After the political upheavals of the summer, developed markets had a lacklustre start to the last quarter, and look to be waiting on clearer political direction, writes Mark Ebert, manager of the Quaero Real Assets fund:
Some of our holdings suffered from the immediate effect of the Brexit vote for the UK to leave the European Union, and we missed out on any gains in emerging markets, where we are absent. The most comparable benchmark for the fund, the synthetic index of real asset ETFs, was mostly flat, as was the S&P 500 index, while the Eurostoxx50 was down 8.1% for the year. Our outperformance of that index is remarkable, as 51% of our total exposure is to Europe and the UK.
We invest primarily in equities and REITs in developed markets to provide exposure to four key sub-classes of real assets: Infrastructure, Real Estate, Forestry Assets and Agricultural Assets. Our agriculture sector has been outperforming the index, although we have no exposure to most agribusiness and commodity sectors.
Three of our four listed fruit and vegetable producers were up. Costa Group did well in September and Total Produce was up 6% after a very strong H1 performance with revenue up 10.4% and an 11.6% increase in adjusted EPS. Fyffes was down 3.2% after announcing the acquisition of a mushroom business in Canada, where it is now the market leader. This adds diversification and improves margins, reducing reliance on the banana business.
Fonterra was up 3% after producing a strong FY16 result with normalised net profit up 42% despite headwinds from an increasing milk price. We are looking for earnings growth of 4% and 8%, respectively for FY 2016 and 2017, respectively. Trading at a prospective PE ratio of 10.6x and a dividend yield of 7%, this remains our most attractive agricultural investment at present.
We have been trailing the index for the moment in Infrastructure, where rail, gas, toll roads and communications sectors have led performance. We are under-represented in gas utilities and had a poor result from toll roads. But Brookfield Infrastructure Partners has done well, rising 7.4% after disclosing the purchase of a 90% controlling stake in Petrobras’ Brazilian natural gas pipeline business.
Some brokers consider it over-valued, but Flughafen Zurich advanced 4%. It forecasts 3.5% passenger growth, 3.5% revenue growth and stable margins, plus upside from its major real estate project adjacent to Zurich airport. We think it is the best of all the quoted European airport stocks.
Among satellite infrastructure companies we like SES, which has suffered from setbacks to related space programmes, but we think it is still the best positioned publicly quoted satellite infrastructure investment globally. Inmarsat has been pulled down by other UK stocks, despite its own solid fundamentals, since the vast majority of its revenues are international.
Transcanada continues to clock gains as it repositions itself. It announced a $848 million acquisition of Columbia Pipeline partners, which should contribute substantial growth, and we expect to see dispositions soon, including its Mexican pipeline minority interest.
In the Real estate we under performed in Europe, where we are well overweight, with a 40% allocation. In the UK our holdings of Land Securities and Derwent London counted against us as both stocks dropped sharply. However, Derwent London increased its dividend by 10%. We still think the company’s portfolio is in good shape, with an average lease length of 6.8 years, a record low vacancy of 2% and exposure to the more volatile finance industry limited to 2-3%.
After a strong summer, Australia proved our worst real estate performer from September, reversing most previous gains. Major shopping centre stocks like Scentre Group and Westfield were weak. In Europe, our German portfolio has had mixed fortunes. Grand City plunged on investor perception of elusive growth going forward, and a negative research report about its reporting standards.
We fared better with our real estate investment in the US, although it remains a difficult call. We hold Kilroy Realty, which has just sold an interest in a major asset in San Francisco. But investors are concerned about its Exchange development in San Francisco (set to deliver in Q3 2017), which still has no leases signed. We think the San Francisco market demand is holding up and that this property will be leased out on a multi-tenant basis.
Our Forestry portfolio reversed its gains over the summer but we are very underweight the sector at just 8%. Smurfit Kappa has been doing all the right things, but still lost 9.9% at one point. It is exposed to FX volatility and recently moved its primary listing to London. DS Smith was another Brexit victim, dropping 4% even after reporting H1 results in line with expectations.
Given the uncertain wider political environment and investment backdrop, our portfolio positioning is risk neutral at present, with cash at 1%. All stock positions can be liquidated in one day. In accordance with our hedging policy, all major FX exposure is hedged for all classes of the fund. Currently 85% of the portfolio is hedged.
We continue to focus on ensuring that there is broad sectoral diversification, spreading risk within sub-sectors and geographically. We avoid concentrated positions (currently holding 69 stocks) with the largest position at 3.1%. Companies which earn a steady, recurring yield from significant, difficult-to-replicate, land-based assets will always be of interest to us.