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 advisors before 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.
For the first time in seven years, all three model portfolios trailed the All Share Index, and all three made negative returns. The index had gained 0.5% during the year ending on 30th November and the three portfolios declined 4%, and as one fund manager pointed out, mostly due to the ‘bashing’ banking stocks had taken. It was the year of the COVID-19 pandemic after all, but the portfolios closing in November, prevented them from enjoying the December stocks rally which saw the ASPI close 2020 with a 10% gain. 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.
The rules of this exercise also prevent them from maneuvering funds to any other income assets for better returns as they would normally do for portfolios they manage in the real world (which they pointed out to us this year! The three fund managers said the model portfolios would have had better returns had they been able to trade frequently). However, only year-end allocations were allowed, because the point of this exercise to get a feel for long term investing.
Ramesh Schaffter of Janashakthi Insurance, Asanka Jayasekera of Guardian Acuity Asset Management and Kanchana Karannagoda of Ceybank Asset Management manage these model portfolios. By end-November 2020, the Rs30 million combined portfolio has grown to Rs46.4 million, down 2.3 million from last year. The annual average return of the combined portfolio for the seven years is 6.3%, compared to the All Share’s marginal 0.93%. We take a look at how each portfolio performed and the present reallocated portfolios, which will be reviewed next year.
Pandemic highlights importance of active Portfolio Management
Asanka Jayasekara guardian fund management, Senior Fund Manager
Echelon’s model portfolio exercise in its seventh year by its limitations highlights the importance of active fund management and the value professional portfolio managers can bring to the table with their experience, insights, and research.
The rules laid down by Echelon prevent us from trading actively and rebalance the portfolio to reflect the market conditions which was in constant flux in 2020; a year ravaged by the COVID-19 pandemic and the unprecedented economic challenges in its wake. As a result, my model portfolio delivered negative returns of 6%, compared to the market’s 0.5% gain during the period. The portfolio has averaged a 7% return annually over the last seven years outperforming the market’s 1% annual gain.
In the year in review, the banking and finance stocks had a sizable allocation on my portfolio. The financial sector enjoyed a brief revival at the beginning of the year on improving business activity after a round of stimulus measures to revive the economy from the devastating impact of the 2019 Easter bombings. Unfortunately, that recovery could not materialize because of the coronavirus and the 52-day lockdown since March to contain its spread. The worst damage caused by the pandemic was in the second quarter with the economy contracting sharply.
Given that the banking and finance sector is the backbone of the economy, it was little surprise that listed banks and finance companies underperformed the market. Incidentally, some manufacturing, construction and consumer stocks did bounce back strong to outperform the market beyond anyone’s expectations. The financial sector will continue to be prominent in my reallocated model portfolio for 2021 because the economy has been improving every successive quarter since.
One hopes a COVID-19 vaccine will be available locally soon and lead to a better recovery and economic stability. I believe the banking and finance sector would serve as a precursor of economic recovery. We must be mindful of the new headwinds confronting the financial sector from the sovereign rating downgrade and balance of payments pressures. Commercial Bank, HNB, Sampath, Central Finance and People’s Leasing, and Finance have considerable weight in the portfolio because they are financially stable and their valuations are attractive, supported by favourable credit quality, business models and management capabilities.
I have either divested or not selected some of the best-performing stocks of 2020 for the 2021 portfolio. These reported exceptional earnings under extraordinary conditions. For instance, some companies won market share from smaller competitors badly hit by the economic fallout of the pandemic or import restrictions; or they benefitted from the new demand dynamics that emerged with COVID-19; or gained an advantage from a macroeconomic policy change.
Some of these companies may continue to post good results over the next few quarters but we have to adjust these shorter term profit jumps and take normalised earnings for valuations with a medium-term perspective while suitably factoring in some secular changes that transpired with new macro-level changes and new policy directions. I dropped stocks that I believe do not have much upside to warrant holding for a full year. I will hold Hemas Holdings and Distilleries for their upside potential.
Hemas has reiterated its commitment to focus on its core businesses by divesting its leisure business and expanding into pharma manufacturing. Despite an initial decline, its FMCG segment demonstrated commendable resilience. My expectation for Distilleries is different. If it can continue to pay a decent dividend yield while maintaining bottomline growth and its dominant market position, that will enable investors to get the required equity risk premium. However, any entry has to be at a price discounted for policy risks inherent to the industry.
John Keells Holdings is at a crucial juncture as it prepares to conclude its largest-ever single investment: the Cinnamon Life integrated resort. The fate of the group hinges on how successfully it implements the original business plan for Cinnamon Life. Its other business segments are doing well except leisure which has always added at a discounted value compared to the other businesses of the group.
I have made allocations to two hotel stocks because I believe they are trading at a discount. Fundamentally, Sri Lanka’s tourism industry is inherently expensive compared to regional peers given its low ROEs and high capex. However, the current prices are unwarranted when adjusted for normalised situations which means a rerating is due over the next few months.
Overall, the outlook for equities is positive for the medium term. However, structural macroeconomic challenges remain, and unless there is a reasonable commitment to address these, portfolio managers will frequently review their equity investment strategies.
A Mostly Unchanged portfolio for 2021 Anticipating an Economic revival
Kanchana Karannagoda Fund Manager, Ceybank Asset Management
The equity market had experienced an upturn after the November 2019 presidential elections on positive investor sentiment, and expectations for stable government and consistent policy. Retail investor participation was overwhelming during that short window from the election to the year-end. I had allocated my model portfolio expecting the economy would recover in 2020. However, the equity rally did not sustain.
The first quarter of 2020 saw the market decline as it became apparent the government had mounting fiscal challenges from the stimulus measures it had introduced to deal with after the economic downturn in the wake of the 2019 East terror attacks. Soon after, came the COVID-19 pandemic which no one saw coming. The market experienced a sell-off which was the case in emerging and frontier markets elsewhere in the world. Foreign investors had existed after the sovereign credit rating downgrade earlier in the year. The market was closed in April due to the curfews and lockdown to contain the coronavirus spreading, and this side-lined local retail investors and irked foreign investors.
During the second half of the year, the All Share Price Index rebounded impressively as retail investor participation renewed once the lockdown lifted in May, and the economy showed signs of a recovery. The market continued to perform well, even despite the second COVID-19 wave.
The government reduced interest rates to stimulate credit growth and imposed import restrictions to contain erosion in the balance of payments and preserve foreign exchange to settle external debt obligations. The low interest rate environment diverted investors in search of better yields away from fixed income instruments to equity, triggering equities’ upswing in the second half of 2020.
My portfolio returned a negative 1.5% in the reference period compared to the market’s 0.5% gain, largely due to the decline in banking stocks and diversified holding companies John Keells and Softlogic. However, from a long term perspective, the portfolio’s seven-year annualized gain was 6% compared to the ASPI’s 1%
The banking stocks in my portfolio returned negative yields due to the impact on earnings from the debt moratorium scheme introduced by the government. During the reference period, Hemas returned 7% on the back of a record financial performance above market expectations. This was driven by impressive gains in its consumer and healthcare segments.
At the beginning of the period, Hemas’ share price was undervalued due to the impact of the 2019 East Sunday attacks and I still see upside for this stock so it will remain in my portfolio for 2021.
Softlogic was the biggest loser in my portfolio returning a negative 35%. I will not hold this stock due its limited upside on account for its highly leveraged balance sheet. John Keells reported negative results during the reference period mainly due to losses in its tourism-related ventures. However, the share did make a recovery in the second half of 2020.
I will continue to hold Access Engineering and Tokyo Cement because I believe the government is keen to revive the construction industry and commence some large infrastructure projects. I included these stocks when I reallocated the portfolio for 2020 expecting the sector will see a revival but the COVID-19 pandemic prevented that. But I do expect a construction boom will commence in 2021. I will also hold on to telco market leader Dialog, and Lanka IOC for exposure to the energy sector and Teejay Lanka for exposure to manufacturing.
I am optimistic that the economy will experience a revival in 2021, especially after the successful deployment of COVID19 vaccines in several countries. At a policy level, we can expect consistency over the next five years. Corporate earnings could see some improvement, and with interest rates expected to remain at low levels, the equities rally could continue well into 2021.
I also hope the government takes measures to reverse the credit rating downgrade which is critical to attracting foreign investments into the country to shore up reserves to meet debt obligations over the coming months. Favourable macroeconomic policy measures can only further bolster prospects for listed stocks.
A final word on the importance of active fund management, Echelon’s model portfolio only allows reallocations at the end of the period, so we did not have the opportunity to readjust the portfolio to account for the post-lockdown rally. In the real world, however, active fund management allows for market-beating returns. For instance, two funds I manage the CEYBANK Century Growth Fund and CEYBANK Unit Trust Fund returned 53% and 48% respectively during March 31 to November 30, whereas the All Share Index returned 37%.
BANKING STOCKS TAKE A BASHING
RAMESH SCHAFFTER EXECUTIVE DIRECTOR, JANASHAKTHI INSURANCE PLC
The model portfolio returned a negative 4% due to the exposure in banking stocks Nations Trust and NDB Bank. All listed banks remained financially sound, but the debt moratoriums dragged their valuations. The two mid-sized banks on my portfolio have been particularly disappointing. They did not recover from the Covid fall when the market declined during the first half of the year due to the prolonged lockdown earlier in the year. I will divest my stake in Nations Trust in the reallocated portfolio for 2021 but hold on to NDB Bank for some exposure to the banking sector.
The two insurance companies in my portfolio Janashakthi Insurance and HNB Assurance had contrasting outcomes. Janashakthi declined but could have performed better had the regulator not restricted the distribution of dividends. Janashakthi’s life insurance business did alright during the year with modest gains. HNB Assurance on the other hand, gained an impressive 39% because its general insurance business benefitted from the sharp fall in claims due to the fewer vehicles on the street for nearly three to four months of the year due to the lockdown. I will divest Janashakthi but hold onto HNB Assurance because I believe there’s upside potential still in this sector.
LB Finance has reported satisfactory earnings, but the share continues to be undervalued. Although LB Finance gave the portfolio a negative return, I am bullish on the stock. The finance company is one of the strongest performers in the non-bank financial institutions sector with a high dividend yield. It is a stock I have been hot about for a while with an attractive net asset value per share of Rs182 (and Rs184 at group level). It is a heavily discounted share price for a company with a large balance sheet so I will continue to hold LB Finance in 2021.
Citizens Development Business Finance (CDB) declined 1% during the reference period. CDB has a net asset value per share of Rs174 or more, and this is phenomenal because its share trades at almost half its asset value. Finance companies performed much better than banks in terms of earnings because they are primarily in the vehicle leasing business, and therefore not severely impacted by the moratoriums or other credit risks.
Banks, on the other hand, do general lending and are more susceptible to the effects of an economic slowdown. Apart from that, banks also had to deal with debt moratoriums first to the tourism sector after the 2019 Easter terror attacks, and then to a broader segment of businesses affected by the pandemic. As a result, in terms of share prices, the entire banking sector has declined substantially during the reference period.
Access Engineering enjoyed the post lockdown equities recovery, and I will continue to hold the stock given the government’s focus on infrastructure development with over 100,000km due for development. Access Engineering will also benefit from the tie-ups with some of the Chinese construction companies operating here, so the upside is considerable in my estimation.
I have included Tokyo Cement, ACL Cables and Royal Ceramics because the construction uptake will be significant under the present government. They will also benefit from the government’s intention to support local manufacturers with tax incentives and restricted imports to revive the domestic economy.
Tokyo Cement’s medium prospects remain positive, and there is upside potential despite the post-lockdown share price gain. Royal Ceramics and ACL Cables enjoy significant market shares and are poised to capitalise on the construction revival amidst the virtually non-existent competition from imports.
Renuka Holdings is terribly undervalued and exposed to sectors I am excited about, such as agri-business, FMCG and property development. The group is well managed, stable, and with very low gearing. It can borrow at prime lending rates given its rating with banks if it ever needs to fund expansion and growth.
I have included Sunshine Holdings and Hemas Holdings because they have admirably navigated the pandemic and have exposure to sectors in the economy that have the potential to recover fast. Hayleys is also in the portfolio for its valuation and satisfactory performances of its subsidiaries Dipped Products and Haycarb. The share moved a lot in 2020, but I believe there is still some upside potential to warrant a place in the portfolio.
Overall, 2020 has been disappointing due to the pandemic, but the outlook is very encouraging for the year ahead. There are three reasons why I believe this is so: first, some businesses are seeing an improvement in profitability, and the low-interest rates have lowered borrowing costs in their P&Ls. Second, the low-interest rate regime the Central Bank is keen to maintain is seeing investors shift from fixed-income assets to equities in search of better yields, and new investors are coming to the equities market for the first time. Third, the stock market’s successful performance in the second half of 2020 sets the platform for success in 2021, which I am optimistic will be the case.