Interview Series

WIOF Global Listed Utilities Fund

Investment Advisor: Barwon Investment Partners

(May 2012)

How has the Fund performed recently compared to its peers and are there any particular stocks or areas where the Fund is performing well?

The Fund has outperformed most of its peers over the last year. A lot of that outperformance came about as a result of our decision to sell all of our holdings in Italy and Spain in July 2011 and the overweight position in regulated US utilities that the Fund has maintained for most of the last year. US utilities outperformed the market significantly over the last year, which is often the case when equity markets turn bearish. The decision to sell our Italian and Spanish holdings was based on our assessment that the sovereign risk associated with owning equities in those countries was too great. We think it is quite likely that both Spain and Italy will end up exiting the Eurozone in the next few years. If that happens, there will almost inevitably be a dramatic depreciation in the new liras or new pesos that are issued to replace the Euro in those countries and a corresponding fall in the value of equity investments denominated in currencies other than the newly issued domestic currency. We do not feel that this is an appropriate risk to be taking.

What are some of the unique characteristics of the sector? Why is the sector considered defensive?

The most important characteristic of the regulated utilities sector is that the earnings and dividends of the companies in it have a relatively low correlation to economic conditions. The primary reason for this is because utilities (which make up 80% of our sector) provide essential services. Demand for these services usually exhibits low levels of price elasticity, and the demand for them does not vary much as economic conditions change. The nature of the regulation is also an important driver of the stability of earnings. For utilities, the fact that earnings are based on a return on capital set by regulators means that the returns to utilities are to some extent underwritten, but also capped by regulation. Because the return allowed by regulators is on both existing assets plus all new CAPEX, utilities aren’t subject to the risk that when they upgrade their network or build a new asset, there is insufficient demand to ensure they earn their cost of capital on that project – this is basically underwritten by the regulator.

Utilities stocks are often attractive for investors during economic downturns because of their stable returns. Does this mean they are only good investments when markets are bad?

Whilst it’s true that utilities tend to outperform the equities market when the economy is weak and underperform the equities market when economies are strong, it’s also the case that over the long term, an investment in utilities has tended to outperform an investment in equities. Since our benchmark index was first published in 1990, the returns on an investment in our benchmark index would have outperformed the returns on an investment in the MSCI World Index by around 2% and done so with a much lower volatility of returns. So utilities will outperform sometimes and underperform at others, but they have tended to outperform equities quite significantly over the long run.

How did utility stocks perform compared to general equities during the turbulence on the markets last year? Did they show their strong defensive qualities?

Very much so. In the third quarter of last year, for example, when investors were getting very worried about sovereign debt issues in Europe, equity markets in Germany, France and Italy fell by over 25% and markets in the UK and US fell by almost 15%. In contrast, our benchmark index was down by 6% over the same period and the Fund fell by less than 1% over the same period.

The Fund comprises a portfolio of 30-50 listed entities. Can you explain your investment process?

Our investment process is anchored in two main principles, investing in those companies which represent the best value and avoiding investing in companies that we consider face excessive risks. The first step in our investment process is to apply a risk screen that excludes from our investible universe companies which we consider to be excessively geared, have poor corporate governance and which face excessive levels of political or sovereign risk. Once we have done this, we narrow down that investible universe through some quantitative based valuation screens and then finally we conduct discounted cash flow valuations on the remaining companies to identify the companies which are the most attractive on a relative basis. The final weighting that we give a security in the portfolio will be a function of not only its relative valuation, but also risk considerations, which include ensuring that the portfolio isn’t overly concentrated in a particular sectors or region. Historically, in the utilities and infrastructure sector, minimizing risk has tended to be the more important driver of returns in bear markets, whereas valuation has tended to be the more important driver of returns in bull markets, so by focusing on both of these in our investment process, we hope to have relatively consistent performance across the market cycle.

Why do you only invest in OECD listed companies?  Do you feel you are missing out on opportunities presented by stocks listed in non OECD, or emerging, economies?

There are great opportunities in emerging markets, but we think that investing in those markets is a very specific skill set and you need to have a lot of local knowledge and people on the ground in those countries to do it well. Amongst other things, investing in emerging markets typically involves taking on much more political risk and regulatory risk that investing in developed markets and without being on the ground there and being familiar with the culture and the politics, it can be quite difficult for an outsider to properly understand and assess these risks. The other reason we don’t invest in emerging markets is that they tend to be a lot more volatile and less transparent than developed markets and we are seeking to deliver a low risk product to investors – one with both lower volatility and a lower chance of capital loss than traditional investments in listed equities.

The majority of the Fund’s portfolio is invested in North American holdings. What is your thinking behind this?

US-based utilities represent almost half of the value of our benchmark index, so in a relative sense, we are not over exposed to the US. More importantly however, we like US utilities because the regulatory environment there is very stable and transparent and there is a lot less political interference in how utilities set prices than there is in continental Europe for example. This means that owning utilities in the US is very low risk. The basic framework of the regulation of the utility sector in the US hasn’t changed significantly since the Public Utility Holding Company Act was legislated in 1935. This regulation subjected utilities to state-based regulation and established the mechanism by which utilities can set prices and the legislation is still in place today. So we like investing in utilities in the US, because we have a high degree of confidence that if we’ve bought a utility in the US at what looks like a good price, that we will earn good returns on that investment.

Why should investors consider investing in the utilities sector?

Because the sector has a relatively low correlation with other asset classes, but has historically earned good returns, an investment in the global utilities and infrastructure sector can improve the risk-return payoff of an investor’s portfolio. From the period from January 1990 to January 2012, our benchmark index had a correlation of 0.68 to the MSCI World index and a correlation of 0.64 to the S&P Global Property Index. Over that same period of time, the return on our benchmark index was 7.3% p.a., which was significantly higher than the return on both the MSCI World Index and the S&P Global Property Index (which both earned a return of 5.4% p.a. over that period).  The low historical correlation of performance of the utilities and infrastructure sector to other asset classes, suggests an exposure to the sector should provide valuable diversification benefits to a balanced portfolio.

In the wake of the Fukushima nuclear disaster, some countries have abandoned nuclear-power, while others, such as the US, are looking at other energy sources e.g. use of shale gas, renewable energy. How do these developments affect the sector and its investment potential?

The nuclear disaster in Fukushima is likely to cast a shadow across nuclear power for a generation. After the Three Mile Island nuclear accident in the United States in 1979 (which was much less serious than the Fukushima accident, and in fact didn’t result in a single fatality), no nuclear power plant was approved to begin construction in the United States until earlier this year, when the Nuclear Regulatory Commission approved the construction of two nuclear reactors in Georgia. The main impact of the disaster is likely to be that very few approvals to build nuclear plants will be given for many years throughout most of the Western world and many older plants may be closed early (as has happened in Germany), or at the very least will be subject to much stricter safety standards, which will increase the cost of running and decommissioning the plants significantly. With CO2 emitting coal-fired plants also unpopular with voters, gas fired plants will comprise the bulk of new (and replacement) generation capacity built, as renewables will only be able to meet a small portion of this demand in the next decade or so. With gas prices at historically low levels in the US due to the shale gas boom, owners of gas fired power plants are likely to do well. The biggest winners, however, from the increase in the demand for gas will be the operators of pipelines and gas storage facilities. Demand for their services has increased strongly as the falling gas price has boosted demand not only from gas fired power plants, but also from industrial users. New pipeline and gas storage capacity takes a long time to build, putting the owners of these assets in an enviable position whilst there is excess demand and a shortage of capacity.

How do you see investment opportunities in the sector developing in both the short and long-term?

We expect the sector to continue to grow strongly in coming years as a result of the significant capital expenditure required to address both decades of underinvestment by governments prior to the privatization of the sector in recent decades and the shift towards renewable energy. In order to ensure that privately owned utilities and infrastructure companies are willing to invest the large sums of capital required, governments throughout the western world have to continue to provide an attractive regulatory environment that enables companies in the sector to earn an attractive return on capital. One of the key risks at the moment is the high level of indebtedness of western governments. Whilst this affects all sectors of the market, we think that the risk to the utilities and infrastructure sector is that governments in continental Europe will be under pressure to sell large stakes in utilities that are currently partly state owned, in order to reduce debt. Broadly however, we expect the financial performance of the sector to be quite steady over the next decade. The large capital expenditure required to upgrade aging assets and accommodate the shift towards renewable sources of power generation should generate solid earnings growth over the medium term.

IMPORTANT NOTE: This report has been prepared for information only, and it does not represent an offer to purchase or subscribe to shares. World Investment Opportunities Funds (“WIOF”) is registered on the official list of collective investment undertakings pursuant to part I of the Luxembourg law of 20th December 2002 on collective investment undertakings as an open-ended investment company. WIOF believes that the information is correct at the date of production while obtained from carefully selected sources considered to be reliable. No warranty or representation is given to this effect and no liability can be assumed for the correctness or accuracy of the given information which may be subject to change at any time, without notice. Past performance provides neither a guarantee, nor an indication of future performance. Value of the shares and return they generate can fall as well as rise. Currency fluctuations, either up or down, may also affect value of the investment. Due to continuing market volatility and exchange rate fluctuations, the performance may be subject to significant changes over a short-term period. Investors should be aware that shares in the financial instruments entail investment risks, including the possible loss of the invested capital. Performance is usually calculated on the basis of the relevant NAV unless stated otherwise. Performance shown does not take account of any fees and costs associated with subscribing or redeeming shares. It is assumed that all dividends were reinvested. WIOF prospectus is available and may be obtained through www.1cornhill.com. Before investing in any WIOF Sub-fund(s) investors should contact their financial adviser / legal adviser / tax adviser and refer to all relevant documents relating to the WIOF and its particular Sub-fund(s), such as the latest annual report and prospectus that specify the particular risks associated with the Sub-fund, together with any specific restrictions applying, and the basis of dealing. In the event investors choose not to seek advice from a financial adviser / legal adviser / tax adviser, they should consider whether the WIOF is a suitable investment for them.