July 22, 2014
Dear Appleseed Shareholder:
“What a drag it is getting old.” -- The Rolling Stones
Released in 1966 when Mick Jagger and Keith Richards were young musicians, this timeless quote from “Mother’s Little Helper” continues to hold relevance today for septuagenarians like the Rolling Stones and generally for an aging world population. Continuing reductions in mortality rates and curtailments in fertility rates act as the primary contributors to an aging global population. This global demographic trend should pick up speed and significance over the next 40 years, with relevant investment implications.
Subsequent to World War II, benign demographic conditions provided a strong boost to U.S. economic growth for several decades as the working population increased. For obvious reasons, an increasing working population acts as a catalyst as national income and related levels of consumption increase, which is why the explosion of the Baby Boomer generation and improved life expectancies created a multi-decade tailwind for U.S. GDP growth.
But that was then, and this is now. By 2025, ~30% of the U.S. population will be over 60 years old. Compared to other developed economies, the
United States has a relatively young population with a median age of 38; nevertheless, the U.S. median age should be rising for decades. In 1970, there were five working adults for every American retiree; by 2050, assuming present trends continue, only two working adults will be supporting each retiree.
As for the larger world population, roughly 16% of people will be over 60 years old in 2025, vs. 9% as recently as 1975. By 2050, the world’s births should more or less equal deaths, and, at that time, the gray population (people older than 60) should exceed 21% of the total population – triple that of 1975. The demographic “leader” of the pack, Japan, with an elevated median age of 46 and a declining population, has been experiencing severe headwinds to economic growth for nearly a quarter of a century in part due to its aging workforce. All of the developed countries are following a demographic path similar to Japan but are merely not as far along.
-5 10 15 20 25 30 35 40 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 1980 2013 2030E 2050E M e d ia n A ge (Y e ar s) P e rc e n ta ge o f G lo b al P o p u la ti o n
Global Gray Proportion
Median Age (Years) Ages 60+ Ages 65+ Ages 80+ Source: UN Department of Economic and Social Affairs
Among the larger emerging markets, Eastern European countries like Poland and Russia face similar age demographics that plague developed economies, while China’s populace continues to gray, as decades of its single-child policy have had a profound impact on its current and future age distributions. The economies of India and Brazil (as well as the economies of many countries in Asia, Latin America, and Africa) stand out in their relative youthfulness, as aging should act as a tailwind for these economies for at least another decade.
Accordingly, dependency ratios should continue to increase as the global population continues to age. The dependency ratio reflects the proportion of non-working members of society (essentially, retirees and children) vs. working adults. Without meaningful reform, aging demographics are expected to have important implications for citizens, for workers, for businesses, and for investors, including the following:
Lower Savings
As a nation’s dependency ratio increases, in countries like the U.S. that provide benefits to retirees, spending on government support for social security, pensions, and medical care tends to rise in absolute dollars and as a percentage of GDP. At the same time, the percentage of working age people paying income taxes to support these benefits declines. Clearly, for countries who have not prepared years in advance for an increasing dependency ratio, demographic imbalances can cause strains on fiscal budgets.
0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0% 45.0% Ja p a n G er man y Fr a n ce UK C an ad a U SA P o la n d Ru ss ia C h in a Br az il In d ia
Share of Population Age 65 and Older
2014 2050
Developed Economies
Emerging Economies
In some countries, like China, government benefits for retirees are limited. As a result, the Chinese personal savings rate is close to 50% because families have to save for their own eventual retirement. As these countries age, their savings rate will inevitably decline as retirees draw from their savings accounts to fund living expenses.
Whether a decline in savings occurs at a national level or at a personal level, an aging population should result in lower aggregate savings rates and commensurate reductions in the aggregate capital available for investment.
Restricted Labor Supply
An increasing dependency ratio should also translate into labor supply constraints over time. All things being equal, a tighter labor supply should contribute to lower unemployment, higher wages, and pressure on corporate profit margins. This trend likely will be partially mitigated by older workers extending their retirement dates in order to make ends meet. In response to potential labor supply constraints, employers are responding by a) automating business processes; b) outsourcing labor
to low cost countries; and c) lobbying for less restrictive immigration policies.
Reduced Economic Growth
A smaller (proportional) workforce, combined with a higher (proportional) population of seniors who receive significant healthcare and retirement benefits and save less, should have a slowing impact on economic growth. The U.N. Department of Economic and Social Affairs estimates that the retirement of the Baby Boomers in the years ahead could reduce the U.S. growth rate by as much as 0.7% per year between 2014 and 2050; this demographic headwind represents a significant percentage of future potential GDP growth. It naturally follows that lower economic growth should translate into lower aggregate revenue growth for the private sector, which, in all likelihood, means more muted earnings growth. To the extent that aggregate debt levels remain high relative to GDP, central banks will feel additional pressure to generate incremental nominal GDP growth via expansionary monetary policies.
Uneven Economic Impact
While real GDP growth should be constrained by demographic trends, certain industry sectors will likely benefit disproportionately while others could face actual declines. Governments with constrained fiscal budgets likely will have less discretionary spending flexibility, and workers who have to bear an increased tax load should have commensurately less money for discretionary purchases. On the other hand, the healthcare sector should perform quite well, and particularly so for companies that offer a product or service that reduces overall healthcare system costs. Consumer staples, always a defensive industry, should remain relatively unaffected by an aging population.
0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% United States World Developed Markets Emerging Markets
Old Age Dependency Ratio Trends
1950 1975 2000 2025 2050
At the current time, the Appleseed Fund’s equity portfolio owns healthcare stocks such as Teva Pharmaceuticals (TEVA), Novartis (NVS), and PDI Inc. (PDII) due in part to our view that healthcare will continue to grow faster than other sectors of the global economy. We are also own consumer staples and agriculture related stocks, such as John B. Sanfilippo (JBSS), Titan International (TWI), Mosaic Company
(MOS), and Rentech (RTK). We have some exposure to Brazil through the Fund’s investment in Avon
Products (AVP), but our exposure to the youthful economies of Brazil and India is limited due to valuation considerations.
Portfolio Changes
New Positions Sold Positions
Teradata (TDC) Tesco PLC (TSCDY)
Sberbank (SBRCY) Pico Holdings (PICO)
We initiated new positions this quarter in the common stock of Teradata Corporation (TDC) and Sberbank (SBRCY). Our long-term shareholders may note that this is not the first time we have owned Teradata. The Company’s mission is to drive data analytics through an enterprise. For decades, its solutions have been designed from the ground up to manipulate corporate data specifically for the purpose of delivering informed analytical and operational business decisions. Teradata’s solutions provide a robust foundation of historical, real‐time, structured and unstructured data for use in analytics, predictive modeling, and intelligent business decisions. This differentiation is what has created Teradata’s best‐of‐breed position in a data analytics market that is in the middle of a multi‐year secular growth market. Sberbank is a highly profitableRussian bank with a very attractive valuation. With a leading market share in deposits and in loans provided to individuals and businesses, Sberbank has generated an average return on equity of more than 20% since 2000. We initiated Appleseed Fund’s position in Sberbank during the quarter at an average valuation of less than 0.9x book value and 5x earnings.
We also sold our positions in Tesco PLC (TSCDY) and Pico Holdings (PICO) during the quarter. Ideally, we like to sell our investments after the share price increases to our estimate of intrinsic value. Put simply, that is how we generate superior returns for our investors over time. However, sometimes we mistakenly overestimate intrinsic value. With Tesco, we sold our shares this quarter after downgrading our assessment of the attractiveness of the UK grocery industry and, with it, our estimate of Tesco’s intrinsic value. Low cost competitors like Aldi are aggressively penetrating the market, and we now expect that normalized industry profit margins will likely decline for Tesco and its UK grocery competitors. The management of Pico Holdings altered its capital allocation strategy significantly since we first purchased the stock, and we have become less confident in its ability to create value. One of the reasons we seek out a margin of safety when we make an investment is that we are then able to mitigate the investment impact of a potential mistake. Appleseed Fund investors generated a gain with Tesco PLC and a slight loss with Pico Holdings.
During the first few days of July, we sold Appleseed Fund’s position in Herbalife (HLF) after its share price appreciated above our estimate of intrinsic value. We continue to closely watch developments that might affect Herbalife’s business and our estimate of intrinsic value, but for now we are watching from the sidelines.
During the quarter, our selling activity outpaced our buying activity, again. In the current, liquidity-fueled market environment, finding sufficiently undervalued investments has become increasingly challenging. We are finding interesting, high quality companies that are slightly undervalued, but the share price discounts are not providing us with a sufficient margin of safety, with the exception of Teradata and Sberbank. As a result, Appleseed Fund’s cash and bond position continues to build and has never been greater than it is today. We are developing our wish list and preparing ourselves to take advantage of an environment in the future where our shareholders might be better paid to take risks.
As always, we thank you for your continued support in our efforts to protect and grow your investment in Appleseed Fund.
Sincerely,
Josh Strauss, CFA William Pekin, CFA Adam Strauss, CFA
The Fund's past performance does not guarantee future results. The investment return and principal value of an investment in the Fund will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Current performance of the Fund may be lower or higher than the performance quoted. Performance data current to the most recent month end may be obtained by calling 1-800-470-1029.
At the end of the Fund’s reporting period on June 30, 2014, Teradata (TDC) represented 3.3%, Sberbank (SBRCY) represented 1.8%, Titan International (TWI) represented 3.2%, Rentech (RTK) represented 2.0%, Mosaic Company (MOS) represented 4.3%, Tesco PLC (TSCDY) represented 0.0%, Pico Holdings (PICO) represented 0.0%, Avon Products (AVP) represented 1.6%, Novartis (NVS) represented 2.6%, PDI Inc. (PDII) represented 0.8%, John B. Sanfilippo (JBSS) represented 4.1%, Teva Pharmaceuticals (TEVA) represented 5.7%, and Herbalife (HLF) represented 0.4% of the portfolio, respectively.
The S&P 500 Index is a widely recognized unmanaged index of equity prices and are representative of a broader market and range of securities than is found in the Fund’s portfolio. The MSCI World Index is a widely followed, unmanaged group of stocks from 23 international markets and is not available for purchase. These indices provide total returns in U.S. dollars with net dividends reinvested. These index returns do not reflect the deduction of expenses, which have been deducted from the Fund’s returns. These index returns assume reinvestment of all distributions and do not reflect the deduction of taxes and fees. Individuals cannot invest directly in these indices, however, an individual can invest in exchange traded funds or other investment vehicles that attempt to track the performance of a benchmark index. Diversification does not ensure a profit or guarantee against loss.
Investments in commodities such as gold may be affected by overall market movements, changes in interest rates, and other factors such as embargoes and international economic and political developments. Commodities are assets that have tangible properties, such as oil, metals, and agricultural products. These instruments may subject the Fund to greater volatility than investments in traditional securities.
The views and opinions expressed in this material are those of the authors. While we believe we have a reasonable basis for our appraisals and we have confidence in our opinions, actual results may differ materially from those we anticipate. These opinions are current as of the date of this letter but are subject to change. There is no guarantee that any forecasts or opinions in this material will be realized. Information should not be construed as investment advice nor be considered a recommendation to buy, sell or hold any particular security.
You should carefully consider the investment objectives, potential risks, management fees, and charges and expenses of the Fund before investing. The Fund's prospectus contains this and other information about the Fund, and should be read carefully before investing. You may obtain a current copy of the Fund's prospectus by calling 1-800-470-1029.
Distributed by Unified Financial Securities, Inc., 2960 North Meridian Street, Suite 300, Indianapolis, IN 46208 (Member FINRA).
