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M&G North American Value Fund Fourth quarter 2016
Fund manager – Daniel White
Quarterly Review
Overview
US equities ended the year on a high note as investor confidence was lifted by the election of Donald Trump as
US president and the prospect of stronger economic growth. ‘Value’ as a style outperformed ‘growth’ and the
broader market, helping value stocks to outperform for the whole of 2016.
The fund was ahead of the S&P 500 Index during the quarter and over the year, with stock selection in most
sectors adding value.
During the quarter, we started a new position in Extended Stay America, an operator of extended stay hotels.
Pharmaceutical firm Shire and Ingram Micro, a distributor of computer and technology products, which was taken
over during the period, left the portfolio.
Performance, attribution & positioning
Fund commentary
US stockmarkets ended the year on a positive note,
climbing to record highs. Over the course of 2016, the
US was the best-performing major market, ahead of
the index of global equities.
Investor confidence was buoyed by the surprise
election of Donald Trump as US president and the
prospect of supportive policies such as tax cuts and
infrastructure spending that could boost the US
economy.
As was widely expected, the US Federal Reserve
(Fed) raised interest rates for the first time in a year in
response to the ongoing US economic recovery, in
particular the robust jobs market. A more surprising
development during the quarter was a deal between
oil-producing nations to cut output in an attempt to
boost oil prices.
As investors’ optimism about global growth increased,
there was a notable rotation from defensive sectors,
which have been in favour lately, towards more
economically sensitive areas. Financials led the way,
buoyed by higher interest rates, while industrials also
outperformed. Energy stocks climbed as oil prices
rose. In contrast, consumer staples, healthcare and
utilities were notable laggards.
In terms of market capitalisation, small-cap stocks
were the best performers. In terms of style, there was
a powerful shift to ‘value’, which outperformed the
broader market and ‘growth’ stocks; this rotation
helped ‘value’ outperform over the whole of 2016. It
also provided a tailwind for the fund, which was ahead
of the S&P 500 Index and the Russell 1000 Value
Index over the quarter and 2016.
During the fourth quarter, at the portfolio level, asset
allocation and stock selection both added value.
Stockpicking was positive in all sectors except in
telecommunications.
The fund’s above-index position and stock selection in
financials made the biggest contribution to relative
performance. The fund’s holdings in Goldman Sachs,
JP Morgan and Citigroup were among the leading
contributors to performance. The financial groups’
share prices gained after reporting robust corporate
results, with revenues boosted by increased trading
activity. The stocks received further support when the
Fed raised interest rates, a move that is expected to
boost their profitability. They also gained on the
prospect of lower regulation.
Stock selection in the energy sector added value as
well. Higher oil prices boosted the shares of
McDermott International, an engineering and
construction company in the offshore oil & gas
industry, as well as ConocoPhillips and Hess, two oil
exploration companies.
Eagle Materials, a building materials firm, was another
notable contributor as the shares climbed to their
highest level in two years on the prospect of increased
infrastructure investment after Trump’s victory.
Conversely, the leading detractors were stocks in
defensive sectors which underperformed when investor
sentiment shifted in favour of cyclicals. The fund’s
holding in Livanova, a medical technology company,
detracted after its latest results disappointed.
In the consumer staples sector, Tyson Foods, a meat
producer, also weighed on performance. The
company’s results were weaker than expected and it
announced that it was replacing its chief executive.
Molson Coors was another notable detractor. The
brewing company’s share price retreated after recent
gains following the multi-billion merger between
Anheuser-Busch InBev and SABMiller. As a result of
the deal, Molson acquired SABMiller’s stake in
MillerCoors, the joint venture between the companies.
2016 performance In 2016, the fund delivered positive returns ahead of
the S&P and the value indices. Returns on the sterling
share classes were boosted by the weakening of the
pound during the year.
Stock selection in a range of areas added value, most
notably in the healthcare and materials sectors.
Newmont Mining, a gold producer, was the leading
contributor, helped by rising gold prices in the first half
of the year. Not holding a number of biotech stocks
helped relative performance as they declined on
concerns about potential controls on drug prices.
Shares in Oshkosh, a manufacturer of specialty
trucks, climbed on solid results, driven by increased
sales of military vehicles. McDermott and Eagle
Materials were also notable contributors.
The leading detractor was Cobalt International, an oil
& gas explorer. The company was hurt by low oil
prices and uncertainty surrounding its proposed sale
of an oil-producing asset to the Angolan government.
Elsewhere, the holdings in Alphabet, the parent
company of Google, and Livanova also cost some
performance.
Portfolio activity The fund’s allocation to financials and energy
increased slightly during the quarter, partly as a result
of robust share price performance in both areas.
Financials is the fund’s largest overweight. In contrast,
the fund’s weighting in the healthcare and information
technology sectors was reduced. The industrials
sector is the fund’s biggest underweight.
There was one new purchase during the quarter:
Extended Stay America, an operator of extended stay
hotels. We believe the stock is attractively valued as it
is trading at a discount to the value of its property. The
company is realising some of this value by selling and
franchising a number of its hotels. Moreover, following
a period of heavy investment, cashflows are expected
to increase.
In terms of sales, pharmaceutical firm Shire and
Ingram Micro, a distributor of computer and
technology products that was taken over during the
period, left the portfolio.
Outlook
We believe the outlook for value investing in the US
remains positive. We believe value’s outperformance
can continue – we note that the recent style reversal
is modest in light of the prolonged underperformance
of value stocks over the past few years. The spread
between the cheapest part of the market and the most
expensive remains wide – ‘value’ has further to go
before it has narrowed the gap with ‘growth’.
While we are optimistic that value stocks can continue
to outperform, we recognise that there may be some
headwinds. The value style has experienced a very
strong recovery and future outperformance may not
necessarily continue in a straight line.
There are plenty of uncertainties that could unsettle
investors – not least President Trump’s policies. We
therefore believe it is prudent to remain selective and
construct a well-diversified portfolio.
Looking ahead, we believe the fund is well positioned
for this environment. The fund has demonstrated its
ability to capture the upside when value outperforms
yet keep pace with the broader market when the value
style is out of favour.
Long-term performance
Please note that the fund invests mainly in company shares and is therefore likely to experience larger price fluctuations than funds that invest in bonds and/or cash.