Commentary
2023 Performance
A year is the time it takes the Earth to complete one orbit around the Sun. Important if you are planting a crop; less so if you are appraising the performance of a long-term investment strategy. The Oldfield Partners Global Income Fund is a case in point. In 2022 fund performance lagged the benchmark by 20%, and this year it is ahead by 17%. Same approach, same process, very different outcomes – simply based on where one anchors a starting point. While we therefore do not want to dampen enthusiasm for the fund, we equally would note that we do not either celebrate or despair at annual performance, and that the following insights are but a page-turn for a long-term approach.
The 20% return for the fund can be broken into four buckets: Fairfax (+4%), recovery of the bottom-5 performers from 2022 (+8%), new investments made in 2023 (+5%) and other holdings (+4%). We will discuss JD Wetherspoon and Fairfax, the two main contributors in 2023, in more detail later.
2023 was an active year in terms of new investments with ten new names added during the year. Many of these new additions were small- and mid-cap companies that we have been following for several years. As 2023 once again saw investors flood to high-priced US large-cap technology companies, the valuations of many small- and mid-cap companies became very attractive, and we seized on this opportunity.
As commented on later, there are two core tailwinds which we expect to contribute to expected returns. Firstly, the portfolio prospects due to the operational recovery potential in holdings that have been weaker in recent years. Second, the outlook for the new holdings added during 2023.
Contributors and detractors
In 2023 the fund rose 20.3% while the MSCI World High Dividend Yield Index rose 3.4% in GBP. The largest negative contributors to performance included two Chinese linked stocks (Alibaba and LG H&H) and two tobacco companies (Philip Morris and KT&G). The two largest positive contributors to performance were JD Wetherspoon and Fairfax.
Alibaba, the Chinese internet company, initially announced that it was going to split into six separate divisions with the possibility of IPOing or selling stakes in each of the divisions other than the core Chinese ecommerce business. The company then subsequently announced that it was not going to spin off its Cloud business. Furthermore, both Alibaba and LG H&H are suffering from a weak Chinese consumer. Adjusting for Alibaba’s net cash, the shares are still trading at around seven times net earnings. Whilst both Alibaba and LG H&H have been disappointing investments until now, we believe they represent attractive value with significant upside and exposure to recovery in Chinese consumer sentiment.
Philip Morris and KT&G were broadly flat in a year where most of the portfolio was up. This is not surprising as both are considered “safe heaven” consumer staples and therefore tend to outperform in weak markets (as they did in 2022) and underperform in strong markets. As commented on in recent newsletters, we are very optimistic about the growth potential from reduced-risk tobacco products of both Philip Morris and KT&G which we do not believe the market is giving sufficient credit to.
Fairfax, the Canadian insurer, has three engines that drive earnings: underwriting profit, investment income and non-insurance profit. All three engines continued to fire on all cylinders in 2023 – as was also the case in 2022. The first engine – underwriting profit – is benefitting from a “hard” insurance market and excellent management of capital by Fairfax, enabling significant growth in the insurance book at attractive levels of profitability. Fairfax’ earnings power from underwriting profit exceeds $1bn which it will almost certainly surpass in 2023. The second engine – investment income – is benefitting from higher interest rates. The yield on invested assets has increased from 1.3% in 2021 to 3.6% in Q3 2023. The earnings power from investment income at current rates exceeds $2bn. The third engine – non-insurance profits – benefits from strong performance in Fairfax’ associates and consolidated investments. The earnings power from non-insurance profits exceeds $0.5bn. Adding the three engines, Fairfax trades at less than ten times current earnings power before allowing for any benefit from gains on equity investments. We believe this is attractive, particularly considering that Fairfax has grown its earnings power by at least 10% per year over the long run.
Q4 2023 Portfolio activity
As commented on, we identified several attractive investment opportunities in 2023, particularly amongst small- and mid-cap companies. In Q4 we added new positions in Heineken, Brembo, Shell, WK Kellogg and sold our positions in Investor and Samsung as they reached our target price.
Investor had been in the fund since inception over which time it provided a total return of 850% or just over 20% per annum. It goes without saying that selling such a strong performer is difficult but, we believe, demonstrates the attractiveness of the opportunities we are finding. Samsung has also been a good investment with annualised returned of 15% since it was purchased in March 2020. Like Investor, we sold Samsung because we felt new opportunities were more attractive and not because our fundamental view on the company changed. Shell was funded by selling half our position in BP, which had become a nearly 8% position. We consider the change attractive because we diversified our risk without impacting the overall upside. Both companies are valued at around six times this year’s earnings and are returning most of that to shareholders through dividends and buybacks.
Brembo is an Italian manufacturer of braking solutions for automotive vehicles. It has specialised in braking solutions since it was founded in 1961 by Alberto Bombassei who remains the majority shareholder. Brembo is a global business with most of its solutions going into passenger cars.
Brembo’s key products are disks and calipers which are essential parts of vehicle braking systems. Its brightly coloured calipers can be seen behind the wheels of most premium/luxury cars and are considered a car culture status symbol among car enthusiasts. Brembo is the clear global leader in calipers for the premium/luxury segment with c. 80% market share. It is sole-supplier to the likes of Ferrari and it supplies all the Formula 1 racing teams.
Commentary
2023 Performance
A year is the time it takes the Earth to complete one orbit around the Sun. Important if you are planting a crop; less so if you are appraising the performance of a long-term investment strategy. The Oldfield Partners Global Income Fund is a case in point. In 2022 fund performance lagged the benchmark by 20%, and this year it is ahead by 17%. Same approach, same process, very different outcomes – simply based on where one anchors a starting point. While we therefore do not want to dampen enthusiasm for the fund, we equally would note that we do not either celebrate or despair at annual performance, and that the following insights are but a page-turn for a long-term approach.
The 20% return for the fund can be broken into four buckets: Fairfax (+4%), recovery of the bottom-5 performers from 2022 (+8%), new investments made in 2023 (+5%) and other holdings (+4%). We will discuss JD Wetherspoon and Fairfax, the two main contributors in 2023, in more detail later.
2023 was an active year in terms of new investments with ten new names added during the year. Many of these new additions were small- and mid-cap companies that we have been following for several years. As 2023 once again saw investors flood to high-priced US large-cap technology companies, the valuations of many small- and mid-cap companies became very attractive, and we seized on this opportunity.
As commented on later, there are two core tailwinds which we expect to contribute to expected returns. Firstly, the portfolio prospects due to the operational recovery potential in holdings that have been weaker in recent years. Second, the outlook for the new holdings added during 2023.
Contributors and detractors
In 2023 the fund rose 20.3% while the MSCI World High Dividend Yield Index rose 3.4% in GBP. The largest negative contributors to performance included two Chinese linked stocks (Alibaba and LG H&H) and two tobacco companies (Philip Morris and KT&G). The two largest positive contributors to performance were JD Wetherspoon and Fairfax.
Alibaba, the Chinese internet company, initially announced that it was going to split into six separate divisions with the possibility of IPOing or selling stakes in each of the divisions other than the core Chinese ecommerce business. The company then subsequently announced that it was not going to spin off its Cloud business. Furthermore, both Alibaba and LG H&H are suffering from a weak Chinese consumer. Adjusting for Alibaba’s net cash, the shares are still trading at around seven times net earnings. Whilst both Alibaba and LG H&H have been disappointing investments until now, we believe they represent attractive value with significant upside and exposure to recovery in Chinese consumer sentiment.
Philip Morris and KT&G were broadly flat in a year where most of the portfolio was up. This is not surprising as both are considered “safe heaven” consumer staples and therefore tend to outperform in weak markets (as they did in 2022) and underperform in strong markets. As commented on in recent newsletters, we are very optimistic about the growth potential from reduced-risk tobacco products of both Philip Morris and KT&G which we do not believe the market is giving sufficient credit to.
Fairfax, the Canadian insurer, has three engines that drive earnings: underwriting profit, investment income and non-insurance profit. All three engines continued to fire on all cylinders in 2023 – as was also the case in 2022. The first engine – underwriting profit – is benefitting from a “hard” insurance market and excellent management of capital by Fairfax, enabling significant growth in the insurance book at attractive levels of profitability. Fairfax’ earnings power from underwriting profit exceeds $1bn which it will almost certainly surpass in 2023. The second engine – investment income – is benefitting from higher interest rates. The yield on invested assets has increased from 1.3% in 2021 to 3.6% in Q3 2023. The earnings power from investment income at current rates exceeds $2bn. The third engine – non-insurance profits – benefits from strong performance in Fairfax’ associates and consolidated investments. The earnings power from non-insurance profits exceeds $0.5bn. Adding the three engines, Fairfax trades at less than ten times current earnings power before allowing for any benefit from gains on equity investments. We believe this is attractive, particularly considering that Fairfax has grown its earnings power by at least 10% per year over the long run.
Q4 2023 Portfolio activity
As commented on, we identified several attractive investment opportunities in 2023, particularly amongst small- and mid-cap companies. In Q4 we added new positions in Heineken, Brembo, Shell, WK Kellogg and sold our positions in Investor and Samsung as they reached our target price.
Investor had been in the fund since inception over which time it provided a total return of 850% or just over 20% per annum. It goes without saying that selling such a strong performer is difficult but, we believe, demonstrates the attractiveness of the opportunities we are finding. Samsung has also been a good investment with annualised returned of 15% since it was purchased in March 2020. Like Investor, we sold Samsung because we felt new opportunities were more attractive and not because our fundamental view on the company changed. Shell was funded by selling half our position in BP, which had become a nearly 8% position. We consider the change attractive because we diversified our risk without impacting the overall upside. Both companies are valued at around six times this year’s earnings and are returning most of that to shareholders through dividends and buybacks.
Brembo is an Italian manufacturer of braking solutions for automotive vehicles. It has specialised in braking solutions since it was founded in 1961 by Alberto Bombassei who remains the majority shareholder. Brembo is a global business with most of its solutions going into passenger cars.
Brembo’s key products are disks and calipers which are essential parts of vehicle braking systems. Its brightly coloured calipers can be seen behind the wheels of most premium/luxury cars and are considered a car culture status symbol among car enthusiasts. Brembo is the clear global leader in calipers for the premium/luxury segment with c. 80% market share. It is sole-supplier to the likes of Ferrari and it supplies all the Formula 1 racing teams.
Commentary
Whilst the company has reported two good sets of quarterly results since we bought the shares, we believe almost perfect execution is now being discounted. We have therefore taken the opportunity to significantly reduce our position during the quarter. At quarter end, WK Kellogg was less than 2% weight in the portfolio. We will likely be exiting the position completely in the near term as we do not consider the risk/reward to be particularly attractive from here.
Arrow Electronics
Arrow was a new purchase during the quarter. Arrow is a US-based distributor of electronic products, mostly semiconductors. It is essentially a middleman between 700+ suppliers (such as Texas Instruments, Samsung, NetApp, Renesas, Infineon, NXP) and 210,000+ customers across a range of end-markets (industrial, automotive, aerospace, defence, healthcare, consumer electronics).
As you would expect from all distributors, Arrow moves products from suppliers to customers. However, it also adds value through helping suppliers with supply chain management and customers with design & engineering.
Suppliers need distributors like Arrow because they are not able to serve hundreds of thousands of customers themselves; customers need distributors to get access to all the suppliers. Due to this network effect, scale is an important factor for distributors and the market is therefore dominated by two players – Arrow and Avnet – who together have c. 60% market share in North America and Europe.
Not unlike many other distributors, Arrow has low margins but generates attractive returns on tangible capital (15-year average ROTE exceeding 30%). Additionally, it benefits from increasing demand for semiconductor products as industries ranging from automotive to industrials to defence continue to digitalise. Total revenue growth (including acquisitions) has been c. 6% annualised over the last 15 years. We expect Arrow will continue to benefit from increasing demand for semiconductor products.
Not surprisingly, Arrow was a beneficiary of the semiconductor shortages in recent years, leading to revenue growth of 20% in 2021 and 8% in 2022. This ended abruptly in 2023 where revenues declined 11%. It was this slowdown in demand that created the opportunity to purchase the shares at an attractive valuation.
A key feature of Arrow’s business model is its counter-cyclical cash flows. During industry downturns, as the one we are currently experiencing, Arrow generates substantial free cash flow. This is because Arrow builds inventory when demand is strong and releases inventory when demand is weak. In 2021-22, when revenues were up 30%, Arrow generated free cash flow of c. $200 million. In 2019-20, when revenues declined 3%, Arrow generated free cash flow of nearly $2 billion. Arrow used the free cash flow in 2019-20 to pay off debt and repurchase shares. We believe the counter-cyclical cash flows is an important feature of Arrow’s business model and is underestimated by the market.
Share repurchases is a key part of Arrow’s capital allocation. Over the last five years, Arrow has bought back shares worth $3.6 billion which is more than half of the current market capitalisation. An important part of the investment case is continued share repurchases which we consider to be very accretive at the current valuation.
At the time of purchase, Arrow had a market capitalisation of c. $6 billion. It generated net income of nearly $1 billion in 2023. The lowest net income over the last ten years is c. $600 million and the average c. $800 million. Consensus estimates net income for 2024 of c. $640 million which we expect to be the trough year. This would put Arrow on less than 10x trough earnings. We think this is very attractive valuation for a business with significant competitive advantages and organic growth at attractive returns on capital.
Russian holdings
Please note that on 3rd March 2022 the Fund’s investment in Lukoil ADR listed on the London Stock Exchange (LSE) was suspended from trading. Our Valuation Committee considered it was in the Fund’s best interests that the holding of Lukoil ADR be fair value priced (FVP) at zero. In June 2022, we elected for the holding to be converted into local shares (Lukoil PJSC).
Given the current international sanctions on Russian securities and cash balances, we believe that if lifted and the Fund was able to access the local market, the holding in Lukoil PJSC (with a current FVP of zero) would represent 14% of the Fund and cash dividend of 2.7%. On 22nd August 2023 a Reuters article suggested that Lukoil was planning to repurchase 25% of its shares from foreign shareholders. The repurchase price would be at least a 50% discount from the quoted price. We continue to monitor the situation closely.
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