Tideway Tideway Asset Management s Update Q 2016
Review Q 2016 Review Summary After a very challenging second quarter we took time in our previous quarterly letter to explain Tideway s investment process and what investors could reasonably expect from us in the future. I am pleased to report that our third quarter results have been positive and more importantly have very much supported our philosophy of buying sound assets and secure income at the right price as a way to deliver solid returns that compound nicely over time. In addition to recent capital gains, we can still expect attractive future returns from our portfolios from the same secure cash flow which we expect to be delivered with a very high degree of certainty. Peter Doherty Chief Officer Our portfolio returns have never been based on macro forecasts, there is no guesswork and we do not need a change in fortune of the companies we have invested in to make returns on our investments. Please take the time to look at your current portfolio valuation. What happened in Q and what can I expect from here? 1. Government bond yields including Gilts fell to record lows as the Bank of Japan, ECB and Bank of England all continued or increased easy money policies and / or asset purchase programs. I remain highly skeptical of the benefits of these policies for a number of reasons. First of all, savers are being punished which means that those in need of income from a given sum of capital spend less which in turn drags down economic growth instead of increasing it. Furthermore, it means investors are forced to take risks they otherwise would not want to as they search for income. 2. Equity markets remained stable despite very high valuations, again supported by the easy money environment. We remain cautious about the ability of equity markets to deliver long term returns in line with their long term averages from here.. Our credit portfolio benefitted from the combination of (1) and (2) which helped both individual bond portfolio performance and the 1 Tideway Asset Management
Review Real Fund which rose over 4% in the period. In the same way that we did not despair in June, we are not massively overjoyed in September! For example the PICORP 6.5 % 2024 had a total return of over 9% in the period made up of about 7.5% price appreciation and just over 1.5% in interest. Clearly that rate of return is not sustainable but the asset still has a yield of over 6.5 % and we fully expect well over 50% total return over the life of the bond from here. 4. No bond we own warrants any specific remedial action and so we fully expect the future returns visible today to arrive in full and on time. I remain entirely sanguine about all of the credits in the portfolio and like the visibility we can provide on future cash flow. We expect the 80% of the Real Fund invested in hybrid securities will deliver net income of 4% per annum across the whole fund. Our two new funds, the Tideway GBP Credit Fund and the Tideway GBP Hybrid Capital Fund, currently offer a net yield of 2.2% and 5.5% respectively. 5. The equity component in the Real Fund added just over 1% to the Fund s performance in the third quarter. This was primarily due to better performance from our largest financial holdings (Aviva, Axa, Lloyds, and Bank of America) versus a flat S&P 500. We see very high potential future returns available from our equity selections, but these returns by their nature are less certain than the bond returns. We have taken steps to further diversify the equity book, recently adding some quality compounders with defensive earnings. We believe that over years our equity selections can deliver 50% total return and can beat the indexes by 15-25%. Therefore the 20% allocated to equities in the Real Fund is expected to deliver 10% over years or about % p.a. 2 Tideway Asset Management
Performance Performance Peter Doherty Sam Glover Guillaume Desqueyroux Following the UK referendum on EU membership at the end of June both bond and equity markets rallied strongly, fueled by low interest rates and continued central bank asset purchase programs. The UK bond markets were particularly buoyant following the Bank of England announcing a base rate cut (-0.25% to 0.25%) accompanied by a bazooka of additional policy moves; a new 100bn four-year Term Funding Scheme (TFS) to aid the transmission of monetary policy at low interest rates through the banking system, 60bn of gilt-based QE over the next 6 months and a corporate bond QE programme of up to 10bn. The raft of new measures was beyond what many economists were expecting and shows that the BoE is determined to prevent the UK from slipping into recession. UK equities also rose strongly, driven by so-called defensive overseas earners, attracting interest due to continued economic uncertainty but more significantly the benefits from an exceptionally weak Sterling. World Financial Markets - Selected Benchmark s Q 2016 2016 5 Year (annualised) 10 Year (annualised) IA Targeted Absolute 1.68% 0.66%.14%.17% UK Equities (FTSE All Share TR) 7.78% 12.8% 11.0% 5.78% Global Equities (MSCI World TR USD) 4.87% 5.55% 11.61% 4.47% UK Gilts (IShares II PLC UK Gilts) 2.2% 14.16% 6.06% - Corporate Bonds (IShares GBP Corporate Bond ETF) 6.75% 16.9% 9.12% 5.57% Tideway Asset Management
Performance Category 1 2 Tideway Asset Tideway GBP Credit Fund Tideway Real Fund Tideway GBP Hybrid Capital Fund Q 2016 Tideway Funds 5 Year (annualised) 10 Year (annualised) -0.04%* - - 4.09% 6.07% - -0.51%* - - Third Party Funds 2 Blackrock UK Absolute Unicorn UK Income Argonaut European Alpha Baillie Gifford Global Alpha Artemis Global Income Lindsell Train UK Equity Fund Schroder Recovery Fund 1.6%.77% 4.20% 12.45% 15.54% 10.86% 6.64% 12.15% 8.09% 1.48% 16.65% - 10.22% 17.42% - 8.82% 18.10% 11.80% 8.98% 16.00% 8.60% *Fund inception 1 st August 2016 Tideway UCITS Funds Two New Fund Launches At the end of April Tideway successfully completed the transfer of the Real Fund from a Luxembourg SICAV to an ICAV structure based in Ireland. We were delighted to finally complete this process, with the new structure bringing benefits such as a reduced cost base, improved operational oversight and ability to launch new sub-funds through the ICAV structure. In this regard we launched two new funds, the Tideway GBP Credit Fund and Tideway GBP Hybrid Capital Fund in September. The Tideway GBP Credit Fund aims to generate income, net of all expenses, equivalent to the Bank of England UK Base Rate plus 4 Tideway Asset Management
Performance 1-2%, from a credit portfolio with low to medium volatility. The Fund is designed for investors with short-term liquidity requirements (0-5 years), with the average duration of the Fund s investments being maintained under five years. The Tideway GBP Hybrid Capital Fund aims to generate 5% per annum income, net of all expenses, from a hybrid capital bond portfolio with a weighted average bond price of less than GBP 100 and with medium volatility. Tideway GBP Credit Fund September 2016 saw the launch of the GBP Credit Fund with over 10 million in assets under management. Assets were purchased through the month in a steady, systematic process and the Fund ended the month approximately 60% invested. Credit markets were a touch soft in September and in addition a small amount of bid-offer spread in the assets led to a very modest mark down in NAV at month end to 99.956. Guillaume Desqueyroux CFA Tideway Credit Analyst Highlights in the portfolio include two new Tier 2 capital issues, Clydesdale Bank 5% 2026 (priced at 96) and Paragon 7.25 % 2026 (priced at 100) both of which traded well in the secondary market. The current portfolio has a duration of 2.25 years and a yield of % gross / 2.2% net. Based on current market conditions we believe it will be possible to maintain this yield going forwards. A dividend of 21.84p was declared on the Class B Income shares with the next dividend to be declared at the end of December. A fund factsheet for the Tideway GBP Credit Fund is available on request, or alternatively through our website. Tideway GBP Hybrid Capital Fund September 2016 saw the launch of the GBP Hybrid Capital Fund with over 5 million in assets under management. Assets were accumulated through the month in a steady, systematic process and the Fund ended the month approximately 70% invested. Credit markets were a touch soft in September and 10 year credit yields moved up by 25 bps creating a mark down in NAV at month end to 99.486. 5 Tideway Asset Management
Performance One highlight in the portfolio is Partnership Assurance 9.5 % 2025 which has traded up on the back of positive results and a wellreceived capital markets day. The yield of over 9% to maturity is attractive for what is a solid, well capitalised business. The Hybrid Capital portfolio has a duration of 5.5 years and a yield of 6.4% gross / 5.5% net (excluding the current cash holding i.e. a fully invested basis). Based on current market conditions we believe it will be possible to maintain this yield going forwards. A dividend of 27.9p was declared on the Class B Income shares with the next dividend to be declared at the end of December. A fund factsheet for the Tideway GBP Hybrid Capital Fund is available on request, or alternatively through our website. Tideway Real Fund Sam Glover CFA Tideway Equity Analyst The Tideway Real Fund is a mixed-asset target absolute return fund, with an emphasis on capital preservation and controlled investment risk. The Fund aims to deliver positive absolute capital growth net of fees on a rolling 12-month basis regardless of market conditions, with low to medium volatility. The Fund has a target return of -month Libor plus % p.a. net of fees on a rolling three year basis. The Fund recently celebrated its fifth anniversary, over which period it has generated returns of 6.1% per annum, which represents a top quartile ranking. We remain confident that the next five years will be as successful as the preceding five. Tideway Real Fund Contribution - Q 2016* Bonds +5.8% Equities +1.1% Hedges -2.4% Fees -0.4% Net Total +4.1% *Contribution figures are estimated using average asset weights over the period with returns in local currency (whilst permitted, there is generally no FX exposure in the fund). Source: Capita, Bloomberg. In the third quarter of 2016 the Real Fund delivered a strong 4.1% return. As already outlined, our credit portfolio performed well with the credit portion of the Fund (approximately 80% of NAV) contributing over 5% to the total return. Our balanced portfolio of 2 to 10 year senior corporate bonds and Hybrid 6 Tideway Asset Management
Capital encompasses a range of returns from 2 to 7% net of fees, a range consistent with a high degree of comfort in credits that are robust and have extremely low probability of ever defaulting. Performance The equity portion of the Real Fund (approximately 20% of NAV) also performed well during the quarter, contributing over 1% to the Fund s return. Particularly strong contributors included Bank of America and UK insurance composite Aviva, which rose 18% and 12% respectively. We have also taken steps recently to further diversify the equity book, adding some quality compounders with defensive earnings. One of our new equity selections, WPP, rose over 15% in the quarter. We believe WPP to be a reasonably valued media agency business with a diversified earnings stream and prospects for double-digit earnings growth, together with a c.% dividend yield. The only detractor in the equity book over the quarter was Danish pharmaceutical company Novo Nordisk, which declined 20% following analyst downgrades due to near-term pricing pressure in the US. This was despite the company releasing very strong data from its clinical trial on a new GLP-1 treatment, semaglutide. We added to the position on weakness as we continue to believe that Novo Nordisk has significant growth potential. The company has a very well-diversified product portfolio and an exciting pipeline of new drugs, with five major new drug launches scheduled in the next five years. We see the biggest growth driver for Novo Nordisk being the relatively untapped GLP-1 diabetes market, with oral semaglutide (currently in phase II trials) possessing the potential to be a major blockbuster. We believe the company can deliver operating profit growth of 7% per annum going forward, translating into EPS growth of 12% per annum and a significant re-rating. As a reminder Tideway are conservative contrarians which means that we often invest against the consensus but with a conservative approach to risk taking and valuation. We invest on a safety-first basis and have a strong aversion to permanent capital losses / overpaying for assets. We have written at length about our concerns regarding government bond valuations and believe that asset bubbles are now also prevalent in large parts of the equity market. Certain businesses deemed to possess defensive, or secure earnings have reached exceptionally high equity valuations which have surpassed all previous market tops. Tideway do not invest in such assets. Below we provide some quotes from world famous investor Howard Marks, cofounder and chairman of Oaktree Capital Management. 7 Tideway Asset Management
Performance We think these words of wisdom are particularly relevant in today s investment environment: I am firmly convinced that investment risk resides most where it is least perceived, and vice versa. The problem is that in bubbles, attractive morphs into attractive at any price. People often say, It s not cheap, but I think it ll keep going up because of excess liquidity. In other words, they say, it s fully priced, but I think it ll become more so. Buying or holding on that basis is extremely chancy, but that s what makes bubbles. Third Party Funds The performance of our Third Party Funds in the third quarter has been very strong. All the third party funds outperformed their benchmarks, with notable alpha generators being Unicorn, Baillie Gifford and Artemis. The overseas investors (Argonaut, Baillie Gifford and Artemis) benefitted from positive equity moves but to a larger extent the depreciation of sterling. The UK focused managers (Blackrock, Unicorn and Lindsell Train) experienced strong rebounds in their portfolios in the post-brexit FTSE rally. We were in regular contact over the period with each manager to understand what changes if any they were making to their portfolios. 8 Tideway Asset Management
About Tideway Asset Management About Tideway Asset Management Tideway Asset Management's primary objective is to deliver secure returns ahead of inflation after all fees with limited risk of capital loss. Tideway are conservative contrarians which means that we often invest against the consensus but with a conservative approach to risk taking. We invest on a safety-first basis and have a strong aversion to permanent capital losses. We prefer a focused list of actively managed investments with genuine diversification rather than a scattergun approach. Our ideas can take months to show results and so investment returns may diverge from mainstream indexes for periods of time. Tideway practices bottom-up investing and importantly we do not invest on the basis of macro-economic forecasts. We employ a robust research-driven investment process to identify individual assets with good risk-return profiles and the capacity to generate consistent income. We perform our own in-house research, including company and fund manager meetings, rather than relying on third party reports. We value certainty of returns and dedicate our resources to finding secure cash flow at the right price. Tideway s core investment expertise is in fixed income credit and specifically in Hybrid Capital. Hybrid Capital is a form of debt that falls between senior corporate debt and equity. Hybrid Capital offers equity like returns from a debt instrument with predictable returns and quantifiable risks. We focus our investments on large, household name companies with investment grade senior credit ratings and prefer regulated industries such as insurance, banking, utilities and infrastructure which form the majority of our portfolio assets. In addition, where we have completed our company research and would like to invest but do not see Hybrid Capital as attractively priced, we may buy equity on a holding period of at least five years. 9 Tideway Asset Management
About Tideway Asset Management Tideway s Tideway s Approach allocates investment capital based on the time horizon, risk appetite and use of funds. We recognise that different assets have different risk and return characteristics as well as different tax treatment, so it is really important to correctly align investments with expected holding periods and tax wrappers. Tideway s are specifically designed for those needing to generate tax efficient income irreplaceable funds in SIPPs, ISAs and General Accounts (GIAs). Different Assets for Three Different Time s Objective s Comments One Up to 5 years Liquid funds required over the next 5 years Minimal risk of loss to capital Target Real of 1-2% p.a. Cash deposits Short dated bonds Lowest return and lowest volatility Clear visibility on return of capital Liquid, can raise cash instantly Two 5 to 10 years Support income and withdrawals over 5-10 years Modestly increase capital value in real terms Target Real of - 5 % p.a. Medium term bonds Absolute funds Target funds Taking some risk in order to generate medium real returns Allow for some higher volatility Focus on strategies with downside limits Three Over 10 years Funds with no call on capital for at least 10 years Volatility tolerated in exchange for higher long term returns Target Real of 4-6 % p.a. Long dated bonds Long only equity funds Individual equities Least constrained portfolio Investing for the long term with a view to generating high positive real returns Can withstand most volatility 10 Tideway Asset Management
More Information If you would like more information on any of our investment solutions, your portfolio in general, or would like to discuss the contents of this document, please do not hesitate to call us on: Tel. 020 178 5982 Or email info@tidewayinvestment.co.uk More information is available via our websites at: www.tidewayinvestment.co.uk You will find fund fact sheets, guides and a client log in to see your six monthly performance reviews. You can also log in daily to see your portfolio valuation, recent transactions, and the cash movement on your portfolio via your platform provider. If you don t know how to do this or have yet to set this up please call in and ask one of the team for help. Who regulates us? Tideway Partners LLP is authorised and regulated by the Financial Conduct Authority ( FCA ). The FCA is the independent watchdog that regulates financial services. We are listed on the FCA register and our Registration Number is 496214. Important Comments on Past Performance Past performance is no guarantee of future returns and the value of investments and the income they produce can fall as well as rise. The last 5 years have provided relatively high investment return opportunities as investments have recovered from the 2008/9 financial crisis and driven by low interest rates. s at these levels are generally not predicted for the next 5 years and investors should plan to expect lower returns. The performance of individual client accounts will vary from those quoted due to a range of factors including the timing of when the account was first invested, the size of the account, the underlying asset allocation and the third party platform used. The calculation basis for all the returns quoted can be provided on request. 11 Tideway Asset Management