It pays to track the peso

Philequity Corner - Ignacio B. Gimenez -
A lot of our readers have been asking us what do equity fund managers, like Philequity, care about the exchange rate. "Does the movement of exchange rates significantly affect the stock market? Does the direction of exchange rate influence Philequity’s strategy and investment decisions?"

Indeed, in recent years, the introduction of the Internet and the advances in media, have caused the investment world to become ever more integrated. Due this strong trend towards international diversification, domestic and foreign assets have become close substitutes in the eyes of global fund managers.

This is precisely the reason why exchange rates play an important role in stock investment decisions. The rate of appreciation or depreciation of the domestic currency affects the rate of return of foreign investors in domestic assets, as well as the rate of return of domestic investors holding on to foreign assets. From a portfolio management standpoint, total investment risk is thus decomposed into (1) the volatility of the local stock market return, (2) the volatility of the exchange rate change, (3) the correlation of the local stock market volatility to the fluctuations in the exchange rate.

Fluctuations in the exchange rate also have real effects on companies, specifically on the profits and operating costs of companies that have businesses abroad. The greater the firm’s dependence on exports or imports for its revenues, the more the currency fluctuations will influence the bottom line.

In the same manner, changes in the exchange rate affect the balance sheet of companies depending on their financing composition. The greater the foreign exchange component of a firm’s debt, the riskier it is for its balance sheet (especially if its revenues are domestic-based).
1997 Asian currency crisis
Never has the importance of currency risk been more evident than during the 1997 currency crisis when the peso fell from 26:$1 to more than 40:$1. But having anticipated that investors (both foreign and local) will quickly shift funds from domestic assets such as Philippine stocks to dollar assets, Philequity sold all of its stock positions except for three.

The first two holdings that were maintained were the preferred shares of Ayala Corp. and DMCI Hldgs. Unlike common shares, they are paid fixed dividends every year.

The third investment which we kept was SPI Technologies, whose clients were based abroad and whose revenues were in dollars. This enabled Philequity fund to have a direct play on the appreciating dollar.

By the end of 1997, our prudent investment strategy enabled Philequity Fund to minimize its losses for the year to just 5.3 percent. In comparison, the Phisix lost 41 percent of its value during the same year.
SPI Technologies
SPI Technologies pioneered what has now become the booming BPO/call-center business. The company started as a data converter processing large volumes of printed scientific articles and legal correspondence into digital form.

In 1999, SPI decided to diversify into call centers. It formed E-Telecare which established its first call-center facility in Eastwood Cyberpark the following year. E-Telecare now has more than 7,000 employees in four Philippine and seven US call centers facilities. The company registered revenues of more than $150 million in 2005.

From 1997 to 2004, SPI remained among the top five investments of Philequity Fund. It was only after Lee Putnam Parallel Venutres made a tender offer in 2004 to purchase the company for $87 million that we disposed all of our holdings in SPI. Prior to that tender offer, however, SPI spun-off E-Telecare by giving E-Telecare shares and warrants as property dividend. We are still holding on to that investment and expect further upside to be realized once the company makes an IPO debut.
Manulife and Sunlife
Aside from SPI, our investments in Manulife Financial Corp. and Sun Life Financial Services also serve as good examples on how Philequity’s investment decisions were guided by exchange rate expectations.

In late 1999, we were looking for a way to hedge against the increasing political risks and an imminent depreciation of the peso during an extremely volatile period. This was also the time when Manulife and Sunlife first listed their shares on the exchange following their demutualization as mutual life insurance companies. Little did we know, back then, that we had stumbled into what will become the two best investments Philequity Fund ever had.

We aggressively invested in both companies for several reasons:

The stocks were dirt cheap. When we first bought into Sunlife and Manulife, they were being valued at only 3x to 4x earnings. True enough, the insiders and the institutional investors were the ones buying up these issues, while the policyholders were the ones disposing their holdings. Both companies announced share buy-back programs not long after.

We were bullish on their growth potentials in Canada, US, and specifically Asia, and we were not disappointed. Since the time we invested, Manulife’s earnings per share (EPS) more than doubled to 4.33 Canadian dollars by 2005 – for a compounded annual growth of 15.3 percent since 1999. Meanwhile, Sunlife’s EPS reached 3.14 Canadian dollars last year – for a compounded annual growth of 11.5 percent since 1999.

The industry was ripe for consolidation, which was a bonus for us. Both Manulife and Sunlife participated in these mergers and acquisitions (M&A) plays and ended up benefiting not only from the price speculation but also from improved valuations. Note that at current prices, Manulife and Sunlife are being valued at 14x to 15x earnings, a four-fold increase compared to the time when they first listed.

Last on the list (but foremost on our reasons) was that Manulife and Sunlife served as a hedge against a depreciating peso. With bulk of revenues in dollars, their EPS per share (in peso terms) were further boosted by the peso’s depreciation. From the time of listing up to January 2001, we can see that Manulife’s share price surged by 184 percent, while Sunlife’s share price increased by 151 percent. During the same period, the peso depreciated by as much as 37 percent against the US dollar.

These two investments alone had a significant impact in our portfolio. At that time, our holdings in Sunlife and Manulife were at the maximum amount allowed by the SEC (10 percent of portfolio in a single security). This enabled Philequity Fund to register gains of +6.8 percent in 2000 and +2.9 percent in 2001. In comparison, the Phisix registered returns of -30.3 percent in 2000 and -21.8 percent in 2001. If not for the 10 percent investment cap, the fund could have earned more.

Fast forward six years… Sunlife’s price has risen more than four-fold to close at P2,190 per share as of last week, while Manulife’s price has increased more than six-fold to P3,220 per share. The fundamentals of both companies remain strong. Up to now, Philequity Fund continues to hold a major portion of its portfolio in both issues.

For comments and inquiries, you can email us at [email protected] or [email protected].

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