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Fisher Funds TWO KiwiSaver Scheme — Your Monthly Update

March 2016

A story worth telling ...

These days there are lots of investment conversations that I'm very happy to miss out on. I also find myself skimming over much of the business news preferring to search out the rare, interesting and value-adding commentaries that might help in my investment decision-making. It's not that I'm not interested — far from it — it's just that today's stories are not helpful. They are often simply noise, they are focused on the very short term and they often miss the wood for the trees.

My favourite part of investing has always been discovering the "story" behind a business, understanding what makes it better than its competitors and what might enable it to grow its earnings for many years into the future. If it can grow its earnings over time, its share price should ultimately follow. I've relied on a couple of guiding principles from Warren Buffett:

  • buy on the basis that the stock exchange might close tomorrow and not reopen for five years (would you still want to own the stock?); and
  • if you aren't prepared to own the whole business for ten years, don't buy a share in it for even ten minutes.

Good luck trying to find stories about businesses that you'd want to own for ten years and not be able to sell on the first whiff of bad news! Rather than being thought of as businesses, stocks are now typically seen as securities that wiggle up and down on a screen, with the wiggles usually explained by factors that have nothing to do with the underlying business.

Two recent market reports attempted to describe the volatility of global investment markets during January and February. In an effort to make their stories compelling they referred to the "six C's" in one case and the "three E's" in the other. The first explained how China, consumer demand, commodities, currencies, central banks and company earnings had "turned the market" and that investors should watch each factor carefully to determine their next moves. The second report suggested that elections (the US being the biggie), exits (especially the possibility of Britain leaving the EU) and energy (low oil prices) had created the "extreme volatility" of late and may be key determinants of investment returns in 2016.

The problem is that these commentaries — which are not unusual — are unhelpful because they focus on general macro themes rather than the specific micro factors that all investors must consider. For instance, when our portfolio managers recently took the opportunity of weak share prices to venture into stocks they had been watching, or bought more of existing holdings, they would have been unnecessarily hindered if they'd waited to first consider the implications of China's growth, currency moves and oil prices on the businesses they hope to own for years into the future.

Carmel Fisher

Warren Buffett's latest shareholder letter referred to the irrelevant and often incorrect "noise" that can cloud our judgement. He noted that "It is election year, and candidates can't stop speaking about our country's problems (which of course only they can solve)". He said that this "negative drumbeat" is making many Americans feel worse about their future even though "America's economic magic remains alive and well". He went on to say that even though many commentators lament America's 2% GDP growth, "that rate will deliver astounding gains" and this tailwind will allow Berkshire Hathaway (Buffett's company) and "a great many other businesses" to almost certainly prosper.

Buffett's comments might sound like a different sort of story-telling — the overly optimistic kind — however he backed them up with a description of how each of the companies in his portfolio will prosper.

We can do the same when it comes to your investments — our stories are the sort worth listening to.

Carmel Fisher
Managing Director | Fisher Funds

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Highlights and Lowlights

February was a busy month for our investment team with a large number of companies across our portfolios reporting their latest results.

  • Highlights and LowlightsResults from Auckland International Airport (AIA) and EBOS were the pick of our New Zealand portfolio. The buoyant New Zealand tourism market has seen AIA again upgrade earnings guidance for the full year. More airlines, flying more often and with bigger planes is driving record profits for the airport and the outlook is for this to continue. EBOS, a bit of a quiet achiever in recent times, reported another double-digit earnings increase for the half year which attracted attention from investors who drove the share price up a healthy 16%. On the flipside, although Freightways recorded a very satisfactory result for the half year ended December 2015, the company was more cautious in its outlook statements following a slower December-January period.
  • Our Australian companies came through the February reporting season very well. All but two of our holdings reported growth in earnings, with ten companies reporting exceptional growth of 25% or more. Our largest portfolio holding, Ramsay Healthcare, had over recent months become the subject of negative speculation as investors feared cost-saving efforts on the part of medical insurers would negatively impact hospitals. In a show of strength, Ramsay Healthcare reported 24% growth in earnings and raised its full year guidance. Ansell suffered a combination of some management mistakes and an adverse currency environment, resulting in a disappointing result. Crucially, we are of the view that Ansell is a good company suffering a bad time, and so we continue to own it.
  • With increasing uncertainty over the global growth and corporate earnings outlook one of the features of company reporting season was the asymmetric share price reaction to results. It appears that the market will not reward anything but close to perfection. Companies that disappointed or guided below market expectations saw quite brutal share price resets. LinkedIn (not owned), for example, beat Q4 earnings expectations but guided well below Wall St estimates and the stock fell 50% — close to $US15B wiped from its market value. In contrast, companies that met or exceeded expectations such as PayPal did not receive the same level of lift in share price.
  • On the fixed interest front, there remains a divergence in behaviour and performance across the market. After a tough end to 2015, corporate bonds have staged a mild recovery which has benefited many of our holdings. Central Bank decisions (Japan's negative interest rate surprise and a highly anticipated ramp up in QE from the European Central Bank next week) are again driving investors into the sovereign bond market which has lifted the value of our holdings in US Treasuries and UK Gilts to new highs. Our holdings in bonds issued by banks and other financial institutions remain weak in the face of lower interest rate expectations, greater regulation, and concerns the economic cycle might be turning for the worse. The good news is that these factors are unlikely to be severe enough to throw into question these institutions' ability to pay their debts.


Your KiwiSaver portfolios

Investing versus speculating

By Manuel Greenland, Senior Portfolio Manager, Australia

Investing versus speculating

We've all felt a little like Alice over the last while. There have been moments when we've questioned the sanity of the share market, and moments when we've had our sanity questioned. Share prices have whipsawed on fleeting sentiment often driven by little more than the latest headline. Understanding the difference between investing and speculating is key to capitalising on these conditions.

As investors we establish the worth of a company by focussing on its ability to generate profits, or "earnings power". Earnings power evolves gradually with changes in the company's markets, and its competitive position. Consequently the worth of a company is relatively stable in the short term, and changes steadily over the long term.

In contrast speculating starts with a focus on share prices. Over the short term share prices are driven by people's appetite for risk which, being a human emotion, can be volatile. With little understanding of the companies issuing the shares he owns, the speculator explains changing share prices in terms of stories which rely more on headlines than reasoned analysis.

Over February our portfolio companies issued performance reports. To our delight most of them have strengthened their competitive positions and grown their earnings. Share prices over the period were generally volatile. This gave us great opportunities to add to holdings in winning companies like Bursons, Regis Healthcare and Technology One. And after a long and patient wait, we got to buy a new holding in Henderson Group at an attractive price. We welcome the opportunities afforded by the madness of the market precisely because, unlike Alice's Cat, we believe in the sanity of our investment process.


When times get tough, profits matter

By Murray Brown, Senior Portfolio Manager, New Zealand

When times get tough, profits matter

Last year's market darling, the technology sector, has had a tough start to 2016 with those tech companies that do not make a profit feeling most of the pain. The tech stocks in the New Zealand share market have been no exception, with many share prices down heavily since the start of the year (although they did bounce towards the end of February). Why is the share market picking on these sorts of companies, seemingly indiscriminately?

We think the answer is that these companies are usually cash-flow negative and need to periodically tap the share market for more capital to top-up their cash levels until they can get their business models to a break-even situation (which might be years away, if at all!). When share markets become volatile, the ability to raise capital becomes significantly harder as providers of equity become more nervous and are reluctant to commit new equity and want a discount for the uncertainty.

The company that hit the headlines in February was Wynyard Group, a crime fighting and security software company. Wynyard got shareholder approval in December last year to raise $30m of new equity over the next 12 months at a minimum issue price of $2.00 per share. Share market volatility meant that the minimum $2.00 share price was no longer achievable by the end of January, and instead Wynyard was forced to conduct a rights issue at $0.85 to replenish its cash levels. The Wynyard share price is now half of what it was at the start of the year. Messy!

Our stock selection process means that we insist on companies having an earnings history and are forecast to be profitable going forward, to avoid this very scenario. While there is of course a viable place for software companies to be listed on stock exchanges, we favour investing in companies whose business models are proven and they generate rather than absorb cash.


Boring is beautiful

By Zoie Regan, Portfolio Manager, Property & Infrastructure

Boring is beautiful

It's fair to say that financial markets have had a rough start to the year. But not all asset classes have experienced the same volatility in returns, and in fact defensive infrastructure (and similarly listed property) investments have generally remained in positive territory.

You won't often see us write about defensive infrastructure assets, such as energy transmission and distribution assets, because for the most part they typically aren't news worthy and in most cases are really quite boring! But by the same token, this is their appeal. These assets provide essential services that communities depend upon for their day to day living so typically have lower sensitivity to economic cycles, feature regulated revenue or long term contracts and operate in industries with high barriers to entry so face limited competition and/or pricing risk (albeit regulation is also a source of risk). Combined, these attributes mean that defensive infrastructure assets typically feature stable and reliable earnings and cashflows.

This defensiveness is a key attribute of infrastructure investment. In times of market turmoil, it makes sense that investors would want to seek out assets with stable and predictable cash flows. An allocation to infrastructure (& property) investments should be considered by investors as part of their broader investment portfolio as a possible lower-risk option relative to shares or an alternative defensive option to fixed income investments.

The recent performance of defensive infrastructure investments is also a timely reminder of their appealing diversification qualities, which when combined with other asset classes (such as shares and fixed income) should enable investors to earn superior risk-adjusted returns overtime.


The mania of Mr Market

We revisit Warren Buffett's 2013 tale of the moody Mr Market

The mania of Mr Market

In the 2013 Berkshire Hathaway Annual Report, Warren Buffett told the tale of Mr Market and a parcel of farmland. The farm in question is a great asset, producing a substantial yield of corn year after year, despite the short term ravages of locusts, drought and the occasional flood. On a daily basis, the farmer from down the road — he's called Mr Market — approaches and offers to buy the farm or sell his at a quoted price. Mr Market is a moody character — a bit of a manic depressive. Some days he is euphoric and exuberant and offers a very high price. On other days though, like a flipped switch, he is quite depressed and quotes a particularly low price. We can ignore Mr Market as much as we want, but he always comes back.

Given that the fundamentals of the farm are sound — increasing revenues, a strong track record and high rates of return — we can be reasonably certain that the farm will continue to perform well into the future. We do not need to respond to our moody neighbour, and we certainly shouldn't come under the spell of his exuberant highs and his depressed lows. On down days when he offers his farm at depressed prices, we may choose to look at its intrinsic value and perhaps buy it — taking the opportunity to earn a high rate of return on a fundamentally sound asset. On his high days, should we sell our farm? Well if the price is considerably higher than its intrinsic value, we may choose to sell, though we should always relate the price to the fundamental value. A business can be held forever. Despite short term gyrations, intrinsic value will always prevail.

As a business partner, Mr Market should never be considered as having the upper hand. He is moody and if we choose to ignore him today, he'll be back tomorrow!


Light at the bottom of the mine?

By Manuel Greenland, Senior Portfolio Manager, Australia

Light at the bottom of the mine?

Over February iron ore prices staged a recovery, reversing some of their 80% fall since late 2011. Long-suffering shareholders in mining heavyweights BHP Billiton and Rio Tinto enjoyed a reprieve from relentlessly falling share prices, with both shares ending the month up. Has the mining sector finally turned a corner?

Mining companies have faced savage falls in prices of the commodities they produce. Their response has been to reduce their cost per tonne of output by cutting expenses, and by spreading costs over greater production volumes. Both these measures, ironically, are likely to further weaken commodity prices, aggravating the very problem they seek to address.

Mining bosses seem to be aware that they are locked in a race to the bottom. BHP Billiton CEO Andrew MacKenzie recently advised shareholders to expect a prolonged period of weak and volatile commodity prices. Last month, both BHP Billiton and Rio Tinto broke with long-standing policies and cut their dividend payments. With some urgency Fortescue Metals Group is paying down a multi-billion dollar debt load. Junior miner Atlas Iron Ore significantly restructured its debt. Last year, Anglo American announced large staff cuts and axed its dividend.

All players are sharply reducing investment. The singular objective is to save the most cash for the longest time; in short, to survive expected hardship.

If commodity prices recover in the near term, everyone who has survived wins. If prices remain weak, eventually the very lowest cost producers win, as they are ultimately the only survivors and have the market to themselves. Along the way the cash rich outlast the cash poor, and get to buy high quality assets cheaply from distressed competitors.

While strategically sound, this would be a very hard won victory, involving earnings contraction and insolvency risk. For share investors, picking the ultimate winner could still mean further losses, and perhaps be likened to having backed the tallest pygmy. We prefer to see the underlying commodity markets stabilise before risking our investors' capital in the mining sector.


Putting your interests first

We share recent comments from FMA CEO Rob Everett

Putting your interests first

Did you know that you are part of a $100 billion sector? You are, and you'll be pleased to know that the regulator of this sector, the Financial Markets Authority (FMA), is determined to ensure that your interests are always put first.

FMA chief executive Rob Everett recently said his organisation is entering the final phase of implementing the Financial Markets Conduct Act which is a set of laws designed to make the financial services industry better serve the interests of the public. The final stage involves licensing funds management firms (like Fisher Funds) and the regulator will then shift to supervising all the activities of these licensed firms. The sector is responsible for around $100 billion of funds under management with KiwiSaver being a third of that total representing over 2.5 million members.

"As more than half of the country's population rely on fund managers to grow and protect their wealth either through KiwiSaver, superannuation, managed funds or PIE funds, it is an important step both for the regulator and the NZ economy."

Everett said "the industry has a huge role to play in helping New Zealanders get ahead and plan for their futures with confidence. Fair, efficient and transparent financial markets have a major impact on the cost of doing business across the entire economy. A strong, well-regulated funds management sector is a critical part of that engine for strong, sustainable economic growth."

We are pleased to confirm that as at February 2016, Fisher Funds Management Limited is licensed under the Financial Markets Conduct Act 2013 as a manager of registered schemes.

We can also confirm that we too are determined to ensure that your interests are always put first. Our Mission Statement since 1998 has been to make investing profitable, enjoyable and understandable for all New Zealanders.


Managing your KiwiSaver account

Volatility: A picture paints a thousand words

When share markets are volatile like they have been in January and February it can be unsettling and easy to forget that this is a relatively small window of time in comparison to the typically long term nature of investing in share markets.

The following chart shows the returns of the Fisher Funds TWO KiwiSaver Scheme Balanced Fund since KiwiSaver started and as you can see, negative markets aren't the norm. As the old saying goes, sometimes a picture paints a thousand words.

While the Balanced Fund has delivered an annual average return of 5.1% since inception (October 2007), the following numbers are an important part of the story:

  1. 7 of 8 calendar years have delivered positive returns.
  2. The significant fall in 2008 caused by the global financial crisis was an outlier.
  3. 2008 was followed by a significant rebound in 2009 — the strongest year of performance.

Volatility - A picture paints a thousand words


End of tax year processing

End of tax year processing

Due to end of financial year processing (for tax purposes), our registry system will be closed on 1, 4, 5, 6 and 7 April. This means we'll be unable to process any transaction requests — such as withdrawals, switches and direct debits on those days.

If you are making a First Home Withdrawal and your settlement date is on one of the above dates, you MUST have your fully completed application form and supporting documents to us by 19 March so that we can pay it out before 31 March.


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