We were not surprised. With the stock exchange’s main index the All Share Price Index (ASPI) falling 4.8% during the reference period for this exercise (from 9 December 2014 to 4 December 2015) and fund managers only allowed year-end reallocations, the results are not disappointing. Not only are the fund managers of ‘Echelon Hot Stock Picks’ portfolios prevented from manoeuvering their portfolios to exploit sudden gains or avoid sudden blips in the market, the rules of this exercise also don’t allow allocations in any other income assets like government or corporate securities.

Although the portfolios fell between 1% and 4% during 2015, we gained some valuable insights on investing for the long term. Two years ago, top fund managers built hypothetical stock portfolios for the January 2013 edition in an exercise to understand how long-term portfolio investments worked. Ramesh Schaffter of Janashakthi Insurance, Indika Rajakaruna of Ceybank Asset Management and Sumith Perera of Guardian Acuity Asset Management were each asked to create a model portfolio valued at Rs10 million. Rajakaruna has since left Ceybank and Kanchana Karannagoda from the same firm takes his place.

Two years later, the Rs30 million combined portfolio has grown to a little over Rs44 million, losing Rs2 billion from last year. We take a look at how each portfolio performed and present reallocated portfolios, which will be reviewed next year.

 

FOCUS ON THE LONG TERM – 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. Sumith Perera, Senior
Fund Manager at the firm, discusses the performance of his model portfolio and reasons for reallocation.

Perera’s portfolio barely lost value in 2015, declining 1% compared with the ASPI’s 4.8% drop. The portfolio gave a return of 56% in 2014 for a compound annual return of 24.2% for the first two years.

“I would describe the year as a ‘risk-off ’ year. Investors were risk averse and took a wait-and-see approach due to the presidential and parliamentary elections, the uncertainty that comes with a change in government, and concerns over how it was going to finance the budget deficit. Equities overall had had a lacklustre year,” he said.

Foreign outflow from the Colombo Stock Exchange during the year amounted to Rs3.5 billion, as global investors sold out of emerging and frontier markets in anticipation of the US Fed rate hike. Sentiments were not helped by a cooling Chinese economy. “The equity market was affected by these domestic and external factors, and the portfolio was able to mitigate the drop,” Perera said. Hayleys Fabric stock performed well for the portfolio. Bottomline growth was driven by a shift to high-margin fabric production and softening raw material prices. “I continue to hold this in the portfolio because the capital expenditure of the firm will also invest in new and more advanced machinery, and further improve capacity and revenue growth.”

Another stock that did well was Hemas Holdings. Its core FMCG sector showed strong earnings growth on better consumer sentiment and higher disposable income. The focus on FMCG and pharmaceuticals, and expansion in Bangladesh will be lucrative for the company, and Perera sees a further upside for this stock.Access Engineering was a popular stock a year ago, but was sensitive to public sector infrastructure projects put on hold last year.

“Access was popular due to a robust project pipeline. Going forward, the infrastructure drive will be revived and I believe Access will get a share of projects, although the project pipeline may not be as robust and margins as lucrative as in the past,” he said.

Dialog’s operating performance and margins were in line with his expectations. The proposed super gains tax affected company earnings. Perera believes revenue growth will be driven by data and television revenues, margin improvements from BBG submarine cable operations, and cost-reduction initiatives.

“Aitken Spence has fundamental value, but significant foreign selling and low local demand did not help the stock price.” With their projects in the pipeline, Perera believes there is value in this stock going forward.

Banking stocks in the portfolio did well, except for Nations Trust Bank. “Despite Nations Trust Bank having a strong and vibrant banking model, I removed it from the portfolio as I was able to identify another bank with a higher share price upside,” he said. Perera has opted to include Seylan Bank because he sees improvements in its banking model, asset quality, cost efficiencies and loan growth.“These factors, combined with recovery of legacy non-performing loans, make it a good stock to buy.” He is increasing his exposure to Softlogic although
concerned about its high leverage. “The company’s business model shows tremendous potential with a renewed focus on core sectors like retail, healthcare, financial services and ICT.” He hopes to see some restructuring and an eventual exit of lowerperforming sectors, which would help ease Softlogic’s net-debt position. “Improving consumption trends and rising per capita income will benefit this company, which is why we are taking it to the top of the portfolio,” Perera said. Distilleries being the largest player in the hard liquor market will see volumes pick up as the crackdown on illicit liquor and tax evasion intensifies.

“The equities market will see short-term challenges in 2016 going into macroeconomic headwinds. There is pressure on the exchange rate and room for interest rates to pick up, which constrain earnings. It is important to note that equity investing and stock picking are long-term exercises, so these times give investors ideal opportunities to pick up good companies that are going at relatively cheaper prices and build strong portfolios rather than having to wait till prices improve again,” Perera said.

 

I HAVE FAITH IN CONSTRUCTION AND FMCG – 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 was managed by the firm’s fund manager Indika Rajakaruna during the first two years. The portfolio is now managed by Kanchana Karannagoda, a fund manager with the same firm, who has reallocated the portfolio for 2016.

This portfolio fell 4.3% in 2015, compared with the 4.8% overall market decline between 9 December 2014 and 4 December 2015. This portfolio gave a compound annual return of 18.6% over the last two years. In 2014, the portfolio grew 47%. “Political uncertainty and sentiment dominated over fundamentals to drive down value on the stock exchange in 2015, and is likely to continue,” Karannagoda said, adding that that she would persist with some of the stocks in the portfolio that were hit the most, like Access Engineering and Commercial Bank.

“Textured Jersey was the growth catalyst of the portfolio, growing its portfolio value by 73%. This is due to the company’s strong financial results driven by wider net profit margins and growth in sales volume, followed by capacity expansion. I have increased Textured Jersey’s allocation in the portfolio because I believe the company will continue steady growth by expanding its valued-added segment,” Karannagoda said.

ACL Cables was another good performer in the portfolio, with its value increasing 52%. She believes the stock was undervalued at the beginning of 2015 and has a potential upside. The company manufactures electrical cables and has a 70% market share. The stock’s good run is expected to continue, with construction activity expected to pick up later this year. The new government had put the brakes on the construction boom. Companies in this sector that were viewed to be close to the previous regime saw their share prices fall. The portfolio value of Access
fell 40%, but Karanngoda wants to hold on to the stock.

“The fall in Access’ stock prices had nothing to do with the financial performance of the company. I am holding on to Access because I am bullish on the construction sector, which is why I continue to hold on to Tokyo Cement as well,” she said. The retail sector is expected to perform well this year driven by improving disposable income. John Keells Holdings’ consumer retail segment saw impressive growth last year and Karannogoda has increased her allocation in the stock. She will continue to hold Softlogic Holdings, which fell 22%, and included Singer Sri Lanka in the portfolio. Hemas Holdings is the other new inclusion, which is mainly backed by strong growth momentum in its core business segments of FMCG, healthcare and leisure. Hatton National Bank was among the few stocks in the portfolio that did well in 2015, and despite a poor performance, Commercial Bank will also remain on the portfolio. “I see potential for Commercial Bank, which was trading at a discount. Even the leasing ban will not affect the bank because it already has a subsidiary specialising in leasing. The portfolio value of the stock fell 25% during the year, but this had nothing to with the bank’s bottomline,” she said.

Union Bank, Aitken Spence Hotel Holdings and Laugfs Gas, which fell in portfolio value by 11%, 17% and 4% respectively, have been divested.The equity market will continue its lacklustre performance in 2016. “I don’t think the stock market will have a buoyant year, but I am positive sentiments will improve. Once the government settles down, and the budget is finalised and mechanisms put in place to implement budget proposals, I believe the stock exchange will have a good run during the latter half of the year,” Karannagoda said.

 

I AM CONCERNED ABOUT THE ECONOMY – 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 bullish at the beginning of last year. He discusses the reasons behind his model portfolio’s performance and the strategy behind his reallocations.

Schaffter’s portfolio fell 4.3% in 2015 after giving a return of 57% the previous year for a compound annual return of 22.6% over the last two years.

“The market had a difficult run because of political changes, and there were few stocks that were badly affected by that. Access Engineering, which was viewed as being close to the previous government, lost almost half its value from peak levels. The stock had a substantial allocation in the portfolio and we are looking at a 38% fall, which is the single biggest decline in the portfolio,” Schaffter said.

At the current price, Access Engineering looks attractive and Schaffter wants to continue holding the stock. The company’s fundamentals are strong and it will play a significant role in the country’s construction sector. He believes the company’s diversification into property development and housing will strengthen it further.

“I will continue to hold Kelsey Developments, which had a good run, up 51% last year. The property sector is quite hot, but unfortunately there are not enough listed property developers.”

Lanka Hospitals and ACL Plastics contributed positively, but Schaffter is exiting these stocks. “At some point you need to take your profits as any investor would,” he said. The share price of Lanka Hospitals could spike this year after the government said it planned to divest its controlling stake, but Schaffter is not tempted. “I don’t believe the company is doing well at this stage, they have their inherent problems and I don’t see good value unless there is a turnaround in the business.”

ACL Plastics was the plum in the pudding as far as this portfolio is concerned, making a 45% gain. “It was a difficult decision to let go of this stock. There is still some upside for the stock, but it is also a cyclical industry and it’s time to move on,” Schaffter said.

“I am getting rid of Royal Ceramics because of negative sentiments arising from the budget where certain duty protections have been removed.”

He exited Commercial Bank, but holds the smaller Nations Trust Bank. The banking sector is exposed to several problems from the 2016 budget proposals, the most significant being a possible ban on leasing. While Commercial Bank has a separate subsidiary that specialises in leasing, Nations Trust could be worst hit because its exposure to leasing is the highest of all banks, at nearly 24%.

I considered the bank’s high exposure to leasing. The budget had several proposals that were adverse to the banking sector, but I will take my chances with NTB,” Schaffter said.

He may not be hot on banks, but finance companies have got his attention. Particularly those that provide micro finance services where margins are good and barriers to enter are high. “Bimuth Finance has increased substantially in value, but its underlying results are growing much faster. Commercial Credit had run its course and peaked at around Rs75, and has now come off by about a third from that peak price; in that context, I believe now is the right time to enter this stock,” Schaffter said. He doesn’t believe in investing in big conglomerates, many of which he believes are overvalued. “I have invested in some Aitken Spence stocks because they have had a few difficult years and have not really stretched themselves enough, so there is potential for growth.”

The Janashkthi Insurance Director is also holding on to his own stocks. “The synergies of the acquisition of AIA’s general insurance business by Janashakthi will be felt this year,” he said.

2016 is going to be a tough year. With the change in government, people expected the market to boom, but it’s been quite the opposite. “I think the government is still finding its feet. The budget was mixed and not pointing at any particular direction. I am concerned about the economy. The conditions are not right for the market to flourish,” Schaffter said.He said high net worth investors who drove the market are probably cautious as well with the regulator planning to tighten governance rules.

“I believe 2016 will be an exciting year for the equities market in terms of mergers and acquisitions, and this is where the opportunities lie, but this is speculation and it is not reflected in the portfolio. We will see mergers in insurance and banking, and some hostile acquisitions because values have dropped in the market, making some companies easy targets,” Schaffter said.

 

Disclaimer:
This story is not meant to represent advice or to 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.