by Tom Bradley

Some of you have recently voiced frustration with our Global Equity Fund’s returns. If you haven’t mentioned this to us directly, you may have thought it quietly. Well, your disappointment is completely appropriate.

We expect our funds to beat market returns over the long run. The Global Equity Fund simply hasn’t done that. Performance has been poor in five of the last six years. I should note that we too are feeling the pain – 89% of our team’s financial assets are invested in our funds, including the Global Equity Fund.

At this stage, its important for you to know why we are sticking with our manager, Edinburgh Partners (EPL).

Undexing

We believe undexing will produce market-beating returns over a complete market cycle. Embedded in the results will be times when one or more of the funds will be out-of-sync with the market, sometimes for an extended period. All our funds have experienced these inharmonious periods. The most memorable ones were the Equity and Small-Cap Funds lagging behind during the resource recovery in 2009 and 2010, the stellar performance of the Equity Fund in the subsequent years, the award-winning streak put together by the Income Fund starting in March, 2009, and of course, the topic of this post - the Global Equity Fund’s struggles since 2010.

The Manager - Edinburgh Partners

In addition to monitoring our fund managers, we constantly speak with others, including global equity managers, as part of our research process. We do this for context. Meeting other managers allows us to compare the practices of our current subadvisors to others. It also helps us maintain our bench, if we feel a change is warranted.

Our conversations with other managers have strengthened our opinion about EPL. The firm continues to stand out compared to others, even those that have performed better. The investment team is deep and has been together for a long time. Moreover, they are owners of the business and invested alongside our clients.

Led by founder and CEO Sandy Nairn, EPL’s experience has shown through in how they’ve approached this tough period. They have worked on refining their process, but have not abandoned their philosophy – investing based on long-term profitability, not what’s hot. The team’s discipline hasn’t wavered either. They continue to add to stocks that are down and re-size winners. In recent days, they added to two pharma companies that have been beaten up – Roche and AstraZeneca.

Performance

Salman and I also look at all the funds a manager manages, or has managed in the past, to gauge skill. Though EPL’s global equity mandate hasn’t kept up, it’s International equity (non-North American) and European equity clients have done well. EPL continues to gain clients for those mandates.

That’s not much solace to you, but it does reinforce our view that the team has not lost its stock picking skills.

Value vs Growth

Since 2010, the fund has been fighting severe headwinds. I say this because over the last few years, Sandy and the team have steadily moved the portfolio to be more ‘value’ oriented.

The market is often divided into two broad groups – companies that are growing faster (Growth) and those that are growing slowly or going through a turnaround (Value). Many investors are willing to pay a premium for higher growth prospects, while they want discounts for the slow growing and/or troubled companies. Over the long-run though, value investors have done better, as the discount has more than compensated for the warts on these companies.

Growth investors, however, do better in certain conditions. Paradoxically, a low growth period is one of those environments, as investors are willing to pay a bigger premium for anything that looks like it will grow more than the market. That’s the situation we’ve been in since the global credit crisis.

EPL’s shift towards value occurred on a stock-by-stock basis over a number of years. The investments in the Japanese market in 2010 started the shift. More recently, it was epitomized by purchases of European and Asian banks, which are now well capitalized and trading well below the value of their assets.

It’s a small consolation to our clients, but EPL has had lots of company. Many iconic value investors, including Mason Hawkins at Longleaf, Franklin Templeton, Brandes and Seth Klarman, have struggled.

Looking Forward

If they could go back and do it over, EPL obviously would have delayed some of their stock picks and strategies, but they, along with Salman and I, have to look forward. When EPL decides what stocks to buy, or when we decide on our managers, we look beyond recent results and focus on generating the best returns possible for our clients going forward.

We expect EPL to take advantage of the huge gap that has emerged between growth and value stocks. By some measures, the price premium for owning growth stocks is as wide as it’s been since the technology boom in the late 1990’s. Over time, this gap will narrow and value stocks will experience a significant catch up.

And finally, for clients holding the Founders Fund, the Global Equity Fund accounts for 23% of total assets. In recent days, Salman and I have brought down the Founders’ equity weight by trimming positions in the Equity Fund and Small-Cap Fund (see our latest Outlook for details). Given how beaten up the Global Fund is, we chose to maintain the position.