informe skagenfunds

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Hope in acast lineThe EU summit in June gave hope that a long-term solution maybe found to the debt problems in Southern Europe. A very good risk

premium in global stock markets relative to supposedly secure fixed

income investments is a good starting point for renewed faith in

equities.

READ THE PORTFOLIO MANAGERS REPORT FROM PAGE 16

T H E A R T O F C O M M O N S E N S E

6Over the rainbow

Why its not all doom and

gloom for equities

8Fighting backagainst excessiveexecutive pay

Shareholders areentitled to dividends

and moderation, says

Kristoffer Stensrud

10Global real estateopportunities

Real estate companies

are relatively easy to

evaluate, can pay high

dividends and are oftenmispriced

12Value investingin Asia

The factors driving

long-term share price

performance are similar

in Asia to elsewhere in

the world

A winning formula:Understanding

structural change

5Torkell T. Eide

Half Year ReportJ U L Y 2 0 12 4 S K AG EN FUNDS . COM


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3

S K A G E N F U N D S H A L F Y E A R R E P O R T 4 J U LY 20 12

SKAGEN Funds -ReturnsThe following tables show the returns for SKAGENs

funds versus their respective benchmarks in euro.

The figures are updated as of 30 June 2012.

EQUITY FUND SKAGEN KON-TIKI

EQUITY FUND SKAGEN GLOBALEQUITY FUND SKAGEN VEKST

BOND FUND SKAGEN TELLUS

Portfolio manager: Kristoffer Stensrud Start: 5 April 2002

Portfolio manager: Kristian Falnes Start: 7 August 1997Portfolio managers: Ole Seberg and Geir Tjetland Start: 1 December 1993

Portfolio manager: Torgeir Hien Start: 29 September 2006

SKAGEN Vekst OSEBX/MSCI AC (50/50)

Return past 12 months Average annual return since start

-10

-5

0

5

10

15

20

-10

-5

0

5

10

15

20

-6,1 %

3,2 %

15,1 %

9,3 %

SKAGEN Kon-Tiki MSCI Emerging Markets Index (Daily Traded Net Total Return)


-6,1 %-3,8 %

-20

-10

0

10

20

-20

-10

0

10

2017,1 %

8,7%

-10

-5

0

5

10

15

20

SKAGEN Global MSCI World Linked Index


-0,2 %

6,8%

15,2%

1,7%

-10

-5

0

5

10

15

20

SKAGEN Tellus Barclays Capital Global Treasury Index 3 - 5 years (euro)

Return past 12 months

6,25 %

11,91 %

Average annual return since start

6,42 %

-20

-10

0

10

20

-20

-10

0

10

2014,48 %

OUR FUNDS

Unless otherwise stated all f igures quoted in this report are in euro, except for the half year financial statement, which is in Norwegian kroner.

SKAGEN Funds only has authorisation to market its money market funds SKAGEN Hyrente and SKAGEN Hyrente Institusjon in Norway and SKAGEN

Krona in Sweden. SKAGEN Avkastning has a limited market area. Information regarding these funds is included in the off icial accounts but is

excluded elsewhere.

The half year f inancial statement was originally prepared in Norwegian. The translated version is published with reser vations regarding possible

errors and omissions as well as erroneous translation. In case of conflict between the Norwegian accounts and the English translation, the formershall prevail. The Norwegian version of the half year f inancial statement is available at www.skagenfondene.no


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S K A G E N F U N D S H A L F Y E A R R E P O R T 4 J UL Y 20 12

L E A D E R

...is their periodic tendency to reflect the

human condition. Preferring sentiment - fear

and greed - to the wiser counsel of observable

fact and honest valuation. Right now, global

risk appetites drive returns over the short-

term; not, sadly, underlying company activity.

Once more we find ourselves amidst a

miasma of ever-worsening economic pre-

dictions. Correlations between stocks

approach record levels driven largely by

deep pessimism due to the poor economy,high estimations of risk, and low valuations.Nations are burdened not just by excessive

debt, but by an absence of effective and far-

sighted political leadership.

And their financial sectors seek to outdo

each other by the scope, and severity, of their

own sharp-practice and moral failings. This

is nothing new. The past three decades have

seen risk appetites drive a wide range of realworld events, and scandals, as the graph

below notes.

The European Condition

What then about Europe, the current cause

clbre? SKAGEN conference alumni Roger

Bootle, and his team at Capital Economics,

have taken the 250k Wolfson Prize awar-

ded for the best plan for dealing with states

leaving the eurozone. In a typically infor-

med treatise, Bootle lays out a considered

analysis of the challenge facing Europe, and

the monetary union in particular. He posits

a reconfiguration of the euro through the

departure of the weaker members, one byone. This would result in a renewed eurozone

built around the Northern core, with a set

of independent floating currencies for the

periphery. I do not know if he is right. I doknow that it is important that the European

leaders get busy doing something...and soo-

ner rather than later.

The value of good corporate governance

Bankers seem set to join politicians, lawyers

and parking inspectors in the tally of dama-

ged professions. And certainly, the latest

round of allegations around LIBOR rate-fixing

undermines public confidence in the moral

compass of the financial sector. Not to men-

tion revealing, yet again, the political prefe-

rence for delving into the short-term tactical,and courting public praise. Taking necessarily

tough, and strategic, decisions for the longer

term seems to lay beyond the wit of many of

our leaders currently.

In SKAGEN, good corporate governance,

or the avowed intent to deliver good corpo-

rate governance, is an important flag in our

analysis of companies, and in our fiduciary

responsibility towards our investors. Chris-

tian Jessen writes on excessive executive pay

awards and on SKAGENs aversion to them,

from page 8. And while were on the moral

compass, the interesting article on page

15 Journeying in the Kingdom of Lesotho

reports on one of SKAGENs charitable dona-

tions - in this instance to Mdecins Sans Fron-

tires.

A tough second quarter

The poor macro-over lay, an excess of market

sentiment, and consequently high correla-

tions, continue to suppress active long-only

equity returns and favour f ixed-income in thesecond quarter.

And SKAGEN is no different. All our equity

funds have fallen behind their benchmarks;

while our bond and money market funds arepulling ahead of theirs. SKAGEN Global, SKA-

GEN Kon-Tiki and SKAGEN Vekst were respec-

tively 5.1, 1.5 and 1.2 percentage points

behind their benchmark indexes during the

quarter. We are unsatisfied with this perfor-

mance but it does not undermine our confi-

dence both in our investment philosophy and

in the value of the companies that we own. In

contrast to this our bond fund, SKAGEN Tel-

lus, ended the half significantly ahead of its

benchmark index having gained 6.6 percent,

versus a benchmark return of 2.1 percent.

Read the portfolio reports from page 16.

Why stay invested?

Why then, should investors hold their nerve

over the medium-term? Two reasons really:

timing, and valuation. The former is the more

difficult to assess, clearly. Many purport to

have an insight; few deliver. In SKAGEN we

have never claimed any particular advantage

over timing. We do know, however, the cost

of missing the party. Recent research by LPL

Financial Research, extract below, sets out

the case quite starkly. Being out of the mar-

ket, for even a week or so, can cost dearly.

On valuation the facts are much clearer:

current multiples envisage some 20 years ofnegative real earnings growth. This clearly

is absurd. Nick Henderson CFA lays out the

case for equities from page 6. Suffice it to say,

valuations in the SKAGEN portfolios are as

low as they have ever been - and that, makeno mistake, is the best possible reason for

staying invested over almost any term.

The trouble with marketsLEADERTimothy Warrington,Head of International,SKAGEN Funds

tcsw ska gen fu nds. com

11.54

7.85

7.32

5.32

6.21

Average Annual Total Returns (%)

0 2 4 6 8 10 12 14

Source: FactSet, LPL Financial Research

Index performance is provided as a benchmark and is not illustrative of any particular

investment. An investment cannot be made in an index.

Stayed Invested

Missed 10 Best Days

Missed 20 Best Days

Missed 30 Best Days

Missed 40 Best Days

MISSING THE BEST DAYS IN THES&P 500: 198 8 -2011

Source: Credit Suisse

10

8

6

4

2

0

-2

-4

-6

-881 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

Oil plummets,equities rally

ContinentalIllinois run

1981recession

Mexicodefaults

Fall ofBerlin Wall

Nikkeipeaks

SaddaminvadesKuwait

Black Monday

Looseiquidity

Mexicancrisis

OperationDesert Storm

ERM crisis,Europeanrecession

Asianfinancialcrisis

Techbubble bursts

Russiadefaults,LTCM fails

9/11,Enron,WorldCom

EM euphoria

US housingbubble

SociteGnrale

BearSteams

1st Greekdowngrade

Jackson Hole,QE2

Japanearthquake

OilPeaks

Debtceiling,S&Pdowngrade

Surpriseitaliandowngrade

Lehmandefault

GLOBAL RISK APPETITE WITH NOTABLE EVENTS MARKED


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5


CO M M E NT

A value investor is by definition a bottom-up

investor. In practice it is exclusively compa-nies underlying values that form the basis of

their analysis. Since the fundamental value

of a company is determined by future cash

flow, however, a bottom-up investor must

also have an opinion as to what may hap-

pen in the future. Although necessary, it is

notoriously difficult to predict the future as

the world in which companies operate is in

a continuous state of flux.

When, as a result of internal or external

events, the market adjusts a companys pro-spects downwards, the share price falls. A

long-term value investor may then go againstthe market and conclude that the situation is

merely a transient one and that everything will

eventually return to normal. In other words,

this may be a good purchase opportunity. If

the stock market assumes an aluminium price

of USD 1200 on the pricing of Norsk Hydro,

investors who believe that prices will come

back up to a more normal level of around USD

2000 in the long term will be well rewarded.

Provided that this is what happens.

The problem, however, is that a number of

the forces affecting companies are not trans-

ient, but rather structural in nature. When onegets the back-to-normal hypothesis wrong,

the outcome is often catastrophic. Just ask

investors in companies such as Ericsson,

Norske Skog, Kodak and Vestas. If, on the

other hand, you have understood these struc-

tural changes early on, the outcome can be

just as spectacular, but in a positive sense.

Many of SKAGENs investments in emer-

ging markets in the 2000s built on the hypo-

thesis that companies in these countries were

not just cheap, but could also benefit from an

improvement of structural conditions.

Although most of the changes companiesare exposed to are one-offs, there are some

major shifts occurring that one should keep a

particularly keen eye on to avoid value traps

and secure ones investments. Here are three

of them:

1) Some must save, while more get rich

It is reasonable to assume that for the foresee-

able future western authorities in debt-laden

countries must concentrate on off loading their

debt. Companies exposed to public spending,

such as the health sector and the defence

industry, have an uncertain future ahead of

them. The exception is companies that are

able to help authorities save money.

On the other side of the equation, there are

over four billion people in emerging markets

who are gradually becoming richer and whoselevel of consumption increases by the day.

That is why we like companies such as Unile-

ver, Naspers and Great Wall Motor, which we

believe have better earnings prospects than

the stock market currently prices in.

2) The world is a market place

The fact that the world is a large market place

is nothing new. Trade from Asia has posed

both an opportunity and a challenge to the

western world for the past couple of millen-

nia. Today all major countries are members

of the WTO, which adds to both scope andcomplexity, which is positive for companies

specializing in everything from logistics to

testing. All goods, be they training shoes or

cars, are produced where it is cheapest with

certain quality requirements. The result is

that companies whose infrastructure is old

and expensive are quickly outmanoeuvred by

their cost-efficient competitors. Korean com-

panies such as Hyundai Motor and SamsungElectronics have as a result stolen considera-

ble market share from their US and Japanesecompetitors over the past few years.

Within the field of outsourcing the trendis the same. Cheap drugs and IT services are

produced in India, and on the whole, electro-

nics is contracted to China. This is a structural

change that we will increasingly see in the

near future and which will influence compa-

nies competitiveness and profitability.

3) The internet kills

The effect of the internet has long been a

central theme. While in the Noughties peoplewere most concerned with the internet win-

ners, such as Google and Amazon, it is now

increasingly clear which companies will lose

in the innovative revolution the internet has

created. The law of the web is simple; inter-

mediaries purveyors of news are being

replaced by databases and web pages, to

the delight of consumers.

Manufacturers of paper and paper pro-

ducts such as telephone catalogues were

the most obvious victims. Now one sees eve-

rything from travel agents to retail chains

wavering on the edge of the same abyss. Andas was the case when the horse and carriage

disappeared with the advent of the motorcar,

an increasing number of these companies are

ending up in the graveyard of capitalism. It is

of little help that they are seemingly attracti-

vely priced on the stock exchange.

As a value investor based in a small

windswept town on the west coast of Nor-

way, we have good experience of resisting

the storms in the financial market. We like

to set off on long excursions when the wind

blows its hardest. Nevertheless, we have

experienced that whether in the stock marketor at sea it is often better to have the wind at

your back rather than heading directly into it.

A winning formula:Understanding structural changeA good value investor must be able to understand a companys current

underlying values as well as foresee what may happen in the future, writes Torkell Eide,

portfolio manager of SKAGEN Global.

Torkell Tveitevoll Eide, portfolio manager of SKAGEN Global


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6


THE M E

Following a very lacklustre ten years for global

stock markets, much has been written on the

end of investors love affair with equities, orat least a severe cooling in the relationship.

Those penning the Dear John letters point

to structural changes, or perhaps irreconci-

lable differences, as to why things can never

be the same. On the demand side, appetite

for stock ownership has been eroded by twomarket crashes, demographic and regulatory

changes, and on the supply side, companiesare making greater use of more sophisticated

and accessible debt capital markets.

But following a sustained period of asset

re-allocation by investors is the cult of equity

finally dead, and what implications are there for

an equity-focused fund manager like SKAGEN?

Historical outperformance (until recently)A brief history lesson illustrates that despite

weak recent returns, equities have histori-

cally delivered much higher returns than

other asset classes. According to research by

Credit Suisse1), from 1900-2011 US equitieshave delivered annualised real i.e. inflation-

adjusted returns of 5.4%, comfortably ahead

of housing (+1.9%), bonds (+1.7%) and gold

(+1.0%) over the same period.

More tellingly, when we look at returns

over 10-year holding periods it becomes clear

that equities have consistently delivered posi-

tive and often significant real returns - buy-

ing the S&P 500 index and holding it for a

decade in each of the years from 1900 would

have delivered losses only 17% of the time.Equally telling is the dire performance over

the past decade, where relative to both his-

torical gains and the performance of bonds,

US equities have delivered the worst returns

in over a century.

Torkell Eide, a portfolio manager in the

SKAGEN Global team, explains, Weak ten

year equity returns have historically had two

explanations; either high inflation, which was

the case in the 1910s and 1970s or valuation,

which was the case in the 1930s with the

Great Crash and the bursting of the techno-

logy bubble at the turn of the millennium.

Where are we now?

If, as some believe, the past can be used to

predict the future then what could this meanfor the next ten years? According to Eide,

High inflation could cause negative real

returns but bonds will perform much worse

if that happens. Valuation is unlikely to be a

cause; on almost every metric, equities are

currently at the cheapest levels they have

been for several decades, particularly relative

to bonds.

In terms of both earnings and book valuemultiples, and from an income perspective

the dividend yield on equities recently rose

above the yield on long-term bonds for the

Over the rainbow:why its not all doom and gloom for equities

Historical performance, current valuations and future expectations all suggest that now isa good time to be long equities, both in terms of investment strategy and holding period.

Source: Goldman Sachs Research-5,00

-

5,00

10,00

15,00

20,00

1910 1930 1950 1970 1990 2010

Inflation Inflation

Valuation Valuation

10-YEAR ROLLING REAL RETURNS (BASED ON YEAR SOLD) OF S&P 500 OVER THE LAST CENTURY

Weak ten year equity returns have historically had t wo explanations: either high infl ation or valuation.


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7


THE M E

first time in over half a century equities have

de-rated and low valuations tend to be fol-

lowed by periods of high returns. Accordingto research from Goldman Sachs 2) , the P/E

range where we are currently has been fol-

lowed by average returns of 49% over the

subsequent five-year period.

Eide explains: The P/E of the MSCI All

countries index has collapsed 63% since

2002 and current multiples imply that the

market expects negative real earnings growth

for the next 20 years, which is clearly absurd.

Although governments and consumers are

deleveraging, companies debt levels have

already come down and they are increasingly

able to tap higher growth markets overseas if

they need to. Current expectations are gene-rally too low and that usually means higher

returns.

After the rain comes the sun

Looking again at the 10-year figures opposite,

buying equities at the end of any of the 14

loss-producing decades before the turn of

the century would have delivered solid 5-year

real returns in the subsequent period on all

but one occasion, with average annualised

inflation-adjusted gains of 8.8%.

So what does all this mean? Clearly pre-

dictions that investors have turned their back

on equities forever are exaggerated global

stock markets are still capitalised at over $50

trillion and while inflation needs to be hedged

and pension liabilities need to be met there

will remain a need for investors to hold equi-ties. Historical figures clearly show long-run

outperformance and provide comfort that

when markets turn, investors particularly

those with long-term holding periods like

SKAGEN tend to do well.

Finally, and perhaps most importantly,

valuation is a key driver of investment returns

and for a value-focused manager like SKA-

GEN with portfolios trading at discounts to

the market, which is itself trading at trough

levels, the long-term future for our clients

should be bright. And whilst we cant predict

exactly when the rain will stop, hopefully theworst of the storm clouds will soon pass andwe are not too far away from the beginning

of the rainbow.

1)Global Investment Returns Yearbook 2012,12 February 2012

2)AsiaPac Valuation: What works, and when,12 March 2012

Source: MSCI and Bloomberg

20,7

13,4

9,8

0

5

10

15

20

MSCI World AChistoric average

MSCI World AC30 June 2012

SKAGEN Global30 June 2012

Price/Earnings

2,5

1,7

0,9

0,0

0,5

1,0

1,5

2,0

2,5

3,0

MSCI World AChistoric average

MSCI World AC30 June 2012

SKAGEN Global30 June 2012

Price/Book

SKAGEN Global currently tr ades at a discount to the market, which is its elf well below average valuation levels

After th e rain come s the sun: Historical figures clearly show long-run equity outperformance and provide comfort that when markets turn, investors tend to do well.

Nick Henderson

nhe skagenfunds.com

P.S. Kryers first studio in Skagen in

Brndums old garden, 1890.

By Thorvald Niss, one of the Skagen painters.The picture belongs to the Skagens museum


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8 THE M E

In the middle of June a minor story circulated

in financial newspapers the world over. It was

the result of shareholder voting in the listedglobal advertising giant WPP.

The long-standing and successful CEO

and founder of WPP, Sir Martin Sorrell, had

together with the top management decided

that his wage package should be increased

by 60 percent, at an annual cost of GBP 6.8

million.

The proposal was voted down, however.

The shareholders in the company in spite

of their large number and wide geographicaldispersion had managed to organize them-

selves in such a way that the proposal was

broadly defeated.Martin Sorrell took the defeat in his stride

at least publicly.

Its a democracy. The shareholders have

spoken, he noted laconically when the pro-

posal was buried.

SKAGEN does not own any shares in WPP,

so we had no involvement in this case. But

the WPP case is a typical one and becoming

more common.

One year ago any kind of successful sha-

reholder resistance was a rarity and made

front page news in the Anglo Saxon presseach time; today we are seeing a case prac-

tically every day.

Institutional investors have armed them-

selves and, using partners specialising in

voting, they are systematically working to

monitor executives wages, to organise resis-

tance and vote against extreme pay packages.

Value belongs to shareholders

SKAGEN is prepared to vote against share-

holder-hostile proposals when necessary.

This year we have done so at the gene-

ral meeting of Weatherford amongst others,where we were against the executives pay

packages. We have also voted against a num-

ber of proposals in Chinese companies such

as Great Wall Motor and China Shineway.

This is a global shareholder rebellion.

Value creation in companies must be trans-

ferred to shareholders. We are enthusiastic

in voting against exaggerated pay packages

and against various forms of f inancial hocus-

pocus in companies, whenever we see it,

says portfolio manager of SKAGEN Kon-Tiki,

Kristoffer Stensrud.The 2008 financial crisis has left its mark.

At the start the discussions were loudest in

the many banks in the UK and the US that

were saved by the state and taxpayers but

whose employees continued to receive relati-

vely high wages. In the UK the state is a share-

holder in the Royal Bank of Scotland amongst

others, whose chief executive Stephen Hester

had to humbly decline an annual bonus of just

under GBP one million in 2012. Since then the

resistance has spread to private companies

also, such as the above mentioned, WPP.

Shareholder confidence in managers isnot what it used to be. Consequently we see

that investors want to get as much of their

money back as quickly as possible, without

this impacting on the companies growth. In

SKAGEN we would prefer to have money in

our pockets in the form of dividends rather

than have the companies buy back their ownshares in immense share buyback program-

mes, says Knut Harald Nilsson, portfolio

manager of SKAGEN Kon-Tiki.

In SKAGEN we continuously strive to see

opportunities where other analysts and inves-

tors may get hung up on market pessimismand specific problems without being able to

see the possibilities. So what are the opportu-

nities to be found in shareholder resistance?For portfolio managers of equity funds

there is no doubt that greater shareholder

focus will allow value to be released in a large

number of companies. A greater determina-

tion to pay dividends would increase trust

and help lift valuations from their currently

very low levels.

A country such as Russia does not imme-

diately strike one as a model of good cor-

porate governance, but in fact the Russianfinance ministry has submitted a proposal

that wholly or partially state-owned compa-

nies pay out at least 25 percent of profits.

Fighting back against

excessive executive payCompanies should think about their shareholders when it comes to salaries and bonuses for top

managers. SKAGEN is prepared to vote against pay packages which are not in the interests of share-

holders. Shareholders are entitled both to receive dividends and to expect moderate behaviour from

companies, stress portfolio managers Kristoffer Stensrud and Knut Harald Nilsson.

General meetings here in Deutsche Bank (which we do not own) are formally the place where shareholders and companyexecutives meet to make binding decisions. The meetings are civilised, but according to SKAGENs por tfolio managers, in-stitutional investors are placing greater demands on the companies management.

Photo:Bloomberg


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9


THE M E

Energy giant Gazprom has become more sha-

reholder friendly.

Shareholder resistance is a great source

of higher valuations. Our aim is to safeguard

our interests as shareholders. Previously ithas been quite tough to fight this battle, but

now shareholders are properly equipped,

says Kristoffer Stensrud.

He puts this conflict into a wider per-

spective, and believes that the new humilityamong business management is here to stay.

The companies that will do best going forward

will be those that understand their sharehol-ders new agenda.

A new kind of shareholder friendliness

However, isnt it true that bonus payments,

option packages and widespread share buy-backs were introduced precisely to benefit

shareholders?

In the good old days, when one didnt have

access to these tools to align the interests

of management with those of shareholders,

a common complaint was that directors of

the largest companies would rather build up

large, but not very prof itable business empi-res than do their utmost to work for the share-

holders through providing the best possible

return on equity.

Financial analysts and economists are cur-

rently fighting their way through a mountainof material on the so-called agent-principal

theory, which maintains that the owners of

companies have to ensure that the manage-

ment have the same goals as themselves by

assigning the right incentives in the form of

share options and other goodies. One also

has to accept that executives will earn as

much as the owners because they managethe firms so much better when they them-

selves have a hand in the pot.

SKAGENs portfolio managers are fami-

liar with the story and do not refute it. They

do believe, however, that the pendulum has

swung too far and that there is no longer a

commercial need which justifies a proportion

of shareholder value automatically being allo-

cated to the management. Or for shareholders

to find themselves invested in overcapitalized

companies providing low returns just because

the management wants to be its own bank.

It has particularly been the case that ina large number of corporations, the execu-

tives have become too strong in relation to

shareholders. This has happened in a diver-

sified and uncoordinated manner. That is why

wages are not linked to results and have been

pushed up to unnecessarily high levels.

What is particularly striking is that no

notable adjustments have been made in spite

of the five-year financial crisis. We expect

that strong engagement on the part of sha-

reholders and a greater willingness to chal-

lenge managers will be value-creating going

forward, says Knut Harald Nilsson.

Enthusiastic support

Some readers may then ask, what about SKA-

GEN itself? The equity funds are run by the

private, partner-owned company, SKAGEN

AS. Both the company and investors in the

funds have done well for themselves and in

successful years, the stock markets havecreated profits that have attracted attention.

In SKAGEN there is no conflict of interest

between investors interests and those of

the management company. Our fee model

ensures that good results must be delivered

before the management company can achieve

high earnings. And both the management and

the employees are bound by regulations that

ensure that they work on behalf of investors

and shareholders interests, says Harald

Espedal, investment director and CEO of

SKAGEN.

Harald Espedal enthusiastically supportsthe portfolio managers wish to get involved

in companies in the companies we own. Thisis perceived as one of the tools that must be

used to break the present deadlock in the

stock markets.

Note: You may follow SKAGENs voting activities on

the Corporate Governance page on our website: www.

skagenfunds.com/About-us/Ethics-and-corporate-

governance/Corporate-Governance.

Christian Jessen

cje skagenfondene.dk

Revolt against the gild-plated terms and conditions in some financial institutions started with the Occupy Wall Street movement, here at a demonstration in San Francisco. The activistsrarely have direct influence on the companies, but have had a considerable impact on the public debate.

Photo:Bloomberg


10/40

10


Property in attractive locations has long been

considered a good way to safeguard financial

assets. And real estate has historically offe-red good protection against inflation. Real

estate has lower expected risk and returns

than equity in general. Instead, the sector

often sees stable returns more characteristicof bonds. Moreover, in the medium term real

estate exhibits low correlation with assets

such as shares and bonds. One way to take

part in the growth within the real estate seg-

ment is to invest in listed real estate com-

panies.

Local markets often mispriced

While many other sectors in recent deca-

des have globalized, the real estate marketremains local. Real estate mirrors local mar-

ket conditions, and developments in other

real estate markets typically only affect local

rental market developments marginally.

Globally, there are about 2,000 listed real

estate companies with a total market capi-

talization of around EUR 2 trillion. The num-

ber of companies is growing rapidly and it

is particularly the urbanisation taking place

in emerging markets that has enabled more

real estate companies to reach the stock mar-

ket. One way in which real estate companies

can be categorised is to distinguish between

companies that hold and manage propertiesand companies that primarily develop and

sell them. In many countries, management

companies enjoy a favourable tax status and

are known as REITs (Real Estate Investment

Trusts).

Strong recovery after financial crisis

Over the past twelve years, global real estate

shares have generated somewhat higher

returns overall than the global stock mar-

ket. The return profile looks completely dif-

ferent, however. During the critical phase of

the financial crisis 2007-2009, global realestate shares declined at a steeper rate than

the overall market after having experienced

higher growth in the years preceding the

Global real estate

opportunitiesFrom time to time we train the spotlight on individual companies in our equity funds. Here we take a closerlook at a number of interesting real estate companies with completely dissimilar characteristics: Norwegianproperty development company, Olav Thon, German real-estate company, GSW, and Asian shopping mall

developer, CapitaMalls Asia.

CapitaMalls Asia, the largest publicly traded shopping mallplayer in Asia with operations in Singapore, China, Malay-

sia, Japan and India, has been part of the SKAGEN Globalportfolio since the beginning of 2012.

Morgan Stanleys broad global real estate index is domi-nated by mature markets and the high property values as-sociated with metropolitan areas. It is interesting to notethat several major emerging markets are missing from the

top as is the industrial nation of Germany. Combined, theNordic countries represent about one percent.

Rest of the world 10,6 %

France 2,7 %

Great Britain3,5 %

Singapore 3,8 %

Canada 3,7 %

Australia 6,7 % Japan 9,7 %

USA 44,7 %

Hong Kong10,5 %China 4,2 %

Source: MSCI April 2012. MSCI ACWI IMI RealEstate covers around 600 companies in both

mature and emerging markets.

REAL ESTATE INDEX BYGEOGRAPHICAL LOCATION

Photo:Bloomberg


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11


financial crisis. Since the bottom of the glo-

bal stock market was reached in late February2009, global real estate shares have deve-

loped at a marginally higher rate than the

global index.

SKAGEN and the real estate markets

It is relatively easy to value real estate com-

panies: they have predictable cash f lows

and often pay high dividends. In spite of

this, listed real estate companies are often

significantly mispriced as a result of the stock

markets traditional focus on the short term.This means that there is scope for bargain

hunting for a value-based manager such asSKAGEN, which focuses on finding inexpen-

sive shares in both the worlds mature mar-

kets and in emerging markets that are still

undergoing urbanisation.

The three listed real estate companies

outlined below are located in various parts

of the world where SKAGENs equity funds

have made investments.

The entrepreneur-led real estate companyOlav Thon in Norway

Olav Thon is a real estate company that pri-

marily develops and manages shopping mallsin Norway and on the Norwegian-Swedish

border. As a shareholder in Olav Thon, you

earn both solid rental income and growth

through property development. The rental

income depends in part on retail outlet sales.

Most shopping malls are conveniently located

in areas that are fully developed. As Ame-

rican author Mark Twain noted as early as

the 1800s: buy land, theyre not making it

any more.

The 89 year-old entrepreneurial legend

Olav Thon is chairman of the board of the

Olav Thon Group. He controls the majorityof the companys shares which means that

the proportion of unrestricted shares is low.

The stock is among the less liquid on the Oslo

Stock Exchange and only a few analysts fol-

low the company in spite of its being one ofNorways largest real estate companies.

SKAGEN Vekst has held shares in Olav

Thon since 2001. Originally, the shares werebought at 187 Norwegian kroner (NOK). At the

time of writing, the share stands at NOK 860,

providing an annual average return in excess

of 30 percent. It is the funds eleventh largest

portfolio holding and constitutes 2.1 percent

of its total value.

German real estate company, GSW, in Ber-lin, Europes newest capital

After its reunification in 1989, Germanyexperienced a long period of weak growth

in housing prices while many other European

countries saw price increases. Meanwhile,

the German economy has become one of thestrongest in Europe and unemployment is

low. One company that has managed to capi-

talise on this is German real estate company,

GSW, which owns and manages rental pro-

perties in Berlin. GSW owns a total of 53,000

apartments in the less expensive segment

and the vacancy rate is low as the number

of households in Berlin is growing rapidly.

Average monthly rent for housing in Berlinstands at EUR 5.2/m2 which is only half as

high as in Munich.

GSW went public in April 2011 at a share

price of EUR 19 and has been part of the SK A-

GEN Global portfolio since January 2012. The

holding represents 0.45 percent of the funds

value. At a price of EUR 27 in late June 2012,

growth has been excellentespecially taking

into account the prevailing harsh stock mar-

ket climate.

Although the share cannot be considered

particularly inexpensive, there are several

triggers for further price increases: Propertyprices are expected to rise as are rental levels

in Berlin and the company is a candidate for

acquisition. The market value of GSWs pro-

perties is at just half their new production

costs. Risks include fears of higher taxes on

real estate transactions and financing chal-

lenges if the European crisis were to escalate.

Asian shopping mall developer, Capita-Malls Asia

CapitaMalls Asia is the largest listed Pan-

Asian shopping mall player. The companys

business model is to startor acquire poorly

runshopping malls, to operate them and to

sell them once they have matured. In Sep-

tember 2011, the company had completed

70 shopping malls and had an additional

26 under construction. The company has

operations in 49 cities in Singapore, China,

Malaysia, Japan and India.

The share price has fallen dramaticallysince the initial public offering in 2009. Areas

of concern have included worries regarding

developments in China and the fact that the

first shopping malls that were completed fai-

led to meet expectations. In January 2012 that

created an opening to buy shares at an att-

ractive price, well below the replacement cost

of the companys existing shopping malls. In

June the holding accounted for 0.36 percent

of SKAGEN Globals portfolio and the share

value has increased substantially since the

first shares were bought.

Provided that the companys aggressiveplans to expand shopping malls over the next

three years succeed, the company stands to

benefit from continued growth in consump-

tion in Asia. Catalysts for a company reva-

luation are that the expansion in China goes

well, that REITs can be registered and that the

company will be appreciated as a consumer

company. On the risk side, there is the poten-

tial of slowing growth in China and that the

companys aggressive and ambitious strategy

fails, which might in turn result in financing

challenges.

Jo na s A Er ik sso n

jae ska ge nf unds .co m

During the credit drought of the financial crisis 2007-2009, real estate shares fell precipitously as a result of the link bet-ween real estate and lending in society. Once the fear dissipated, real estate shares broadly recovered.

0

50

100

150

200

250

MSCI Global Index

1998 2000 2002 2004 2006 2008 2010 2012

Source: Bloomberg, 28 June 2012. MSCI World Real Estate. This real estate index is narrower than the index mentionedabove; it includes only developed countries but has a longer historical outlook and is therefore used in the chart.

MSCI Global Real Estate Index

REAL ESTATE INDEX COMPARED TO THE GLOBAL IN DEX 1998-2012

DETAILS RELATING TO THEREAL ESTATE SHARES

PRICE* SIZE %)P/E012 P/B

AR EPRICE

Olav Thon 860 .1 11.5 0.9 1,200

GSW 26.9 .5 14 0.8 36

CapitaMallsAsia

1.49 0.33 18 0.8 .1

* June 26, 2012

The target share prices for the three real estate companiesshow an upward potential in the range of 35-40 percent

from todays levels.


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12


THE M E

Invest in value creators

Looking at the 100 largest companies in Asiaover the 10-year period from 2000 to 2010, it

is clear that those delivering the worst returns

(bottom quintile) also consistently destroyed

value over the period having a return on

invested capital below their cost of capital.

Thus, when investing for the long term you

want to own companies that create value.

Estimating when the stock markets will reflect

the true underlying value of the companies

we own is obviously extremely difficult. By

holding companies that create value, time

works in our favour. While waiting for the

stock market to price the shares correctly, the

underlying fundamental value is rising and,if the share price doesnt move, the upside

will increase.

Investing in stocks that do not create value

has the opposite effect. While waiting for the

stock to rerate towards fair value, the funda-mental value of the company declines (on a

risk-adjusted basis). Furthermore, it is very

unlikely that a company that consistently

destroys value will be revalued.

Buy cheap value creators

Simply buying companies with the highest value creation is by no means a magic formula

for creating good returns. The price you payfor this value creation obviously matters.

Again looking at Asian companies from

2000 to 2010 there is a very clear relationship

between the starting valuation in the year

2000 and the return over the ensuing decade.

As illustrated in figure 2, the 20% best-

performing shares (top quintile) had the

lowest starting valuation. This group of stocks

includes a number of commodity-related com-

panies. In the year 2000 commodity compa-

nies were extremely unpopular after a long

period of weak operating performance, resul-

ting in those companies having a low returnon invested capital at that time. The situa-

tion changed with the rise of China and other

emerging markets, creating strong demand

Value investing in AsiaGiven the strong macroeconomic growth and even stronger earnings growth many investorsthink they need to focus on different factors when investing in Asia. In SKAGEN we believe thefactors driving long-term share price performance are similar whether you are investing in fast-growing emerging markets or low-growth mature economies.

Source: Bloomberg , CLSA Asia-Pacific Markets

0

5

10

15

20

25

30

Top quintile 2nd quintile 3rd quintile 4th quintile Bottom quintile

(%)

RETURN ON INVESTED CAPITAL PROFILE OF ASIAN STOCKS BY 10 YEAR TOTALSHAREHOLDER RETURN QUINTILES

Figure 1: Over the 10-year period f rom 2000 to 2010, the bottom quintile Asian companies delivering the worst returns alsoconsistently destroyed value over the period.

TRAILING VALUATION IN JUNE 2000

BY TOTAL SHARE RETURN QUINTILES

TOTALETU

TRAILIN EARNINGS YIELD

TRAILINGF YIELD

Top quintile 575% 13% 16%

2nd quintile 166% % 3%

r quintile 7 % 1% 2%

4th quintile -9% % %

Bottom quintile 77% 3% -2%

Figure 2


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13


1313THE M E

for commodities. This increased earnings,

return on invested capital and thus share-

holder focus on these companies.

In contrast, the table also shows the pitfall

of investing in popular and expensive com-

panies. The worst 20% performers (bottomquintile) over the 10 years are characterised

by a high starting valuation followed by a

decade of weak operating results, see figure

1, leading to a dreadful share price perfor-

mance of minus 77% for the period.

The latter group of companies includes

a number of Taiwanese IT hardware com-

panies, priced for outstanding growth and

value creation going into 2000. As it turned

out, most IT hardware products were in fact

commodities, giving companies no pricing

power. Combined with a high requirement

for ongoing capital investments due to fast-evolving production technology, this drove

returns on capital to very low levels and

also resulted in numerous capital raisings,

diluting existing shareholders.

Even the fourth quintile companies pro-

ved a painful experience for shareholders,

despite delivering good operating results with

a high return on invested capital. The reason

was simply a too high starting valuation, thus

already discounting the future value creation.

Buy cheap value creators that pay dividends

Since the year 2000, reinvested dividendsin Asia have constituted more than 40% of

total shareholder return. So even in an envi-

ronment with high earnings growth, a focus

on dividends has been vital when picking

stocks in Asia.

Another important aspect of dividends is

that companies with a disciplined approach

to dividends also tend to have a disciplined

approach to allocating their capital to the

areas that create the best return.

A prime example in Asia is Japan, where

management has been extremely reluctant

to pay out dividends, despite having few att-

ractive investment opportunities. This has

led to increasingly overcapitalised balance

sheets and a major drag on return on invested

capital, thereby pushing down valuation mul-tiples in Japan.

It is equally important to allocate your

capital in a high growth environment, as we

have seen with a number of Chinese com-

panies. They have witnessed their share

price slide despite delivering strong ear-

nings growth mainly a result of aggressive

investments at low marginal returns, drivingvaluation multiples towards ever new lows.

Paying the earnings out as dividends and

growing more slowly would clearly have been

a much better option.

Investing in Asia is no different from any-where else

Buying cheap unpopular companies that went

on to create value over the ensuing years has

clearly been the recipe for success in Asia overthe past 10 years. Over longer time periods

this has also held true in every other region in

the world. The same may not be the case over

shorter time periods but staying the course

is the key to delivering strong long-term per-

formance. SKAGENs long-term approach to

investing has therefore remained unchanged

since the first fund was launched in 1993.

By Sren Milo Christensen

Figure 3: Since 2000, reinvested dividends in Asia have constituted more than 40% of total shareholder return.

-50

0

50

100

150

200

250

300

Dec. 00 Dec. 02 Dec. 04 Dec. 06 Dec. 08 Dec. 10

PE

EPS

Dividend

Currency

MSCI ASIA EX. JAPAN DIVIDENDS HAVE CONTRIBUTED 40% OF TOTAL RETURN SINCEDECEMBER 2000

Sren Milo Christensen,portfolio manager of SKAGEN Global

In SKAGEN we believe the factors driving long-term share price performance are similar whether you are investing in Asiaor elsewhere in the world.

Photo:istock


14/40


15/40

15


NE W S

The landlocked country, which is entirely

surrounded by South Africa, is one of the

poorest in the world. More than 23 per-

cent of the population in this sparse

mountainous country suffers from HIV/

AIDS. Nevertheless, what we remember

best from our visit is the beautiful lands-

cape, the horsemen, shepherds, womens

singing and the commitment of the Mde-

cins Sans Frontires (MSF) employees.

Accompanied by the general secretar y Anne-

Cecilie Kaltenborn and marketing and collec-tion manager Grete-Lise Christensen from

Mdecins Sans Frontires, Norway, four

SKAGEN employees went on a field trip to

Lesotho in March this year. We spent three

days visiting one of the projects we have been

sponsoring for the six years we have been one

of their main partners.

A local health community worker made a

lasting impression on us when, at a meetingin a remote village, he candidly demonstrated

how to use a condom with the help of a woo-

den device. With a twinkle in his eye, and a

dozen condoms fastened to his sunglasses,

bracelets and in his pockets, he discussed thistaboo subject with the 60 or so people present,

explaining why, and how, condoms are used.

The talk on birth control and health education

was organised by MSF and drew people from

several villages. The aim was to keep everyone

seated long enough so that as many people as

possible would go over to one of the tents set

up for the occasion and take a 15-minute HIVtest. Of the 52 people tested, four were positive.

The long-term goal is zero new HIV infections.

The goal of Mdecins Sans Frontires with

the Lesotho project is to support the authori-

ties and demonstrate how a health district can

be organised. They instruct health workers to

ensure that a minimum standard is maintained

at the nine health clinics which attend to the

HIV/AIDS and mother/child issues in the Romaregion with 200,000 inhabitants.

Lesotho is a spartan, agricultural society

and only one in four live in towns. Part of the

reason why HIV/AIDS is so widespread is thatmen often migrate to neighbouring South Africa

to work, often for 3-9 months at a time. Poly-

gamy is forbidden, but it is not unusual for men

to have several sexual partners. Women stay

home in the villages to tend their little patches

of land and take care of the family.

Public education and more knowledge is the

first step on the road to getting more people toseek out health services, post-natal care and

get tested for HIV/AIDS in order to receive the

correct treatment. The state covers the expen-ses for HIV/AIDS medication.

Each year more than 20,000 people die of

AIDS-related diseases and almost 100,000

children are left orphaned. Around one in four

is HIV positive and this is the third most pre-

valent infection in the world. HIV/AIDS related

diseases are still the most common cause of

death (60%) closely followed by childhood

diseases and women who die at home during

childbirth without medical help. Information,

rapid and correct medication and better health

services could turn this trend.

SKAGEN is proud to support MSF in itsimportant work.

ge K. Westb , Anne- Cecili e Kaltenbor n, Silje N atland, Tone W illoch Re ttedal, M argret he Vik a, Grete -Lise Ch risti ansenand Marleen Dermaut, project leader, all wrapped in traditional wool blankets.

At the meeti ng, men and women sit apart. Shepherding isa mans job. They are often out travelling for several weeksat a time. at a time.

An MSF e mployee at the meeting,or Pitso as it is calledin Lesotho, encourages everyone to take an HIV test. Thegoal is zero new HIV infections.

Proud horse people. In the villages we visited there weremore horses than cars. Several villages do not have roads,so horses are the best means of transport.

Margrethe Vika

MV skagenfondene.no

Journeying in the

kingdom of Lesotho

FACTS ABOUT LESOTHO

The country does not have a coastline and is sur-

rounded by South Africa.

Lesotho is 30 000 km and has just over 2 million

inhabitants, of whom only 25% live in towns.

The capital Maseru is the largest city.

The distric t of Roma (200 000 inhabitants) that we

visited is mountainous and has several mountain

plateaus.

Two thirds of the countrys GDP is from the agri-

culture industry.

Around 40 % of the population live below the

poverty level (USD 1.25 / day). The country is ran-

ked 160 out of 187 in UNDPs Human Development

Index.

SKAGEN and Mdecins Sans Frontires (MSF)

Mdecins Sans Frontires (MSF) is a neutral and

independent medical humanitarian organisation

that saves lives and alleviates need. They help

those who need it most regardless of who, where

or why.

SKAGEN is a main partner for MSF in Norway and

Denmark

Would you like to support MSF and become a regu-

lar donor? http://www.msf.org/msf/donations/

donations_home.cfm


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16


PO RTFO LIO M ANAGE RS RE PO RT

` The improved risk appetite we saw

among equity investors at the startof 2012 reversed in the secondquarter and the macro focus onceagain dominated.

` Disappointing key economic figures,renewed debt fears in Europe andweaker growth figures from Chinahad many people reaching for thesell button.

` Once again investors fled toso-called safe havens in the West.

` Bond yields in the US and Germanyreached an all time low, and riskpremiums in the stock market an alltime high.

`

Falling commodity prices have madeit possible for most countries inemerging markets to pursue astimulatory economic policy.

` Signals came from the EU summit atthe end of the quarter that work isbeing done to possibly find a long-term solution to the debt problemsin Europe.

` All our equity funds performedpoorly in the quarter, in bothabsolute and relative terms, butpricing is now at historically lowlevels.

` Less stringent regulations for lifeinsurance companies and pensionfunds, which will allow them toincrease their currently low stock

holdings, may be a trigger for stocksas an asset class to make a sorelyneeded comeback.

Hope in a cast line

The death of equities: BusinessWeek announced the death of equities on its front page in 1979. A couple of years later sawthe start of the longest consecutive upturn in the global stock markets ever. At the end of May 2012 the Financial Times hadthe same message on its front page, though followed by a question mark. Will history repeat itself ?

Handshake for union: German chancellor Angela Merkel and Italian premier Mario Monti decided at the EU summit at theend of June together with the other EU leaders to work towards political union, at the same time as undercapitalised bankswould have easier direct access to fresh capital.

Photo:Bloomberg

Seeing the light: At the end of the quarter global stock markets were priced at historically low levels relative to companiesearnings. New regulations for life insurance companies and pension funds, which would enable them to increase their rela-tively low stock holdings, could kick start the stock market and be the start of a new er a for equities as an asset class.

Photo:Bloomberg

Photo:Bloomberg


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17



After a strong first quarter of increased risk

appetite among equity investors, the second

quarter was dominated by new concerns and

risk aversion. Disappointing key economicfigures, renewed debt fears in Europe and

weaker growth f igures from China had many

people reaching for the sell button. Grexit

and Spainout became increasingly popular

expressions among investors.

The capital markets have been longing

for a credible solution to the debt problems

in Southern Europe, with or without Greece

and Spain. It is well known that uncertainty

is an equity investors worst enemy. The EU

summit at the end of the quarter gave signals

that something is happening at least.

The EU bailout fund, the European Stabi-lity Mechanism (ESM), will now inject capitaldirectly into undercapitalised banks, instead

of the money going to the respective govern-

ments. This is a step in the direction of unified

credit supervision, and a certain coordination

of fiscal policy. The next step may be poli-

tical union. Eurozone problems have in no

way been resolved, however, and countries

in the region will continue to struggle with

debt, recession and low growth for several

years to come, although the uncertainty will

be reduced.

The global economy will also meet newheadwinds, and volatility in the capital mar-

kets is something we must be prepared to

live with for some time to come.

With the US election set to take place in

the autumn, investors eyes will once again

be on the large deficits in the fiscal budget of

the worlds largest economy. The dramaticswe witnessed last summer whether the USdebt ceiling would be raised or not, when

everyone knew there was no other option

may be about to enter a second act.

The comfort for those who still believe in

equities as an asset class, and in our equity

funds, is that they provide a very good risk

premium relative to supposedly secure bond

investments. The pricing, both in terms of cur-

rent earnings and book equity, is at historically

low levels. Pending better times, sharehol-

ders and unit holders in our funds can enjoy

dividends from companies which exceed theyield on 10-year government bonds in the safe

havens of the US and Germany.

Time will tell whether the reactions to the

EU summit at the end of the quarter were just

transitory or whether the risk appetite of glo-

bal investors is on the rise. A trigger for better

times in the stock markets may be new regu-lations for life insurance companies and pen-

sion funds in terms of capital coverage, which

could lead to the latter once again increasing

their share of equities.

Weak quarter for equity fundsThe second quarter was less than pleasant

for our equity funds. Having lost 6.0, 5.7, and

3.7 percent respectively, SKAGEN Global,

SKAGEN Kon-Tiki and SKAGEN Vekst were

respectively 5.1, 1.5 and 1.2 percentage

points behind their benchmark indexes.

Our bond fund, SKAGEN Tellus, ended thequarter up 3.9 percent, versus 5.2 percent for

the benchmark index. Year to date, SKAGEN

Tellus is significantly ahead of its benchmark

index having gained 6.6 percent, versus a

return of 2.1 percent for the benchmark index.

Russia and Brazil pulled down

Some of the reason for the weak returns of

our equity funds can be attributed to the

downturn in the Brazilian and Russian stock

markets of 19 and 11 percent respectively,

measured in euro. Stocks and currencies alike

in these countries were unpopular amonginvestors.

All the equity funds have relatively large

positions in Brazilian Eletrobras and Pet-

robras as well as in Russian Gazprom, all

three of which ended up among the losers

for the quarter. The US was again perceived

to be the safest stock haven, and the broad

equity index, the S&P 500, ended the quarter

in positive territory measured in euros. Other

markets that were relative winners were the

UK, Hong Kong, Singapore and Turkey, whilethe Oslo Stock Exchange felt the full effect of

the oil price drop and lost four percent.From its top quoted price in March, at its

lowest point the oil price was down around

30 percent. The oil price drop is a welcome

Lost on Russia and Gazprom: The Russian stock market was extremely weak in the second quarter, and all the equity funds felt the ef fects of the substantial drop in the share price ofGazprom. The CEO of Gazprom, Alexei Miller, is pictured here showing Vladimir Putin a model of the companys gas pipe to Europe.

Photo:Bloomberg


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18



relief in most Asian countries. Of the countries

in the region, only Vietnam and Malaysia arenet exporters of oil. Korea, Taiwan and Thai-

land are the largest importers, relative to thecountries economic size. For India the oil

price drop means significant reductions instate subsidies.

The Iranian oil embargo and a happier

mood among investors gave the oil price a

lift at the end of the quarter. This continued

going into July. Based on developments in the

real economy globally, and the fact that there is

strong growth in unconventional oil extraction,

particularly in the US, people are no longer

talking about peak oil. Now it is more popularto discuss how low the oil price can go.

How cheap?

Investors focus on bad times in large parts ofthe western world and emerging markets which

are no longer growing as quickly as previously

(though from an increasingly higher level) has

brought down the pricing of stocks significantly.

In Europe you can now buy the index at 12

times the years expected earnings. Emerging

markets are priced at 10 times, while the P/E

level for the world index is below 14. This cor-

responds to a return for shareholders of eight,

ten and seven percent (E/P).

In other words, earnings estimates have

taken into account the difficult times around

the world.Price relative to companies book equity

for the respective regions is at 1.5, 1.6 and 1.3

respectively (see graph).

Although several Southern European

countries are in recession, and growth in the

US does not look as healthy as earlier this year,

the wheels of emerging markets continue to turn

(see graph). In other words, everything points to

growth in companies earnings in 2013.

If the stock market is right, current risk pre-

miums indicate that companies earnings will

fall going forward. It will come as no surprise

that as active equity managers, we think thatthe stock market is wrong, again.

Wont China save the world after all?

Fifty years ago China set itself the target

of producing more steel than the US. The

nations Great Helmsman, Mao Zedong, was

convinced that steel production was the most

important factor for industr ial development.It is therefore no coincidence that China is

currently the worlds largest manufacturer

of steel by far, with around 45 percent of the

worlds production.

Being the worlds largest steel produ-cer does not necessarily mean that econo-

mic growth will continue unabated, howe-

ver. Worse times globally have a particular

impact on demand for steel. The building

and construction industry is quick to put on

the brakes. Building activity in China, which

many people believe has been artificially

high in order to stimulate growth, has also

experienced a shot across the bow. Togetherwith infrastructure, building and construction

constitutes around 55 percent of the Chinese

demand for steel.

The price of iron ore, the central input fac-tor in steel production, has fallen from USD

200 per ton at the start of 2011 to around

USD 135 per ton. Steel producers in China,

which have enjoyed a double-digit growth

rate in demand for more than a decade, must

now make do with a growth rate of around

four percent.

The recent improvement in the leadingeconomic indicators from China signals that

the fall in the growth rate may be in the pro-

cess of flattening out. If that is the case then

global companies with substantial exposureto emerging markets could be about to expe-

rience better days ahead. The fact that the

Source: Capital Economics

16

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8

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4

2

0

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-4

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10

8

6

4

2

0

-2

-4

2000 2002 2004 2006 2008 2010 2012

Households Private sector

Non-financial corporations

MFI lending to the Private Sector (% y/7)

EURO COUNTRIES BORROW LESS

Cold summer in Europe: Although the European Central Bank continues to pour capital into distressed banks, there are few

signs of increased lending activity in the private sector. Uncertainty about future economic developments means that thebrakes are still on.

Source: The Economist

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0

1791 1810 20 30 40 50 60 70 80 90 1900 10 20 30 40 50 60 70 80 90 2000 2012

British 2.5% perpetual bond

US ten-year bond

An all-time lowGovernment bond yields, %

RECORD LOW LONG YIELDS

Lowest since the 1700s: Fear and risk aversion among investors have pulled down the yields on government bonds in theUK and the US towards and below the levels we saw during the Great Depression in the 1930s.

5

4

3

2

1+0-1

2

3

World GDP* Rich countries

Source: The Economist*Estimates based on 52 countries representing 90% of world GDP. Weighted by GDP at purchasing-power parity.

BRICs Other emerging countries

2007 08 09 10 11 12

% change on year earlier Total

SLOWDOWN IN GLOBAL GROWTH

A fallin g curve: Growth in the world economy has been falling since the end of 2009, including in emerging markets. Is itstarting to flatten out?


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copper price which often warns of danger in

the stock market also seems to be flattening

out, may also presage better times ahead.

New regulations may kick start stock markets

As a result of the tightening and regulation

that has taken place in the banking and insu-

rance sector (Basel III and Solvency II) over

the last decade, assets have flown out of

equities and into government bonds. This has

pushed down yields on government bonds to

new lows, with the exception of the periphe-

ral, debt laden part of the eurozone.An increasingly lower return on bond port-

folios has slowly but surely drained the life

out of the returns of life insurance compa-

nies and pension funds. The result is an evergreater imbalance between the development

of assets and the liabilities associated with

future pension payments.

Recently we have seen several proposals

for regulatory changes from a number of

countries, including Sweden and Denmark.

The proposals broadly aim to get authorities

to put a floor under the discount rates that

life insurance companies and pension fundsuse to calculate their future liabilities. This

will enable them to loosen the straitjacket

that has led to the stockpiling of government

bonds and the sale of equities.

If the regulatory changes become wides-

pread, we would first see a reduction in the

forced sale of stocks. In the second round

the above mentioned pension players would

gradually start to increase their equity hol-

dings again.

This may be just what is needed to kick

start the stock markets, after a protracted and

miserable period for global equity investors.

Source: Bloomberg

4.5x

4.0x

3.5x

3.0x

2.5x

2.0x

1.5x

1.0x

0.5x

0.0x

-0.5xJan-92

Jan-93

Jan-94

Jan-95

Jan-9

6

Jan-97

Jan-98

Jan-99

Jan-00

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-0

6

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

1.64x

1.46x

Trailing PBV

MSCI EM MSCI World

CHEAP BOOK VALUE GLOBALLY

Down in the dumps: Fear and distrust of equities as an asset class has meant that the price you pay for companies bookequity is almost down to the trough levels of 2008/09.

Source: FactSet, MSCI, IBFS. data as of Jun 22.2012

39.0x

34.0x

29.0x

24.0x

19.0x

14.0x

9.0x

4.0x

Jan-92

Jan-93

Jan-94

Jan-95

Jan-9

6

Jan-97

Jan-98

Jan-99

Jan-00

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-0

6

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

+1 SD

-1 SD

Average

10.2x

MSCI EM Trailing PBV

LOW EXPECTATIONS OF FUTURE EARNINGS

Historically cheap in emerging markets: Emerging markets are now priced at only ten times current earnings from compa-nies. We have seen equally low prices twice earlier in the past twenty years: in the spring of 1992 and late autumn of 2008.

Geir Tjetland

gt ska ge nf ond ene. no

May kick start the stock market: Regulatory changes for life insurance companies and pension funds which make it possibleto increase stock holdings may kick start the stock market after a long and lamentable period for global equity investors.

Mao Zedong counted on copper: Fift y years ago, ChinasGreat Helmsman, Mao Zedong, set himself the goal ofproducing more steel than the US. He succeeded. China iscurrently the worlds largest steel producer with around45 percent of the global market.

Photo:Bloomberg


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Powerful changes taking place

Investors risk appetite waned again during

the second quarter, which ended weakly forSKAGEN Vekst, both in absolute terms and

relative to the benchmark index.

The southern part of the euro-area has

been mired in the widely known problems

of too much debt due to generous welfare

programs and high, but insufficient tax pro-

ceeds. Politicians have been squabbling for

a long time and harsh decisions on reformsin the labour market, pension systems and

welfare systems need to be taken and imple-

mented as soon as possible.

The economic indicators for China, Bra-

zil and Russia amongst others also pointed

downwards, which didnt help the mood.

Prices for raw materials such as oil and alu-minium have declined 10-30% in the second

quarter, reflecting the economic uncertainty.

It is hard to know when the outlook will

begin to improve but at the risk of sounding

nave there are actually some very forceful

changes taking place, which will change glo-bal history and which current stock prices

seem to ignore.

1. The one billion affluent people living in

the traditional OECD area are daily being

joined by several hundred thousand new

middle class consumers in Asia, Af rica

and Latin America. In ten years time there

will be one billion more middle class

consumers in need of cars, houses,

vacations, smart phones and nice

clothes.

2. Technology changes and productivity

improvements are currently faster thanthey were just ten years ago. It seems

like much longer, but Apples iPad is only

two years old.

3. Governments with too much debt can look

forward to playing a smaller role in the

future society and the geo-political power

spectrum will change.

Each of the three themes above will change

the world as we know it today and SKAGEN

Vekst is working to achieve the best returns

for its unit holders from these changes.

Cornerstones disappointed

SKAGEN Veksts weak(er) share price deve-

lopment in the second quarter can partly

be explained by the fact that several of the

cornerstones of the portfolio disappointed,

particularly our Brazilian holdings in Petro-

bras and Eletrobras (see table).

News from Eletrobras actually shows

improved earnings from operations, though

this has not been rewarded by the stock mar-

ket. As their hydro power expansion program

comes to an end in 2015 then electricity will

generate good cash flow for shareholders(see SKAGEN Kon-Tiki comment). Petrobras

on the other hand guided lower production

volumes in future and higher capex due to

more expensive rental terms for rigs, supply

boats and higher wages.

But beyond all the company-specific

news, the big news for the development of

the Brazil stock market was the Argentinean

privatization of YPF - the Repsol controlled

oil-company. The nationalisation risk spread

to other countries in the region. We believe

the nationalisation risk in Brazil is close to

zero.

Eight kroner for aluminium

Norsk Hydro was one of the funds most

negative contributor in the quarter due to

the 13% decline in aluminium prices since

the end of March 2012. With the aluminium

SKAGEN VekstPERFORMANCE (EUR) APRIL JUNE 2012* YEAR TO DATE*

SKAGEN Vekst -3.68% 8.2%

MSCI/OSEBX Index -2.43% 8.3%

*As of 29 June 2012

SKAGEN Vekst team

Portfolio managers Ole Seberg ,Geir Tjetland and Beate Bredesen

SKAGEN VEKST KE Y FIGURES FOR THE LARGEST HOLDINGS

CONTRIBUTORS SECOND QUARTER

Largest positive contributors

Company MNOK

Marine Accurate Well +45

ongsbergGruppen +

Gjensidige Forsikring +15

Origio +15

TGS-Nopec +1

Cermaq +12

TTS Group +12

Telekomunikasi Indonesia +11

annover Re +11

Austevoll Seafood

Largest negative contributors

Company MNOK

etrobras -45

Sevan Drillin 40

Solsta O shore

OF 7

letrobras -34

Chiquita -23

orsk Hydro -21

G Elect onics -19

MGS -18

ockwise -18

LARGEST PURCHASES/SALESAP RI L- JUNE

L ARGEST PURCHASES LARGEST SALES

EMGS ltek

Norsk Hydro vry

Continental airstar Heavy Transport

SAP Gjensidige Forsikring

Baker Hu hes arn val

Gazprom TGS-NopecRoyal Caribbean Cruises Transeuro

RSA Insurance Group yocera

Samsung Electronics pref. Samsung Electronics ord.

Company Size of holding Price P/E 12E P/B last Target priceamsungElectronics 5,3 % 74 ,2 1,1 1 15

ongsberg Gr ppen ,9 % 113 10,2 2,3 150

oyal Caribbean Cruises 3,0 % 26,0 12,1 0,7 0

Wilh Wilhelmsen Holding 2,6 % 145,0 ,3 0,8 200

Teva Pharmaceuti al 2,3 % , 7, 1,7 0

olstad Offshore 2,3 % 5,0 5,3 0,7 17

DOF 2,3 % 30,0 7,3 0,8 0

Norsk Hydro 2,3 % 26,7 23,8 0,7 38

Eletrobras 2,2 % 1 , 7,1 ,3

Norwegian Air Shuttle 2,2 % 108,0 9,0 1,9 17

lav Thon Eindom 2,1 % 860,0 11,5 0,9 1 200

an er Rolf 1,9 % 110,0 12,9 0,8 150

Top 12 weighted average 3,0 % 7,6 , 59 %

SCI 12,1 1,7

Oslo benchmark index 10,4 1,4


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Hit by the aluminium price drop: Due to the fall in aluminium prices, Norsk Hydro is one of the worst contributors to SKAGEN Vekst year to date. Adjusted for the value of the companys po-wer rights, you now get the companys aluminium activity at spot prices.

Photo:Bloomberg

price at USD 1,850/ton it is not profitable

for most producers to produce.Norsk Hydro trades at NOK 26, which

means that you get the aluminium business

for a song. The companys hydro power acti-

vities are worth NOK 18 per share, so the

remaining NOK 8 is basically the current

perception of the future cash flow stream

from the aluminium business. That is NOK

16bn or EUR 2bn for one of the worlds lar-

gest aluminium producers just ahead of a

period in which one billion new middle class

consumers will be buying cars and houses

and needing infrastructure, whereby alumi-

nium is a large par t of the demand.A falling oil price is partly to blame for the

weak share price development of our Nor-

wegian investments within the supply sec-

tor, Solstad Offshore and District Offshore.

Norwegian supply companies are generally

extremely cheap, based both on earnings

and book equity. The rates are rising too

much, and hopefully we wont see too many

new ship contracts in future which could tip

the market balance.

Samsung down on good figures

During the second quarter Samsung Electro-nics gave up almost its entire 22% perfor-

mance seen in the first quar ter, despite the

operating performance being very strong.

Samsung mobile became the worlds lar-gest mobile phone company in units and is

number two in revenue share after Apple.

The Galaxy III mobile phone was launched

during the second quarter and has been well

received.

The memory chip business was slightly

weaker as a bankrupt competitor in Japan

apparently had a fire sale of their invento-

ries, so pricing was down. The balance in the

memory chip market is, however, moving in

the right direction.

In the TV business, Samsung Electronics

is the world leader with a 26% market sharedriven by SmartTVs and 40 plus screen

sizes. Interest in T V producer stocks gene-

rally was lacklustre after slightly disap-

pointing sales up to the European Football

Championship.

SKAGEN Vekst holds the preference sha-

res in Samsung Electronics, which get their

share of added value in the company, but

with no voting rights. The preference sha-

res now trade at a record discount to ordi-

nary shares with an earnings yield of 19%

for 2012.

New major contract for Kongsberg

Kongsberg Gruppen, the Norwegian defence

and marine contractor, made a moderate

positive contribution to the fund in thesecond quarter. In June the company repor-

ted a NOK 20-25bn multi-year defence

order for the F-35 aircraft program, which

is obviously a huge lift to Kongsberg Grup-

pen whose 2012 revenues are expected

to be NOK 15-16bn. In addition to the F-35

news flow there is a higher likelihood that

Kongsbergs naval missiles program will get

orders.

The strong order book in the marine busi-

ness and the coming order flow in defence

more than outweigh the lack of new large

orders in the remote weapon system divisionin our view. Kongsberg Gruppen trades at an

earnings yield of 10%, but going a few years

out it will be trading at a 13-15% earnings

yield (based on the current price).

Large premium for fertility

Origio, the Norwegian-listed and Danish-

based human fertility service provider, recei-

ved an attractive acquisition offer from Cana-

dian Cooper Companies at a 72% premium.

Growth prospects are good for fertility

services, but the financial results over the

past few years have been unimpressive. Thenew Canadian owner will therefore be able

to harvest synergies and utilize production


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22



facilities better than Origio on a stand-alone

basis. At NOK 28 (the take-out price) Origiois valued at an earnings yield of 3.9%, which

we believe is an attractive exit level.

Other positive contributors worth mentio-

ning in the second quarter are our insurance

investments, Gjensidige, Royal Sun and

Hannover Rueckversicherung. All of these

contributed nicely in a period in which the

development for the banking sector in gene-

ral has been extremely weak.

Unlocking hidden values

The SKAGEN Vekst portfolio comprises

companies with attractive valuations andwith assets of high value in other owner-

ship structures. SKAGEN Vekst focuses onunlocking these values and hence bringing

prosperity to the funds unit holders.

The Origio takeout serves as a good

example of how value can be unlocked.

Other cases from the recent past are Kver-

neland, Winn Dixie Supermarkets and a

partial change in ownership in Hurtigruten.

SKAGEN Vekst ended the second quar-

ter at a share price of EUR 159. Based on

the proportionate share of earnings in the

companies Vekst owns the estimated EPSfor 2012 is EUR 21 and EUR 26 for 2013.

The book value per Vekst unit is EUR 185,

so Vekst has an 11.4 % return on equit y.

Since the beginning of the year 2012 EPS

is up 8 percent and 2013 EPS is up 11 per-

cent. The higher earnings are mostly due

to port folio changes.

During the quarter we reduced the Nor-wegian exposure ot the portfolio, and at the

halfway point this constituted 57 percent.

For information on specific changes in

the portfolio, please refer to our monthly

status reports at ww w.skagenfunds.com

Read more about the fund on page 32

SKAGENFUNDS.COM/SKAGEN-VEKST

Many more will have iPhones: Although many people have an iPhone, or Samsung Galaxy, already, there are several hundred million people in emerging markets which will cross the thres-hold to become middle class and buy their first smart phone, first home and first car.

Photo:Bloomberg

Major contract: Kongsberg Gruppen got a major contract with the US army in June to deliver equipment for their F-35 fighterjets. They also recently extended their CROWS II contract f or NOK 500 million (picture).

Photo:KongsbergGruppen


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23



To safety

As has happened many times before in times

of turmoil, global investors fled to the per-

ceived safety of government bonds, and in

particular the US and Japan in the second

quarter. Their currencies also strengthened,

in particular the Japanese yen, and interestrates fell to record lows. In Germany, the

interest rate on two-year bonds declined to

negative levels.

The US stock market had a relatively strong

quarter, while several of the most prominent

emerging markets such as Brazil and Russiaexperienced considerable declines. Typically

also in times of turmoil, the emerging market

currencies took a beating, particularly those

of the two above-mentioned countries and

India which is experiencing higher inflation

and lower economic growth. The country is

also struggling with political unrest and largetrade and budget deficits.

In short, the forces at play in the second

quarter were many of the same that affected

the markets in the second half of last year and

in 2008. With this as the backdrop, SKAGENGlobal has had a period of relative and abso-

lute weak develo

Documents

informe skagenfunds