Commentary

The European Union is set on minimising its imports of Russian coal, crude oil, refined oil products and gas. In 2021, the EU spent over €99bn on Russian fossil fuels of which €4bn was coal and €70bn was oil and oil products with the remainder on gas. Without curtailment, the total would be over €150bn at 2022 average prices to date. A key enabler of Putin’s war against Ukraine. With ambitious plans to curtail the EU’s use of gas already announced in April, in May the EU’s internal negotiations sought to end imports of oil. While the EU failed to agree a total ban on crude imports, they did agree to end 90% of Russian oil and oil product imports by the end of 2022. Together with news that China was ending its COVID-related lockdown of Shanghai, pushed crude prices up 15% during the month ensuring the energy sector was the best performing sector globally last month.

With inflation running rampant and the US mortgage rates having reached over 5.5% in early May, it was unsurprising to see signs of weakness in new mortgage applications, building permit applications and new housing starts in the US. The US market declined slightly led by the FANG technology-related stocks. The strategy is diversified across countries and sectors and is unconstrained by the country weights in MSCI World. The country weights are the product of our bottom-up stock selection. With a US weighting of c.25%, this helped the performance relative to MSCI World during the month.

At the stock level, the largest positive contributors to the fund’s relative performance were, in order of their impact, Mitsubishi Heavy Industries (+10% total return in local currency), Bayer (+11%), NOV (+10%), Citigroup (+11%) and BT (+6%).

The fund’s exposure to energy is through Italy’s state-controlled integrated oil and gas company, Eni, and the US-based oil and renewables services business, NOV. NOV was among the top 5 contributors and Eni was the 7th biggest contributor (+10% in local currency during the month).

Mitsubishi Heavy Industries (MHI), the Japanese industrial conglomerate, is the biggest contributor to fund performance year-to-date, providing a total return of +86% in local currency terms and, despite the weakness of the Yen, +67% in US dollar terms. At the end of December last year, Seiji Izumisawa, the Chief Executive of MHI briefed reporters that the group could require a sweeping overhaul and restructuring to focus the group on businesses with the strongest opportunity set. We have been engaging on this issue with the company since we bought the shares in 2017. We have seen the value created at Siemens through the last twenty years of restructuring and refocussing. MHI’s shares were strong from the start of 2022 on the back of the CEO’s comments but since the war in Ukraine began investors have also noted that MHI is Japan’s largest defence contractor. We believe that MHI has the potential to generate a significant increase in shareholder value if they take this revolutionary road.

Commentary

Citigroup benefitted from news that Berkshire Hathaway had made a $2.9bn investment in the shares. Citi is mid-way through a major strategic shift away from retail banking outside of the US including its large franchise in Mexico. This will leave the group focussed on credit cards and retail banking in the US, global treasury services, wealth management and investment banking. This should release around five percent of its equity capital and improve returns, though the largest drag to this metric remains the investment bank. While the bank has returned c.$77bn of capital over the last five years its average return on tangible equity has struggled to average 10% per annum. With this return only at about 8% this year, there is much that needs to improve at Citi but given current returns and the likelihood of improvement the shares remain too lowly valued at just 0.55 times tangible book explaining Berkshire’s interest.

In May, the largest negative contributors to the fund’s relative return were, in order of their impact, LG Household & Health Care (-19%), easyJet (-8%), Alibaba (-6%), Berkshire Hathaway (-2%) and Mitsubishi UFJ Financial (-3%).

LG Household & Health Care had a poor month with results that were worse than we had expected but explained largely by the disruption from the Chinese Government’s pursuit of its “zero-covid” policy. The lockdown in Shanghai impacted on one of LGHH’s two Chinese distribution centres but we also learned that the lockdown areas suffered a de facto restriction on internet shopping for non-food items as the authorities struggled to meet food deliveries to those in lockdown. Importantly, the company noted that price negotiations with the duty-free company DFS have ended amicably and DFS sales are showing signs of improvement. Our due diligence continues to suggest that the Whoo luxury skin care brand remains strong and sales should recover significantly as China eases its COVID-related restrictions. LGHH management believe this will be seen in the second half of the year though that will rely on COVID abeyance rather than any relaxation from President Xi this side of the People’s Congress meeting in the fourth quarter of this year.

There were no transactions during the month.

The fund ended the month valued at a forward price earnings ratio of just 10.3 times and a price to book ratio of 1.1 times. MSCI World Value has a price earnings ratio of 12.7 times and a price to book ratio of 2.1 times. The fund’s weighted average upside to fair value is 46%, well above the average level since we began tracking this in 2009.

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