Aug 2019 - Templeton Global Growth Fund Limited (ASX:TGG) Chairman, Chris Freeman presents the company's FY19 results and Portfolio Manager, Peter Wilmshurst, provides a portfolio update on the oldest global equity LIC in Australia.
Hi, my name is Chris Freeman, and I am the chairman of Templeton Global Growth Fund Limited, or TGG.
I'd like to start by taking this opportunity to thank our shareholders for their strong support of the company. TGG is a Listed Investment Company that provides investors with access to world equity markets via an actively managed investment portfolio.
TGG is one of the oldest global equity LICs in Australia with a track record going back more than 30 years, having first listed way back in 1987.
The preliminary final report for TGG was lodged with the ASX on the 22nd of August. Now I'll step through the key results for the financial year, ended the 30th of June, 2019, and make some additional comments around those results and the direction of the company. I'll then hand over to Peter Wilmshurst, the Portfolio Manager, for review of the investment portfolio and his views on global equity markets.
On the back of the performance of the company's portfolio of investments, the company's net tangible asset backing, or NTA, decreased from 1.56 cents per share at the 30th of June last year to 1.45 cents per share, the 30th of June, 2019. Which is after the payment of the eight cents per share dividend in September 2018, and the two cent per share interim dividend in March.
An unusually high surplus of franking credits and LIC capital gains was generated throughout the year as a result of the portfolio manager's decision to move to a more concentrated, high conviction portfolio. To the extent that in conjunction with the fully franked interim dividend of two cents per share, the directors have also declared a fully franked dividend of five cents per share.
The resulted annual fully franked dividend yield of over 5.8 per cent is substantial for global equities and for those eligible investors that can take advantage of LIC capital gains. The after-tax impact may be worth somewhat more.
The directors of the company have opted to suspend the operation of the dividend reinvestment plan, or DRP, for the upcoming dividend payment, as it works against the objectives of the current on-market share buyback.
The company maintained the on-market share buyback throughout the year providing some additional liquidity for shareholders. During the year ended 30th of June, 2019, there were 8.5 million shares bought back on market by the company at an average price of $1.30 per share. With the shares bought back at an average discount of just over 12 per cent. This was value accretive to the company.
The management expense ratio, or MER, was relatively stable compared to the prior period, reducing marginally from 129 basis points to 128 basis points this year. This still represents one of the lower MERs for global equity LICs in the Australian market.
The company's portfolio of investments returned 4 per cent or 2.7 per cent net of fees and expenses during the 2019 financial year.
The Morgan Stanley World Index in Australian dollars returned 11.3 per cent. This was a disappointing result for shareholders in what was again another challenging year for value style investments.
I'll defer any further discussion about investment performance to the portfolio manager, as he has a more detailed analysis of returns for the year. The board and management have remained focused on several initiatives to increase shareholder engagement and ultimately narrowed the trading discount, increased media exposure for the company and the portfolio manager's views on the global equity markets, and how TGG is positioned to take advantage of these changes over a longer term.
This was also a challenging year for LIC industry. Firstly, from political uncertainty and potential changes in the franking credit refund eligibility, investors sold out of LICs and some did not return. The negative sentiment post the Royal Commission was significant.
The financial press commentary around the payment of broker commissions by the many new LICs coming to market has also seen the relative attractiveness of the industry diminish with pressure on discounts increasing as a result.
This commentary relates more to new LICs entering the market. And we consider TGG and LICs in general to remain a useful structure for shareholders to gain exposure and diversification to global equities.
The investment portfolio has also been transformed throughout the course of the year into a more focused structure of 40 to 60 stocks. And one that displays a higher level of conviction in terms of stock selection. Both the board and the portfolio management team feel that this structure positions the company well to capture the returns that are expected to flow when the value style recovery begins and outperforms broader markets.
I'd like to remind shareholders that the company's AGM is to be held on the 22nd of October at 11:00 AM at The Westin Hotel in Melbourne. The directors encourage interested shareholders to attend the meeting as it is an excellent opportunity for us to hear firsthand the investing priorities of the shareholders.
Shareholders unable to attend the AGM in person are encouraged to lodge a proxy vote with the share registry. The notice of meeting will be mailed to shareholders no later than the 15th of September.
With over 30 years as a company listed on the Australian stock exchange. TGG has stood the test of time and continues to provide investors with easy and cost effective access to global equity markets.
At this point I will hand over to Mr. Peter Wilmshurst, the Portfolio Manager, make his observations on the results for the portfolio of investments in 2019. Before I hand over to Peter, I'd like to once again thank all shareholders for their continued support of TGG. And we look forward to a strong 2020. Thank you.
Performance for TGG for 2019 was somewhat disappointing, with the portfolio returning 4 per cent for fiscal year '19, as against an index which returned a little bit over 11 per cent. So overall, the portfolio was 7 per cent behind index.
The longer-term performance numbers are more attractive on an absolute basis and even relative to the index and somewhat supportive. TGGs portfolio suffered from two key headwinds over the last five, even 10 years really, since the global financial crisis.
One of those as the fact that value investing has underperformed growth investing, really for the last 10 years. The longest period of value under performance that we've seen through the history. And you can see here from the chart that, that's a really significant drag on portfolio. We've always been a value investor as TGG and that's been a significant headwind for the portfolio.
The other significant thing the portfolios had to face is being underweight the U.S. market. The U.S. market has been the strongest part of the world's economy, strongest part of the world stock markets over the last five and 10 years. And that's really been a drag on TGGs performance, which as shareholders would be aware, it takes a very approach and invests very differently to what the average global equity manager has done.
We're sometimes asked, why don't we use the value index as the index for TGGs performance rather than the MSCI All Country World? While value is the way we go about doing things and we think it is indicative as to whether we're having an easy or hard time of it in terms of delivering out performance, there are also some very different elements to the way we apply value to the more backward-looking quantitative approach that they take in constructing the index.
The chart here, we've split the portfolio in two, looking at the stocks that TGG holds in the U.S. and then stocks TGG holds outside the U.S. And really, since the global financial crisis, you can see that TGG stocks in the U.S. have outperformed the U.S. value peers, and outside the U.S. have outperformed the rest of the world value peers.
But overall, we haven't used the value index as one of our barometers primarily because it's geographically neutral. It's constrained to have the same amount invested in whichever country as the overall index. At the moment, that means the vast bulk of the portfolio is in the U.S.
At other periods, like when TGG started, it meant that the portfolio would have been benchmarked against something that had 45 per cent invested in in Japan, when Japan was a market where there was no value whatsoever.
So when we think about the macro overview, how we're positioning the portfolio, clearly positioning to take advantage of that rebound in value when it occurs is the core part of the portfolio. You can see that that last 10 years of outperformance by growth stocks has basically dissipated all the outperformance via value since the MSCI started measuring value and growth indexes. And goes back even longer in the U.S.
So we do think it's a very interesting, compelling time to be a value investor. And we think the portfolio is very much positioned for that. So positioning a portfolio to be overweight the markets outside the U.S, positioning a portfolio to be value. Other elements that have really bifurcated in the stock market is the extent to which some investors have really chased quality, chased defensiveness. And if you look ... split the market into those stocks that act like bonds, so-called bond proxies, they've re-rated and re-rated such that there are now very few of those stocks are cheap. They're trading on average at over 20 times earnings.
Equity investors are buying those stocks because they deemed them to be defensive. But the other part of the market, the stocks that are deemed to have some whiff of cyclicality, have been de-rated, notwithstanding interest rates going down, notwithstanding them delivering pretty attractive results overall. Such that if you look at the half of the market that is least correlated to bonds, it's now trading on only something around 10 times earnings.
Now, people who are buying the bond proxies should realise that they're not buying bonds. If you look at SocGen analysis, last time when we had the GFC, now that's a pretty deep cycle. These stocks saw their earnings fall by 35 per cent. You're not going to get a lot of protection buying a stock on more than 20 times earnings if the profitability can fall that far.
Contrast that with some of the stocks that are really pricing in a bearish outcome, and we think that's the compelling way to position your portfolio.
Now that's not to say that we think the economic outlook is dire, by any means. If you look at wages, they're growing. They're growing at a faster rate than they have through most of the time since the global financial crisis. That's true for the U.S., it's true for much of Europe. So we're seeing wages recover. And we're also seeing solid employment gains in most economies.
Now wages aren't going up as fast as many employees would like. We understand that, but with job growth, wages going up, that leaves the 70 per cent of most developed economies that are reliant on consumer incomes and consumer spending, they should be pretty resilient. Interest rates are very low. No one's deferring their spending because interest rates are too high. We don't think central Banks should necessarily cut rates further, but they will. But ultimately, that 70 per cent of the economy that's reliant on the consumer, we think that means that the economy will be relatively resilient going forward. And therefore, we're not thinking that we're going to see a very severe market downturn.
So when we come to the positioning of the portfolio, you can think of TGGs portfolio is positioned in something of a barbell right now. We have increased the defensive elements of the portfolio over the last 12 months, increasing the exposure to attractively valued stocks that have defensive characteristics, less economically exposed, better balance sheets, more resilient earnings, if you like. You can see that in the high weighting in the portfolio to healthcare and increased exposure to areas such as the Integrated Energy Companies and telecoms.
At the other end of the barbell, you've got some of those cyclicals that the market's really concerned about the next economic downturn and have sold them off to have some very low valuations. You can see that in the financials part of the portfolio, which has come down slightly over the last 12 months. But underneath that there's been some change within the financials. We hold much more exposure to the banks, where you're really getting some distressed valuations. But also a slightly increased exposure to the industrials, where we're getting some very attractive businesses at attractive valuations.
Turning to a few of those in turn, Standard Chartered is a London headquartered emerging markets bank. The stock's been going through new management, repositioning their portfolio, de-risking their lending book, and is now coming out the other side. They've improved capital significantly. They're now growing their balance sheet again, driving revenue well ahead of costs, and we see a great path to them of further improving profitability and the valuation is very attractive, trading at something around 40 per cent discount to their tangible book value, for one of the leading emerging market franchises in the world.
This is a stock that has recently done the first buyback they've had in the last 20 years. If you look at the Integrated Energy Companies, we actually do think they are going to be defensive aspects of the portfolio, starting from their dividend yields.
So the red bars in this chart show you the dividend that you're getting each and every year out of these Integrated Energy Companies. So the Exxons, the Shells, the BPs of this world. Those dividend yields are on average something around five and a half to 6 per cent right now. So that's a good starting point. The companies, though, have free cashflow yields, something north of 10 per cent. And they're growing production even after that capex and delivering that free cashflow. So when you look at the total return, even without considering what re-rating you might get from these stocks, you've got a five or 6 per cent dividend yield and then you've got production growth on a per share basis that's organically growing production, and then combining that with buying some shares back. So that you as the remaining shareholder end up with more production per share in your pockets.
And so even without a re-rating, we can easily see a path to sort of 10 to 12% returns for these companies. And we think there should be a re-rating, 10% free cash flow in a yield in a world where bonds are at zero, is the wrong number for these type of companies.
And looking to one of our healthcare holdings, one of the new holdings in TGGs portfolio over the last year is a Japanese company called Takeda. We originated our holding in this position when they took over one of our other holdings, Shire Pharmaceuticals. So you had a company by one of our holdings at what was a reasonably attractive price, actually fit together. We weren't thrilled with giving up Shire at the valuations they bid for it, but we've then followed up and bought more shares in Takeda.
We think this is now a company with a good management team. Lots of opportunity to drive cost reductions as they pull together those two businesses. And the combination of Takeda's historic business, as well as Shire's business, has a broad spread of products across a number of therapeutical areas.
So you've got a company here that's delivering a 5% dividend yield, 12 times earnings in the next year, and with some room to drive earnings significantly higher as they can deliver some of their cost cuts over the coming years. So we think Takeda's an example of a compelling value idea in the global healthcare space.
So overall for TGGs portfolio, the continued re-rating of growth stocks while value stocks have languished somewhat, has left the price to book ratio of the portfolio on around 1.2 times. That's practically as low as it's been at any point for the last 10 years. And with an attractive set of businesses in there, trading at pretty compelling valuations, we think not withstanding that there is some overvalued part of global equity markets within TGGs portfolio. Overall, it's pretty well positioned to outperform over time.