Rootstock SCI Worldwide Flex comment - Mar 19
The Rootstock Fund delivered a top-quartile performance for the one-year period ended 31 March 2019, with a return of 15.8%. This performance masks the pandemonium in financial markets during the past twelve months. At the end of 2018, the Fundfs one-year performance was negative 4.3%. The dramatic reversal can be attributed to a recovery in some of our large holdings and several investment views coming to fruition. Over the longer term, the Fund maintains its top-quartile above-benchmark performance. This is detailed on page three.
Our work is never complete. The investment team has undertaken an in-depth review of all our holdings, ensuring they have the business characteristics and growth prospects we desire and are free from major capital-destroying company-specific risks. Valuations, a critical component of our investment process, have been reviewed and stress tested. Moreover, we continue to debate and, where necessary, adjust weights of constituents to manage the imperceptible risks concealed in the structure of our portfolio. This process leaves us satisfied that the Fund is well positioned to deliver, on its mandate of inflation + 5%, real wealth-generation over time.
On the domestic front, in the build-up to national elections, the South African economy is approaching stall speed. The lack of business confidence, painfully-high real lending rates, the ongoing implosion of state-owned enterprises and policy uncertainty does not portend a rosy post-election outlook, regardless of the outcome. Unfortunately, endemic structural inefficiencies are no closer to remedy and will remain a handbrake on growth.
On the JSE All Share, the pickings are meagre. The investable universe reflects the decade-long deterioration of the South African business environment. There are few stocks that make the grade on both our quality and valuation criteria, with only a handful of South African companies presenting long-term value, in our opinion. For quite some time, the Rootstock Fund has been focused offshore where the opportunity set is deep and rewarding.
Abroad, the much-vaunted synchronised global growth of mid 2017 has dissipated, replaced with the spectre of recession. Economic data points from the US are conflicting. Fears over economic growth have augured Federal Reserve-mandated interest rates to remain flat for the year. Short-term treasury yields now exceed long-term treasury yields, an indicator that has presaged recession in the past. Opposing, real-world economic indicators point to things going quite swimmingly for the consumer. Unemployment is at historical lows, wages are rising, inflation is quiescent, residential building starts are strong and retail sales buoyant. All point to a healthy and growing economy. Curiously, esoftf data on consumer expectations do not align with this seemly lived reality. Market volatility reflects this dissonance.
The US and China remain at loggerheads, despite some moderation of rhetoric in their trade dispute. Brexit, an own-goal by the British ruling class, is an unmitigated mess, reflecting the tormented soul of democracy. Brussels, playing hard ball with the United Kingdom, and increasingly haunted by the rise of EU-wide nationalist sentiment, is not making the withdrawal process any easier. The European Central Bank, rapidly approaching gdo whatever it takesh mode, is trying to arrest painfully-slow economic growth.
Despite the uncertainty, the outlook for investment markets are not as dire as a cursory reading of financial media may lead you to believe. Consumers will continue to consume, technology, presently machine learning and cloud computing, will drive productivity, new business models will disrupt, more people will travel, and standards of living will continue to rise. In the chaos presented in investment markets, our challenge remains to find quality businesses at fair valuations that deliver relevant and profitable goods and services.
In the presence of slowing global growth, lofty equity valuations and continued market volatility, the Fundfs equity exposure remained unchanged from the 77% at the end of 2018. Foreign-equity exposure, measured as a percentage of our total-equity holding, remains high at 88%.
South Africafs dearth of growth opportunities and poor economics are reflected in market prices. At quarter end, two of our South African holdings, namely Clientele and Pioneer Foods, detracted from an otherwise strong quarterly performance.
A notable event in the quarter was Naspersf proposed unbundling to existing shareholders, and listing 25%, of a European company temporarily named NewCo. NewCo will hold all Naspersf underlying assets excluding Takealot and Media24. Naspersf management argue that such a listing will allow foreign investors and tracking funds, currently restricted from investing in South Africa, to access the counter, serving to reduce the perennial .40% discount to nett asset value at which it trades. While the argument has some merit, the greater part of the discount is likely due to the opacity in the shareholder control structure, rather than a large pool of investors being restricted from investing in Naspers. Whatever the outcome, this is a step in the right direction and lays the ground work for the ultimate break-up of the group. An unbundling of its highly-valuable underlying assets, primarily Tencent, but including its Classifieds, Food Delivery and Payments Processing businesses may be on the horizon.
In other news, the Fundfs holding in MTU Aero Engines, who produce engine components for the enormously-popular Airbus A320 series of aircraft, has been a strong performer, showing remarkable stability in volatile markets. MTU, with a full-capacity order book of some eight years, stands to be a significant beneficiary of airlines increasing preference for Airbus-manufactured commercial aircraft.
We remain cautiously optimistic about the return prospects of the Rootstock Fund. We believe our focused investment philosophy and diligent investment process, which we discussed last year, will protect our investors from potential landmines in financial markets while allowing us to capitalise on exciting opportunities.We highlighted the importance of original research and having eboots on the groundf. A good example of this is a recent research trip to the United States where we met with several companies based in Illinois, Michigan and Ohio. We met with management, inspected production facilities and reviewed product and service offerings. The field research enabled us to identify several new investable opportunities that satisfy our investment criteria. Moreover, the research also confirmed our concerns around a number of industrial companies left behind by technology. Some of their valuations seemed too good to be true.
During the quarter we took several actions to improve the quality and return prospects of the Fund. We sold Transaction Capital at R17.2, for a modest gain on our purchase price of R14.7, enjoying generous dividends along the way. The company will most likely continue generating healthy returns over the next few years. Notwithstanding, we have erred on the side of caution. Recent developments have raised material governance and operating-complexity risks. Firstly, SA Taxi, a subsidiary of Transaction Capital, recently announced that the South African National Taxi Council (SANTACO), the body governing for all major minibus taxi associations, will acquire a 25% interest in the company, partly vendor financed by Transaction Capital with substantial third-party finance from Future Growth (Old Mutual) and Standard Bank. The transaction improves Transaction Capitalfs BEE rating and holds various client-alignment and operational benefits. However, SANTACO has a colourful history and is a questionable long-term business partner. New conflicts of interest also emerge. Secondly, Transaction Capital has a small, although growing, appetite for overseas deals. We believe that capital allocation risk has increased and so too the complexity of the business model. The risks now inherent in Transaction Capital are beyond our tolerance.
Amadeus IT Holdings, a familiar name to our long-term investors, was reintroduced to the portfolio. We previously disposed of our holding in Q3 2017 after the company reached our estimation of fair value. Recent share price weakness, a decline from a high of .82 to .58, has significantly increased return prospects. The company provides a mission-critical ITbackbone to the airline industry and has a 43% global market share for flight bookings. Airlines, online and offline travel agencies use Amadeus to book flights for their clients. In addition, Amadeus offers airlines, airports and hotels the platform to manage their inventory, board passengers efficiently and provides a host of other essential airline-IT services. The companyfs dominant position and indispensable service offering makes it difficult to disrupt. The business is highly profitable with a stable and predictably-growing revenue base. A great business at an attractive valuation.
Lingering in the travel department, Booking Holdings is now one of our largest positions. Booking is the owner of the online hotel-booking platform Booking.com. Like Amadeus, Booking has a dominant market position and offers an efficient, high-quality service. Its revenue growth is underpinned by a growing demand for travel which has historically grown at a multiple of global GDP expansion.
The first quarter of 2019 has been a boon for investors. Global equity markets, as measured by the MSCI World Index in US dollar, recovered 12.7% for the quarter. This stands in stark contrast to the 2018 full year loss of 8.2%. Although global economic growth may slow, it nevertheless remains robust by traditional economic measures. South Africa, on the contrary, is struggling to show any signs of meaningful growth, which clearly reflects in the share prices of local companies and the weakening of the rand.
Our focus on international investment opportunities persists, although we selectively invest in high-quality local companies. Indeed, several local prospects appear exceptionally cheap, however, with no avenue to generate meaningful growth along with rising cost pressures, remain value traps.
The Rootstock team maintains its single-minded focus, looking to capitalise on the everevolving investment opportunity set. We diligently adhere to our focused investment philosophy and measured investment process. We pride ourselves on transparency and full disclosure. As a reminder, all our investors have access to the entire, real-time Rootstock portfolio online. Please feel free to get in touch if you have any questions regarding the Rootstock Fund and its holdings. Our door remains open, and we are always available to assist. As ever, we strive to preserve and grow your, and our, capital as best we can. We thank you for your continued support.
The portfolio may invest in global and local securities, government, corporate and inflation linked bonds, debentures, non-equity securities, property shares, property related securities, preference shares, money market instruments and asset in liquid form.
The portfolio may also invest in participatory interests and other forms of participation in portfolios of collective investment schemes or other similar schemes operated in territories with a regulatory environment which is to the satisfaction of the manager and trustee of a sufficient standard to provide investor protection at least equivalent to that in South Africa and which is consistent with the portfolio's primary objective.
The manager may make active use of listed and unlisted financial instruments to reduce the risk that a general decline in the value of equity, property and bond markets may have on the value of the portfolio. The manager shall have the maximum flexibility to vary assets between the various markets, asset classes and countries to reflect the changing economic and market conditions.
Nothing in this supplemental deed shall preclude the manager from varying the ratios of securities or assets in liquid form in changing economic environment or market conditions, or to meet the requirements in terms of legislation and from retaining cash or placing cash on deposit in terms of the deed and this supplemental deed.
The Manager will be permitted to invest on behalf of the portfolio in offshore investments as legislation permits.