It was both a steady quarter in absolute terms and a decent quarter against our peers, with healthy contributions from some of our small and mid-cap stocks.
Some countries in Europe are either very close or likely in a technical recession with Italy and Germany the most notable. This is despite the ultra-supportive monetary policy stance taken by the ECB. The message that monetary policy is no longer effective appears finally to be hitting home. The outgoing Mario Draghi and the incoming Christine Lagarde have both stressed the need for fiscal policy to pick up the baton. Whilst it might need worse economic news again to force governmental hands, it is clear that the pressure for responsible but looser fiscal policy is increasing.
The implications for capital markets are very significant. Generation low interest rates have driven bond yields down and many governments now receive interest from risk averse investors. In turn this has driven equity markets up but also meant that quality growth or long-duration equities have re-rated to a point where the valuation gap between traditional growth and value is very extended. Any regime shift in policy has the potential to alter a dynamic that many investors have taken for granted for over a decade.
We have been making these observations for some time but what we have been lacking from our argument has been a catalyst. It could be that worsening economic data and a switch from monetary policy to fiscal policy is that catalyst.
We invest where we see undervalued cashflows as well as an attractive balance of value and growth. It is not our style to second guess macro catalysts such as a potential policy shift. However, it is worth noting that our stock ideas and therefore portfolio activity for Q3 has included a tilt away from steady growth stocks that have served us well thus far (Unilever, Danone, RELX) towards more obviously value (increasing bank holdings and adding to cyclical positions).
Encouragingly our process continues to deliver a steady stream of interesting new ideas
Encouragingly our process continues to deliver a steady stream of interesting new ideas. In the quarter we have returned to the salmon farming sector with the initiation of a position in Salmar. We like the long-term supply demand dynamics of this sector and valuations have tracked back with the short-term salmon price. We would like to add more here on weakness. We added to our IT service cluster with Infotel, a small French company which integrally works with large French corporate clients on their digitisation strategies. The net cash balance sheet is particularly noteworthy here. Valmet is a Finnish company perceived as being a capital goods cyclical but generating cash like the service company it has developed into. We added to our Nordea and Santander positions as well as starting a position in Bank of Ireland which trades on less than half its book value despite having decent capitalisation and return on equity potential.
On the sell side we have reduced positions in our steady growth holdings as well as cutting position sizes in the semiconductor sector. Our semi stocks have contributed strongly to performance year to date but valuations are a bit more nuanced now. We exited Leonardo after strong contribution, ISS after becoming concerned about acceleration in their use of factoring and Akka because Infotel offered much better risk/reward.
We believe the portfolio metrics continue to tell a strong story. Better sales growth than the market, significantly less leverage than the market all for much cheaper cashflows than the market. The changes in the portfolio have increased our Free Cashflow Yield ('FCFY') premium to the market to c.40% the highest level we have observed, albeit in the relatively short time we have been formally recording this metric.
Source: Chelverton & Factset