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LISTED EQUITIES SEEMED to reverse the 15% decline of the previous two years, gaining 3% during the year ending 30 November 2017. The market was weighed down by policy uncertainty, mute business confidence and low consumer spending despite encouraging foreign inflows in search of attractive valuations. The All Share Index (ASPI) gained 2.74% during the reference period, and two of the model portfolios returned 10.5% and 6.3%, while the third gave a negative 7% return.

Fund managers are restricted from buying and selling stocks during the year. 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. Only year-end allocations were allowed.

Four 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-2017, the Rs30 million combined portfolio has grown to Rs45 million, gaining Rs1.5 billion from last year. We take a look at how each portfolio performed and the present reallocated portfolios, which will be reviewed next year.

2017 was a year for setting the platform
Ceylon Guardian Investment Trust has expertise in investment management and provides investment solutions for its clientele in varying asset classes. Head of Portfolio Management Sumith Perera discusses the performance of his model portfolio and reasons for reallocation.

“201 7 HAS BEEN A MIXED year with the stage being set for structural changes in the economy, and thereby markets. We had a positive return on ASPI of 2.74%. When we look at the negative performance of the previous two years, it seems reasonably good, but I don’t think anyone can be happy with an ASPI return of 2.74%. My model portfolio returned 10.5%, which is commendable given the dynamics that shaped the overall market performance. The ASPI performance was largely influenced by heavy foreign inflows both to the bond and equity markets, so it’s been a marginally positive year ending 30 November 2017.

As an equity investor looking at the long-term perspective since we started this exercise in 2014, the ASPI has given a CAGR return of about 2.31%, but my model portfolio yielded a return of 12.6%, outperforming the ASPI by about 10.3%. The companies in this portfolio enjoy a combination of strong fundamentals, businesses exposed to growth sectors in the economy or they’re attractively priced with good upside potential. However, overall economic progress has been slow, and this is reflected in how the overall market has performed. Low consumer demand and rising inflation have impacted earnings, resulting in domestic investor sentiment continuing to be weak. However, foreign investment inflows were encouraging because global investors were more risk-on- and attracted by cheap valuations. I expect foreign inflows to continue into 2018, with global trade improving as well.”

Portfolio performance
“Aitken Spence Hotels was the biggest decline. The local hotel business has experienced intense competition from the informal sector, which exerted pressure on room and occupancy rates on star-class properties. The company’s properties in the Maldives, India and the Middle East did not perform up to expectations either. I continue to hold this stock in the portfolio for 2018. Although challenges may persist, in terms of valuations, I see upside opportunity as the company trades at a discount to replacement cost. I don’t expect high returns in 2018, but over the next three to five years, the company will yield high returns on the strength of its hotel properties and locations, and growth in tourism. Softlogic Holding’s businesses are exposed to the right growth sectors like retail and healthcare, but weak consumer demand and regulatory pricing on private healthcare proved challenging. The group leverage continues to increase to uncomfortable levels, which could be challenging. This will eat into bottom-lines and shareholder returns, which is why I’ve exited the position for 2018. If Softlogic can raise capital and divest its non-core businesses, it could place the group on a better footing.

Despite low consumer demand and taxation eroding disposable incomes, Cargills’ share price returned nearly 17%. The company too has gearing concerns, but with its recent disposal of property, we witnessed a significant reduction in its borrowings. This reinforced my positive view of the company, as it was focused on its core businesses. I feel the stock has much more upside potential.

Sampath Bank returned 30% largely because of the bank’s aggressive branch expansion strategy a few years ago allowing it to grow its loan book by 18% during the year, faster than any of its peers. It’s ROE at 19% is impressive. The stock is trading at book value, which is very attractive, and hence remains in my portfolio.

Hemas Holdings has returned 31%. We’ve actually caught the tail-end of the performance because this was a share priced at Rs30 levels a while back, now it’s Rs125. I haven’t included the stock in the reallocated portfolio for 2018 as its existing business will probably grow at a slower pace with competition increasing in Bangladesh and more regulation in the healthcare segment.

Dialog yielded 25%, which is not surprising given the growing penetration of data in our day-to-day lives. However, with capital intensity of the business, I am cautious of exposure to the company.

I’m maintaining my position in People’s Leasing and introducing the allocation of Central Finance. I expect net interest margins to improve because of lower interest rates, but slow growth in vehicle leasing due to high taxes will be something to watch out for. Both finance companies are attractively priced. People’s Leasing is trading close to its book value, whereas historically, the stock has traded at twice book. Central Finance is trading at a steep discount-to-book value, indicative of good upside potential.”

Outlook for 2018
“It’s going to be an interesting year. The new Inland Revenue Act will come into force. Some sectors may feel the added tax burden more than others, but more importantly, the act will relieve some of the pressures on the fiscal side, which was much needed. It may be a painful year of adjustments, but there is opportunity to get the economy on a firmer footing. I expect foreign investment flows to continue from last year. The question is whether local investors will become active; this will be a function of interest rates and general confidence in the economy.

I’ve included Chevron Lubricants despite declining margins. The company found it challenging to increase prices along with its input base oil prices. Market share fell because of heavy competition. The share price declined steeply during the year. However, the price weakness is an opportunity to invest in the company, which provides a high dividend yield.

I’ve picked Nations Trust Bank because of its unique banking model compared to peers. It’s more retail driven and customer-centric, engaging in cross selling across their customer base. They have good focus on SMEs and salaried employees. The share is trading close to book value with a good upside.


Equities could rally in 2018
Ceybank Asset Management Limited manages five open-ended unit trust funds, two of which are directly in the stock market – Ceybank Unit Trust and Ceybank Century Growth Fund. The model portfolio is managed by the firm’s fund manager Kanchana Karannagoda.

“2017 WITNESSED a degree of volatility. Listed equities returned 2.74% during the year ending 30 November 2017, and my model portfolio was able to return 6.3%. Compared to the market’s four years annualised return of 2.44%, the portfolio achieved 13.3%.

The year began on a negative note. Investor sentiment was low due to policy uncertainty, the absence of an investor-friendly budget for the year and interest rates rising after the Central Bank tightened monetary policy rates following the US Fed hike. Stocks rebounded in the second quarter as foreign investments improved as a result of the reallocation of funds to emerging markets with attractive valuations. Institutional investors were also seen consolidating their positions in value counters. It seemed as if they were selling to create an opportunity to buy at lower levels.

However, the upward trend couldn’t be sustained because domestic investors weighed in uncertainties in the economy due to the lack of clarity about the 2017 budget—several proposals were not implemented—and the proposed new Inland Revenue Act that was being drafted. Some confidence returned towards the end of the year after the passage of the Inland Revenue Act, which was mostly viewed as being positive.

Tokyo Cement was the growth catalyst in the portfolio, gaining 33% in line with the construction boom and capacity expansion through a grinding and bio-mass power plant. ACL Cables was expected to ride the construction boom, but its stock price fell 29%. This was due to rising aluminum and copper prices eroding margins.

Fabric maker Teejay Lanka was also impacted by rising raw material prices. The stock declined 15% as the company’s bottom-line took a hit due to a surge in cotton prices. Administrative overheads, capacity expansion and its tax holidays ending contributed to falling earnings. However, Teejay Lanka will benefit from rising demand due to GSP Plus going forward.

Hemas Holdings returned 32% backed by heavy foreign investor interest. The group’s earnings declined towards the latter part of the year, with businesses segments in FMCG, leisure and healthcare impacted by falling consumer demand, intense competition and regulatory price ceilings. Lanka Hospitals attracted considerable interest earlier when the government announced plans to divest its stake. However, this never materialized, cooling demand for the stock, which declined 6% during the year.

Hatton National Bank returned 28% on improving net interest margins and fee incomes, translating into bottom-line growth. This was despite higher trading losses due to increasing swap rates and rising impairment provisioning due to higher volumes. Dialog gave a return of 25%. The telco had a strong financial performance driven by growth in data and broadband earnings, and improved cost efficiency.

Lanka Indian Oil Company was impacted by high taxes and the inability to adjust prices due to price controls. The stock returned a negative 17% in 2017, but I’m confident the company will report a strong performance in 2018 when the government introduces a fuel pricing formula in accordance with its commitments to the IMF.”
Looking ahead

“The 2018 budget proposals announced in November 2017 improved sentiments further. It proposed to list the largest two state banks, and if this happens, the market could rally. The budget was positive overall, but implementation will be challenging. I’m holding on to Hatton National Bank and Commercial Bank because of sound fundamentals and attractive valuations. The Commercial Bank voting share is trading at a slightly higher premium than the non-voting share. The bank commands a dominating position in the corporate banking segment, which will drive loan growth, while its extensive reach supports deposit mobilization.

I’ve included Sampath Bank, which is trading at attractive valuations supported by potential growth in earnings from its rapid branch expansion, strong loan growth through SMEs and mortgage financing, improved cost efficiencies and strong risk management processes. Its ROE at 19.5% is impressive compared to the banking sector average of 13.7%.

Chevron Lubricants is in the portfolio despite falling turnover and profits because its dividend yield is above the market at 9-10% and the stock is trading at attractive medium-term valuations. A turnaround is expected in 2018 as it regains competitiveness in the market, with a downward revision of lubricant prices.

Access Engineering saw earnings fall due to the sluggish performance of its construction and property segments. However, the construction company will have a better year with several projects to take off in 2018.

Dialog will see growth in data and broadband usage after the government removed the 10% levy on internet usage. However, the implementation of the Cellular Tower Levy will have a negative impact on the telco’s bottom-line.”


A victim of political interference
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, is the outlier in this group. He discusses the reasons behind his model portfolio’s bleak performance and reallocation strategy.

“MY MODEL PORTFOLIO gave a negative 7% return in 2017, which underperformed the All Share Price Index by 10%. The portfolio was a victim of political interference like ad hoc taxes, restrictions and price controls.

The market promised much, but did not deliver. Expectations were high that the economy would pick up after two years of uncertainty. Political issues have affected business sentiment. Being a coalition government, budgets gave mixed signals and the bond scandal dampened sentiment and the market drifted. During the year, interest rates moved up before settling at current levels. Various policy measures impacted businesses negatively; for example, non-bank finance companies, which had a heavy weightage in my portfolio, were impacted by loan-to-asset ratios that stifled credit growth along with the increase in motor vehicle duties. The sector also experienced increasing non-performing loans. The economy was recovering from the 2016 floods when floods hit us again in 2017.

The market was affected by John Keells Holdings, which is the single major stock in the exchange. While many of its businesses are doing well, there is some doubt about the group’s major exposure to the Cinnamon Life mixed development project.

A few sectors have done well, but many have been affected adversely by government policy or international market conditions such as rising oil and raw material prices.”

Long overdue corrections
“I’ve tended to take a contrarian approach. I could always allocate to banks and safe stocks, and yes, some of them did perform despite difficult market conditions. There was too much uncertainty in 2017, even with regard to the Inland Revenue Act. No business likes uncertainty. It’s better to have bad news with certainty than deal with the uncertainty of good news.

I believe fundamentals are just one aspect. Many companies are fundamentally sound. But this is just one aspect of valuations. External market conditions—which are completely beyond Sri Lanka’s control—create some instability in the market here because of how global funds decide to invest, or not. Valuations are also impacted by local sentiments: uncertainty, scandals and political instability. Retail investment in the Colombo Stock Exchange has dried up. We see PE multiples for a lot of companies dropping to very low levels. Some companies are valued at below asset value despite making profits. The market is due for a correction. The correction will come.

In my portfolio, Nations Trust’s valuation is almost flat. I believe the bank’s major shareholders John Keells Holdings and Central Finance will trim their holdings, which will create liquidity and more interest in the share. I believe, with its track record and profitability, the share has a tremendous upside. I have vested interest in Janashakthi Insurance. It’s consistently churning out profits and has a good dividend yield, but it’s on a low PE multiple and low price-to-book valuation, so I believe a correction is due.

Access Engineering was my big bet for the year and I will continue to hold the stock. Profits have declined, but it’s the only company with liquidity for an investor looking for exposure to any form of large industry.

Around 35% of my portfolio was exposed to finance companies. I expected this sector to outperform banks. However, in its attempt to reduce foreign exchange outflows and contain vehicle import growth, the government took measures that negatively impacted finance companies. Floods and low consumer spending also had a negative impact on the microfinance businesses of finance companies. Commercial Credit and Bimputh have considerable exposure to microfinance. Swisstek was affected by global aluminum prices, but the company is a turnaround success story.

Despite the fall in share price, Royal Ceramics has performed well. It has a large market share and is growing, and the construction sector is booming, so the stock has good upside potential.

Bairaha Foods was a disappointing stock, which I will continue to hold nonetheless. The removal of price controls and import restrictions on chickenfeed could result in a better performance.

I’m including Hemas Holdings given its strong performance and growth over the last few years. It’s a good long-term investment. LB Finance is another inclusion. It’s managed well.

Growth and profitability have been extremely good, but the share’s valuation is unjustifiably low. It’s difficult to make decisions based on fundamentals if the goal posts keep shifting. Businesses don’t mind paying more taxes as long as there is policy consistency. I hope this is the case for 2018 then we will see more investments flow into the market.

The future looks bright. The 2018 budget was a good one. The governor of the Central Bank also brings stability to the financial system and monetary policy. I believe interest rates will be steady and fiscal management will be better.

The Inland Revenue Act will considerably improve the business environment and build the economy.