Quarterly Letter

Fourth Quarter 2017

"We are able to find good companies and segments with the greatest potential."

Dear investor,

Firstly, on behalf of the BESTINVER team, I would like to thank you for your continued trust and long-term commitment. This is essential so that we can achieve better returns over the long term.

Such was the case in 2017, another good year for BESTINVER, which we closed with returns of 11.74% for the international portfolio and 10.37% for the Iberian portfolio. More importantly, if we look at a longer term, this figure rises to a return of 40.5% over 3 years.

We have achieved these figures withstanding, and even taking advantage of, the volatility and uncertainty in the market, without assuming unnecessary risks or making or concentrating our commitments excessively in specific sectors. We have achieved this by building robust portfolios over these 3 years, based on exhaustive analysis of companies and their risks. Dedicating over 30,000 hours to this task every year allows us to be always prepared, with a shopping list we update every day to take advantage of opportunities.

These solid portfolios allow us to face the future with great confidence, despite the risks we see in the market, of which we will offer an overview shortly.

Firstly, very low levels of volatility, a sign of false complacency brought about by 10 years of expansive monetary policy which is beginning to be reversed, causing a distortion in the valuation of many assets.

Secondly, the shift in focus of economic policies, leaving monetary stimulus behind and advancing towards an expansive fiscal policy. The United States is leading this change, where the greatest impact is felt in the normalisation of interest rates and in equity.

This change may have a major impact on specific sectors and securities, for which we are already prepared. For example, taking advantage of the opportunities in the discount store segment (so called outlets) with securities like TJX and Burlington, we have been able to enter a segment with attractive potential returns.

This is a sector protected from the threat of online sales for two reasons: the low average purchase ($14), which makes it difficult for online sales to be profitable, and the fact that the majority of brands sold at these stores do not want to be sold online, due to the transparency of prices and the damage this would do to their brand reputation.

Thirdly, there are the early symptoms of complications in the credit market. Complacency on the part of investors together with excessive liquidity generated by central banks have led to a significant reduction in credit differentials, which over the last quarter of 2017 have touched minimums for this economic cycle which began in 2010.

As investors need to invest liquidity, companies have taken advantage to refinance existing debt at lower levels or to increase their leverage. Part of this new credit has gone towards mergers and acquisitions, to pay dividends and to buy up their shares. In a normal context, without the distortion of the central banks, many of these companies would have been unable to finance themselves. Some are already suffering from excessive leverage, such as Altice, Steinhoff, Astaldi, Mattel and Sears, and their viability may be complicated further with the removal of stimulus by the central banks. We do not want exposure to these risks.

Finally, there is the technological disruption, which continues to threaten many sectors. That standard-bearer is Amazon, which continues to grow its share, now with 33% on the online market in the US. It started selling books and now covers diverse industries from groceries to furniture and even beauty products, developing its own brand in some segments. It has also entered the pharmaceutical sector, where it is a supplier of hospital utensils, corrective lenses, hearing aids and has not ruled out the distribution of generic medicine. In other areas, it is already enormously successful. It has positioned itself at number 1 in physical music sales, number 2 in music downloads and number 3 in sale of music streaming (in terms of number of subscribers), despite being present in only 4 countries (the number 2, Apple, is in 115 countries and number 3, Spotify, in 63).

What will we do, faced with this uncertainty? And if volatility returns?

At BESTINVER we don’t see volatility as a good measure of risk, even though it is the measure the market uses to quantify it. For us, as Howard Marks said, risk is the possible permanent loss of capital. We work to be prepared for any adverse environment, by buying good companies at good prices, which offer us high potential returns to compensate for the risk assumed.

That’s why we carry out in-depth analysis, in search of solid businesses with healthy balance sheets and sustainable business models. In some cases, we find good, isolated opportunities as in the cases of Befesa and Arjo.

On other occasions, we find attractive companies while analysing another company we are considering investing in and we study their suppliers or competitors, which may give us greater sectoral or thematic exposure.

Despite this difficult environment and with markets at historic highs, we are capable of finding good companies and segments with great potential and anomalies in valuation. For example, the distribution sector in the United Kingdom, where we find profitable niches that generate cash flow, with high barriers to entry and that benefit from technological disruption. Fundamental analysis to distinguish winners and losers. The same goes for the banking and energy sectors.

Or maritime transport, whether it is crude oil, the refined product or other cargo. Due to the boom years when contracts for ships, to be delivered some years subsequently, increased exponentially, the sector has seen an adjustment to supply and demand. The result was a severe contracting some years later, with major oversupply almost leading to its collapse. Today, the situation is in reverse, leading to more balanced supply and demand, with interesting opportunities emerging at attractive prices.

Our value investing philosophy is based on finding undervalued companies that allow us to achieve good returns over the long term, and therefore it is important for us that our investors accompany us on this long-term journey remaining patient. Patience, together with teamwork, is the secret to the success of all investment; it is necessary to be disciplined in the execution of the investment process. In 2018 we will continue to work to build robust portfolios that preserve our capital over the long term.

Thank you again to each of our 46,000 investors to whom we dedicate our efforts. Many thanks for the trust you have shown in the BESTINVER team.



Beltrán de la Lastra
Presidente y Director de Inversiones

BESTINVER

 

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