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Fisher Funds TWO KiwiSaver Scheme — Your Monthly Update

September 2016

Go forth and become a fund manager

I wonder how many parents would consider fund management as a worthy career for their sons and daughters? I would, but then I've enjoyed being part of the fund management industry for nearly thirty years and seen its impact on people's lives.

There is no doubt that investing has changed in the past three decades and will most likely be a completely different art (or is it a science?!) in future decades.

It used to be that being a good fund manager essentially involved beating a benchmark index by picking the good investments from the index and avoiding the bad.

You could identify the investment philosophy or style that most resonated with your own personality — a growth investor would look for investments that offered the best prospects for profit growth, and a value investor would look for investments that were cheaper, and therefore offered better value than the rest of the index.

You could decide how often you transacted — perhaps you were a buy and hold investor like Warren Buffett, buying shares in companies that you intended to own forever. Or you could attempt to time the market and get into investments before other investors discovered them, and sell before others sold and pushed the price down.

Investors would generally appreciate the skill and effort required of a stock picker and would seek out those who had a better-than-average track record of success.

But that was in the old days. As in all industries, the investment business has experienced significant change, and the rate of change is accelerating.

Much of the change relates to the investment industry itself — investment styles are now interchangeable with growth investments often behaving like value investments and vice versa; information and markets change so rapidly that owning anything forever is out of the question; and few fund managers have been able to achieve a better-than-average track record, so investors are unsure who to pick!

Significant change has also occurred in investors' attitudes. Having a fund manager beat an index has become less important than the manager generating returns to beat the bank deposit rate. Today dividend yield is considered more important and appealing than capital growth. Investors want to have a greater say in the sort of investments their fund manager owns (eg. ethical and socially responsible businesses) yet at the same time, they like passive or index funds which offer no opportunity to choose particular industries or companies.

Our ageing population and the era of low interest rates and economic growth has led to another significant change — a focus on 'decumulation' rather than accumulation. That is, as many people are investing to ensure their funds last their lifetime and provide a retirement income, as those who are looking to accumulate assets and grow them as quickly as possible.

The one thing that hasn't changed about fund management, and the reason that I would still recommend it as a career choice for my children, is that fund managers perform a vital function, and the number of people needing investment management services is going to keep growing as people live longer.

Carmel Fisher, Managing Director, Fisher FundsInvestors don't just need good stock-picking, or a choice of investment products; they need someone to hold their hand and make the right decisions for them, in good markets and bad, so they can achieve their financial goals. Clients need someone to anticipate changing trends and adjust accordingly, so that whatever happens next, their financial journey will continue as planned.

As you'll read in the following pages, we've provided the stock-picking and the diversified range of investment products and we've made some good decisions to ensure our performance remains competitive. But most importantly, we've helped investors stay on course and reach their destination; that's our primary function.

Carmel Fisher
Managing Director | Fisher Funds

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Highlights and Lowlights

This month we share how each investment portfolio is tracking, including some of the highs and lows direct from our investment team.

Highlights and Lowlights

New Zealand

The New Zealand results season did not disappoint. We had six companies in the portfolio record a 5% or more share price increase for the month, in an overall flat market. The best performer was retirement village owner Summerset which again recorded strong earnings growth on the back of increased sales of new and existing units and beds, along with increased development margins.

The Metro Performance Glass share price rose on the back of likely additional work it will receive from Auckland's new Unitary Plan, and from a bolt-on acquisition it made in Australia during the month. Tegel got an unexpected boost when Australia announced their decision to allow imports of all chicken from New Zealand, not just cooked chicken as per the current regulations. Fisher & Paykel Healthcare was counter-sued by rival Resmed over disputes around alleged patent infringements. This could be messy with only lawyers likely to benefit from this two-way dispute, although the overall impact on Fisher & Paykel Healthcare's earnings is likely to be minor.


Australia

August saw a tough reporting season in Australia. Lofty investor expectations made it hard for companies with a record of strong earnings growth to surprise positively, and any signs of weakness in these companies saw their shares sell off. Our large portfolio positions generally fared well, led by Ramsay Healthcare, which beat expectations and traded up strongly. While the majority of our portfolio positions beat or met their numbers, a miss from APN Outdoor saw a significant fall in their share price.


International

US markets were down slightly for the month, pulled into negative territory by Health Technology and Retail Trade stocks. Globally, Finance stocks were the best performing as interest rates remain at record low levels. The international portfolio's top contributors had a heavy weighting to the Financial sector including Bank of America (up 11.4%), HSBC (up 13.3%) and Citigroup Inc. (up 8.8%).

Emerging markets outperformed their developed market counterparts again in August continuing the trend since the start of the year. Last month's stellar results were due to the strong performance of the Pacific Rim region — led by China and Hong Kong. Our external manager Somerset's performance lagged due to low weighting to these countries, consistent with their long held strategy of investing in other Asian economies.


Fixed income

August is typically the month when most northern hemisphere investors trade their computer screens for the latest best-selling novel and head to the beach. So it was of little surprise that financial market activity was rather muted this month. However, the major theme we've been highlighting remained – low deposit rates continue to cause demand for corporate bonds to significantly outstrip supply. This positive dynamic helped our fixed income funds post another month of outperformance over their benchmarks.

This month, Federal Reserve members went to great lengths to prepare market participants for a hike to the U.S cash rate over the coming months. This provided the catalyst for a mild retracement in both U.S and other developed world government bonds. This resulted in fixed income assets registering only a very mild rise in value this month, following what has so far been a strong year for these safe haven assets.


Your KiwiSaver portfolios

The benefits of marketing yourself

By Murray Brown, Senior Portfolio Manager, New Zealand

The benefits of marketing yourselfMany of you will know that our NZ Growth Fund has been a long term investor in the jeweller — Michael Hill International. Whilst we've been delighted with their overall long term performance, their shares had languished until recently, performing below the broader NZ equity market for the past two years.

Cue a potential listing on the Australian Stock Exchange (ASX). The company decided to market itself the way other listed companies do. It's commonplace now to see post results conference calls, subsequent group meetings with smaller institutions, and one-on-one meetings with more informed managers (like Fisher Funds). Typically the CEO and CFO make themselves available to answer questions about the results and will repeat this exercise in Australia and often in other offshore markets as well. It is a commitment made by the company to keep current and potential investors fully informed, and is repeated every six months.

With Michael Hill International seeking shareholder approval to change The Main Board listing from NZX to ASX, the company actively visited Australian and New Zealand institutions in the lead up to the shareholder vote to make current and potential investors aware of its many attributes. Further, it made a commitment to make this a feature of its investor relations programme going forward.

The end result is that the shares are up a staggering 60%+ since the end of March this year. Whilst some will argue that the re-rating of its shares are a function of deciding to list in Australia, we believe it is because it has finally marketed itself properly to a wider group of investors and made sure that existing shareholders fully understood the company. As meaningful shareholders in Michael Hill International, we are delighted with the outcome and always knew that this is a gem of a company.


Results season conundrums

By Murray Brown, Senior Portfolio Manager, New Zealand

Results season conundrumsNow that the dust has settled on the June profit results season, it is a good time to reflect on the surprises from our New Zealand companies, good and bad. As always, we use our STEEPP criteria to re-evaluate our portfolio companies post-results, to see if our view is materially changed.

Overall, the results season was very satisfactory but as always, there were things that surprised us at the margin. The standout results for us were Summerset, Michael Hill International, Trade Me and EBOS. All recorded solid share price gains post the results after reporting strong earnings growth.

Summerset has been a star performer in the New Zealand portfolios for some time and its half year result in August did not disappoint. Often when a share price runs up before a result, it will flatten off or fall when the company actually reports its results (reality sets in). In the case of Summerset, the share price ran up 7% in the week before its results and lifted another 10% in the week following! We have been delighted with our investment, which we first bought when the company listed in 2011.

The only negative surprise (in terms of share price movement) was Vista Group which fell 7% on the day it announced its results. In this case, a bit of context is required. The Vista share price had risen 8% in the two weeks leading up to the result, so it just fell back to where it was. Did the result itself disappoint us? No, the result confirmed to us that the company has many years of growth ahead of it, and in fact we added to our investment once we had fully critiqued the result. We feel that using 'STEEPP' and taking a three to five year time horizon is a good discipline in not getting caught up in the result 'hype' and end up making emotive decisions that we may regret later.


Why every company should worry

An excerpt from a New York Times article by Steven Davidoff Solomon

Why every company should worryUnilever is paying $US1 billion for Dollar Shave Club, a five-year-old start-up that sells razors and other personal products for men. Every other company should be afraid, very afraid.

The deal anecdotally shows that no company is safe from the creative destruction brought about by technological change. Dollar Shave Club is a phenomenon in the men's grooming industry. The idea is simple. Instead of paying $US10 or $US20 a month for disposable razors, a Dollar Shave Club subscriber could go online and set up a regular order to be shipped to his home monthly at a fraction of the retail cost.

Gillette had previously dominated the razor business, and was so dominant in advertising and shelf space that Procter & Gamble paid $US57 billion for the company in 2005.

Everything changed in 2012 when Dollar Shave Club posted a free ad on YouTube. The ad went on to get over 20 million views and rocketed Dollar Shave Club to over $US240 million in revenue. From there, Dollar Shave Club raised $US160 million in venture capital, captured about eight percent of the market in only a few years, and expanded into other personal care products such as wet wipe toilet paper.

It used to be that if you wanted to sell razors, you needed a factory, a distribution centre, a sales force, a research and development team and a marketing budget. But the internet, mass transportation, free advertising, low-cost and easy distribution and globalisation destroy everything.

This means all companies should be fearful, but not all is lost. In this world, intellectual property and unique assets become paramount. Gillette sued Dollar Save Club for patent infringement, but it is hard to patent a simple razor. Unique technology or assets mean you have a right that cannot be taken away or commoditised.

Fisher Funds comment: We agree with this analysis which reinforces our insistence on a competitive moat or sustainable advantage that each of our portfolio companies must possess if they are to make the grade.


What is responsible investing?

By Mark Brighouse, Chief Investment Officer

What is responsible investing?Listed companies are often, by their nature, fairly large and complex organisations. This means that even the most well-meaning are likely to eventually face some kind of ethical challenges. They could be environmental challenges, social challenges or governance challenges. Some companies will do a good job of dealing with these challenges and investors should recognise this.

At the other end of the spectrum, some companies operate in industries where their products cause such broad and significant harm that responsible investors have no choice but to avoid them. Examples of such industries are tobacco and armaments.

Given the range of potential ethical challenges, investors are right to ask their fund managers what is being done to invest their portfolios responsibly. Some fund managers are going to be in a better position to answer than others.

As a New Zealand fund manager we are able to design our investment process to meet our clients' concerns; as opposed to large overseas firms who may not have the desires of Kiwis at the front of their minds.

Also, we are active as opposed to passive managers and this is an important difference when it comes to the ability to invest responsibly. Active managers analyse prospective portfolio companies taking into account factors affecting their long term sustainability. Active managers exercise their voting and provide increased oversight of company management.

Contrast this with passive management which involves buying a fund that mimics a particular market. Passive management has become very popular.

The problem is, a passive fund doesn't choose its investments — it will own good companies and bad, in all sorts of industries, usually based on the composition of an index. The companies in an index are determined by their size, not by their goodness. Passive funds don't visit management, lobby companies or vote to change practices to encourage "good corporate citizenship".

Responsible investing involves being aware of the issues that portfolio companies might face, engaging with them to achieve sustainable long term growth and avoiding those companies where the concerns are simply too great.


Nike — still doing it

By Roger Garrett, Senior Portfolio Manager, International

Nike — still doing itNike has been somewhat overshadowed by the renaissance of Adidas in recent quarters. Adidas has impressive business momentum, their strong brand and innovative products are now coupled with a more cohesive and committed strategy. They're starting to 'walk the walk', and while their turnaround is still in its infancy, we believe it still has some distance to run.

Nike on the other hand, has never stopped 'walking the walk'. They are the clear market leader, with technology, innovation and an iconic brand at the core of their success. The focus for Nike is on improving production, increasing their Nike branded retail market and growing in the high margin apparel business.

Labour costs at Nike equal around a third of their overall expenses. They are reducing these costs by improving their production process, making shoes faster, with less labour and less material. Creating an engineered knit that only uses fabric where it's needed, has reduced material use by up to 75% and reduced the number of workers touching a trainer from 32 to just two to four. The company has also improved its supply chain process so their products get into the hands of waiting consumers faster.

The majority of Nike sales are through third party distributors like Footlocker, with just over 20% of Nike sales being through their own retail channels — which deliver a higher margin. Nike is investing in direct to consumer campaigns to increase their own retail sales to over a third of total sales in five years.
The global athletic apparel market is double that of footwear and is growing faster as the trend for 'leisure wear' evolves. Nike and Adidas are both benefiting from this trend by virtue of their strong brand and dominance in this fragmented market. We believe apparel could in time generate over half of their sales, up from 28% currently.

Nike remains a best in class company with an iconic brand, great management and a long growth runway. Both Nike and Adidas remain strong conviction positions in the international equity portfolio.


Keep your eyes on the road

By Manual Greenland, Senior Portfolio Manager, Australia

Keep your eyes on the roadHaving a three year old daughter, I am often reading bedtime stories, listening to children's songs, or watching kids' movies. The song "The Wheels on the Bus" is popular with children. It is repetitive, easy to sing along to, and helps pass the time on long trips. It occupies the mind on the immediately obvious; the wheels on the bus go round and round. Essentially this relieves children of the great patience needed to get to the final destination.

Share prices also go round and round. Over the last 12 months the Australian market has fallen 5% or more seven times. After each fall it has subsequently rallied again, to end the period over 8% up. After every downward move everyone agrees "the sky is falling down" and sells their shares cheaply. A move up is accompanied by a rousing euphoric chorus, "everything is awesome" and everyone dreamily buys shares at ever higher prices.

So the prices of the shares go up and down, but what is the ultimate destination and what will it take to get there? The destination is a more valuable portfolio of shares over the medium term. To get there we must recognise that in contrast to the gyrations of share prices, the value of companies change slowly over time. The key is to invest in companies whose strengths will see them grow in value. Share price movements usually do not reflect this value, but rather offer opportunities to add to holdings when share investors are unduly pessimistic, and to reduce holdings when they are too optimistic. Although it demands greater patience, investing with a keen sense for the underlying value of your portfolio of companies is ultimately more profitable than focusing on share prices.


Managing your KiwiSaver account

Four tried and true ways to plan for retirement

We know that many working people are not adequately preparing for a comfortable retirement. A recent survey confirmed that more than 50% of people were unsure how much their KiwiSaver would be worth at retirement, or how much income they'd need once they were retired.

HSBC recently surveyed a number of Australian retirees and asked what they would do differently before retirement, if they had their time again.

40%Starting early

Two in five retirees admitted to not saving for their retirement early enough. Starting early and making small contributions to your retirement fund allows your money to grow through compounding and reduces the burden of saving much larger amounts later in life in order to catch up. Whether it's increasing your contribution rate or adding to your KiwiSaver account occasionally, there are many ways that can help boost your pool of funds in retirement.

25%Not being able to afford it

A quarter of retirees said they could not afford to prepare adequately for retirement. However, they acknowledged that if they had budgeted better and kept a closer eye on their finances, many could have allowed for some surplus funds to be directed to their retirement savings.

30%Didn't know how much to save

Three in 10 retirees said they did not know how much they needed to save for a comfortable retirement. We have online tools that can help you work out if your current level of savings is going to achieve the nest egg you will need. If there is a gap between what you earn and what you're going to need, our team can give you some direction on how to narrow the gap.

10%Paying off other debts

One in 10 retirees cited paying off the mortgage as one of the biggest obstacles in preparing for a comfortable retirement. And 16 percent of retirees said debt repayments were a barrier to saving. Repaying debt can put a large strain on limited cash flow in retirement. Ideally all mortgages and debts should be paid off before retirement. While it's not always easy, having a plan well in advance can make debt-free retirement a reality.


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