
Asia Pacific Equities | 2.81%
Fixed Interest | 13.74%
Convertibles | 2.48%
UK Fixed Interest | 12.69%
UK Equities | 1.88%
Money Market | 12.55%
North American Equities | 1.84%
Other International Equities | 12.41%
Other | 3.92%
18 | International Investor SEPTEMBER 2012
USD Aggressive emx
KEY: Commodity & Energy | 28.76%
Money Market | 6.92%
North American Equities | 20.33%
European Equities | 3.95%
Alternative Investment Strategies | 14.00%
Global Emerging Market Equities | 3.13%
Asia Pacific Equities | 9.69%
Other International Equities | 2.50%
Global Fixed Interest | 7.52%
Other | 3.21%
USD Balanced emx
KEY: Global Fixed Interest | 48.98%
Asia Pacific Equities | 2.12%
Commodity & Energy | 23.00%
European Equities | 2.00%
Money Market | 9.74%
UK Equities | 1.39%
UK Fixed Interest | 8.34%
Japanese Equities | 0.75%
North American Equities | 3.55%
Global Emerging Market Equities | 0.13%
USD Cautious EMX
KEY: Global Fixed Interest | 72.10%
North American Equities | 0.51%
Alternative Investment Strategies | 10.00%
UK Equities | 0.33%
Money Market | 9.61%
Asia Pasific Equities | 0.24%
UK Fixed Interest | 7.36%
Global Emerging Market Equities | 0.03%
Japanese Equities | 0.75%
European Equities | -0.93%
International Investor SEPTEMBER 2012 | 19
Glossary Risk-on trade
— When traders feel more positive about the market or economy, they feel safer taking on risk. They will move out of cash and treasuries and into stocks, commodities and the like. This is oppose to ‘risk off’ when they don’t feel good about how the market or economy is doing so they move out of the stock market and into ‘safe’ places like cash and treasuries.
Long or Long position
— When you buy a stock from the long side, you are purchasing the shares with the hope that they will rise in price.
Short or short position
— A short position in an investment indicates a position in an investment that would increase in value as the underlying asset(s) decrease in value.
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