; TB WISE MULTI-ASSET GROWTH FUND MANAGER COMMENTARY H1 2018-9 | Wise Funds

TB WISE MULTI-ASSET GROWTH FUND MANAGER COMMENTARY H1 2018-9

Written by Vincent, 02 October 2018

TB WISE MULTI-ASSET GROWTH, INVESTMENT REVIEW

Performance

Cumulative returns for the periods ended 31 August 2018

(%)

6 months

1 year

3 years

5 years

TB Wise Multi-Asset Growth – A Shares

3.14

5.27

48.36

56.57

TB Wise Multi-Asset Growth – B Shares

3.48

5.96

51.19

61.49

TB Wise Multi-Asset Growth – W Shares*

3.61

6.22

N/A

N/A

IA Flexible Investment Sector

3.10

4.62

32.88

44.77

UK Consumer Price Index (CPI)

0.86

1.93

5.48

7.19

Cboe UK All Companies Index

5.23

4.28

34.40

44.26

Source: Financial Express. Total return, Bid to Bid. Sterling terms.

Past performance is not a reliable indicator of future results. Investors are reminded that the price of shares and the income derived from them is not guaranteed and may go down as well as up.

* The W shares were launched on 9 December 2016.

Performance

While the TB Wise Multi-Asset Growth beat its peer group over the period, it lagged the Cboe UK All Companies index (formerly known as the Bats UK All Companies index). The B-share (representing 98% of our external assets) returned 3.5% over the period while the IA Flexible Investment Sector returned 3.1%. This put the fund in the top half within its peer group. Over 3, 5 and 10 years, the fund is easily in the top 25%. Relative to the UK equity market however, while medium to long term performance remains strong, it underperformed over the past 6 months. UK equities have broadly fluctuated in line with movements in the pound, itself moving with the latest updates on the Brexit negotiations. Our direct exposure to the UK, while important, is not currently a key driver of our performance. The asset allocation breakdown below shows an allocation of 17% to UK equities at the end of August 2018. In practice, we also try to break our allocation down by looking at where the underlying companies we invest in generate their revenues. This is far from an exact science and we need to make some approximations, but we estimate that our UK exposure by this measure is actually closer to 24%. What is key to understand however, is that this exposure is very different from what the UK equity index looks like: we tend to have a bias towards small and mid-cap names, have a mixture of growth strategies -which have performed well- and value strategies -which, as a group, have underperformed the broad index by 25% since 2005 and we think are due a comeback-, invest in UK private equity, invest in UK long/short managers which both buy and sell shares, etc…All in all, this means that looking purely at our asset allocation from a regional standpoint doesn’t give the full story. Our UK exposure is thus relatively little exposed to the vagaries of British and European politicians’ negotiating tactics.

We are not suggesting that asset allocation isn’t an important factor. It clearly is and we are not pretending to isolate our portfolio completely from the broad macro factors at play. This is why we spend a lot of our time trying to understand what those dynamics are, in order to allocate capital to the right regions and asset classes. While being in the right asset classes helps, the next step is to find the best possible managers in those. Over the reporting period, our largest contributors to performance are good examples of this fund selection effect and why we focus a lot on meeting managers to find the outstanding ones as opposed to simply investing in indices. As an example, our largest contributor to performance was HG Capital Trust. The manager of the trust invests in private equity, focusing primarily on companies in the technology or technology-enabled services which can grow their earnings through operational improvements and exploiting new markets (e.g. so-called “platform” companies which generate growth by integrating smaller companies and creating synergies by sharing common systems or infrastructure). The trust is composed of solid, fast growing companies (weighted average of 23% sales growth and 19% earnings growth) and, while valuations are high, the manager has focused on taking profits for the past 12-18 months recognizing that now is a good time to exit positions given the large amount of capital willing to enter the private equity space. In 2017, the average uplift to carrying value was 40%. This means that, on average, positions were sold at 40% higher than what they were valued at in the portfolio. In the first half of this year, the average uplift to carrying value has come down but is still a very attractive 28%, allowing the manager to concentrate the portfolio on the highest conviction ideas and raise some cash as a means to limit the downside. Overall, our private equity managers have performed strongly by focusing on their respective niches and taking advantage of new capital waiting to enter the space.

Our position in EF Realisation was another good example of performance uncorrelated to equity markets. This investment trust was set up in September 2016 to hold, manage and realise the illiquid assets previously owned by the Ecofin Water and Power Opportunities Trust. This is a very specialised vehicle with a set lifetime of 2 years (extensible if necessary by shareholders’ approval). We used to invest in the Ecofin Water and Power Opportunities Trust so have known the managers for some time and are also now invested in the Ecofin Global Utilities and Infrastructure Trust which holds the liquid assets of the original trust. EF Realisation was, by far, the strongest performer in our portfolio for the past 6 months, with returns in excess of 88%. There are two main drivers for this performance. The first one is the large position in LoneStar Resources, a small US listed resources company specialised in the acquisition, development and production of unconventional oil and natural gas properties. The company announced a strong increase in their production numbers which helped its share price dramatically. The second driver of performance was the expectation that, as one got closer to the 2-year lifetime of the trust, the board would have to make an offer to shareholders to realise their investments. As it happened, in early September, a proposal was put forward by the Board to close the trust as expected and give the option to shareholders to realise their assets at more than 20% premium to the trading price. The “catch”, however, was that the realisation wouldn’t be done entirely in cash but by receiving in specie shares in LoneStar. This caused an issue to us because owning an illiquid, US-listed stock we haven’t researched ourselves would certainly add an unreasonable amount of risk to our portfolio. We thus decided to take our profits before the vote and found a buyer willing to purchase our shares at an attractive price (since the upside is obvious for an investor better able to research US companies). This example shows how one can find attractive opportunities when one is prepared to look beyond the obvious areas many investors focus on.

Looking at the main detractors in the fund, our Mining and Resources names had a difficult period. While we have a strong conviction in the managers of the funds we have in that field, they didn’t manage to shield themselves completely from the poor performance of their asset class as a whole. Looking at individual companies in the sector, their strong balance sheets and ability to generate free cashflows are attractive. There is also a strong sense that capital discipline is prevalent now in the boards of most of the largest miners, which makes them much more investable than in the run-up to the last downturn when cash was spent as if there was no tomorrow. This capital discipline also implies that supply should be limited in the years ahead because new investment projects are few and far between. Despite these strong fundamentals, the asset class suffered in the second half of the period as trade tensions between the US and some of its largest counterparties escalated. The strong US Dollar was also a hindrance for the sector.

TB WISE MULTI-ASSET GROWTH, INVESTMENT REVIEW (CONTINUED)

Allocation Changes

We made a number of changes to the portfolio over the period. These can be classified under the four main categories below:

· Profit-taking: as part of our investment process, we constantly monitor our holdings and try to be disciplined about taking profits when performance is working in our favour. This process is more of an art than a science, but we use a number of indicators such as our macro-economic view, conversations with managers, sentiment surveys or flow data in order to assess when a theme, a style or a manager is getting close to the top of the cycle. Given that we still haven’t found a magic formula that would tell us the exact exit or entry points, we tend to exit and enter positions gradually -unless of course the investment rationale has changed completely. We also do not see profit-taking as a black and white process and haven’t got any issue with adding back to a position after having trimmed it. In our mind, this is part of an active management of the portfolio and we think value can be generated by using opportunities that the market throws at us.

Over the reporting period, we thus reduced our allocation to the following asset classes:

  • Japanese equities: Japan is a notoriously difficult market to read. While it presents ample opportunities for stock picking given the depth and diversity of companies listed in the country, those continue to suffer from the failed attempts by politicians and the central bank to create sustainable inflation. As a very open economy, the market is also vulnerable to trade wars and is in large part driven by foreign investors’ sentiment and flows. As such, we don’t have a huge degree of conviction in the region, hence why our allocation was small at the start of the period. Having benefitted from strong performance from both the Atlantis Japan Growth Trust and the Baillie Gifford Japanese Fund, we have kept taking profits in these positions over the months until the point when they were too small in the portfolio and were closed completely.
  • Alternative Energy: this has been a sector in high demand from investors recently for good reason given its attractive and sustainable growth prospects. This attraction reflected itself in the price of the Impax Environmental Markets Trust however with its discount practically disappearing in the second quarter. For valuation reasons, we thus decided to exit our position.
  • UK Growth: we have been fortunate enough to have been invested in the Polar Capital UK Value Opportunities since its inception in 2017. Since then, the managers have performed extremely well, outperforming the market by close to 12% in the space of a year to Q2 2018. While our conviction in the managers remains high, we reduced our allocation and took some profits as part of our prudent management of the fund.
  • Private equity: this is an area that we have mentioned several times in previous commentaries and have been gradually reducing in the portfolio. While private equity as an asset class remains small in the scale of global financial markets (an estimated 3.4% of the total according to Prequin), it is seeing an increased interest from investors thanks to attractive long-term returns and a continued decline in the number of publicly listed companies (the number of global publicly listed companies has dropped by 41% over the past 20 years according to Prequin again). As such, there is talk of a wall of money waiting to be invested in private equity which drives valuations higher to, possibly, unsustainable levels. In this context, our managers are able to take advantage of these high valuations to sell some of their assets. They are very experienced and have built their current portfolios over years, which means that they are able to realise strong returns. We still have a strong conviction in the asset class and our managers, hence why this represents the second largest asset class in the portfolio after International equities, but continue to gradually take profits. Over the reporting period, this was expressed by reducing our positions in the ICG Enterprise Trust and the Pantheon International Trust. On the other hand, it is worth mentioning that we added to our position in the Woodford Patient Capital Trust. This portfolio is composed of early stage companies, many in the UK, which differs from the larger and more developed companies our other private equity managers focus on. The valuation on this trust remained very attractive so we took the opportunity to build our position up.
  • Property: we reduced our allocation to the TR Property Trust as its discount turned into a premium in the second quarter.

· Addition on weakness: the natural corollary of trimming positions on the way up is to be prepared to deal with positions that don’t perform as expected. If, after having reviewed our investment case, we still have conviction in our views, we should be prepared to back them up and add on weakness. If the market, for whatever reason, is offering us opportunities to add to a position at an even more attractive price than when we initiated the position, we would be foolish to pass on the offer. This isn’t an easy thing to do however. As fund managers, we spend our time questioning not only our fundamental views on an asset class or a particular fund, but also questioning what is going through other investors’ minds. We will never be able to know everything that is going on, so we need to tread with caution. Therefore, we tend to add cautiously on weakness when we still think that we should hold on to an underperforming investment. It is great if we pick the bottom but, more often than not, this will involve several iterations when we keep adding at lower and lower prices.

Over the reporting period, we thus added to the following asset classes:

  • Utilities and Infrastructure: the asset class was hit badly earlier in the year due to a combination of increase in bond yields and, in the UK, concerns about nationalisation plans from a potential future Corbyn government. We think that the sector remains attractive, offering not only attractive yields but, more importantly for this portfolio, sustainable growth prospects. We thus added to our positions in the Ecofin Global Utilities and Infrastructure Trust, as well as in the Miton Global Infrastructure Income fund.
  • Asian equities: the region was hit badly by concerns over the escalation of the trade war between the US and China but also, more fundamentally, by a slowdown in the Chinese economy. Finally, the general weakness in emerging markets dragged the region down. We believe that those concerns are overblown and still see Asia as a significant driver of global growth going forward. We continue to stay away from the large technology names that have stolen the headlines recently however, and gain exposure through small and mid-cap managers (Aberdeen Asian Smaller Companies Trust and Fidelity Asian Value Trust).
  • International equities: more than a view on the asset class, we have used an attractive discount to add to the Caledonia Investment Trust in the second quarter. Also, it is our view that we should slowly increase our allocation to value investors while taking profits on more growth-oriented ones that have done well for us in the past few years. We quoted the relative performance of value versus growth styles in the UK previously in this report but, on a global basis, the relative underperformance of value companies to the growth ones is even more staggering at -38% since the end of 2006. In itself, there is nothing to stop this underperformance from becoming even more extreme. At this advanced stage in the cycle, however, the argument for investors to rebalance their portfolios out of the expensive growth names into the cheap value ones is strong: if the cycle continues, this should be part of the normal rotation into ideas presenting more upside while, if it comes to an end, value stocks would offer greater downside protection. We thus added to our position in the Schroder Global Recovery Fund.
  • UK Smaller companies: it is with a similar thinking that we added to our position in the Aberforth Smaller Companies Trust whose managers are looking for value opportunities in the small and mid-cap section of the UK equity market.

· Risk management: a third category of changes can be seen as a risk management exercise. Delivering strong performance is at least as much about not losing money as it is about generating returns. As such, managing our risk is paramount to the way we run the fund. Profit-taking, mentioned above, is one form of risk management. Other ones include cutting losses and raising cash in periods of uncertainty.

  • Mining and Resources: This is what we did with our allocation to the BlackRock Gold and General Fund for example. In “normal” periods of uncertainty or risk aversion, gold is usually an asset class of choice thanks to its capital preservation properties. It also offers great diversification characteristics. This was -and still is- our reasoning for owning it in the portfolio. Recently, however, gold suffered because of the strength in the US Dollar. As the asset is priced in US Dollars, and as the Dollar goes up, less of it is needed to buy a given quantity of gold. We took this factor into consideration and thus reduced our allocation to the fund.
  • Emerging Markets equities: we explained above that we added to our exposure to Asian equities during the period. Part of this trade was financed by reducing our allocation to emerging markets equities as a way to focus our allocation to the region we are the most optimistic about. We think however that the recent concerns about the asset class are overblown by the “noise” surrounding trade wars and country specific issues such as Turkey and Argentina. We have thus kept some exposure to the broad emerging markets despite this reduction.
  • Cash: all the above changes left us with higher levels of cash at the end of the period than at the start. This gives us some dry powder to allocate to future opportunities.

· Funds switch: finally, we added a new position in the portfolio during the period. The Odyssean Investment Trust was launched in April and is managed by a manager we used to invest with in the past. We believe he brings a unique approach to investing in UK Smaller Companies by focusing on the pricing anomalies and engagement opportunities that can be found in this part of the market. In order to finance this acquisition, we sold our position in the Strategic Equity Capital Trust, as well as in the Downing UK Micro Cap Growth Fund, both of which being invested in a similar part of the market.

The asset allocations as at the period end are shown below:

Sector

Asset allocation as at

31 August 2018

(%)

Asset allocation as at

28 February 2018

(%)

Absolute Return

9.0

8.9

Asia

6.1

5.6

Emerging Markets

1.1

2.0

Europe

2.1

2.0

International

25.1

22.3

Japan

-

2.1

Mining and Resources

9.9

11.1

Private Equity

15.5

16.6

Property

1.2

2.0

Specialist - Alternative Energy

-

1.9

Specialist - Biotechnology

1.1

0.9

Specialist - Technology

1.3

1.5

Specialist - Utilities

5.4

3.2

UK Growth

4.6

6.1

UK Income

2.9

2.5

UK Mid-Cap

1.1

3.0

UK Smaller Companies

8.4

6.6

Cash and Other

5.2

1.7

Total

100.0

100.0

Outlook

It is hard to see a clear path for the global economy over the next few months. While economic expansion continues, the path of growth is slowing and there is greater disparity between regions. For example, compare the US where the central bank is now firmly in a normalisation process of its interest rate policy to prevent its economy from overheating, with China, at the other extreme, which is considering new stimulus measures in order to stop its economy from slowing down. Europe and Japan are somewhere between these two, while the UK has the additional task of dealing with Brexit. Emerging markets are generally on a decent footing, but their future path of growth will be mainly governed by what is happening in the rest of the world…Add to the mix increasing political tensions, protectionism and populism and it makes for a very blurry picture, especially at a time when many are questioning how much longer this cycle has to run, 10 years on from the Great Financial Crisis.

We are not macro-economists however and our role is to manage our funds to deliver an attractive rate of return to our clients. As multi-asset investors, we have many tools at our disposal and we continue to find attractive opportunities. The fund currently offers a mix of defensive strategies and cash, steady performers, exciting growth as well as attractively valued assets. Although we try, we cannot predict what is going to happen to financial markets in the coming months, but we believe that the TB Wise Multi-Asset Growth fund offers a path to continued attractive returns.

General Update

I would like to conclude with an update on our assets and the team. Firstly, our assets under management have come down slightly during the period. We started in March with £55m and finished in August with £51m, despite a performance of 3.5% (B share class) during that time. While the fund is gaining increased recognition and we are getting more and more enquiries and regular inflows, our largest investor decided to switch some of their investment from the TB Wise Multi-Asset Growth (MAG) into the TB Wise Multi-Asset Income fund due to the relative recent outperformance of the former versus the latter. In a way, this is in line with the “take-profit/add on weakness” approach that we discussed earlier for our own portfolio. This switch alone represented a 14% drop in MAG’s assets under management, but we are pleased that the client retains its confidence in our team and process. This drop in assets doesn’t affect in any way how we manage the fund.

Finally, our team went through a period of change since our last annual report with both our analyst, Manasa, and our team assistant, Debbie, deciding to leave. We wish them all the best for their future endeavours. Meanwhile, this marks some new beginnings for us as we recruited two outstanding new members for our team. Philip Matthews joined us in September from Schroder as a Fund Manager. He will work alongside Tony and myself on both of our funds and his experience will greatly complement the range of skills we already have. Last but not least, Joanna Scavuzzo-Blake also joined us in September as an Office Manager. She is already contributing substantially to our overall process and tasks, freeing up our time to focus on managing the funds. We are delighted to have them both on board.

As always, thank you very much for your support. Do not hesitate to get in touch with us directly, would you like to discuss anything in greater detail.

Vincent Ropers

Fund Manager

Wise Funds Limited

September 2018

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