August 2019 Letter
Investing in a time of Political Gridlock
The reality we’ve all woken up to is that the democratic political system has produced sides that will not work together. This is true across virtually all major democratic societies from the United Kingdom to Brazil to the United States to Italy. Those within the political establishment have vested interests in fighting only to defeat the views and goals of the opposition. Compromise is equivalent to writing a letter of resignation. Surfacing without defeat or blame from a squabble is essential. The enemy of my enemy is my friend. If you have not read and want to understand more about where we are politically, “It’s Even Worse Than It Looks” by Thomas Mann and Norman Ornstein, is a very good read on the topic from a U.S perspective. The question going forward is, how should this impact the way we invest?
I believe there are three implications of the new political paradigm. First, we must stay focused. The noise from the political fray can literally sabotage your daily productivity. Most of what you could miss is meaningless political theater. Over the next 6 weeks, the daily quotes and clicks from the UK’s continuing fight for political blame for Brexit will be incessant. Prepare for Brexit, and focus on your daily routine. Second, as long as there is some balance to the power in governance, the gridlock will make policy changes almost impossible to pass, even if they make sense for everyone. This means the economic framework that your companies are operating under is unlikely to shift. For example, the Republicans controlled the Presidency and the Congress from January 2017 until the mid-term elections in November 2018. This period brought a period of meaningful changes in regulation for the banking sector and energy sectors. Now that the Democrats control the House of Representatives, the gridlock will rule the day. Nothing will get passed. If your company is looking for a bill to pass that will bring economic opportunity, forget about it. Finally, third, we must understand that the big issues of the day - climate change, inclusive growth, the safety of digital high technology, global trade, healthcare - will not be dealt with by policymakers. The gridlock will not allow them to agree or compromise on policy for even the small things. The policymakers are even unwilling to agree on what the major issues are, given that this might amount to a concession to the opposition. We will unfortunately have to accept the course we are currently headed upon in relation to these major issues.
There are a few interesting exceptions to the three implications mentioned above. Where there may be progress on the big issues, however small, is from the local level, corporates, NGO’s, etc….Perhaps the greatest momentum we experience all the time is the movement of the largest institutional investors to effect change at the corporate level. Some policymakers may want to allow for more coal mining in West Virginia, or more clearing and burning in the Amazon, but most if not all major corporates will not be allowed to participate or benefit from it due to pressure from financial institutions. Financial incentives can exert subtle, but often powerful pressure. $26 trillion of investors created Climate Action 100+ in response to the Paris accord, and specifically to push the actions of the 100 largest emitters in the world.
The other exception to the new political paradigm is China. The one party system can act on all things, big or small. Therefore, be prepared for moves along the existing trajectory by China. That would suggest that a U.S. friendly trade accord with the current administration is very unlikely. Even a country without political discord can still be disagreeable.
It is very disappointing that our political society has ended up in this place. We can hope for a new reality to emerge, but we must invest our savings confidently within the existing one. At Ballina, we believe our portfolios can handle the worst that political gridlock may bring.
International All-Cap Value returned -4.53% (gross basis) in August 2019 versus -2.17% for the benchmark. Year to date performance was 6.76% (gross) versus 8.7% for the benchmark.
Global Small Cap Value returned -4.02% (gross) in August 2019 versus -3.75% for the benchmark. Year to date performance was 7.09% versus 9.43% for the benchmark.
Top Contributors and Detractors
International All-Cap Value’s top contributor was Centerra Gold. The Canadian Gold producer returned 13.9% in the month of August as the Gold price climbed due to market uncertainty regarding future interest rates. Centerra represented the strategy’s biggest position exiting the month. The top detractor in the strategy was Yangzijiang Shipbuilding. The stock declined -36.8% as rumors surfaced about the Chairman being under investigation in China.
Global Small Cap Value’s top contributor and top detractor in August were the same as those in International All-Cap Value - Centerra Gold and Yangzijiang Shipbuilding. Centerra was also Global Small Cap’s largest position exiting August.
 Benchmark for Global Small Cap Value comprised of 50% weight iShares Russell 2000 Index (IWM) and 50% weight Vanguard FTSE All-World ex-US Small-Cap ETF (VSS)