Portfolio Manager's Commentary

Fourth Quarter 2014

Performance Review

We are pleased with fourth quarter performance for the Fund (see table below) ending a year that was defined by the further outperformance of U.S. stocks, as well as two events that almost no one—economists, companies, or investors—saw coming at the beginning of the year:  1) The price of oil dropped almost 50%, 2) The yield on the 10 year Treasury dropped over 25% to 2.17%.

Performance as of 03/31/15

Retail (PORTX)
Institutional (PORIX)
QuarterReturn (%)3.933.992.31
1 YearReturn (%)2.823.125.42
3 YearReturn (%)9.810.1210.75
Standard Deviation10.7410.7610.56
Information Ratio-0.32-0.21n/a
5 YearReturn (%)7.597.918.99
Standard Deviation13.7613.7714.4
Information Ratio-0.43-0.33n/a
10 YearReturn (%)6.36.616.44
Standard Deviation15.4815.4916.56
Information Ratio-0.030.04n/a
Since InceptionReturn (%)5.285.604.37
Standard Deviation16.716.7116.25
Information Ratio0.150.2n/a
Periods greater than one year are average annual returns.

Performance data quoted represents past performance; past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Current performance of the fund may be lower or higher than the performance quoted. Performance data current to the most recent month end may be obtained by calling 877-351-4115.

PORIX performance reflects a blend of retail class shares (PORTX) and institutional class shares (PORIX) adjusted to reflect institutional class (PORIX) fees. PORTX performance is used from fund inception date, 9/30/99, until the launch of PORIX on 3/30/07. PORIX performance is used from 3/30/07 to date.

The decoupling of U.S. stocks from the rest of the world has been pronounced over the previous ten years (see table below). This divergence was especially prominent in 2014 and drove “buy the dip” to the extreme as investors piled somewhat indiscriminately into domestic stocks.

Country Performance as of 12/31/14

MSCI Index
Q4 2014
3 Yr
5 Yr
10 Yr
HONG KONG2.74%2.02%11.13%6.03%5.96%
UNITED KINGDOM-4.84%-8.74%5.52%3.02%0.77%

Meanwhile, the Euro continued to tumble as the possibility of Greece’s exit from the eurozone resurfaced at a time when economic growth was elusive across the region. High unemployment and deflation concerns continue to hamper debt reduction efforts even in stronger countries like Germany. As the U.S. stock market continued to outperform foreign counterparts, the dollar continued to appreciate against other global currencies, doubling the headwinds for international investors. The Fund’s overweighting of Western Europe was somewhat offset by its underweighting of Asia Pacific. Both areas were bolstered by strong stock selection during the fourth quarter and 2014, led by UK and Japanese positions, including Croda International, Compass Group, Panasonic, and KDDI.

BB_Currency Chart 12-31-14

Source: Bloomberg


Oil prices brought some volatility to the fourth quarter, but stocks were still influenced greatly by central bank policies. While stock prices have seemed less tied to fundamentals since the financial crisis, investing in companies with the highest quality operating fundamentals remains a cornerstone of the Portfolio 21 Global Equity Fund. Quality’s return to favor continued for the second quarter in a row as the fourth quarter saw companies with higher Return on Equity (ROE) and Return on Invested Capital (ROIC) outperform after lagging off the market bottom in 2009.

MSCI Quality Comparison as of 12/31/14

Total Return 3/31/2009-9/30/14
Total Return 9/30/2011-9/30/14
Total Return 9/30/2014-12/31/14
Return on Equity (Trailing 12 Months)Top 50%130.86%53.78%1.49%
Top 25%134.91%55.75%2.90%
MSCI ACWI139.80%61.15%0.41%
Return on Invested Capital (Trailing 12 Months)Top 50%131.61%54.52%0.80%
Top 25%145.46%56.58%1.50%
MSCI ACWI139.80%61.15%0.41%

An additional company attribute valued by the Fund is investment for growth. Firms that earn a return greater than their cost of capital add to shareholder value by reinvesting their cash into the business. The chart below shows more companies choosing to return capital to investors since 2009. We believe that over the long term, companies investing for growth will be best positioned to innovate and adapt. Ultimately, we believe they will also be more likely outperform the MSCI ACWI Index.


Compustat breakdown 12-31-14

Source: Compustat and Goldman Sachs Global Investment Research

Note:  M&A = mergers and acquisitions
2014E , 2015E, 2016E = estimated numbers

The increase in return to shareholders has also been a driving factor behind the increasing income inequality in the United States. The wealthiest group, which owns the majority of stocks, has been the major beneficiary of recent corporate largesse. The historically high wealth gap is starting to become a larger part of the political dialogue and its ultimate ramifications could be far reaching.

On the oil front, lower gas prices should be a boon to consumer spending and, at least in the short term, reduce inflation. Less inflationary pressure should give the Federal Reserve more leeway in timing short-term rate hikes. However, lower oil prices can also bring ripple effects. Financial markets are much more levered to the Energy sector than is the economy as a whole. Continued weakness in oil prices could have a wider negative impact as energy companies and oil exporting nations encounter financial woes. Also, although oil does not compete directly with renewable energy in developed markets, the perception is that the two are negatively correlated. The chart below shows how energy bonds and renewable stocks reacted to oil price decline in the fourth quarter.

Collateral Damage Green Energy 12-31-14

Source: Valuewalk


The Fund’s fossil fuel free strategy was a driver of outperformance in the fourth quarter as the Energy sector sank. The Materials, Consumer Discretionary, and Financials sectors also boosted performance through good stock selection. Materials stocks in the Fund gained 4% as a whole, while the Materials sector of the MSCI ACWI Index declined more than 5%. On the down side, overweighting of the Information Technology and Industrial sectors was amplified by weak stock selection. In particular, holdings in these sectors that correlate with the Energy sector suffered. First Solar, a global leader in photovoltaic solar energy solutions, plummeted 30%, and Quanta Services, an energy and telecommunications infrastructure contractor, dropped 20% during the fourth quarter.

Environmental Performance

Not only did the Fund’s fossil fuel free strategy contribute to outperformance in the fourth quarter, it also contributed to the Fund’s strong environmental performance. Across all sectors, Portfolio 21 identifies and invests in companies that have lower carbon intensities than their peer set. Carbon intensity is the average emission rate of a given pollutant from a given source relative to the intensity of a specific activity. Utilizing data from Trucost, a leading global research and environmental data provider, the carbon intensity of the Fund and its benchmark, the MSCI All Country World Index (ACWI), were calculated for nine greenhouse gases and then converted into tons of carbon dioxide equivalents.

At the close of the quarter, Portfolio 21 Global Equity Fund achieved a 56% lower carbon footprint than the MSCI ACWI.


While low carbon intensity is an essential characteristic of companies held in the Fund, Portfolio 21 also considers a company’s environmental impact. Alternatively stated, the impact a company has on water use, waste, land and water pollutants, air pollutants, and natural resource use. To determine the overall environmental impact of the Fund and its benchmark, Trucost weights a company’s environmental impact by revenue and the amount of environmental impact the company contributes to the portfolio based on the Fund’s ownership share. All of the companies in the portfolio are then added together, creating the environmental impact apportioned to the Fund. This is then normalized by the total revenue apportioned by each holding to create the data presented in the chart below.



These metrics demonstrate the effectiveness of Portfolio 21’s inclusion of environmental research in portfolio management. For more information on the Fund’s impact as it compares with the benchmark and additional information on the methodologies used, please see our latest Global Equity Fund Environmental Impact Report.

2015 and Beyond

U.S. interest rates were expected to rise on the back of a looming Federal Reserve rate hike and increased economic growth. As we enter 2015, there is still an expectation of rising rates, although doubt has started to creep in. Lower oil prices have stoked deflation fears across the globe. With pressure on the European Central Bank to take further action to increase inflation, European interest rates will likely remain below domestic ones. Increased demand for U.S. bonds, which may be perceived as relatively higher yield and safer, could provide price support, limiting yield upside.

Performance Leaders

Shares of Tractor Supply climbed more than 25% after the company beat third quarter earnings forecasts on strong sales comparisons and gross margin improvement. The stock slipped over the previous three quarters on concern over the impact of the Midwest farm economy. However, Tractor Supply targets small farmers and ranchers with little exposure to the more cyclical and weather dependent commercial and industrial farming sector. The company is also well guarded from encroachment from the likes of Amazon.com due to regional focus of store products. Going forward, sales comps will likely improve in 2015, after a year of slowing comparisons, and intensify as the economic recovery endures and consumer spending accelerates. Tractor Supply could add new stores at a faster pace and/or repurchase shares to increase shareholder value further.

After a sluggish first half, Croda International showed signs of renewed growth in the third quarter. Investors noticed, bidding the stock up over 30%. The Consumer Care division is the company’s main driver, depending heavily on innovation to maintain industry-leading margins. Focus on new products and customization enabled all three components of the division, Personal Care, Health Care, and Crop Care, to return to organic growth. As the risks of toxic chemicals become better known, Croda’s emphasis on less harmful ingredients becomes more attractive to clients such as Unilever, P&G, and Henkel.  With over 65% of its raw materials coming from renewable sources, Croda has staked out a large competitive advantage in the fast growing green chemical space. As a result of Croda’s focus on renewable inputs, less than 1% of the company’s existing raw materials are classified as carcinogenic, mutagenic, or reproductive toxins (CMR) or persistent, bio-accumulative or toxic (PBT). In addition, Croda has an objective to replace these toxic raw materials when suitable renewable alternatives exist.

Performance Laggards

First Solar dropped after reporting a decline in utility projects in early November after generating record sales in 2013. Its fall continued in tandem with oil prices throughout the remainder of 2014. The stock ended down 30% for the fourth quarter. However, the pullback due to falling oil prices is an overreaction, as solar and oil are used for completely different applications. Furthermore, First Solar has some positives that may propel shares in 2015. Anti-dumping duties in the U.S. and Europe, entry into the residential solar market, and global political ambition supporting renewable energy are factors that bode well for the company’s future growth prospects.

As with most companies involved with the oil and gas industries, Intertek’s stock took a beating in the fourth quarter, down over 10%. Weakness across the whole commodities sector is certainly a headwind for the company as customers push off capital expenditures until things turn up. But Intertek’s Commodities division accounts for only around 25% of the company’s sales and its strong exposure to the steadily growing Consumer Goods and Commercial & Electric areas should help the company weather the storm. Additionally, increasing environmental legislation bodes well for Intertek as customers require testing to meet compliance.

New Positions

We added two positions to the Global Equity Fund during the fourth quarter:  Sempra Energy and Merck. Sempra Energy is a natural gas storage, transmission, and distribution company headquartered in San Diego, CA. Sempra is the largest investor-owned utility in California. Its Southern California Gas subsidiary is the 5th largest gas distribution utility in the world. Sempra is also active in non-regulated areas. The company is majority owner of IEnova, Mexico’s only publicly listed energy infrastructure company. It also owns 80% of Luz del Sur, one of Peru’s largest electricity distributors, and 100% of Chilquinta Energia, a large Chilean distributor.

Sempra’s California-based, regulated business is responsible for the majority of its revenue and income. A constructive regulatory environment and growing rate base provide a solid growth foundation while current capital expenditures focused on grid safety, reliability, and lower carbon intensity fill out the profile. Sempra Energy’s approach to meeting the growing energy needs of customers is based on a low-carbon model with four key elements:  use of natural gas, energy efficiency, renewable power, and smart grid innovations. Capital expenditures planned for its smart grid deployments alone total approximately $3.5 billion for the years 2011-2020. The company has estimated the deployment will result in benefits between $3.8 and $7.1 billion, including both societal and environmental benefits. Sempra also offers unregulated growth through its other infrastructure exposure. Its Chilean and Peruvian investments have benefited from strong customer and energy use growth and produced an ROE of 14-16% with room to grow. IEnova has doubled in value since Sempra spun it off in 2013, catalyzed by Mexican energy reform and attendant infrastructure needs. Natural gas infrastructure and power generation (including renewables) are areas of current demand and Sempra expertise. In the U.S. non-regulated space, Sempra is active across the gas supply chain, yet has no exposure to fossil fuel exploration and production. Its largest project is a liquid natural gas (LNG) terminal in Louisiana that is currently slated to be converted from an import facility to one of the first LNG export terminals in the U.S. Sempra is poised to potentially benefit from the changing energy landscape in the U.S. Some of the risk of being an early mover in the area is mitigated by the company’s investments being relatively commodity-neutral.

A regulated business with attractive characteristics, bolstered by growing, well hedged infrastructure businesses, make Sempra a distinct utility. Its diversification across the energy supply chain and strong balance sheet give it great flexibility. The company looks to grow earnings 8-11% through 2019 vs. 5% growth for the S&P Utility Sector  Index (companies included in the S&P 500 that are classified as members of the utilities sector). Sempra’s growth is backed by very transparent, relatively low risk plans.

Merck is a diversified global healthcare company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies, animal health and consumer products; which it markets directly and through its joint ventures. Following the Schering-Plough acquisition, just under half of the company’s sales are generated in the U.S.

We are attracted to Merck’s portfolio of high-margin branded pharmaceuticals and promising pipeline of new drugs. The company is through the worst of its patent cliff, which has inhibited growth over the past four years. Merck still faces patent losses on Nasonex and Zetia over the next few years but now just around 15% of Merck’s total sales are subject to patent losses, down from 25% over the past five years. Existing drugs and new products, including diabetes and HIV treatments and vaccines, are helping to offset generic competition. Furthermore, cost cutting efforts and savings from the Schering-Plough acquisition are helping the bottom line. We believe Merck’s growth rate may improve in 2016, as the company plans to launch several new products.

Merck has shifted its research and development focus toward areas of unmet medical needs from incremental improvements in existing treatments, which we believe provides greater growth potential due to a higher probability of regulatory success and stronger pricing power. Merck is early in the immuno-oncology (IO) development, along with Bristol Myers and Roche, which seems to be on track to becoming a game-changer in cancer treatment. IO therapy data suggests improved progression free survival, fewer toxicities, and may have broad applicability in a variety of cancers. Merck’s cancer immunotherapy drug, pembrolizumab, has an initial indication for melanoma, followed by lung cancer in 2016. It could be the first IO class drug to attain marketing approval in both Europe and the U.S. Keytruda (the U.S. version of the drug) received accelerated approval on September 4. Additionally, Merck is developing a BACE (Beta-secretase) inhibitor Alzheimer’s drug that could transform how the condition is treated. Merck is a leader in the field, with AstraZeneca further behind. Finally, the recent acquisition of Idenix provides an entry into the lucrative Hepatitis-C market with pipeline products holding similar characteristics to Gilead’s market leading Sovaldi. Merck could differentiate itself with a product that is easier to use and has a shorter treatment duration to gain market share.

Merck is a beacon of stability in an increasingly volatile market environment. Merck's operations generate large amounts of cash that support a powerful salesforce and the company’s research laboratories have a database of knowledge that should help the firm maintain its leadership in drug discovery and development. Merck’s balance sheet is conservatively managed, providing the potential for strategic bolt-on acquisitions or collaborative partnerships should opportunities arise.

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 ACWI (All Country World Index) is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. The MSCI ACWI consists of 44 country indices comprising 23 developed and 21 emerging market country indices. Returns reported reflect the net total return index, which reinvests 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 MSCI USA Index is designed to measure the performance of the large and mid cap segments of the US market. The MSCI Hong Kong Index is designed to measure the performance of the large and mid cap segments of the Hong Kong market. The MSCI Germany Index is designed to measure the performance of the large and mid cap segments of the German market. The MSCI Netherlands Index is designed to measure the performance of the large and mid cap segments of the Netherlands market. The MSCI Singapore Index is designed to measure the performance of the large and mid cap segments of the Singapore market. The MSCI Switzerland Index is designed to measure the performance of the large and mid cap segments of the Swiss market. The MSCI Japan Index is designed to measure the performance of the large and mid cap segments of the Japanese market. The MSCI Sweden Index is designed to measure the performance of the large and mid cap segments of the Swedish market. The MSCI Australia Index is designed to measure the performance of the large and mid cap segments of the Australian market. The MSCI United Kingdom Index is designed to measure the performance of the large and mid cap segments of the UK market. The MSCI Canada Index is designed to measure the performance of the large and mid cap segments of the Canadian market. The MSCI France Index is designed to measure the performance of the large and mid cap segments of the French market. The MSCI Spain Index is designed to measure the performance of the large and mid cap segments of the Spanish market. The MSCI Portugal Index is designed to measure the performance of the large and mid cap segments of the Portuguese market. The MSCI Norway Index is designed to measure the performance of the large and mid cap segments of the Norwegian market.

The S&P Materials Sector Index is an unmanaged index considered representative of the materials sector market. The S&P Utility Index is an unmanaged index considered representative of the materials sector market.An investment cannot be made directly in an index.

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.

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.

Return on Equity is the amount, expressed as a percentage, earned on a company’s common stock investment for a given period.

Return on Invested Capital is a calculation used to assess a company's efficiency at allocating the capital under its control to profitable investments.

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