Bangkok--17 Feb--Aberdeen
Last year was a challenge for many long-only asset managers. Markets everywhere were volatile. US equities fell over the year but the decline was tempered by: a) expectations of a domestic recovery, cemented by a long-anticipated interest rate rise, b) low energy prices, which ought to put more money in consumers' pockets, and c) M&A activity that boosted individual stock prices, especially in pharma and IT.
US small companies did LESS well than the main market. Still, our Aberdeen Global - North American Smaller Companies fund* had an OUTSTANDING year. A return of 10.1% in the 12 months to end December represented OUTPERFORMANCE 14.5% over the benchmark Russell 2000 index.
Performance Summary
Performance for the asset class would have been better but for a weak year-end, which has dragged into January (with the S&P 500 down almost 5% and the Russell Small Cap Index down 8.8% over the month). This follows renewed concerns over global growth. Cheap oil now looks less beneficial to the economy at large. The worry is that it is a symptom of weak demand as much as over-supply (with OPEC unable to agree cuts and Iran now pumping again after the lifting of sanctions). If so, there could be implications for energy bonds, with yield spreads now widening. We have consistently been underweight energy and find quality companies there hard to find.
The materials sector has also been hurt by oil and pressure on commodity prices, amid worries of a slowdown in growth in China and emerging markets. We have been overweight, although we own higher quality less cyclical names, which helped compensate. Industrials have been another laggard. Blue chip companies have done well to cut costs and boost operating margins. Yet cutbacks on capital expenditure will constrain the ability of companies to grow – and that will hinder share prices in the long term. We don't own any utilities as returns are tightly regulated. That also helped us last year.
Process comes first
Overall, it is our stock picking that has benefited the fund. We never feel obliged to buy stocks in the benchmark or to follow any trend. This approach can lead to periodic divergence from the index but over the long term should prove rewarding provided we stick to companies we trust and avoid over-paying for new ones. We look especially for companies with strong balance sheets and tried-and-tested management; and for ones whose core business is reasonably immune to competition/price wars. Around one third of our portfolio is in a net cash position. This does not mean we do not like companies to borrow but it is vital the company's business model and cashflow can support any leverage.
1/3 of portfolio still sits in net cash position
tr>/tr>td bgcolor="#ffffff" height="20" width="45%">/td>Market Captd bgcolor="#ffffff" height="20" width="19%">Count/td>td bgcolor="#ffffff" height="20" width="36%">Weight (%)/td>tr>td bgcolor="#ffffff" height="23" width="45%">Under $500m/td>td bgcolor="#ffffff" height="23" width="19%">2/td>td bgcolor="#ffffff" height="23" width="36%">2.93/td>/tr>tr>td bgcolor="#ffffff" height="20" width="45%">Between $500m-$1.5b/td>td bgcolor="#ffffff" height="20" width="19%">19/td>td bgcolor="#ffffff" height="20" width="36%">37.58/td>/tr>tr>td bgcolor="#ffffff" height="20" width="45%">Between $1.5b-$3b/td>td bgcolor="#ffffff" height="20" width="19%">17/td>td bgcolor="#ffffff" height="20" width="36%">34.57/td>/tr>tr>td bgcolor="#ffffff" height="20" width="45%">Above $3b/td>td bgcolor="#ffffff" height="20" width="19%">11/td>td bgcolor="#ffffff" height="20" width="36%">22.84/td>/tr>
Performance Snapshot
Approximate December gross return: 3.06% vs benchmark return of -4.99%
Approximate 2015 gross return: 10.11% vs benchmark return -4.33%
Fund Size: Aberdeen Global NA Smaller Companies Fund - $107
Top monthly performer: Heartland Payment Systems (+19.5% total return) – bid to be acquired by Global Payments
Worst monthly performer: Forum Energy Technologies (-20.4% total return) – energy related weakness
The muted outlook for 2016
North American small caps appear solid. We are confident our companies can raise sales thanks to automation and productivity improvements. However, the scope for margins to increase is capped because companies have already done the obvious things to trim overheads.
The core problem is a lack of growth. Only a month ago markets were sure that the Federal Reserve would raise borrowing costs through the year by 2-3 times. Now that seems less likely. The Federal Reserve has consistently over-estimated the timing and strength of a rebound in demand. Asset prices have gone up but measures of economic activity such as hourly wages remain subdued.
So, 2016 promises could be a see-saw year. Companies that have taken risks to increase market share need to watch out. Although we have seen good figures lately for the likes of car sales – a rare bright spot in Q4 reports – cheap debt has clearly helped that industry. Share prices for that sector have actually come down.
Company fortunes may further depend on:
Elections: the race to the White House looks wide open. Candidates' views on taxation, healthcare and foreign policy could affect decision-making among companies
Spending: many retailers are struggling to adapt their business models in a dynamic environment as customers change their shopping patterns. More online buying is the result. Some brands are more vulnerable.
Energy: aside from the domestic issue of energy re-financing, cheap oil has divided the world into winners and losers, with some emerging markets facing slower growth, budgetary problems and political issues. This is a potential drag on global trade.
Finally, valuations.
The small cap premium to big caps has shrunk from historical premiums to more in-line. We believe this is fair for earnings growth in the mid-to-upper single digits. While there is little scope for a re-rating higher given the current environment, we are encouraged that small caps have not used debt to nearly the same extent as the main market to fund buy backs, which has become an epidemic. Small caps are also less exposed internationally to the strong dollar, which hurts foreign earnings.
Activity highlights
Three new stocks we introduced in Q4:
OSI Systems: a vertically integrated designer and manufacturer of specialized electronic systems for a variety of end markets (most notably the security scanners at airports and other security checkpoints). The company has cash to deploy.
EXLS: a business process outsourcing (BPO) company which provides functional services (finance, accounting, legal support, analytics, etc.) to a variety of industries. The company has a history of strong sales growth as big companies move these functions out of house.
GBCI: a Montana-based multi-bank holding company whose loan growth benefits from being in relatively insulated geographies with limited competition. The bank also has a very strong credit culture and good returns on equity.