After several years of relatively benign equity market conditions, the COVID-19 crisis provided a stern test for investors. Like most funds, SKAGEN Global experienced a roller-coaster few months as the coronavirus forced the world into lockdown, but it has emerged stronger as focus now turns to recovery.
SKAGEN Global is designed for clients to "get rich slow" which helped the fund to weather the market turmoil. Its long-term investment horizon (stocks are typically held for 3-5 years) means the fund managers can avoid getting side-tracked by short-term market moves. A concentrated portfolio of 35 stocks also represents a strong pool of high conviction ideas (and fewer companies to keep tabs on) while its global mandate provides the maximum flexibility to find them.
Lead Portfolio Manager, Knut Gezelius, explains: "Unprecedented is an over-used word but since March we've seen the VIX volatility index set a new record and the S&P 500's fastest ever bear market, followed by its quickest recovery, so it’s fairly apt. Markets have largely been sentiment driven; we navigated this by tuning out of the noise and sticking to our investment process, not trying to time the market by remaining invested and staying focused on the long-term."
Consistent returns
SKAGEN Global is around two percent ahead of the MSCI All Country World Index year-to-date and leads the benchmark over one, three and five years on an annualised basis[1]. This outperformance has been achieved in both up and down markets and during periods of high and low volatility. Independent analysis by Morningstar (see figure 1) ranks the fund in the first quartile over one, two, three and five years and in the second over five and ten.
This year the fund has been boosted by its underweight (currently zero) exposure to the worst performing energy sector, which has fallen 38% on oil price weakness[2]. Being overweight technology (25% vs. 21% for the index) has also helped, with the sector up 14% as our reliance on IT grew even further during lockdown[3]. Long-term holdings Microsoft and Adobe are among the fund's top three contributors. SKAGEN Global's geographic exposure has also provided a tailwind; the fund is 79% invested in the US[4] which has delivered positive performance year-to-date, while the fund has no holdings in Brazil (-30%) and Spain (-26%), which have been among the weakest markets for investors[5].
As always, the key determinant of performance has been company selection. The huge dispersion in returns between stocks this year has been supportive for active managers, illustrated by the chasm between the best (Top Glove Corporation; +435%) and worst (IRB Brasil Resseguros; -83%) performers[6]. With valuations broadly in line with their 25-year average on a free cashflow yield basis despite sizeable COVID tail risks, it is likely that picking the right companies at the right prices will be even more important in the period ahead[7].
Portfolio resilience
While the fund is built bottom-up and the portfolio is a result of the individual stocks selected, certain themes have emerged with holdings sharing common drivers of shareholder return:
The portfolio is designed to outperform in a variety of macro and market scenarios, as Gezelius explains: "In most cases we believe our holdings should be able to not only weather a storm but come through it stronger and capitalise on the relative weakness of their competitors." The bar for inclusion is very high and several companies have been exited this year, including Unilever, Hiscox, Schindler Medtronic and Pernod Ricard, to make way for more attractive long-term ideas such as Aon, ASML, Intuitive Surgical and Verisk.
An uncertain economic outlook means this should provide the fund with its own competitive advantage. Bank of America Merrill Lynch's Fund Manager Survey recently showed that the majority (44%) expect a U-shaped recovery with other investors split between a W-shaped (30%) V-shaped (14%) or other-shaped (12%) revival[8]. The World Bank[9] expects global GDP to contract 5.2% this year, followed by 4.2% expansion in 2021, and Gezelius is positive on the longer-term equity market outlook: "Valuations generally look attractive and equities should be supported by government stimulus and quantitative easing, provided economies hold up reasonably well. We're confident that our holdings look undervalued under a number of different scenarios."
Proven philosophy
Dissecting the current portfolio using the investment criteria that has underpinned the fund's strong recent performance provides further reassurance (see figure 3). The holdings' competitive advantage is illustrated by an average operating margin of 21.1%, which is more than double that of the index (9.6%) while their return on equity is also much higher at 14.4% versus 8.7% for the benchmark. Balance sheet strength, which is likely to be a key determinant of company success during economic recovery, is also superior; SKAGEN Global's holdings trade with a net debt / EBITDA ratio of 1.5 against 2.1 for the index, while the interest coverage ratio is more than double (13.9 vs. 6.8).
In this context, the portfolio looks significantly undervalued. Its 35 holdings have weighted upside of 34%, based on current price targets over an approximately two-year horizon. The MSCI All Country World Index, by comparison, currently trades 47% and 28% above its 15-year average on a forward Price/Earnings and Price/Book basis, respectively, despite the down-side risks to economic recovery[10]. The fund managers have a pragmatic approach to value and look beyond companies that may be optically cheap based on obsolete valuation metrics which are ill-suited for a world increasingly powered by intangible assets, as outlined in a previously published white paper.
As we enter the second half of the year, SKAGEN Global has a diversified portfolio of leading companies across a range of financial, operational and sustainability metrics (the fund has been awarded five globes and a 'high' sustainability rating by Morningstar, ranking in the top-3 percentile out of 1,000 funds). Hopefully the remainder of 2020 will be calmer, but the fund is prepared and primed for continued strong performance, whatever comes next.
NB: All figures as at 31 July 2020 unless stated otherwise
References:
[1] As at 31/07/2020 in EUR, net of fees
[2] MSCI World Energy Index in USD, as at 31/07/2020
[3] MSCI Information Technology Index in USD, as at 31/07/2020
[4] Underlying revenue exposure of the portfolio to US is c. 55%
[5] Based on MSCI Brazil and Spain indices in USD, as at 31/07/2020
[6] Stock performance based TSR in USD, MSCI AC World Index, Jan-Jul 2020, Source: SKAGEN
[7] MSCI All Country World Index valuation
[8] July 2020, Source: Bank of America Merrill Lynch
[9] Source: World Bank, Pandemic, Recession: The Global Economy in Crisis, June 2020
[10] 1-yr forward P/E: 19.2x (15-year average forward P/E: 13.1x); 1-yr forward P/B: 2.3x (15-year average forward P/B: 1.8x)