q4 2014 treetop convertible pacific · pdf filetreetop convertible pacific aims to increase...

TreeTop Convertible Pacific – Q4 2014

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TreeTop Convertible Pacific is a sub-fund of TreeTop Convertible SICAV, an open-ended Investment Company (SICAV) incorporated under the laws of Luxembourg. TreeTop Convertible Pacific aims to increase the value of your investment over the long term. Under normal market conditions, the main part of the portfolio is invested in convertible bonds and/or other fixed income securities, bank deposits and warrants or call options on shares. The fund may also invest in shares or other instruments equivalent to shares and use derivatives for investment purposes or to reduce investment risks (hedging). The fund manager selects -based on criteria such as product innovation, quality of management, sector leadership, valuation- 25 to 35 companies based or operating predominantly in countries of the Pacific region and that appear to offer solid growth prospects or whose securities seem undervalued in the eyes of the fund manager. The fund invests in shares of these companies and/or in financial instruments convertible in shares or entitling the fund to acquire shares of these companies. The main part of the portfolio is managed in an endeavour to replicate the financial behaviour of a convertible bonds portfolio. To this end, the fund manager ensures that (i) at least 50% of the portfolio is invested in bonds or other fixed income instruments and (ii) the global exposure of the fund to the equity market, through shares and other financial instruments whose value is linked to shares, shall not exceed 100% of the fund’s net asset. Most of the fund's exposure to foreign exchange risk is hedged in the reference currency of the share class. The MSCI All Country Pacific index provides a reference of the investment universe of the fund manager. It is provided for information purpose only as indeed the fund is managed on a discretionary basis and will not replicate the index. This fund may not be appropriate for investors who plan to withdraw their money within 5 years.

Commentary by TreeTop Asset Management S.A., Manager of TreeTop Convertible Pacific

Economic and market environment

2014 was a highly variable year for the stock markets. Characterised by low overall volatility (except for two brief episodes of panic in October and December), there was an average increase of +9.3% (for the MSCI World All Countries Index). Yet more importantly, there were significant monetary, sectoral and geographic disparities. The rotation between value types (value or growth, small or large caps) and sectors also complicated the task of managers focused on the long-term. Here are a few examples:

- Regionally, the United States posted the best performances, especially if we add the rise of the dollar against the euro.

TR E ET O P CO N V E R T I B L E P A C I F I C QUARTERLY REPORT Q4 2014


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COMPARATIVE EVOLUTION OF MAJOR MARKET INDICES IN 2014 (IN EUR)

Source: Bloomberg

- In emerging countries (especially the BRICs), the disparities were even more enormous: China and

India increased by 48% and 29% respectively while Russia, where the rouble collapsed, saw its overall performance reach -43%.

COMPARATIVE EVOLUTION OF THE PRINCIPAL EMERGING MARKET INDICES IN 2014 (IN USD)

Source: Bloomberg

- Sectoral differences were also rather marked. For example, in the United States, biotech gained

34% and utilities (traditionally low volatility) 26%, while oil services lost 25%.

The unexpected shock of 2014: a sharp fall in oil prices It is often wise to be sceptical of consensus. All the economists had forecast that energy prices would remain high, despite the downturn in world growth. The decline in crude oil, triggered in July, reached about 50% in less than six months! Traditionally, we see an inverse relationship between the value of the dollar and oil prices, but the extent of this movement cannot be explained just by fluctuations in the exchange rate. Its origins are more fundamental and no doubt long lasting. It is certain that this


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development will have a significant economic and financial impact in 2015 and that the economists, the central banks and business managers will have to seriously reconsider their scenarios…

WTI OIL PRICES (IN USD): -50% SINCE JULY 2014

Source: Bloomberg

It is actually quite surprising that the fall in oil prices occurred so late. All raw materials had already responded to the worldwide economic slowdown since 2011 and the fundamentals relative to oil supply and demand hardly justified such elevated prices.

CRB COMMODITIES INDEX

Source: Bloomberg

Among the key elements that triggered the decline in oil prices, we note:

1. Regarding oil supply

The technological revolution in the exploitation of shale oil provoked a doubling of production in the United States in less than five years.


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US PRODUCTION OF CRUDE OIL (BARRELS PER DAY)

Russian production reached a new record in 2014. Certain countries, whose production had fallen sharply due to war or unrest (Libya, Nigeria,

South Sudan, Iraq), succeeded in reviving their production. More fundamentally, the influence of OPEC has sharply declined in recent years.

DAILY OIL PRODUCTION IN BARRELS

Source: Minak

As to be expected, the high level of oil prices generated substantial investment in the sector

(particularly in shale oil), which has led to over-capacity.


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GLOBAL INVESTMENT IN OIL AND GAS (IN % OF SALES)

Source: Thomson Reuters, Credit Suisse Research

We also note the eternal paradox of oil: the more we consume, the more the proven reserves

increase (almost tripling since 1980), which is explained not only by new discoveries but mainly technological innovation (gas and shale oil in the US, deeper drilling, etc. became profitable due to higher prices).

PROVEN RESERVES OF OIL (BILLION BARRELS)

Source: Manicore, BP Statistical Review 2013

2. Regarding oil demand The economic slowdown, particularly in Europe and China, has reduced consummation: so supply already exceeded demand in 2012, then again in 2014, and should remain abundantly in surplus until 2017.


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SURPLUS OR DEFICIT BETWEEN SUPPLY AND DEMAND FOR OIL WORLDWIDE

Source: IEA, Deutsche Bank

It is not certain that the deficit, which according to IEA forecasts should appear in 2017, will provoke a new surge in oil prices. Like most commodities, the evolution of oil prices occurs in long cycles, whose downturns (in black on the graph below) are generally much longer than the upward phases (in red). The long-term evolution of oil in real prices (after inflation) is interesting in this respect.

REAL PRICE OF OIL (1861 – 2014)

Source: CS Fixed Income Research

Nevertheless, the decline in oil prices, if sustained long enough, is good news for growth worldwide. How, then, can the panic in the stock markets sparked by its acceleration in December be explained?

The share of producers and oilfield services in the market indices is relatively minor, and thus does not explain the contagious impact on other sectors.

Excessive fluctuations of a market always cause fear of intermediate to short term failures because they involve significant losses that must be compensated through sales of other positions, or risk bankruptcy.

Investments in shale gas have been heavily funded by bond issues: 260 billion dollars issued by companies whose ratings have already begun to deteriorate and some of which will result in


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bankruptcies because their cost is much higher than the current price of oil. According to the Financial Times, a fifth of low-rated issues are already considered « distressed »…

The fall in prices is obviously very bad news for the producing countries and especially Russia. Already virtually in recession, the decline is wrecking havoc on its currency.

Finally, it contributes to strengthening the short-term scenario of deflation, which is the main concern of investors.

In short, the stock markets do not like uncertainty and increased volatility is always a consequence. More long term, we maintain the opinion that the drop in oil prices is excellent news:

For economic growth in importing countries: Europe, Japan, China, India, Korea…

For sectors where energy costs are significant: transportation, electricity producers, heavy industry in general…

For reviving consumption: The Economist estimates that 1.3 trillions dollars will pass from the pockets of producers to those of oil consumers (when oil was still at 65 USD), a significant income effect.

Finally, it should be positive for the stock market: o The decline in oil prices should prompt the European Central Bank to finally initiate without

delay policies of quantitative easing (QE) successfully employed by the United States, United Kindgom and Japan. Certain economists caution, however, that these measures may be ineffective because they are intervening too late, and that the European economic and financial context is very different from that of Anglo-Saxon countries. Indeed, Europe suffers from structural disadvantages (labour costs, institutional rigidity, demography…), which we emphasised in the third quarter report.

o More generally, the decline in oil prices will have a positive effect of the profits of most companies.

2014 review TreeTop Convertible Pacific ended the year with an increase of 1.22%1. The key positive contributors were Kepco, China Power Intl and Mahindra & Mahindra while the main negative contributors were Hyundai Mobis, Rexlot Holdings and Samsung (position sold). Among countries, the prize went to India, Hong-Kong and Korea. However, Japan had a negative impact on performance.

Investment strategy In a world of low yields (savings accounts, term deposits, bonds), equities continue to offer a high earnings yield (inverse of the PE*2 ratio).

1 Cumulative returns over 1 year. Other returns of the same share class are presented on page 10 of this report. Past performance

is no guarantee of future performance. 2 Terms followed by an asterisk are defined in the glossary in the appendix of this report.


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COMPARATIVE REAL YIELDS OF BONDS AND EQUITIES

Source: MSCI, Goldman Sachs Global Investment Research

This does not prevent them from continuing to be highly volatile, particularly in periods of shock like the current decline in oil prices, which we regard in positive terms.

Geographically, we favoured countries that should benefit most from lower energy prices: the best-positioned Asian countries (China, India, Korea) already constituted the bulk of TreeTop Convertible Pacific’s investments. We avoided Japan where the return on equity of companies, although improving, leaves something to be desired. We were especially enthusiastic about Tata Motors, as well as Mahindra & Mahindra (luxury cars and utility vehicles in India), Fufeng Group (food additives in China), and Kepco (electricity producer in Korea, particularly sensitive to the decline in oil prices). However, we have started to reduce, with important profits, our positions in Hyundai Motor and Hyundai Mobis (automobiles and accessories, Korea) whose growth rates are decelerating.

Sector wise, we have increased our healthcare sector with the acquisition of: o IHH Healthcare: important owner of hospitals in Asia (Malaysia, Singapore, Turkey, China,

India...) o Bangkok Dusit Medical Services, owner of hospitals in Thailand.

TreeTop Convertible Pacific holds no oil producing companies, only energy suppliers, who benefit

from the development of Asian consumption (Kepco in Korea, China Power Intl and ENN Energy in China).

We begin 2015 with relative confidence, conscious of the lack of macro-economic and geopolitical visibility globally, but convinced that, above all, the judicious choice of sectors and values is the most important.


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NAV evolution of TreeTop Convertible Pacific A EUR 3

NAV EVOLUTION OF TREETOP CONVERTIBLE PACIFIC A VS. MSCI AC PACIFIC *

PERFORMANCE SUMMARY AS OF

31/12/2014

TreeTop MSCI AC

Conv. Pac A Pacific*

Cumulated returns

December -3.7% -0.4%

YTD 1.2% 7.0%

1 year 1.2% 7.0%

Annualized returns

3 years 6.3% 17.3%

5 years 4.4% 7.6%

10 years 6.5% 5.8%

Inception** 7.1% 2.8%

CALENDAR YEAR PERFORMANCE OF TREETOP CONVERTIBLE PACIFIC A

VS. MSCI AC PACIFIC* SINCE 2005 (AS OF 31ST DECEMBER OF EACH YEAR)

3 There is another share class (B USD), and the relevant statistics are available on request and free of charge from TreeTop Asset

Management S.A. 12 rue Eugène Ruppert L-2453 Luxembourg and are also presented on our website www.treetopam.com


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Yearly performance of TreeTop Convertible Pacific A since inception (**)

Period Date NAV € Periodic Return

08/07/1999 97.89

1999 31/12/1999 102.07 4.27%

2000 31/12/2000 106.99 4.82%

2001 31/12/2001 113.45 6.04%

2002 31/12/2002 108.76 -4.13%

2003 31/12/2003 128.48 18.13%

2004 31/12/2004 150.54 17.17%

2005 31/12/2005 212.08 40.88%

2006 29/12/2006 236.75 11.63%

2007 01/01/2008 262.55 10.90%

2008 01/01/2009 150.11 -42.83%

2009 01/01/2010 227.88 51.81%

2010 01/01/2011 264.66 16.14%

2011 30/12/2011 235.70 -10.94%

2012 31/12/2012 260.65 10.59%

2013 31/12/2013 279.75 7.33%

2014 31/12/2014 283.16 1.22% The returns are calculated in the reference currency (EUR), reflect ongoing charges, including management and performance fees, taken from the sub-fund, but do not reflect any entry charges you might have to pay. Past performance is no guarantee of future performance. * The investment policy does not stipulate any correlation between the sub-fund and the index (MSCI All Country Pacific in local currency - code Bloomberg : NDLECPF). Consequently, the performance of the sub-fund may differ from the performance of the index. ** The A share class was launched on 8th July 1999.


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PORTFOLIO COMPOSITION AS OF 31ST DECEMBER 2014

Underlying Region % portf

Convers.

Premium

*

Delta

*PER* LTG* ROE*

Credit

spread

*

Duration

*

Market cap.

EUR bn*Sector

51JOB INC-ADR PAC/CHINA 5.27 26.08% 0.68 18.94 21.00 15.39 850 3.97 1.8 CONS. DISCRET.

BANGKOK DUSIT MED SERVICE PAC/THAILAND 1.01 19.94% 0.38 30.44 18.37 16.76 250 4.72 6.7 HEALTH CARE

CHINA POWER INTERNATIONAL PAC/CHINA 5.20 -0.02% 0.99 7.30 14.06 14.10 335 2.62 3.6 UTILITIES

E-HOUSE CHINA HOLDINGS-ADS PAC/CHINA 5.03 97.23% 0.34 9.10 25.00 5.00 800 1.91 0.8 TECHNOLOGY

ENN ENERGY HOLDINGS LTD PAC/CHINA 3.71 21.13% 0.46 14.88 21.23 21.45 150 3.16 5.1 UTILITIES

FUFENG GROUP LTD PAC/CHINA 5.15 28.42% 0.53 6.01 28.20 12.63 600 3.69 0.8 MATERIALS

HAITONG INTL SECURITIES PAC/HK 4.77 0.00% 0.82 10.95 9.00 12.80 400 3.47 1.1 FINANCE

HYUNDAI MOBIS PAC/KOREA 4.17 0.00% 1.00 6.07 9.35 16.48 0.00 17.4 CONS. DISCRET.

HYUNDAI MOTOR PAC/KOREA 5.23 0.00% 1.00 3.88 7.47 13.98 0.00 28.2 CONS. DISCRET.

IHH HEALTHCARE PAC/MALAYSIA 1.34 10.67% 0.47 40.94 24.97 4.07 120 3.82 9.3 HEALTH CARE

JINKOSOLAR HOLDING ADR PAC/CHINA 4.42 104.36% 0.50 5.34 25.50 22.60 1000 1.94 0.5 ENERGY

KEPCO PAC/KOREA 6.50 0.34% 1.00 6.93 10.00 5.29 0.32 20.7 UTILITIES

MAHINDRA & MAHINDRA LTD PAC/INDIA 7.88 0.00% 1.00 13.06 10.00 18.84 0.00 10.0 CONS. DISCRET.

SOHO CHINA LTD PAC/CHINA 4.27 0.00% 1.00 19.05 5.00 5.66 0.00 3.0 FINANCE

SOUFUN HOLDINGS LTD-ADR PAC/CHINA 5.13 140.96% 0.27 12.96 23.00 43.65 500 1.93 2.5 TECHNOLOGY

TATA MOTORS PAC/INDIA 8.04 0.00% 1.00 7.42 16.10 24.78 0 0.00 19.6 CONS. DISCRET.

TECH MAHINDRA LTD PAC/INDIA 1.86 0.00% 2.80 15.90 20.83 28.17 0.00 8.0 TECHNOLOGY

ZHEN DING TECHNOLOGY PAC/TAIWAN 5.08 12.57% 0.28 9.40 12.14 21.78 173 0.44 1.6 TECHNOLOGY

TOTAL WEIGHTED AVERAGE 84.06 25.41% 0.66 10.82 15.85 17.16 341 1.74 8.6


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PERFORMANCE CONTRIBUTION

Performance contribution*:

- is defined as Equity Play when coming from stocks or convertible bonds with a premium lower than 50%

- is defined as Yield Play when coming from convertible bonds with a premium higher than 50%

- is defined as both Equity and Yield Play when coming from both concepts during the period

- is calculated in the currency of the security.

Performance Contribution* over the last 12 months (31 Dec. 13 - 31 Dec. 14)

Performance Contribution* over the last 3 months (30 Sept. 14 - 31 Dec. 14)

1.92% 1.91%

1.20%

0.91% 0.84% 0.83%

0.55% 0.51%

-0.35% -0.39% -0.45%-0.60%

-0.77% -0.84%-1.00%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%Top 15 Absolute Perf. Contributions* (last 12 months)

TOTAL PORTFOLIO VALUES:

Perf. Equity Play: 5.32%

Perf. Yield Play: -0.01%

Both Equity and Yield play: -1.11%

-1.0%-0.5%0.0%0.5%1.0%1.5%2.0%2.5%3.0%3.5%4.0%

Sector contribution (last 12 months)

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

Country contribution (last 12 months)

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

Country contribution (last 3 months)

-1.4%-1.2%-1.0%-0.8%-0.6%-0.4%-0.2%0.0%0.2%0.4%0.6%

Sector contribution (last 3 months)

0.52%0.46% 0.44% 0.40%

-0.06% -0.07% -0.11% -0.12%-0.20% -0.22%

-0.54% -0.56% -0.59%

-1.00% -1.02%-1.2%

-1.0%

-0.8%

-0.6%

-0.4%

-0.2%

0.0%

0.2%

0.4%

0.6%

Top 15 Absolute Perf. Contributions* (last 3 months)

TOTAL PORTFOLIO VALUES:

Perf. Equity Play: -1.77%

Perf. Yield Play: -0.76%

Both Equity and Yield play: -0.11%


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WARNING The present quarterly report on its own does not give complete information about TreeTop Convertible Pacific and should therefore be read before any investment together with the Key Investor Information Document (KIID), the prospectus as well as the latest annual/semi-annual report of TreeTop Convertible SICAV. These documents are available on request and free of charge from TreeTop Asset Management S.A. 12 rue Eugène Ruppert L-2453 Luxembourg, from the bank in charge of the fund administration in Belgium: Banque Degroof NV/SA, rue de l'Industrie B-1040 Brussels or on www.treetopam.com. Regarding the TreeTop Convertible Pacific A EUR share class (capitalisation): the Net Asset Value is published in l’Echo, La Libre Belgique, De Tijd, De Standaard, Financial Times and International Herald Tribune, subscription fees are freely negotiable up to 3%, the minimum subscription amount is €250, the Stock Exchange Transaction Tax in case of redemption/sub-fund transfer is 1.32% (max €2,000) since 1st January 2015 and the Belgian withholding tax is currently 25% at redemption (cf art. 19 bis of CIR). Although they are based on the best possible sources, the figures in this document have not been audited. Furthermore, the present quarterly report contains opinions that should not be considered as investment advice.

TreeTop Asset Management S.A.

12 rue Eugène Ruppert L-2453 Luxembourg

Tel : +352 26 36 38 22 Fax: +352 26 18 75 97

TreeTop Asset Management Belgium

Rue des Francs, 79 B-1040 Brussels

Tel: +32 2 613 15 30 Fax: +32 2 613 15 31

www.treetopam.com


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GLOSSARY BOND FLOOR: the bond content of the convertible, or its naked value: if you know the interest rate and maturity of a convertible bond, it is possible to calculate the price at which this bond should trade if it was not convertible. All that you need to do is apply the current yield of a government bond having the same term, add the credit spread corresponding to the company’s credit status and you obtain the price below which this bond cannot fall if the share price falls, assuming that interest rates remain unchanged and that there is not a significant deterioration in the issuer’s rating. This concept is essential in understanding the risk cushioning effect of convertibles. CONVERSION PREMIUM: the difference, expressed as a percentage, between the current price of a convertible bond and its share content (or parity). This corresponds in fact to the premium that an investor is willing to pay over the current share price in order to obtain capital protection. CREDIT SPREAD: the interest rate spread, expressed in basis points (bps), which debt issued by a corporate borrower must offer, over the same term, versus government debt. By way of example, this spread will be around 20 bps (i.e. 0.20%) for an investment grade corporate borrower (AAA or AA rating), whereas it could easily be as high as 200 bps for a higher risk company (B rating). The general level of spreads fluctuates, of course, according to economic conditions: they will increase very sharply during a recession or a financial crisis and decrease when the economy picks up. DELTA: the degree of sensitivity (between 0 and 1) of a bond to a change in price of its underlying share. A delta of 0.50 means that the convertible tends to increase or decrease by 5% for a 10% increase or decrease in the share price. The problem is that the delta itself is correlated positively with the share price and that it is not symmetrical: a statistical analysis gives only one delta value, which is valid only at that time and does not take into account the difference in a convertible’s sensitivity to upward and downward price movements (asymmetry). DURATION: a concept which is similar to, but more scientific, than the average life of a bond in general, and a convertible bond in particular. If interest rates rise or if a company’s creditworthiness starts to deteriorate, it is obvious that a short-term bond will suffer less than a long-term bond. LONG TERM GROWTH (LTG): an estimate, by analysts, of a company’s earnings per share growth rate. PER (Price-Earnings Ratio): this ratio gives the rate at which a company capitalises its annual earnings. It is an indicator of a share’s relative expensiveness. As a general rule, this ratio is influenced by the stock’s sector and quality: thus

growth stocks will have higher multiples than cyclical stocks. Increased momentum normally leads to a revaluation of the PER, which has a multiplier effect on the stock market price. The inverse of the PER is the earnings yield of a share, which can be compared to a bond yield. PERFORMANCE CONTRIBUTION: it represents the performance (excluding currency exchange impact), positive or negative, realised for each security held over a given period of time (quarter or year). The same calculation is performed by country and by economic sector. The absolute performance contribution charts show the 15 most important contributions of the portfolio, positive or negative RETURN ON EQUITY (ROE): the ratio between a company’s net profit and shareholders’ equity (capital + reserves). This is a good criterion for assessing whether the management is making good use of the capital provided by shareholders. STOCK MARKET CAPITALISATION: a company’s total value at a given point in time, obtained by multiplying the stock market price by the number of shares in circulation. There are three commonly recognised categories of capitalisation, namely large caps (>2 billion $), midcaps (between 0.4 and 2 billion $) and small caps (< 0.4 billion $). Stock market capitalisation and the volume of shares traded on a daily basis are used as indicators of the liquidity of the shares selected.

q4 2014 treetop convertible pacific · pdf filetreetop convertible pacific aims to increase...

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