TM Cerno Global Leaders2018-09-19T15:14:37+00:00

TM Cerno Global Leaders

TM Cerno Global Leaders Fund Information

The best prospect for outperforming the World Equity Index is to invest long term, in a concentrated, high conviction and low fee portfolio and transact only when necessary.

TM Cerno Global Leaders invests in global companies with sustainable competitive advantages delivering above average returns. Its target is to deliver performance in excess of MSCI World Total Return (GBP) on a 3 year rolling basis.

The fund will  hold 25-30 securities, equally weighted, selected according to a distinct investment thesis that accents industry structure, the sustenance of return on capital and secular growth.

For more information on TM Cerno Global Leaders please contact Tom Milnes.

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TM Cerno Global Leaders Fund Manager

James Spence
James SpenceLead Fund Manager
James is a co-founder of Cerno Capital and lead manages a number of the firm’s collective and private portfolios. After qualifying as a chartered accountant in London (Coopers & Lybrand, 1989) he relocated to Asia. Between 1991 and 2004 he worked as an equity analyst, head of research, and latterly as an equity strategist at WI Carr, Paribas, HSBC and UBS, based variously in Hong Kong, Singapore and Jakarta. James graduated from the University of St Andrews, Scotland with an MA in Philosophy & Logic in 1986. James is a Member of the Chartered Institute for Securities & Investment.

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Latest Investment Letter by James Spence

The current economic and stock market cycles are unusually long in duration and this leads to obvious questions about what will be the cause of its ending.

There are several oft mentioned candidates: protectionism, a fall in historically high margins, a strong dollar and interest rates or some combination of these factors.

Students of stock market valuation over time are liable to point to how highly valued equities are and this is hard to dispute.

To our minds, the biggest threats to the US stock market lies within the international (non-US) outlook combined with shifts in demand for equities and their valuation.

The valuation observation is notoriously difficult to narrow down in a causal sense and apply to time frames. Current high valuations are a pointer to sub-normal returns over the medium term but not the short term. Specifically, they tell us something, in a probabilistic sense, about how returns will pan out over a seven-year time frame, not a one-year time frame. (This is what our own testing has shown).

Considerations of the net-demand for equities is thinly trampled terrain for the equity market analyst. It is common place in bond circles to speak of such things – they are more readily predictable, especially in the government sphere. For countries have to re-finance their existing stock of debt (the majority of which has known maturities) as well as its budget deficits, items that are forecast with great care.

Seldom is the subject of demand for equities spoken of with any degree of assurance. However good clues lie when the sources of demand are characterised.

Who is the largest buyer of US equities today? The listed companies themselves. Goldman Sachs estimated in 2017 that aggregate share buy backs in the US would reach US$590bn this year. More recent data from Trim Tabs shows that US$436bn was bought back in the second quarter of 2018 alone, suggesting that the full year total could crest US$1tn. The second biggest purchaser of equities are ETFs at an estimated US$400bn for 2018. Foreign investor activity net of sales of US active equity funds are expected to sum to a meagre US$25bn.

What can be seen at a glance is that the largest segment of demand lies in the hands of company buy-back schemes and ETFs.

Our view of these groups is that they are essentially blind in the sense of undiscriminating. ETF buying is a consequence of inflows, which itself is a function of a) the general switch from active to passive and b) the market continuing to rise. The second factor at least partially drives the first. Active fund managers are trained to take punishment from their clients in the event of poor performance. Investing in ETFs allows less room for blame apportion – a financial intermediary may be on hand for an ear bashing but no comfort can be had from a inky-dink web site or self-directed investment.

Share buy-backs have been a feature in a larger study we are doing on US corporate indebtedness and this study is yielding notable conclusions.

The phenomenon of buy-backs is not by any means new – it is, though, reaching its apotheosis. The underlying rationale and practices have morphed overtime. The “classical model”, if we can call it this, for buy-backs suggests that company boards face decisions as to whether to expand via investment, buy assets or competitors and – if no such profitable avenues exist – consider buying back their shares if those shares are undervalued or at least not overvalued. For all we know, this example of decision tree modelling is still at work in some boardrooms.

The “modern model” is more pragmatic and is driven by the tax efficiency of returning capital to shareholders via buy-backs as against the “tax inefficient” method of paying dividends that would be subject to income taxes. By reducing the share count, earnings per share rises and continuing shareholders own proportionately more of a company (as long as uncancelled bought back shares are ignored). Not surprisingly, CEOs with pockets stuffed with share options, are keen on this too.

Warren Buffet was, until recently, intriguingly ambivalent on the subject. He is on record for being in favour of buy-backs in Berkshire Hathaway held companies but restricted Berkshire in buying back its own shares. He loosened his belt on the subject just two months ago by permitting buybacks in Berkshire when the board “believe that the repurchase price is below Berkshire’s intrinsic value, conservatively determined.” Prior to this, his board was restricted to buying back shares only when the stock price were no more than 20% premium to book value.

In one fell swoop, Buffet has migrated from the classical model to the modern. With cash of US$64bn in the holding company and debt to equity of just 26%, he may have a lot of buying to do. The average debt to equity of the non-financial universe within the S&P500 is 130%. With a market cap of US$523bn and a book value of US$358bn, Berkshire’s first repurchase will signal his and Munger’s thoughts about where intrinsic value may lie. Berkshire’s share price will doubtless rise on the news.

If you cast your eyes over the balance sheets and cash flow statements of a representative number of large US listed companies it becomes patently clear that the buy-back trend has become a reflexive action of US CFOs – not just deploying all surplus cash but adding leverage to do so. Triple B bonds entail a financing cost of 4% and the average S&P constituent has a Return on Equity (RoE) of 12% so the very action of buying back adds value up until the leverage becomes dangerous.

Even before that point comes, any deterioration in US cash flows will halt the tide )as corporate cash flows are fairly fully committed) and we have the prospect of a buyers’ strike were ETFs to go into net redemption mode, as they would be likely to do.

Which brings us back to the cause of that deterioration.

The problem with the winner-takes-all approach to trade that has roosted in White House policy is that the blow-back effects are considerable and not well understood by the incumbent of the White House. 46% of sales of the S&P500 are non-US and interruption of trade flows via tit-for-tat tariffs weakens the global growth picture.

To our minds, it is waning global demand which presents the greatest threat, exacerbated by a strong dollar, weakening of the Chinese economy and trade friction. These are hardly imaginary events. The US stock-market is a loop and when that loop gets broken we should expect a nasty bear market.

Within the multi-asset portfolios in our charge, we have responded to these risks by moderating equity allocations (cycle peak of 72% and now at 50%), adding generic put option protection on broad equity indices and US Treasuries and maintaining balance sheet emphasis within held companies. Debt-equity ratios within Global Leaders constituents are a more moderate 58% on average.

By |September 10th, 2018|

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TM Cerno Global Leaders Key Contacts

Tom Milnes
Tom Milnes

Business Development Director
[email protected]
020 7036 4126

Olivia Martin
Olivia Martin

Client Relations and Business Development
[email protected]
020 7036 4123

FAQs on the Cerno Global Leaders Fund

Our aim, within the context of the Global Leaders Fund, is to own great companies over multiple market cycles. In this way we operate over a timeframe where competition is scarcer, allowing us the best opportunity to outperform global markets. This overarching objective is underpinned by three concepts: growth, long term relevance (sustainability of returns) and financial soundness. All three are crucial in delineating the leading businesses we want to own. Companies that we can employ in a concentrated, low turnover portfolio and sleep comfortably at night.

Growth is perhaps the easier to define: does the company have the tools at its disposal to compound earnings at an attractive rate over time. Relevance and sustainability has sharply diverging meanings depending on who one asks. Our preference is to cast the net as broadly as possible: simply, a company whose current earnings to do not borrow from its future earnings. This concept is wide ranging and influences the fund exclusions. Tobacco for example, where new customers must be found to offset the natural elimination of the existing base by the product itself. Old energy with the extensive disruption from renewables already in full swing. Banks, where inherent leverage hangs like a sword of Damocles over the thin slivers of equity that supports it.

The idea of a sustainable business is also interwoven into our investment process; how does the company treat its stakeholders, is adequate capital being invested to support the economic moat, how aligned are management, are cash returns in excess of the cost of capital, is leverage employed conservatively, to name a few. Used prudently, leverage can support growth and optimise the cost of capital for a given business. Used imprudently, it results in a front-loading of returns and increasing vulnerability to future shocks. A decade of easy money, unspectacular economic prospects and rising corporate margins have nudged many CFOs, particularly in the US, down the path of least resistance, that of financial engineering.

The results are stark: US corporate leverage has doubled when compared to 2007. Excluding banks, net debt to EBITDA ratios now stand at 1.8x, just below the 2x above which issuers tend to be viewed as sub-investment grade. The median leverage of the 27 Global Leaders is just 0.6x.

The Next Global Downturn - Corporate Debt & the Concept of Fragility

A good proxy to mitigate downside risk is the avoidance of fragility. As the essayist and fund manager Nassim Taleb* proffered, “it is far easier to figure out if something is fragile than to predict the occurrence of an event that may harm it. Fragility can be measured; risk is not measurable”.

Who can say how fast rates will have to rise to temper the heat of the US economy? It may be that overleveraged corporates will find the space to gradually paydown debt before any recession. This is possible but by no means probable. Indeed, as the cost of capital rises, corporate indebtedness is likely to be source of increasing angst for investors, in our view. As Mr Buffet famously quipped in 2008, “you only learn who has been swimming naked when the tide goes out”.

*Antifragile: Things that Gain from Disorder (2012)

Fund Facts

Fund Size £64.5mn
Fund Launch Date 01/11/17
Legal Structure UK OEIC (UCITS)
Dealing Frequency Daily
Suitable for SIPPs/ISAs/JISAs Yes

Available Share Classes

Name Class A Class B
Cerno Capital AMC 0.65% 0.55%
Investment Minimums £5,000 £10mn

Risk Data

Net Equity Exposure*
Gross Equity Exposure*
Short Equity Exposure*
Long Equity Exposure*
Best Month*
Worst Month*
Sharpe Ratio
Calmar Ratio
Upside Capture*
Downside Capture*
Maximum Drawdown*
Annualised Volatility*
Beta (vs World Equity Index)*

Fund Codes

ISIN SEDOL Bloomberg
A Acc GB00BF00QK62 BF00QK6 TMCGLAA LN
A Inc GB00BF00QJ57 BF00QJ5 TMCGLAI LN
B Acc GB00BF00QM86 BF00QM8 TMCGLBA LN
B Inc GB00BF00QL79 BF00QL7 TMCGLBI LN

Fund & Risk Rating

ARC 2015 3D Awarded

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CERNO CAPITAL’s website contains certain information about its approach to providing investment management services but does not provide specific investment advice and is presented for informational purposes only. It does not represent that the services described on the site are suitable for any specific investor. You are advised not to rely on any information contained in this site in the process of making a fully informed investment decision. Instead, you are urged to base investment decisions upon a thorough investigation and to obtain all necessary professional advice.

The information provided on this website is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution, publication or use would be contrary to local law or regulation or in which CERNO CAPITAL does not hold any necessary registration or license. Individuals or legal entities in respect of whom such prohibitions apply, whether on grounds of their nationality, their place of residence or on other grounds, must not access or use this website.

 

DISCLAIMER

CERNO CAPITAL’s website contains certain information about its approach to providing investment management services but does not provide specific investment advice and is presented for informational purposes only. It does not represent that the services described on the site are suitable for any specific investor. You are advised not to rely on any information contained in this site in the process of making a fully informed investment decision. Instead, you are urged to base investment decisions upon a thorough investigation and to obtain all necessary professional advice.

The information provided on this website is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution, publication or use would be contrary to local law or regulation or in which CERNO CAPITAL does not hold any necessary registration or license. Individuals or legal entities in respect of whom such prohibitions apply, whether on grounds of their nationality, their place of residence or on other grounds, must not access or use this website.

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CERNO CAPITAL is a registered limited liability partnership in England and Wales (Incorporation Number OC326579), registered office: 34 Sackville Street, London, W1S 3ED.

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