Goldman Sachs US Equity Portfolio
Quarterly Review
3Q 2016
Market Overview
· The S&P 500 Index gained 3.85% in Q3, driven largely by a 3.69% rally in July (all total returns, in USD). In July, US equities were buoyed by strong economic data and solid corporate earnings despite heightened uncertainty following UK’s decision to leave the EU (Brexit). June US Nonfarm Payrolls reached an 8-month high of 287k, comfortably beating consensus estimates. The July statement from the US Federal Reserve (Fed) was somewhat hawkish, but market hike expectations were pushed out after Q2 GDP missed estimates. US payrolls surprised to the upside for the second straight month in August with July’s 255K in new jobs. Along with this strong labor data, Fed Chair Yellen’s hawkish Jackson Hole speech near month end significantly increased the market-implied probability of a rate hike by end-2016, causing US equities to sell off and finish the month roughly flat. In early September, equities fell as the European Central Bank (ECB) disappointed markets with its lack of commitment to extending quantitative easing. However there was a subsequent rebound following the Fed’s decision to leave rates unchanged. The best performing sectors over the quarter were Information Technology, Financials and Industrials while the worst performing sectors were Utilities, Telecommunication Services and Consumer Staples.
Portfolio Attribution
· In the third quarter, the GS US Equity Portfolio (Base shares) outperformed the S&P 500 (net). Stock selection within the Information Technology and underweights in Utilities and Health Care contributed to returns while stock selection within Industrials and Materials and an overweight in Consumer Staples detracted from returns.
Contributors
· eBay, Inc. was a top contributor to relative returns during the quarter. Shares rose sharply through July following strong second quarter earnings results which were well ahead of market expectations. The company also raised its 3rd quarter outlook for earnings and revenues and authorized an additional $2.5 billion stock repurchase program. During the period we believed that eBay’s management team is taking the right steps to ensure the company continues to grow and improve its offerings to customers. eBay has a strong balance sheet and good cash flow generation which is a reason for us to have strong conviction in the company and its financial flexibility to invest in its business for future growth.
· Bank of America Corp., a US-based bank holding company, was a top contributor to relative returns during the quarter. The stock’s performance was driven by a positive earnings report in July as well
For Third Party Distributors Use Only - Not For Distribution to your clients or the General Public. Portfolio holdings and/or allocations shown above are as of the date indicated and may not be representative of future investments. The holdings and/or allocations shown may not represent all of the portfolio's investments. Future investments may or may not be profitable. Past performance does not guarantee future results, which may vary. The economic and market forecasts presented herein are for informational purposes as of the date of this presentation. There can be no assurance that the forecasts will be achieved. Please see additional disclosures at the end of this presentation.
as a continued focus on a potential rate increase in the US. Despite not raising rates during the quarter, the Federal Reserve has indicated that the case for raising interest rates has strengthened given improvements in the economy. This news caused the market implied probability of a rate hike to increase for upcoming Fed meetings, especially in December. We believe Bank of America’s outperformance relative to its peer group is due to good banking fundamentals and management’s continued emphasis on cost reductions. During the period we were positive on Bank of America’s business outlook and we continue to find the company’s valuation attractive.
· MasterCard, Inc. was a top contributor to relative returns during the quarter. In July, the company announced solid second quarter earnings that beat market expectations on both revenues and earnings. MasterCard also announced early in the quarter that they would be acquiring VocaLink, a payment processing company headquartered in the UK that provides greater opportunities to grow market share in Europe. MasterCard additionally held an investor day in September and modestly raised guidance for 2016 as third quarter metrics were tracking better than expected. During the period we were optimistic on MasterCard’s ability to grow its core payments business as well as further differentiate itself by expanding to new growth areas such as consumer credit, peer-to-peer lending, and services such as security and analytics. Our thesis is based on operating trends remaining strong and MasterCard’s continued focus on diversification and fee-based revenue stream, which we believe position it well relative to competitors.
Detractors
· Wells Fargo Co. was a top detractor from relative returns during the quarter. The company performed well through much of July and August following a generally in-line second quarter earnings report and improved sentiment with respect to the prospects of higher interest rates in the US. In September, Wells Fargo was fined $185 million for opening 2 million unauthorized client accounts. The company has taken corrective action, refunding $2.6 million for potential charges, completing an extensive review by a third party firm, and terminating 5,300 employees associated with the account activity. The events have generated significant negative scrutiny for the company, leading its stock price lower. Despite the negative attention this has created, we do not believe the events will have any material impact on the long-term performance of the company. We maintain our conviction in Wells Fargo’s strong deposit franchise and leading national distribution network. Additionally, we believe shares now trade at a compelling valuation relative to its peer group. In our view, the company’s experienced management team and strong balance sheet position it well for increasing shareholder distributions as well as a more challenging credit environment.
· Viacom, Inc. was a top detractor from relative returns during the quarter. The company announced fiscal third quarter earnings in August which were in-line with market expectations. The biggest news for Viacom during the past quarter has been the changes taking place in top leadership positions. In August, CEO Philippe Dauman resigned, former COO Tom Dooley was named interim CEO, and the company added five additional board members. In September, however, new CEO Dauman announced that he too would be leaving the company in November. In addition to significant managerial turnover in the quarter, the company also announced it would abandon its plan to monetize a minority stake in its studio, Paramount Pictures. The stock price did jump toward the end
of the quarter on talks of a potential CBS-Viacom merger, which was viewed positively by shareholders. Both the CBS and Viacom are now formally reviewing a potential merger. During the period we remained optimistic on the company because of its attractive valuation, its broad network and viewership base which we believe will support stable profitability through the company’s leadership transition, as well as the potential for acquisition by CBS.
· Whole Foods Market, Inc. was a top detractor to relative performance during the quarter. The company announced earnings in July that were in-line with market expectations on EPS, but disappointed on both revenue and comparable same store sales. The company also offered Q4 guidance that was below market expectations. Whole Foods has also faced continued deflationary headwinds throughout the quarter that have particularly affected grocery store stocks. Despite the miss in earnings earlier in the quarter and the more difficult macro environment, we believed that the company is attractively valued and remain optimistic because of its dominant market position. Whole Foods’ management has taken active action to improve the company’s pricing and marketing.
Portfolio Changes
· During the quarter we added Lincoln National Corp. Lincoln National is a financial company that operates multiple insurance and retirement businesses. The company reported earnings that were in- line with expectations during the quarter and we expect the company to continue to generate healthy organic growth in both its retirement and insurance businesses. Due to the company’s strong franchise and superior product development, we believed the company provides substantial optionality at current prices as these assets will allow them to further return capital to shareholders.
· During the quarter we initiated a position in National Oilwell Varco, Inc. The company is a leading capital equipment provider to the upstream oil and gas industry. Through investments in technology and acquisitions, National Oilwell has achieved a strong market position that has the scale and scope to achieve better pricing power with the supply chain. The management team has taken a disciplined and focused approach on increasing efficiencies and operational performance and the company generates good cash flow and has a strong balance sheet. While oil prices could still potentially be a headwind, during the period we were positive on the company and their ability to leverage potential improvements in onshore drilling and deliver potentially stronger returns.
· During the quarter we exited our position in multi-channel specialty retailer Williams-Sonoma, Inc. The company has faced increasingly strong headwinds in the home furnishings space due to disruption caused by online retailers and a sluggish retail environment. The company’s most recent earnings announcement in August also saw a cut in full-year guidance due to weakening sales trends. At this time we feel that the continued headwinds Williams-Sonoma could face in the retail space make it less attractive and are taking the opportunity to allocate capital elsewhere.
· During the quarter we exited our position in McKesson Corp. McKesson, a provider of pharmaceutical distribution services and medical supplies, has seen their stock price decline in the recent months as the health care sector in general has seen increased scrutiny over drug pricing
procedure. While we continue to like the company, greater uncertainty in the near term has led us to find other companies that offer a more compelling risk/reward outlook.
Market Outlook
· We continue to believe that equities are more attractive than other asset classes in a low-return and modest growth environment. While the market has been focused on a variety of issues recently including US elections, oil prices, weaker economic activity, and monetary policy, we believe fundamentals look reasonably solid in many sectors. We are constructive on the US economy, although key economic data points have been mixed. Risks to the market remain as volatility is likely to persist and as the US economy continues through the later stage of the cycle. With earnings quality gaining more attention and top line growth becoming harder to find, we believe selectivity will become increasingly important.
· While the lost art of active management has been tested in recent years, we remain committed to our core philosophy and process. We will maintain a long-term time horizon, rather than forecast the next quarter. We will continue to favor high quality growth businesses over breathtaking concepts. We intend to invest when valuations are attractive, rather than following the trend. These core beliefs have guided our team over the past 35 years – we believe they hold the answer for the next 35.
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Investment Advice and Potential Loss
Financial advisers generally suggest a diversified portfolio of investments. The fund described herein does not represent a diversified investment by itself. This material must not be construed as investment or tax advice. Prospective investors should consult their financial and tax adviser before investing in order to determine whether an investment would be suitable for them.
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Swing Pricing
Please note that the fund operates a swing pricing policy. Investors should be aware that from time to time this may result in the fund performing differently compared to the reference benchmark based solely on the effect of swing pricing rather than price developments of underlying instruments.
Past performance does not guarantee future results, which may vary. The value of investments and the income derived from investments will fluctuate and can go down as well as up. A loss of principal may occur.
Economic and market forecasts presented herein reflect a series of assumptions and judgments as of the date of this presentation and are subject to change without notice. These forecasts do not take into account the specific investment objectives, restrictions, tax and financial situation or other needs of any specific client. Actual data will vary and may not be reflected here. These forecasts are subject to high levels of uncertainty that may affect actual performance. Accordingly, these forecasts should be viewed as merely representative of a broad range of possible outcomes. These forecasts are estimated, based on assumptions, and are subject to significant revision and may change materially as economic and market conditions change. Goldman Sachs has no obligation to provide updates or changes to these forecasts. Case studies and examples are for illustrative purposes only.