The focus of investing into companies when they are trading on wide discounts to NAV means that as those discounts diminish and the risk of discount widening increases, we seek to recycle capital into more attractive opportunities. During the course of the month, there was a reasonable amount of such rotation as a number of stocks reached their target values and/or discounts.

Two property stocks have performed well recently and were trading very close to NAV.

In Germany, we reduced our weighting in Gagfah substantially. We first invested into this company in March 2013 at prices around the 9 Euro level and on a discount to NAV of 30%. The thesis for investing was that the company was likely to focus on deleveraging, reducing the cost of its debt and improving the management of its portfolio of German residential properties, with the ultimate objective of initiating a dividend after years of poor management. Over the last 15 months the company has benefitted from all these factors. Debt has come down. The cost of debt has been reduced significantly and as a consequence the discount at which the stock trades has narrowed to sub 5%.

We invested into British Land at the start of 2014. Underperformance relative to its peers allowed us to invest into it on a reasonable discount, and in addition we anticipated further strong growth in its NAV. Some of this growth has indeed come through during the period of our ownership. The discount however, has largely been eliminated and British Land is now trading in line with its peer group and is no longer on a discount to its NAV. As with Gagfah, we prefer not to own companies that are trading on narrow discounts and would rather recycle cash into companies where there is more upside from both NAV growth and discount contraction. Hence we have sold out of British Land.

Whilst we focus on buying stocks on wide discounts, it is not always our expectation that discounts are entirely eliminated and that all stocks in the portfolio trade at NAV. In the case of Hyundai Motor Preference shares, we invested into the company when the preference shares were trading at a 60% discount to the ordinaries. This was towards the wider end of the historic range. Our target was a 30% discount which was in line with the narrowest level over the past decade. It was not simply a case of buying into the company on wide discount. We also believed Hyundai Motor to be undervalued. Over the past 6 months since we first invested, the preference shares have appreciated by about 30% and the discount on the preference relative to the ordinaries has come in to 28%. With no explicit catalyst for the discount to be eliminated entirely we have started to take profits and shift our cash into cheaper opportunities.

These included TUI AG, a German-listed holding company whose principal asset is its 55% stake in London-listed tour operator TUI Travel. TUI AG also owns a portfolio of branded hotels and operates a cruise line. In addition, TUI AG owns a 22% stake in Hapag-Lloyd, a container shipping business that recently merged its operations with Chilean peer, CSAV. The combined entity is scheduled to IPO in the first half of next year and will provide TUI AG with an opportunity to exit a business it has long regarded as non-core. We believe the disposal of this stake should prompt a re-rating in TUI’s shares, which trade at a 35% discount to our estimated SOTP. The second catalyst we foresaw was an eventual merger of TUI AG with TUI Travel Plc, although we were pleasantly surprised to see events unfold so quickly after establishing a position with the announcement on 27th June of a nil-premium all-share merger recommended by both boards. The muted share price rise of just 4% reflects scepticism that a deal will be approved by TUI Travel shareholders and that “we have been here before” with previous approaches – nevertheless, this is the first time that TUI Travel’s board has recommended the merger and that precise merger terms have been put forward. Management and directors of both companies clearly have much work to do to steer the merger through, but the prospect for TUI Travel shareholders of sharing in the release of the value trapped in TUI AG may prove attractive to many. Were a merger to be consummated, the upside for our position is substantial.

Cash at month end was 3.1% and the weighted average discount on the portfolio increased from 26.9% one month ago, to 28.4% at the end of June.

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