A Few Predictions for the New Year (and Beyond)
Now that we are a couple weeks into the New Year, most economists, market strategists, bloggers and other prognosticators have already pushed the send buttons on their annual forecasts for stock market levels, interest rates, foreign exchange rates and the like. Most will be off the mark come year-end, but that never seems to stop them from gazing into their crystal balls and letting the world know what they see. Some have called for more aggressive Fed interest rate hikes, while others predict a “one and done,” on the view that a weakening economy plus an election year will minimize the likelihood of additional increases to official short-term interest rates. Many have made bold predictions for the dollar after two strong years of gains against other currencies (a major challenge for our global portfolios), and plenty have thrown out their guesses for stock market returns around the world.
Our investment team here at FIM Group is constantly asking hard questions about the future. After all, our jobs ultimately come down to making informed, thoughtful judgments about the magnitude and probability of the long-term future cash flows generated by every position we own (this is the essence of fundamental investment analysis). We structure portfolios with investments made as a result of these judgments, and constantly work to refine them as the future becomes “now” and our outlooks for the future evolve.
Rather than add to the pile of prognosticator outlooks for this Year of the Monkey (and let’s face it, many of these forecasts for 2016 stock, bond and currency returns will be no more accurate than those made by a room full of monkeys), We’ll share a few predictions that are effectively reflected in the way we are structuring client portfolios today. We don’t expect these to necessarily play out over the next 12 months (far too many factors, like government policies, interest rate changes, currency valuation, business cycles can have outsized influence over a short time period), but we do have high confidence that over our investment strategy-appropriate time horizons (ranging from three to five years at FIM Group), these predictions will play out in our client portfolios’ favor.
Prediction #1: Value Investing Will Once Again Come Back Into Style
In last month’s newsletter, we noted the underperformance of “value” investments versus “growth” investments globally these last few years. Most studies show that over longer time frames, investment strategies incorporating valuation criteria instead of just revenue and earnings growth have delivered superior performance. Data also shows that after extended periods of weak relative performance, subsequent recoveries for “value” strategies have been quite robust. In the chart below, the post-tech-bubble early 2000s perhaps best represent this phenomenon. While relative performance is not our primary concern here at FIM Group (we care most about generating absolute performance over strategy-appropriate time horizons), the outlook for a value “rebound” is as good as it’s been in years. As FIM Group portfolios are chock-full of these investments, we should benefit as this broad cycle comes back our way.
Prediction #2: Closed-End Fund Discounts Will “Revert” to More Normal Levels
Recall that a closed-end fund trades independent of the market value of its holdings (also known as net asset value or NAV). Because of this, there are periods, usually when investors are nervous about the future, where the funds can trade at 10%-20% below NAV (and in extreme cases even cheaper). This effectively allows us to buy $1 worth of assets for less than 80-90 cents and wait for the discounts to revert back to their average levels or even close back to NAV. This discount normalization acts as a return bonus to any income distributions and NAV improvements made during our holding period. In 2015, discounts across the closed-end fund world widened to levels not seen since the financial crisis. This widening comes, interestingly enough, during a period where the supply of closed-end funds is shrinking and as activist investors press fund boards of directors to take actions that can reduce such discounts.
For example, in 2011, there were almost 700 closed-end funds in existence, while at the mid-point of 2015 there were only 565. Meanwhile, fund boards are increasingly directing their funds to buy back stock, merge into open-end funds, and liquidate funds as proactive measures to reduce or eliminate discounts. In 2015, we saw several FIM Group holdings benefit from such action (including ACG, SGL and FTT), and we expect more of these actions in the years ahead. This, plus renewed investor demand as the historically large discounts attract value-oriented investors, is likely to pressure discounts back down and provide an additional return driver for our closed-end fund holdings.
Prediction #3: Demand for Life’s “Basics” Will Stay Resilient Through the Uncertainty Ahead
Could we have a recession in the next few years? If history is any guide, that seems likely. Will consumers cut back in certain areas during such an economic downturn? That seems likely too. But as we all know, there are certain bills that must get paid first. It seems reasonable that even in a future recession, consumers will stay current on their water bills, hospitals will pay their rents, and well-financed utilities will honor their power purchase agreements with those producing the power they distribute to their customers. FIM Group portfolios include a healthy allocation to companies exposed to these essential services like Global Water Resources (Phoenix-based water utility), Capstone Infrastructure (solar and wind power production and water distribution), and Medical Properties Trust (world-class hospital owner throughout the U.S. and Europe and featured in this month’s Portfolio Team Spotlight).
Prediction #4: Global Demand for Health and Wellness Products and Services Will Remain Robust
It’s no secret that consumers around the world are increasingly demanding products and services that improve their health and wellness. In developed countries, some of this demand comes from the dual demographic wave of Boomers who desire to stay active in their retirement years and Millennials adopting healthier pathways earlier in life. Across emerging economies, billions of newly minted middle classers are also spending discretionary income on wellness-improving things. FIM Group portfolio holdings stand to benefit from these trends across a wide spectrum. Gaiam, for example, is bringing yoga goods to the masses via stores like Target and Kohl’s. Singapore-listed OSIM International is selling massage chairs, nutritional supplements (as a GNC franchisee) and high-end tea throughout Asia. Ten Peaks (a chemical-free decaffeinated coffee producer) and Sunopta (one of the largest sourcers, processors
and packagers of non-GMO and organic foods) are both bringing healthier food options to North American consumers. And IHH Healthcare, a major hospital group held by Symphony Holdings, is filling healthcare gaps throughout Asia and the Middle East. The list goes on, but needless to say, we expect our portfolios to benefit from this bullish long-term trend.
Prediction #5: Skilled Management Teams Will Continue to Positively Transform Companies
Part of our investment strategy at FIM Group is to allocate funds to corporate turnarounds and other situations where a successful investment result is much more dependent on company-specific actions than on broader economic or sector growth tailwinds. Cott Corp, for example, is developing a leading North American home and office beverage delivery business that will transform the company away from reliance on its slowly declining private label carbonated soft drink manufacturing business. FirstGroup PLC, a U.K.-based public transportation company with U.S. and U.K. bus and train operations, is in the early stages of a company-wide cost savings initiative that offers a good chance of boosting profitability even without robust top-line growth. Immofinanz, an Austrian commercial real estate company, is rationalizing its valuable Eastern European real estate portfolio by selling its non-core logistics and residential properties to focus ahead on its under-appreciated retail and office assets. We believe that actions like these can boost a company’s future cash flow generation and therefore boost the return profile of our portfolios through a wide range of global economic scenarios.
Prediction #6: Currencies Will Remain a Performance Swing Factor
FIM Group has always been a global investor. We believe that historically our willingness to invest abroad has benefitted clients. Including international stocks and bonds into the portfolio mix offers diversification benefits and opens up return opportunities not available to U.S.-only portfolios. It does, though, create several additional elements for us to contend with, and one of these elements is foreign currency movements.
2015 was the year of the greenback, as the dollar appreciated strongly against just about every other currency we invest in. The Singapore Dollar, for example, dropped about 6% against the dollar, the Euro 10%, and the Canadian dollar more than 15%. Emerging market currencies like the Russian Ruble (-20%) and the South African Rand (-25%) fared even worse. These currency movements negatively impacted our performance in 2015 and will remain a swing factor in the years ahead, adding or subtracting to the interest, dividends and price appreciation we earn from our foreign investments. We view most of the foreign currencies that we invest in as undervalued relative to the dollar. As such, we expect that even though we’ll have years like 2015 where the dollar spikes higher, the longer-term impact from currency exposures in our portfolio will predominantly be a positive one.
Prediction #7: Governments Will Continue to Interfere (and Create Great Investment Opportunities)
The notion of “market economies” is largely a relative one. Governments around the world manage their economies to various degrees with the goal of benefitting their citizens (or at least themselves) via all sorts of interventions. These include things like trade, regulatory, fiscal and monetary policies which frequently send waves through our globally connected financial markets. With 196 countries in the world engaging in a complex dance of maximizing the benefits to their own populations without causing too much pain abroad, the results are often less than pretty. At times (some would argue most of the time), these interventions end up backfiring and/or causing dislocations that patient investors like FIM Group can benefit from.
One example of this is the current disruption in energy markets, in part the result of aggressive Saudi government policies. This disruption has led to fire sales across a wide range of stocks and bonds in regions and sectors perceived to be permanently impacted by the lower oil price (real estate companies with modest Russian exposure like Atrium Real Estate is just one example of this). For our team, we expect such government interference in economies to provide continued investment opportunities. The fact remains that such interference often leads to unintended consequences, investor over-reaction and significant value for those like us who can take a more patient, longer-term view.
Anticipating a Year of Noise, Volatility and Compelling Investment Opportunity
2016 will surely give our team plenty of “noise” and associated market volatility to sort through. We have little skill in forecasting election outcomes, short-term movements in interest rates or currencies, or the more-often-than-not irrational behavior of our fellow market participants, so our confidence in predicting 2016 developments along these lines is quite low. It is hopefully clear that we won’t be betting the portfolio “farm” on guesses related to these areas. Instead, we will stick with our beliefs in the areas mentioned above. We will stay value-oriented in our investing and search out high-conviction ideas in areas like closed-end funds, “mission critical” products and services, bullish secular themes like health and wellness, and companies with value-adding management teams.