Each year, Portfolio 21 conducts a comprehensive review of each of the Fund’s holdings against the environmental and social criteria that are so important to our investment selection process. This review is in addition to our daily monitoring process and results in formal internal reports. We are pleased to report that we have completed this review process for 2013. Our review confirmed that all of our current Fund holdings continue to meet our rigorous criteria for inclusion in the Fund; however, in an effort to deepen our understanding of our holdings’ performance we directly engaged with ten companies on a range of topics, including climate change strategy, environmental accounting, and water and waste management. We are committed to seeking the companies that are global leaders in terms of environmental and social practices, and we are pleased with the performance of the Fund holdings on these measures.
The Portfolio 21 Global Equity Fund produced a strong return of 20.03%, close to its benchmark return of 20.21% for the 12 months ended September 30, 2013. However, for the most recent quarter, for 2013 year to date, and for the past three-year period, the Fund is lagging the global equity market. While the Fund’s longer-term results are competitive with the benchmark, the recent underperformance warrants discussion.
|Retail (PORTX)||Institutional (PORIX)||MSCI World Index (GTR)||MSCI World Index (NTR)|
|1 Year||Return (%)||19.67||20.03||20.9||20.21|
|3 Year Average Annual||Return (%)||8.88||9.2||12.46||11.82|
|5 Year Average Annual||Return (%)||7.54||7.85||8.46||7.84|
|10 Year Average Annual||Return (%)||7.81||7.93||8.16||7.58|
|Since Inception Average Annual||Return (%)||5.1||5.18||4.09||3.58|
|Gross Expense Ratio (%)||1.47||1.17|
We invest in companies that we believe are among the best in the world in terms of their financial strength and quality, with above-average growth records and, by our estimation, above-average growth prospects. As you know, companies must meet our rigorous requirements for environmental and social performance in order to be considered for the portfolio. Later in this commentary, we present certain fundamental characteristics of the portfolio and we think you will agree that the underperformance is not due to fundamental or quality problems with the portfolio. The portfolio is full of companies that are doing very well in terms of business profitability, growth performance, and key environmental and social performance measures.
What has been holding the portfolio back is its above-benchmark exposure to European stocks, modest exposure to emerging market stocks, and, perhaps of greatest impact, the fact that the high quality, somewhat conservative type of companies we favor have gone up less than the more aggressive companies during the strong recent stock market rallies. As the table below shows, during 2013 and for the three years ending September 30, 2013, European stocks and emerging market equities have substantially underperformed U.S. stocks and the global market.
|As of 9/30/13||3-Month Return||Fiscal YTD||3 Year Annualized||5 Year Annualized||10 Year Annualized|
|S&P 500 Index Total Return||5.25%||19.81%||16.26%||10.02%||7.56%|
|MSCI Europe Net Total Return||13.62%||16.09%||8.73%||6.03%||8.47%|
|MSCI Emerging Markets Net Total Return||5.77%||-4.35%||-0.33%||7.22%||12.80%|
Our European exposure has held the results back, but we continue to see strong corporate results from our holdings in these areas. We hope this brief discussion of performance is adequate, but if not please feel free to contact us for a more in depth conversation.
We believe that keeping the portfolio in high quality, conservative companies is especially important given our view of the ongoing challenges to increased growth faced by the global economy. The U.S. Federal Reserve’s program of quantitative easing, including its massive and ongoing purchases of bonds, has served the goal of raising the prices of risk oriented assets like real estate and stocks, however, the rest of the plan has not yet panned out. The second part of the Fed’s plan, counting on the “wealth effect” to stimulate the overall economy to a degree that it would no longer need central bank help, has been less effective than expected. Unemployment remains stubbornly high and, while there certainly has been improvement in the housing market and industrial activity, the Fed’s reluctance to “taper” its stimulus speaks to its lack of faith in the strength of the economy.
Perhaps some of the problem is due to the destination of the value created by the “wealth effect.” The chart below shows how unevenly the benefits of the billions of dollars of money printing have accrued. Middle- and lower-income families saw their average household income decline from 2010-2012 while upper-income households experienced a 2% increase and the average incomes of the top bracket increased 5.2%. Instead of trickling down, the stock market rise has just increased economic inequality.
Source: Center for American Progress, as of March 31, 2013
The next two charts show that there may be limits to what worldwide central bank intervention can achieve on the unemployment front. The large (and increasing) gap between employment and corporate profits seems to indicate that many jobs may not come back. Companies have been able to increase profits through efficiencies and low interest rates, which has created little incentive for them to hire. The Fed has targeted lower unemployment as a condition for tapering but it is hard to see how the continuation of its same policies will have a different effect as we move forward.
Source: zerohedge.com (The data presented in this chart are displayed in five-year intervals from 1956 through 2014, however data presented does not extend beyond 2013. This is intended to indicate past trends, and is not a prediction of future events.)
The employment issue is even more exacerbated in Europe. The Euro crisis and resultant austerity programs have given rise to extreme unemployment numbers for youth across Europe, despite the best efforts of central bankers. Loss of future productivity and chances for further social unrest will both increase as this condition persists.
Despite the challenges noted above, we continue to find that certain companies are able to adjust to conditions and deliver solid growth. However, we are mindful of these economic conditions and continue to position the portfolio conservatively. The table below illustrates that the companies held by the Fund have, on average, produced much greater growth than the global economy as a whole and have produced better financial results than the companies in the Fund’s benchmark.
|As of 9/30/13||Portfolio 21 Global Equity Fund||MSCI World Equity Index|
|EPS – 5 Year Geometric Growth (Latest Filing)||7.75%||6.01%|
|EPS – Estimated Long Term Growth||11.50%||11.19%|
|Last 12 months Sales Growth||5.49%||0.98%|
|5 Year Average Return On Equity (Latest Filing)||22.32%||18.18%|
|Estimated ROE (Forward 12 mos)||22.15%||19.40%|
|Profit margin (Trailing 12 mos)||12.47%||6.44%|
|5 Year Average P/E Ratio||21.21||20.90|
|Current P/E Ratio (Trailing 12 mos)||19.59||17.57|
|Estimated P/E Ratio (Forward 12 mos)||15.67||14.03|
Emerging markets steadied a bit in the third quarter which lessened their negative impact on the fund. Social unrest cooled off in Turkey and Brazil while investor concerns about a hard landing in China seem to be easing for now.
Japanese stock performance slowed, which helped Fund returns as it has lower than benchmark exposure. The Fund’s over benchmark investment in Northern Europe helped performance as Denmark, Switzerland, and Sweden benefited from increasing confidence that the worst is over for at least some of the Eurozone. The “risk on” mentality of investors could be seen in the countries with the best performance for the quarter: Greece and Spain both returned well over 30%. The Fund was underweight both countries as we feel there are better risk/return stories elsewhere given continuing structural problems. Underallocation to the United Kingdom was also a drag on Fund performance.
All sectors had positive returns in the quarter. Being overweight Industrials and Information Technology helped performance, while less than benchmark exposure to Consumer Discretionary stocks was a drag. We moved to lower the Fund’s risk profile in the quarter by adding to four underweighted sectors: Financials, Consumer Discretionary, Consumer Staples, and Energy (Royal Vopak).
New Britain Palm Oil Ltd (NBPO) is an integrated industrial producer of palm oil in Australasia. The company owns and operates palm oil plantations, seed production and plant breeding facilities, and two refineries. NBPO’s plantations are located in Papua New Guinea (PNG) and the Solomon Islands. The company operates a refinery in Liverpool, UK where it processes its palm oil into food ingredients for the European market. NBPO also manages sugar and livestock plantations.
NBPO is exposed to some very healthy growth trends. Vegetable oil growth will be driven by an increasing population and expanding middle class in emerging economies. Palm oil is the most produced vegetable oil; its share of the market has risen steadily to around 35%. Palm oil has advantages over other vegetable oils, including cost and significantly better yield per hectare. Furthermore, NBPO receives a premium price for producing a fully traceable palm oil that is certified by the Roundtable on Sustainable Palm Oil (RSPO). Major food companies, such as Unilever, Nestle, and Tesco, have pledged to source all palm oil from certified sustainable sources by 2015. New Britain clearly sees market opportunity in providing responsibly produced palm oil, stating “We believe that palm oil should be sustainable and traceable to source. The customer and the end consumer have a right to know where their oil comes from, and what principles and practices have been applied in the production.” In addition, growing biodiesel requirements, due to higher blending mandates in developing nations, will push demand even further. The Organization for Economic Co-operation and Development estimates that biodiesel will account for 15% of total vegetable oil consumption by 2020.
As the demand for palm oil as a raw material in food and non-food items has increased over the last decade, the environmental and social impacts of growing palm have also garnered attention, specifically surrounding the topics of deforestation and human rights violations. NBPO recognizes the environmental and social impacts of palm oil production and has initiatives in place to proactively address these areas of concern. In tandem, the company has exceeded industry best practice of achieving RSPO certification by partnering with other palm producers and leading environmental non-profits in the creation of the Palm Oil Innovation Group. The Palm Oil Innovation Group aims to build upon RSPO’s standards to break the link between palm oil and deforestation along with other human, land, and labor violations.
NBPO’s plantations and operations have distinct advantages over Indonesian and Malaysian producers: Palm oil exports from PNG to the European Union are exempt from duty under the Contonou trade agreement (European sales provide approximately 80% of group revenues and 90% of palm oil products.). PNG receives income from palm oil producers only from standard corporate tax. There are fewer land concerns in PNG and NBPO is accustomed to the regional requirements of land procurement in its home country. Finally, PNG has lower climate volatility due to the more limited impact of La Niña and higher soil fertility due to volcanic activity.
Unlike many of its competitors, NBPO is a fully integrated palm oil producer, from seed research and production to palm oil refineries in PNG and the UK. Its seed unit allows access to high quality seeds for use on its own plantations, resulting in some of the highest yielding palm oil plantations in the world. NBPO is continually working to develop seeds with an increased yield and shorter time to maturity. Vertical integration also ensures completely sustainable and traceable status for easy RSPO certification.
NBPO’s peer set includes Malaysian and Indonesian palm oil producers as well as other agribusiness entities in the ASEAN region. NBPO trades at a discount to the group, at least partially attributable to more ambitious near-term expansion plans by most peers, and the fact that most investors have been selecting larger, more liquid players for palm oil exposure. NBPO has experienced higher sales growth over the past five years and enjoys higher Fresh Fruit Bunch yields and extraction rates than most competitors.
In short, investment in NBPO provides the opportunity to own an undervalued asset with exposure to attractive demographic trends. NBPO can also be considered a European recovery play.
Tennant had another strong quarter, with shares up almost 30%. The company’s proprietary ec-H2O technology, which uses electrolysis to clean surfaces without chemicals, continues to attract new business. Tennant will launch a total of 25 new products in 2013 and many have already been well received. This marks the beginning of a large new product cycle that will continue through 2016 with the focus being squarely on energy efficiency and safety. The company also recently introduced a new floor coating (Eco-ITS) that uses plant-based raw materials to reduce the amount of petroleum-based materials by up to 50%.
Shares of IPG Photonics were lower due to concerns over sustained economic growth in China and reports of insider selling. Also, some investors continue to worry about the company’s ability to sustain high gross margins. IPG Photonics shares fell 7% during the third quarter, despite trouncing earnings and revenue estimates for the second quarter on strong demand for high powered lasers for materials processing in Asia and the U.S. Sales climbed 22% (China sales grew 54%) as original equipment manufacturer penetration increased and fiber lasers continued displace conventional cutting and welding applications. Fiber lasers consume 70% less energy when compared with carbon dioxide lasers, operate with a higher degree of power and accuracy, and require less maintenance, which drives down the cost of operation. Furthermore, order flow was strong during the period, resulting in a book-to-bill ratio above 1, and the company increased its sales force and manufacturing foot print in the U.S., Russia, and Asia. We believe that IPG will continue to grow earnings at an above industry pace due to a competitive technological advantage, resulting in higher efficiency and higher quality beams, as well as a lower-cost manufacturing structure provided by vertical integration of diode and fiber manufacturing.
Ansys showed strength across all geographies and product lines in the second quarter. The stock was up nearly 20% as customers continue to find value in the company’s engineering simulation software. As its clients’ products become more complex and prototypes more costly, Ansys’s simulation products become more indispensable. Ansys offers clients the ability to refine product designs at a stage where the cost of making amendments is minimal, which has resulted in renewal rates in the high 90s. Given the breadth and depth of the company’s offerings, from its use in clean tech sectors, to its presence at over 2400 academic institutions, and its 40-year commitment to engineering simulation, we expect there is potential for further good news for Ansys over the long term.
Jeronimo Martins stock declined after the company missed second quarter analyst sales estimates due to a slowdown in Polish sales growth. Comparable sales at the Biedronka supermarket chain slowed to +2% after growing 8.8% in the first quarter. Still, the company managed to post sales growth of 17.9% in Poland on store expansion and maintained its double-digit sales growth target for 2013. The company’s Chief Financial Officer, Alan Johnson, attributed the shortfall to bad weather, a slowing Polish economy, and lower inflation. Intensified pricing campaigns by competitors were undoubtedly a factor as Jeronimo Martins increased its promotions level in order to maintain price leadership. Several peers have been struggling with negative sales growth and may eventually exit the market, leaving Jeronimo Martins an opportunity to further increase its already large share of the Polish retail landscape. Meanwhile, the company continues to post positive comps in Portugal and build its retail network in Columbia. Despite sluggish financial results, the company continues to demonstrate strong commitment to local sourcing. In Poland, more than 90% of food products sold in the Biedronka stores are sourced from local suppliers. Among these, milk and dairy products are entirely of Polish origin. The company’s commitment to local sourcing provides local economic benefits while minimizing the carbon footprint of its products.
The information provided herein represents the opinion of the Portfolio Manager of the Fund and is not intended to be a forecast of future events, a guarantee of future results, nor investment advice.
Past performance does not guarantee future results.
Holdings are subject to change and are not recommendations to buy or sell any security. See complete fund holdings information.
The MSCI World Equity Index is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance. An investment cannot be made directly in an index. Gross total return indices reinvest as much as possible of a company’s dividend distributions. The reinvested amount is equal to the total dividend amount distributed to persons residing in the country of the dividend-paying company. Gross total return indices do not, however, include any tax credits. Net total return indices reinvest dividends after the deduction of withholding taxes, using a tax rate applicable to non-resident institutional investors who do not benefit from double taxation treaties.
The S&P 500 Index is a broad-based unmanaged index of 500 stocks, which is widely recognized as representative of the U.S. equity market.
The MSCI Europe Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of the developed markets in Europe. The MSCI Europe Index consists of the following 16 developed market country indices: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, and the United Kingdom.
The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The MSCI Emerging Markets Index consists of the following 21 emerging market country indices: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.
The USERTOT Index (U.S. Employment Population Ratio Total in Labor Force) tracks the employment ratio, also referred to as the employment rate, which represents persons in employment as a percentage of the working age population.
The CPFTATAX Index (U.S. Corporate Profits without Inventory Valuation Adjustment and Capital Consumption Adjustment of Profits after Tax) tracks income that corporations earn from current production. It is normally measured before income taxes.
Index performance is not indicative of fund performance.
Earnings Growth is a measure of growth in a company's net income over a specific period, often one year. This is not a forecast of the Fund's future performance. Earnings growth for a Fund holding does not guarantee a corresponding increase in the market value of the holding or the Fund.
Earnings per share (EPS) is calculated by taking the total earnings divided by the number of shares outstanding. EPS Growth and Earnings Growth are not forecasts of the Fund's future performance.
Return on Equity is the amount, expressed as a percentage, earned on a company’s common stock investment for a given period.
The Price to Earnings (P/E) Ratio reflects the multiple of earnings at which a stock sells.
Standard deviation is applied to the annual rate of return of an investment to measure the investment's volatility. Standard deviation is also known as historical volatility and is used by investors as a gauge for the amount of expected volatility.
Alpha is a measure of performance on a risk-adjusted basis. Alpha takes the volatility (price risk) of a mutual fund and compares its risk-adjusted performance to a benchmark index. The excess return of the fund relative to the return of the benchmark index is a fund's alpha.
Information Ratio is a ratio of portfolio returns above the returns of a benchmark (usually an index) to the volatility of those returns. The information ratio (IR) measures a portfolio manager's ability to generate excess returns relative to a benchmark.
Free cash flow is revenue less operating expenses including interest expenses and maintenance capital spending. It is the discretionary cash that a company has after all expenses and is available for purposes such as dividend payments, investing back into the business or share repurchases.
The Fund is distributed by Quasar Distributors, LLC.