Portfolio Manager's Commentary
Fourth Quarter 2012
We have put the U.S. presidential election behind us, avoided the worst of the potential outcomes related to the “Fiscal Cliff,” and seen China’s leadership execute an apparently smooth transition of power. Investors seem to finally be adjusting to a world that produces slower economic growth and whose developed country governments have substantial debts to pay. Perhaps the world is ready to move forward, or at least to look forward with a hopeful attitude and put the financial crisis of the prior decade behind its collective psyche. During the fourth quarter, equity markets throughout the world produced positive returns to finish a strong year and Portfolio 21’s results were superior to the benchmark.
Performance as of 3/31/13
| Retail (PORTX) | Institutional (PORIX) | MSCI World Index (Gross) | MSCI World Index (Net) | ||
|---|---|---|---|---|---|
| Quarter | Return (%) | 7.36 | 7.44 | 7.88 | 7.74 |
| 1 Year | Return (%) | 12.45 | 12.76 | 12.54 | 11.86 |
| Std Dev | 12.77 | 12.80 | 12.42 | 12.47 | |
| Alpha | -0.20 | 0.71 | 0.00 | 0.00 | |
| Information Ratio | -0.03 | 0.39 | N/A | N/A | |
| 3 Year Average Annual | Return (%) | 6.99 | 7.31 | 9.08 | 8.47 |
| Std Dev | 15.97 | 16.00 | 16.62 | 16.65 | |
| Alpha | -0.68 | -0.68 | 0.00 | 0.00 | |
| Information Ratio | -0.69 | -0.38 | N/A | N/A | |
| 5 Year Average Annual | Return (%) | 2.39 | 2.69 | 2.83 | 2.23 |
| Std Dev | 19.66 | 19.67 | 20.72 | 20.72 | |
| Alpha | -0.35 | 0.50 | 0.00 | 0.00 | |
| Information Ratio | -0.12 | 0.12 | N/A | N/A | |
| 10 Year Average Annual | Return (%) | 9.58 | 9.68 | 9.46 | 8.88 |
| Std Dev | 15.93 | 15.94 | 16.22 | 16.22 | |
| Alpha | 0.46 | 1.06 | 0.00 | 0.00 | |
| Information Ratio | 0.03 | 0.19 | N/A | N/A | |
| Since Inception Average Annual | Return (%) | 4.82 | 4.89 | 3.57 | 3.06 |
| Std Dev | 17.51 | 17.52 | 16.59 | 16.58 | |
| Alpha | 1.39 | 1.94 | 0.00 | 0.00 | |
| Information Ratio | 0.20 | 0.29 | N/A | N/A | |
| Gross Expense Ratio (%) | 1.47 | 1.17 |
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 investment team at Portfolio 21 spends its time researching individual companies. We are searching throughout the world for companies we believe are leaders in managing their businesses to mitigate environmental harm and that are also capable of producing above-average returns for shareholders. As we look forward into 2013, and out over the next several years, we find positive developments in terms of how the world’s best companies (by our definition) are dealing with natural resources and the environment. We also see attractive investment opportunities based on company fundamentals.
However, not every company in our portfolio performed as we would like. Portfolio 21 recently divested from two stocks due to concerns about environmental, social, and governance (ESG) related issues. As you know, we monitor our holdings closely and we sell if a company fails to meet our standards.
Recent Divestments due to ESG Criteria: Ecolab & United Natural Foods
Ecolab was sold as a result of the company’s proposed acquisition of Champion Technologies, which followed the firm’s 2011 acquisition of Nalco. These water treatment related acquisitions significantly increase Ecolab’s exposure to the energy sector, as their products are used in oil and gas production. Prior to these acquisitions, Ecolab had virtually no exposure to the fossil fuel sector; their business was making and selling cleaning and sanitation solutions to the food service, consumer, and health care sectors. During our initial research on Ecolab, Portfolio 21 engaged the company in lengthy discussions to ensure that it met our raw material guidelines; specifically that Ecolab was dedicated to formulating non-toxic substances with the least impact on human and environmental health. With Ecolab’s recent acquisitions, Portfolio 21 does not anticipate that these same standards will be met. We believe that Ecolab’s risk profile has shifted with its new increased emphasis on the fossil fuel sector and that the company will likely face more stringent chemical regulations and increased litigation.
We also sold our shares in United Natural Foods, Inc. (UNFI), the largest distributor of natural foods in the U.S. On the evening of December 10, 2012 workers at the company’s, Washington distribution center went on strike, citing 50 unfair labor practice violations. On December 13, UNFI published a press release, stating that “It is pleased that members of Teamsters Local 117 have voted to end its strike and return to work.” UNFI also stated that it looked forward to continuing negotiations; however, when the union-workers returned, 72 of the 163 warehouse workers who went on strike had been fired. In solidarity, the strike resumed that evening. Portfolio 21 wrote to the company seeking additional information on the specific steps it is taking to improve its employee relations and did not receive a response. The company’s poor treatment of its workers and lack of transparency in its communications led us to sell the stock during the first days of 2013.
Portfolio Fundamentals
We are pleased with the operating fundamentals of the current Fund holdings on average, compared with the global equity market. We have continued to find companies with above-average profit and growth characteristics. We find that the price we have to pay for what we consider to be excellent companies is reasonable compared with the market and by historic standards.
| As of 12/31/12 | Portfolio 21 Global Equity Fund | MSCI World Equity Index |
|---|---|---|
| Growth measures: | ||
| EPS – 5 Year Geometric Growth (Latest Filing) | 6.47 | 4.94 |
| EPS – Estimated Long Term Growth | 11.56 | 10.42 |
| Last 12 months Sales Growth | 7.71 | 4.17 |
| Profitability measures: | ||
| 5 Year Average Return On Equity (Latest Filing) | 27.23 | 19.40 |
| Estimated ROE (Forward 12 mos) | 23.93 | 19.77 |
| 5 Year Average Net Profit margin | 14.81 | 13.73 |
| Valuation measures: | ||
| 5 Year Average P/E Ratio | 17.58 | 17.57 |
| Current P/E Ratio (Trailing 12 mos) | 17.54 | 16.06 |
| Estimated P/E Ratio (Forward 12 mos) | 13.68 | 13.14 |
We believe companies throughout the world are generally in good fundamental shape as we head into 2013 and expectations are for continuation of the modest corporate profit growth seen in the fourth quarter. Housing and manufacturing data in the U.S. has been somewhat positive and unemployment is well off its highs. That said, there are some things worth noting on the risk side of the ledger:
- While a greater than average number of S&P 500 companies beat their earnings estimates for the third quarter, over half of the companies missed their revenue estimates, which indicates cost cutting is still a major driver of profit increases.
- In our opinion, big banks, due to lack of meaningful legislation since 2009, are still “too big too fail,” more opaque, and more risk-oriented than ever. This could present an ongoing risk to a recovering world financial system.
- “Fixes” to Europe and the Fiscal Cliff contained more than a little deferment, which will need to be dealt with at some future point.
- The Federal Reserve continues to pump liquidity into the U.S. economy and has been successful in its stated goal of raising stock prices. What remains to be seen are the consequences of such money printing, both intended and unintended, once it stops and interest rates begin to rise.
Given these risks, among others, and the projected moderating of corporate profits, we continue to hold and seek companies with growth prospects that are related to product, market, and business model advantages.
Fund Companies: Schneider Electric and Apple Computer
Two current fund holdings, Schneider Electric and Apple Computer, both enjoyed fourth quarter profit growth in 2012; however, the two stocks received very different responses from the market.
Schneider Electric shares gained more than 20% in the fourth quarter on sustained pricing power and a track-record for margin resilience. The company is a big player in automation and electrical distribution with a diverse customer base focused on serving the residential, building, industry, energy, and infrastructure sectors. Schneider has carved out growth by focusing on emerging markets, energy efficiency, and data centers. Strong networks and local partners allow for cross-selling and value-added service. Schneider certainly understands how to profit from changing energy infrastructure.
It was a tough fourth quarter for Apple Computer, which saw its stock decline by 20%. Some selling occurred in order to take gains before 2013 tax increases, but investor sentiment has also turned sour. The Apple maps snafu and talks of supply chain cuts for the iPhone 5 shook confidence in the company, while competition on all fronts intensified. The valuation of the stock still remains exceedingly cheap, but bigger picture questions revolve around the company’s ability to innovate. With areas such as TV, mobile commerce, and radio still ripe for disruption, there seem to be plenty of avenues for Apple to apply its massive intellectual and financial capital while still penetrating world markets with existing products. Moreover, Tim Cook is stepping out to lead the way on governance and environmental issues that will strengthen the company and the brand.
During the fourth quarter Apple was again spotlighted for its social and governance practices, however this time it was an acknowledgment of progress. The New York Times featured Apple and its Taiwan-based industrial partner Foxconn for their actions to improve employee working conditions and overall corporate governance structure. Apple tripled its corporate social responsibility staff and has engaged with competitors and advocacy groups to curb excessive working hours and increase employee pay.
An Important Step Toward Pricing Externalities
A significant move forward in energy policy has recently taken effect. California’s landmark global warming legislation, AB32, commenced on January 1, 2013. This is the first U.S.-based cap and trade program that will cover all industries. AB32 will help California meet its goal of reducing greenhouse gas (GHG) emissions to 1990 levels by 2020. Under the program, California sets an emissions “cap” for individual companies that emit more than 25,000 metric tons of carbon dioxide or other GHGs. Companies that emit less than their allotted cap can sell or trade their unused allowances to companies that exceed their emissions. Since Portfolio 21’s inception we have pursued investment opportunities in companies around the world and across all sectors that recognize ecological limits and have strategies in place to manage related risks, un-priced externalities, and growing environmental regulations.
Looking Forward
The outlook for stocks this year seems favorable as most economists expect the global economy to maintain a steady recovery. Companies have proven time and again over the last four years that they can deliver strong bottom-line results in a moderately expanding global economy. Consensus estimates have 2013 sales growth pegged in the 3-4% range for MSCI World stocks, which is essentially the pace estimated for 2012. Earnings growth is predicted to grow by nearly 12% in 2013, which is down from around 16% growth anticipated for 2012. Should consensus expectations for earnings growth play out for the final quarter of 2012 (corporate results are still coming in as we write), trailing valuation metrics would remain below long-term averages and only slightly above 2011 year-end levels.
As we said previously, there are risks to the favorable outlook for stocks and the conservative nature of Portfolio 21’s investment strategy seems well suited for these conditions. And as the recent divestments of Ecolab and United Natural Foods demonstrate, even as investors adopt a more hopeful outlook, one must be ever vigilant for changes at the corporate level.
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 capitalization weighted index that monitors the performance of stocks from around the world. 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. It is not possible to invest directly in an index.
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 is calculated by taking the total earnings divided by the number of shares outstanding. EPS Growth is not a forecast 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.
The Fund is distributed by Quasar Distributors, LLC.
