Portfolio Manager's Commentary

First Quarter 2014

Performance Review

After the unusually strong performance in second half of 2013 and for the year as a whole, it is not surprising that the global equity markets spent the first quarter of 2014 performing in a generally sideways direction. Frankly, with the unrest in the Ukraine and a new Federal Reserve Chair in the United States, one might be relieved that we made it through without a loss.

The Portfolio 21 Global Equity Fund’s performance trailed the MSCI ACWI for the first quarter of 2014. In fact for the entire past five years, a period that began with the global stock market recovery from the depths of the financial crisis, the fund has not kept up with the market. Despite the significant lag in the Fund’s recent performance, the record for the since inception period is ahead of the index. Although it is frustrating to underperform the market for any period, we believe that the market will come back to the type of high quality, and what we believe to be reasonably valued, companies that our approach emphasizes.

Performance as of 3/31/14

Retail (PORTX)
Institutional (PORIX)
QuarterReturn (%)0.610.691.08
1 YearReturn (%)14.4814.8216.55
3 Year Return (%)7.728.048.55
Std Dev13.3713.3914.54
Information Ratio-0.25-0.15
5 Year Return (%)15.6515.9817.80
Std Dev15.3115.3116.22
Information Ratio-0.63-0.53
10 Year Return (%)6.907.216.97
Std Dev15.7815.7916.63
Information Ratio-0.020.01
Since Inception Return (%)5.465.774.29
Std Dev17.1317.1416.66
Information Ratio0.190.20
Gross Expense Ratio (%)1.451.15
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.

Over the long-term history of the fund, we have engaged in relatively low portfolio turnover (about 10% per year on average), which is indicative of our long-term investment approach and emphasis on high quality companies. However, in the first three months of this year we made an unusually high number of portfolio changes. We sold eight of the fund’s 72 holdings. Three of the sales were due to issues at the companies that were contrary to our environmental, social, and governance (ESG) standards and five of the sales were due to our fundamental analysis and view that there were better investment opportunities available for the fund.


The stocks sold due to ESG issues were Toyota, Nucor and SKF.  It is always troubling to have to sell a stock due to a revelation of an unattractive business practice, but Toyota was a large disappointment. Portfolio 21’s investment team had recently purchased the stock, based on attractive fundamentals and Toyota’s strong position in producing fuel efficient vehicles. Our team had struggled over the issue of investing in any company that was closely associated with the use of fossil fuel, but in the end had decided that Toyota’s positive impact on fuel efficiency was a strong enough positive to warrant purchase. We knew that the company had recently gone through a difficult recall of vehicles due to a serious safety issue, but we did not know how deep the trouble ran at Toyota until after the purchase. When the news broke that Toyota had agreed to a $1.2 billion fine with the U.S. Justice Department over the concealment of safety flaws in vehicles, flaws that led to human injury and death, we sold the stock within a day. Safety issues and recalls are one matter; concealment of information that could cost human safety and lives is intolerable.

Nucor is steel manufacturer that uses recycled scrap as raw material and a manufacturing process that is significantly less energy intensive than traditional steel makers. We have always valued the reduction in environmental impact from Nucor’s methods in this high impact area. However, over time we became aware that Nucor was investing, through a partnership with an outside entity, in natural gas production assets. Portfolio 21 has a strict fossil fuel free mandate and Nucor’s involvement in natural gas, even through a partnership, is a violation which led to the sale.

The third stock sold due to ESG related issues was SKF, a Swedish manufacturing company with an excellent record in the environmental arena and a long history of solid fundamental performance. However, the company was recently found guilty of being a major player in an industry price fixing cartel. While we realize that the sad fact of the matter is that the capitalist world in which we operate has innumerable pockets of corruption and that many companies run afoul of lesser regulatory requirements, the size of the issue at SKF was material to our analysis and the stock was sold for a combination of ESG and related fundamental concerns.

Five stocks were sold during the quarter due to concerns over slowing business growth. Three of the five are very large companies: China Mobile, Unilever, and Samsung. The two other sales were NetApp and Itron, which are small to medium size companies. While none of these companies are believed to have extraordinary problems, our investment team believes that there are clearly better opportunities available for the fund in smaller and faster growing companies.

New Holdings

The seven new positions added to the portfolio are a diverse group and include companies in Africa, Brazil, Australia and the U.S. Three companies, Sao Martinho, Silver Spring Networks and First Solar, have especially strong environmental stories.

Sao Martinho

Sao Martinho harvests and processes sugarcane to produce sugar, ethanol, and bioenergy from its sugarcane fields across Brazil.  The company primarily harvests sugarcane mechanically (87% in the 2012/13 harvest year) and as a result has seen associated reductions in air pollution from eliminating field burning and preservation of soil health.  Other practices the company implements to maintain soil health include composting, which supports soil humidity and avoids leaching and loss of nutrients while improving fertility.  In addition, Sao Martinho uses integrated pest management (IPM) with organisms cultivated at its laboratories for pest control.  The use of IPM is group-wide and the company has been able to completely eliminate the use of pesticides it once used to control the broca and cigarrinha pests, the two main pests in sugarcane production.  Finally, Sao Martinho has devoted capital expenditures to expand electricity generation from sugarcane bagasse.  Recent upgrades at one mill will produce 244,000 megawatt hours of surplus electricity, establishing Sao Martinho as, in the company’s words, a “major independent producer of electricity.”

Silver Spring Networks

Silver Spring Networks provides networking platforms for smart energy networks.  The company’s networking platform connects utilities to homes and businesses with a goal of “achieving greater energy efficiency for the planet.”  Silver Spring offers an array of solutions, including advanced metering, distribution automation, and demand-side management.  All of Silver Spring’s solutions permit improved data analytics and communications that enable the smart grid. The company’s energy efficiency solutions allow utilities to send customers personalized data on their energy use trends, as well as suggestions on how to reduce use.

First Solar

First Solar is the largest manufacturer in the world of photovoltaic (PV) solar modules based on thin film cadmium telluride (CdTe) semiconductor technology.  The company also designs, constructs and sells PV solar power systems.  In March 2014 the company announced it set a world record for CdTe photovoltaic module conversion efficiency.   The new record of 17% total area efficiency is an increase over the prior record of 16.1% efficiency, which the company set in April 2013.  First Solar has evaluated the product life cycle management of its technology from raw material sourcing to product take-back.  The semiconductor material (CdTe) used in First Solar PV modules is primarily sourced from the byproducts of mining operations.  Specifically, tellurium is a byproduct of copper mining and in 2011 it was reported that First Solar used approximately 30% of the global tellurium supply.  First Solar also has a comprehensive module recycling program that achieves recovery rates of up to 95% for the semiconductor material and 90% for the glass.   To facilitate this take-back program, the company has recycling facilities operating at each manufacturing facility.

The other four new holdings, Westpac Banking Corp, Woolworths Holdings, Safaricom, and Stratasys meet our strong ESG criteria, but have less of a direct environmental impact than the other three additions.

Westpac Banking Corp

Westpac is Australia’s oldest bank and financial services group, with a significant franchise in Australia and New Zealand in the consumer, small business, corporate and institutional banking sectors, in addition to a major presence in wealth management.  The biggest ESG risk confronting the banking industry is that its clients' credit quality and/or asset value deteriorates because of the failure to address environmental and/or social issues. Westpac minimizes this risk in numerous ways.  First and foremost, the bank is an Equator Principle signatory exceeding requirements by applying the principles to all project finance transactions assessed regardless of project value.  Westpac also has established a sustainability strategy for 2013 to 2017 that includes lending commitments of $6 billion to the clean tech and environmental services sector.

Westpac is among a handful of banks around the globe currently retaining very high credit ratings (AA- by Standard & Poor’s and Fitch) and the bank ranks third in assets across the four major Australian banks.  We believe Westpac is well positioned to see an increase in demand for credit and banking services as economic conditions improve in Australia.  The bank has the lowest cost-to-income ratio in Australia and we see potential for it to improve productivity through more innovative technology and be able to cross-sell more products/services to retail and business customers, resulting in a higher return on equity (ROE).  Westpac spreads its operating costs over a wide variety of products and has economies of scale to potentially improve further.  The bank's integrated business model, continued investment in cost-out initiatives, the digitization of banking, and an eventual return to a stronger credit growth environment in the more populated eastern states bodes well for earnings growth.

Woolworths Holdings

Woolworths Holdings LTD is a South African-based retail group operating a chain of retail stores offering a selected range of clothing, food, home-ware, beauty and financial services under its own brand name.  The company also owns a clothing and home-ware retailer and has stores in selected African countries and the Middle East.

Woolworths is committed to the growth of organics and free range products in its stores, the protection of biodiversity through its supply chain and the reduction of its key performance indicators. In 2013, the sale of free range and organics increased to 23% of food sales from 8% the previous year. Additionally, 98% of the company’s produce suppliers qualify for its Farming for the Future program in which biodiversity conservation is key. Lastly the company has joined the World Wide Fund for Nature South Africa’s Water Balance Program to address the company’s water management practices.

Woolworths leads the retail sector in free cash flow and its ROE of 50% is above the sector average of 30%.  A strong balance sheet completes a solid fundamental profile.  Growth has been generated through new and existing stores in South Africa, Australia and other countries in Africa.  Current revenue is fairly evenly split between food and clothing though clothing accounts for closer to 70% of the company’s earnings.  The financial services division is small but growing and is, in our opinion, of very good quality.  Disappointing sales growth and effects of a possible rate hike in South Africa pressured Woolworths’ shares in the second half of 2013, providing a good entry point for the stock.


We believe Safaricom is the best emerging market telecom operator worldwide. The company has high market share, a superior fiber-optic infrastructure, an efficient operating base and strong management.  Safaricom is the dominant mobile operator in Kenya, with a subscriber market share around 66% and even higher revenue market share.  It controls nearly 80% of voice traffic and accounts for 96% of all SMS (short message service) traffic.  Safaricom’s market position has continued to strengthen due to the unique benefits of it its mobile money service M-Pesa, reduced competitive pressures, and a more stable macroeconomic environment.

We believe continued revenue and profit growth will be driven by increased voice usage, sustained SMS growth, the emergence of mobile data as a meaningful contributor to growth, a reduction in handset prices that should support smartphone penetration, and increased circulation of money within M-Pesa platform.  M-Pesa is a payment network allowing the banked and unbanked people of Kenya to transfer funds. Mobile based money transfer services, such as M-Pesa have helped increase the percentage of Kenyan adults with access to banking services to 66.7% in 2013, up from 41% in 2009.


Representing almost 60% of the market, Stratasys is the current leader of the disruptive 3-D printing industry.  The company makes money from printer sales, consumable sales, and services.  Stratasys invented and commercialized Fused Deposition Modeling, which creates objects by extruding thermoplastic layer-by-layer according to a computer design.  This additive form of manufacturing has proven cost-effective and customizable for both consumer and commercial uses.  In addition, additive processing only utilizes the materials necessary, thereby reducing material waste.  The company’s merger with Objet gave it access to a more precision-based platform, expanding its markets and presenting cross-selling opportunities.  The MakerBot merger allowed the company to instantly become a leader in the growing desktop/consumer market.  The last big end market not currently addressed by the company is metals which it acknowledges will probably be addressed by further acquisitions.

Stratasys is the most profitable company in the nascent industry with gross margins of 50-60%, operating margins of 20-25%, and strong cash flow.  There is significant leverage in both earnings and margins as the mergers continue to be integrated and machine penetration expands.  The industry itself has been around for more than 20 years, growing at an 18% compound annual growth rate, but the recent innovations and recognition have boosted that number to 27% over the last 3 years.  The company currently has no long term debt and a return on invested capital well in excess of its weighted average cost of capital.

Portfolio 21 recognizes the environmental benefits 3D printing can bring. The first is through the production of replacement parts. Rather than replacing an entire gadget or appliance 3D printing can allow for specific part replacement. The second is upcycling. Upcycling refers to making modifications to existing products through 3D printing to expand their range of use.

As we have discussed, this has been an unusual level of activity for the fund portfolio relative to our long term history. We are pleased with the resultant portfolio fundamentals, reflected in the table below. 

Selected Fundamentals as of 3/31/14

Portfolio 21
Historical 5 Year EPS Growth (%)35.1828.05
Trailing 12M EBITDA--1 Year Growth (%)11.088.79
Long Term EPS Growth Estimate (%)12.3111.61
5 Year Average Return On Equity (%)18.1517.44
Current Return on Equity (%)18.8318.30
Long Term Estimated Return on Equity (%)21.6819.09
Debt/Capital (%)32.2340.33
Historical 5 Year Average P/E (X)18.1314.86
Current P/E (X)19.3616.99
P/E based on next 12 months (X)16.8414.07

In closing, we would like to make the observation that the valuation of the portfolio, the price to earnings (PE) multiple is relatively high for both our portfolio and for the market overall. It would be difficult to build a case that said stocks are cheap at this point. We are working hard to find attractively priced, high quality companies and we are maintaining a good level of diversification. Nonetheless we expect the markets’ recent volatility to continue for some time. A long-term investment horizon and a well-established discipline are essential during such periods.

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. An investment cannot be made directly in an index. 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.

Standard deviation (Std Dev) 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.

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.

EBITDA is intended to indicate the current operational profitability of a business. It is created by considering a company's earnings before interest payments, tax, depreciation, and amortization are subtracted for any final accounting of its income and expenses.

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.


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