Accommodative backdrop and temporarily abated risks lead to slightly more cautious approach


Fund Commentary
21 Sep 2017


Over the course of August, investors had to digest the usual slur of economic data releases alongside a trifecta of uncertainties (natural disasters, geo-political tensions, and fiscal policy complications). As such, the S&P500 declined by approximately 2% till mid August, but later recovered lost ground as economic data remained supportive.

Investors were left with an environment that remained accommodative in terms of financial conditions and was characterised by strong business confidence (as indicated by surveys from the Institute for Supply Management (ISM)) as well as a solid consumer profile.

Uncertainties abated slightly at the beginning of September as a potential government shutdown in the United States was pushed back to December. Moreover, Hurricane Irma is no longer anticipated to have an impact on oil production or processing. Additionally, tensions with North Korea are currently being dealt with via the United Nations Security Council, imposing sanctions rather than conducting military interventions.

Nevertheless, these uncertainties alongside many others are not over yet. Consequently, the Investment Adviser decided to increase the Fund’s cash level, whilst also adding some more direct protection to certain positions via stock options. The objective thereby is to protect the portfolio from a potential short term market retracement, whilst at the same time also increasing the available “gunpowder” in order to re-deploy resources for potentially more compelling risk/reward opportunities that may occur through the expected pullback.

In August, the Fund returned -0.07%, whilst the benchmark increased by +0.25%. Not being exposed to Energy whilst overweighting in Information Technology worked in the Fund’s favour. However, not being exposed to Utilities and Real Estate acted as a headwind. In terms of stock selection, Biogen was the largest contributor on a relative basis versus the benchmark, followed by Dollar Tree and Cerner. On the other side Shire, Allergan and Priceline were the largest detractors in August.

Shire published solid Q2 results. Cash generation was strong with an Operating Cash Flow of $1.2 bn and a Free Cash Flow of $1 bn for the quarter. The management also lowered their guidance (at the top-end) to reflect production approval of a generic version of Shire’s lucrative Lialda drug.

Nonetheless, management’s strategic review of the Company’s neuroscience segment, which may be sold or split, demonstrates the direction the company wants to take. This direction has however not convinced investors as the sale of the neurology business doesn’t necessarily create value for shareholders. Moreover, the potential impact on shareholder value is difficult to estimate due to the amount of unknowns such as the rate the business would be taxed at or the actual value of the business. All in all, the Investment Adviser believes that the main argument for this investment (its valuation) is still intact but with these unresolved issues in mind and the lack of pipeline catalysts for this year, the stock price might take more time to fully appreciate Q2 results.

Allergan manufactures specialty pharmaceuticals. Its stock price has been under pressure since the Company’s last earnings release on 3rd August. So far no fundamental issue has been identified and the main worries seem to be related to the short-term.

However, Allergan is well known for its compensation packages that executives enjoy (and which are stock price dependent). Before these compensations took effect on 1st September, there have been assumptions that Allergan would seek to make a material step before the execution date in order to boost the stock price and trigger higher compensations. As time went by and management didn’t act as hypothesised, short term money could have exited. 

In short, the Investment Adviser does not see a fundamental reason which could warrant caution. What appears to be more likely is that Allergan is still exposed to hedge funds (6.37%) and is likely to reduce its exposure as summer vacations end. For the Investment Adviser the two identified reasons do not warrant an intervention. Overall, the team is pleased with the current portfolio and the risk/reward profile it offers on both a relative and absolute basis.

The views and statements contained herein are those of the Eric Sturdza Banking Group in their capacity as Investment Advisers to the Fund as of 13/09/2017 and are based on internal research and modelling.