Cartesio November 2019 commentary
Llevamos ocho años enviando un comentario mensual en inglés a los clientes institucionales que siguen nuestros fondos en Luxemburgo (réplicas de los domiciliados en España). Los clientes nos llevan diciendo tiempo que encuentran el comentario útil y, suponemos, algo más entretenido que el comentario de las fichas mensuales donde, por razones de espacio, el comentario es necesariamente más breve y menos elaborado. El inglés es el latín de nuestra época y en el mundo financiero es, a efectos prácticos, la lengua vehicular.
Cartesio November 2019 commentary
Pareturn Cartesio Income (PCI) is up 0.88% in November and up 3.83% YTD. Pareturn Cartesio Equity (PCE) is up 2.23% in November and up 8.69% YTD. Since inception (March 2004), Cartesio X (replicated by PCI) is up 88.35% (4.12% p.a.) with a volatility of 3.1%; Cartesio Y (replicated by PCE) is up 133.5% (5.6% p.a.) with a volatility of 9.5%. Both funds have outperformed their benchmarks in risk adjusted terms since inception (March 2004).
As always, we enclose the factsheets (November 2019) of both funds and a pdf file showing the best and worst equity performers of the fund in the month.
Good going but pause for reflection…
More of what we have been seeing since August. European equities making a new high, long term rates rising and continued rotation from growth into value. This is what we have been waiting for during most of the year and it has now worked in our favour.
PCE has captured nearly 100% of the five per cent move in European equities since the end of July, but with an average equity exposure of 60%. PCI has captured 40% of the move with an average equity exposure of 20% and has avoided the small loss (-0.5%) of its reference index (Long term eurozone government bonds). Our equity portfolio, which had underperformed significantly during the first half of the year, is up 20% YTD, trailing European equities by only three percentage points.
European equities are up 23% YTD but EPS growth expectations have been whittled down to zero during the year. One can argue that this year´s rise stems from the losses of last year and the ECB´s monetary policy, but a sense of vulnerability is inevitable, particularly against a backdrop of a very expensive and narrow US market, a very long economic cycle and even record highs in European equities.
Looking at the usual valuation metrics (P/E, P/B, Div Yield, Shiller P/E) we would argue valuations are middle of the road to slightly expensive. It is only when comparing them to interest rates that they become interesting. As we have argued before, we are wary of interest rate-based valuations when rates are at zero because it can be a sign of very dire growth prospects ahead. On the other hand, rates may be at zero because central banks are hyperactive, too pessimistic about growth and certainly clueless about why inflation is stubbornly low. We have some sympathy for the TINA (There Is No Alternative) school of thought. Do we park our money at close to zero or negative rates and wait for the end of the world? Do we do a Chuck Prince and keep dancing as long as the music is playing? Neither, is our answer.
So, what do we see and what do we do? European holding companies (companies where the majority of their assets are stakes in quoted companies) are currently trading, on our numbers, at an average discount to NAV of 5%. We last saw that level in 2007. The historical average discount is 20%. Red flag or at least something to be aware of.
The search for yield and higher returns is particularly visible in the world of private equity but the M&A scene is also giving us food for thought. ABERTIS acquired in October a toll operator in Mexico paying 13x EV/EBITDA, eight toll roads with 870km and a concession duration to 2046. We own PINFRA in Mexico at 7x EV/EBITDA, twenty-nine tolls roads with 1000km and slightly higher duration. Emerging market equities are probably cheap.
Institutional and private investors are seeking higher returns in private equity. The multiples paid by private equity investors are now well above the multiples we see in the market. Partners group, the largest European private equity group, recently acknowledged that they expect their exit multiple to be 20% lower than what they are paying today, hence relying more on the heavy lifting of growth and efficiencies to achieve their desired returns.
Finally, the valuation and performance gap between growth and value remains at almost historical highs. We are not value fanatics although we confess a certain value/contrarian bias. This is not the place to dwell on the marvels of value investing although, for the record, we think profitable growth, at the right price, is the most important driver of long-term returns. What is clear to us is that the market is fairly polarized in terms of valuations and themes. This represents an opportunity and explains our position in many of the stocks we own.
Our bottom line, as far as equities are concerned, is that we are dancing on the edges of the ballroom (investing mainly in the cheaper, unloved part of the market) and we have a foot by the door (we still have a significant cash allocation in both funds). We are still dancing but not a la Chuck Prince.
In the bond space a debate is emerging over the need for fiscal policy to take over monetary policy. The ECB´s policy of QE and negative rates is not only questioned internally and politically. Negative externalities in the form of asset bubbles, inequality, zombie banks/companies, covert deficit financing are becoming the subject of debate. Central banks and economists have difficulty in explaining persistently low rates of inflation with structural factors at play (excessive debt, technology enabling almost perfect competition, globalisation, demographics). Current monetary policy is probably delaying the inevitable (recessions happen and help to cleanse the system and allocate resources better) and complicating the monetary response when it happens. Modern Monetary Theory (MMT) has gone from being fringe, wonky economics to mainstream discussion.
We think that the process of executing a more expansionary fiscal policy in Europe will be slow and its results debatable. The practical implications for us of the current debate is that we should be past the lowest bond yields in history (our reference index in PCI is down 2.6% from its all-time high in early September) and that the debate is equity friendly.
We are likely to maintain risk exposures around current levels in both funds but will manage the equity portfolio actively. We believe our equity portfolio is well positioned to outperform, it is undervalued against the market and has potential upside of 25%. We are not counting on a year-end rally beyond what we have seen so far. We retain in PCI a residual 14% exposure to mostly low-trigger AT1s which are likely to lose regulatory value and expect them to be called. Our long-standing short position in the bund/bono stays at 7.5% of assets.
Madrid 30th November 2019