Disclaimer:
This story is not meant to represent advice or suggest transactions in securities referred to. It is not a substitute for the exercise of independent judgment, and readers should consult independent investment advisers in making investments. Neither Echelon nor the investment funds mentioned in this story accept any liability whatsoever for any loss arising from the use of the information presented here.
Three years on , only one of three model portfolios built by fund managers for Echelon escaped the bear to make 8% returns in 2016. Bearish sentiment dragged stock prices down despite companies’ earnings growth, with the stock exchange’s main All Share Index (ASPI) falling 9% during the reference period (4 December 2015 to 30 November 2016).
Fund managers are restricted from buying and selling stocks during the year. The rules of this exercise also prevents them maneuvering funds to any other income assets for better returns as they would normally do for portfolios they manage in the real world. Only year-end allocations were allowed. Three years ago, three top fund managers built hypothetical stock portfolios valued at Rs10 million each for Echelon’s January 2013 edition in an exercise to understand how long-term portfolio investments worked. Ramesh Schaffter of Janashakthi Insurance, Sumith Perera of Guardian Acuity Asset Management and Kanchana Karannagoda of Ceybank Asset Management manage these model portfolios.
By end-2016, the Rs30 million combined portfolio has grown to Rs43.5 million, losing Rs500 million from last year. We take a look at how each portfolio performed and the present reallocated portfolios, which will be reviewed next year.
Negative sentiments undervalu-ing good stocks
SUMITH PERERA
Guardian Acuity Asset Management is a joint venture equally owned by Ceylon Guardian Investment Trust, a subsidiary of Carson Cumberbatch, and Acuity Partners, the investment banking arm of DFCC Bank and Hatton National Bank. Head of Portfolio Management Sumith Perera discusses the performance of his model portfolio and reasons for reallocation.
How would you explain the model portfolio’s performance?
Stocks have had a weak performance throughout 2016. In January 2016, foreign investors reacted negatively to a US Fed interest rate hike, and as a result, there was a sell-off and the market tumbled.
The market recovered slightly, but concerns about the domestic economy—external debt levels, falling reserves and the Central Bank of Sri Lanka tightening monetary policy—weighed down the market further with the ASPI returning a negative 9% up to 30 November 2016.
My selected portfolio gave a negative 6% return. Even though it outperformed the ASPI, it’s still a negative return, and as an investor, I am concerned about my absolute return.
However, if I take a longer term view, my portfolio has returned an annualised 13.25% over the last three years, against the ASPI’s annualised return of 2.35%. My portfolio has done significantly better than the market, with a reasonable three-year absolute return. This shows that fund managers can give above-market returns in Sri Lanka through fundamental investing.
We see stocks making negative returns, but the companies are growing earnings. Why is this?
Yes, some companies are seeing better results, but share prices don’t reflect this. One such company is Distilleries. A shift in taxation policy in 2016 saw consumers migrate to hard liquor. The company benefitted in volume growth, but the share price did not reflect this.
Softlogic, which is highly leveraged, saw its price fall because investors were concerned about rising interest rates impacting the company. Given the company’s business interests in retail and healthcare, cyclical fluctuations in interest rates shouldn’t have a large bearing on the decision to hold the company for the long term.
Seylan Bank’s share price falling is surprising. The bank’s fundamental performance has been on an improving trend. Profitability is increasing and non-performing loans are on a better footing. The bank’s management is focusing on all the right places. Its share price does not reflect any of thesepo sitives.
Overall, companies are growing earnings, but share prices are falling. There is a disparity between fundamentals and share price performance. We have more of a sentiment-driven market, which is why when a little positive sentiment comes in, there can be large upward corrections.
Valuations are attractive in a downturn. We were in a similar situation three years ago. Because we were exposed to fundamentally strong companies, the portfolio gained 56% compared to the ASPI, which gained 24%.
This could be the typical cycle and we could see the market perform really well. Portfolio managers are psychologically trained to have a long-term view, absorbing the negative years along with the positive; and over a period of time, returns are better than most assets out there.
Explain your allocations for 2017.
I have added Sampath Bank to my portfolio for 2017 because of profit growth arising from its branch expansion, improved cost efficiencies and above-industry loan growth, which I expect will continue. The bank’s capital adequacy is relatively lower than that of other banks, but I am bullish on the stock. Hatton National Bank’s performance remains strong, with growth in non-interest income, reduced operational costs through restructuring and streamlining of processes that have resulted in strong profit growth over the last few years. The bank’s non-voting share price is attractive compared to other listed banks, which is why it has a higher allocation in my portfolio, along with Sampath Bank.
The portfolio will maintain its exposure to Softlogic Holdings, despite concerns about its high leverage. I believe its focus on healthcare and retail will continue to be fruitful going forward, overcoming gearing concerns. Continuing increases in internet penetration will benefit Dialog, with data already grown to around a quarter of group revenue. Business growth in data will be slightly affected after the recent tax increase in the latest budget proposal, but will still have strong growth.
I have increased the portfolio’s exposure to Access Engineering for 2017. The last two years have seen the construction sector slowing down, with many large infrastructure projects put on hold. I believe another phase of infrastructure development is on the cards for Sri Lanka with projects being lined up by the authorities. Access has demonstrated its expertise in the sector, and its ability to successfully bid for such projects. I have increased exposure to leasing companies by including People’s Leasing and maintaining exposure to Central Finance. The pricing on these stocks is attractive, especially now that interest rates are rising and they are not expected to perform well in a high interest environment due to slower re-pricing of assets. Here, I am taking a medium-term view, as profitability for the sector is expected to decline in the short term. When interest rates eventually come down, earnings will improve.
Hotel stocks are not doing so well due to competition and declining occupancy levels. Aitken Spence Hotels is experiencing tough competition in its Sri Lankan properties due to growth of more affordable hotels and weak occupancy in the Maldives where it has significant exposure. Its recent capacity expansion is yet to bring in the numbers. I maintain the stock in the portfolio as an attractive investment for the medium term.
[pullquote]Overall, companies are growing earnings, but share prices are falling. There is a disparity between fundamentals and share price performance
– Perera[/pullquote]
Cargills is another stock I have included to the portfolio. Increasing incomes and changing consumption patterns will benefit the company, which holds half the market share in modern retail trade. The company has been expanding its supermarket chain, improving operational efficiencies and investing in developing its own brands of fast moving consumer goods.
I have reduced the portfolio’s exposure to Hemas Holdings because prices have appreciated significantly, reducing the upside. I have also maintained Distilleries in my portfolio, which remains a play on income and consumption patterns.
Stocks that escaped the bear
KANCHANA KARANNAGODA
Ceybank Asset Management Limited manages five open-ended unit trust funds, two of which are directly in the stock market – namely Ceybank Unit Trust and Ceybank Century Growth Fund. The model portfolio managed by the firm’s fund manager Kanchana Karannagoda made an impressive 8% gain in 2016.
How did your model portfolio perform in 2016?
The portfolio returned 8% in 2016, outperforming the market by 17%, the All Share Price Index declining 9%. Annual average return over three years is 15.8%.
The year 2016 began with foreigners exiting from high liquidity stocks following the US Fed increasing rates in December 2015. During the year, investor confidence was stimulated from time to time on news of healthy corporate earnings, support from the IMF’s Extended Fund Facility and the conclusion of the Port City agreement.
However, uncertainty over a capital gains tax and lack of clarity in the national budget for 2017 drove down indices towards the end of the year. Some stocks were spared overall bearish sentiments that prevailed throughout the year.
TeeJay Lanka (TJL) was the best performing stock, returning 26%. The company’s acquisitions of a fabric printing business here and an India-based knit fabric company created a platform for synergies, capacity optimisation and production efficiencies.
Tokyo Cement (TKYO) gained 23%, benefitting from large infrastructure development projects taking off during the year. Hemas (HHL) shares returned 12%. There was significant foreign and local institutional demand for the stock. The company’s FMCG and healthcare businesses are growing on rising disposable incomes and health conscious households. The company’s hotel businesses have positive outlooks, with tourist arrivals growing and the rupee depreciating.
Lanka Hospitals (LHCL) gained 10% largely due to the government announcing plans to sell its controlling stake.
Hatton National Bank (HNB) non-voting shares gained 8% on improving financial results across all KPIs. Core earnings and asset quality are improving as a result of the bank’s strength in the SME and micro segments.
Access Engineering (AEL) gained 8% after the government recommenced the infrastructure development drive. It is the only listed company significantly exposed to a wide range of construction and engineering-related operations.
Softlogic (SHL), Distilleries (DIST), Commercial Bank (COMB) non-voting, John Keells (JKH) and Lanka IOC (LIOC) made negative returns mostly due to bearish investor sentiment and ad-hoc policy implementation.
What does your reallocated portfolio look like for 2017?
I will hold on to the same stocks for the most part, changing the allocations. I am including another bank Nations Trust (NTB) and exiting Distilleries.
Nations Trust has a high upside delivering strong financial results and shareholder returns. High margins and loan book growth make it an attractive stock. I divested Distilleries due to its group restructuring. I am bullish on construction-related stocks, with large infrastructure development activity picking up like the Colombo Port City project. I have increased the portfolio’s exposure to this sector by 34%, with Access Engineering, ACL Cables and Tokyo Cement.
Banks are allocated 23%. Commercial Bank returned a negative 9% in 2016, but this had nothing to do with the business’ financial performance. Interest rates are forecast to rise in 2017, impacting banks positively.
TeeJay Lanka’s allocation remains unchanged at 12%. I am confident the company will continue to
enjoy steady growth, which could improve further with the renewal of the GSP Plus concession.
Exposure to Lanka Hospitals is reduced slightly, but there is upside potential with the government deciding to dispose of its controlling stake.
I slightly reduced the allocation to Hemas. The company has a strong cash position that can be deployed into strategic investments, while the FMCG and healthcare businesses continue growing.
I have increased the allocation to Dialog. The market – leading mobile telco will sustain margins supported by its voice and broadband business units. Investments in broadband infrastructure will have a positive impact on earnings. The government’s budget proposal on 3G and 4G infrastructure conversion is unlikely to affect Dialog, but smaller telcos could be looking at industry consolidation in the medium term.
[pullquote]During 2016, investor confidence was stimulated from time to time on news of healthy corporate earnings, IMF support and the conclusion of the Port City agreement
– Karannagoda[/pullquote]
The portfolio’s exposure to John Keells is reduced to 3% from 9% in 2016. The group’s profitability is driven by businesses in consumer foods, retail, hotels and logistics, which could be affected by falling disposable incomes as a result of higher taxes and monetary policy tightening. For the same reason, I have reduced the allocation to Singer (SINS).
I have also reduced the allocation to Lanka IOC. Oil prices will rise, with producing countries cutting production, adversely affecting the company.
Still bullish on finance, construction stocks
RAMESH SCHAFFTER
Janashakthi Insurance has the third-largest market share in general insurance premium and fifth-largest in life insurance in a highly competitive market of 22 players. Ramesh Schaffter, a director of Janashakthi Insurance, was concerned about the economy at the beginning of last year. He discusses the reasons behind his model portfolio’s performance and the strategy behind his reallocations.
How did your model portfolio perform in 2016?
It’s been a difficult year for stocks. I said last year that uncertainties will continue, and sadly I am proven right. My portfolio made a negative 10% return, and this can be attributed to the common thread of policy inconsistency that came in from 2015. Companies were either undervalued despite businesses doing well or operated in sectors negatively impacted by ad hoc policy. The year 2016 was tough on conglomerates for several reasons. First, stock valuations fell because investors overseas decided to exit. Many of these continue to be undervalued, although underlying businesses are performing well. Second, some groups of companies are exposed to underperforming businesses. Aitken Spence did not perform to my expectations. The manufacturing sector was impacted by uncertainties over taxation for most of the year and the VAT increase that came later, which is why Renuka Agri Foods didn’t perform to expectations. Manufacturers here also struggle with efficiencies of labour and scale.
Banking and finance stocks took a beating in 2016 despite increasing profits, improved efficiencies and better control over non-performing loans. Most of these companies are poised for further growth. Political and economic uncertainties will continue for some time. Corporates will not have the space needed to reach potential. It’s very difficult to select a winning sector or company to invest in. Whenever a sector does well, the Treasury lights up because it can take that all away with new taxes. This is not a sustainable way to raise government revenue. The budget process was a lot better in 2016 than in the previous year, but there are far too many grey areas. Take taxation, for example. I believe a lot more clarity is needed post-budget, especially on areas like taxation on investment income.
Can you explain reasons for reallocating the portfolio for 2017?
Given the uncertainty that continues to underlie the economy, it is difficult to pick sectors you would like to be exposed to, but I am bullish on construction, banking and finance. I included Royal Ceramics (RCL) in the portfolio. It will benefit from the construction industry picking up again and from being the market leader in floor and wall tiles, controlling two other listed tile companies. I have increased my exposure to Access Engineering because it is the leading construction company in terms of acquiring large scale projects from the government and the private sector. We may see margins reduce, but it will make up for this with volume. But I am a bit concerned about the company diversifying into non-construction-related businesses, which could dilute its core.
Swissteck (PARQ) is another inclusion. Its construction-related Aluminum business has seen impressive growth and I expect it to continue. It’s a turnaround story really. A few years ago, the company was not doing great and its share was trading at almost nothing (Rs12). Its connections to conglomerate Hayleys (via Royal Ceramics-controlled Lanka Tiles and Lanka Walltiles) also makes an interesting company to be exposed to.
I am bullish on the construction sector, but Kelsey Developments’ stocks did not perform as expected because trading volumes continued to be very thin. I have decided to exit this stock, but the company is not performing badly.
I would like some exposure to the food sector, so I included Bairaha Farms. The company’s profits are growing. However, government food price controls is a concern. I have exited Aitken Spence. The conglomerate failed to perform to expectations because businesses exposed to certain sectors are not doing well. I continue to be bullish about Janashakthi Insurance (JINS). The company is making strong growth in profits and I am confident the share price will reflect this.
[pullquote]It ’s been a difficult year for stocks. I said in 2015 that uncertainties will continue, and sadly I am proven right
-Schaffter[/pullquote]
I will maintain my exposure to Nations Trust Bank and three finance companies, Citizen Development, Commercial Credit and Bimputh Finance. The stocks are undervalued with significant upside potential.