Fund Manager Review October 2023

Mind the Bogeyman

October was really a bad month for finan­cial markets. The list of concerns was a long one: exces­sive infla­tion, possible additional Fed tightening (or at least higher rates for longer), incre­a­sing federal budget deficits bringing ever-larger supplies of new Treasury issuance, rising geopo­li­tical concerns, a possible near-term reces­sion, and the specter of a federal govern­ment shutdown (yes, again) on November 17.

Long-term Treasury securi­ties saw a sharp drop in prices, with the 10-year yield reaching 5% (last seen in 2007) and equity markets also strug­gled. The S&P500 fell by 2.1%, the Nasdaq dropped by 6.4% and the small-cap Russell2000 Index was down 6.1%.

The MSCI Europe ex-UK Index declined 3.3% on the month, as cracks continued to emerge in the economic outlook for the eurozone. In the UK the FTSE All-Share fell 4.1% as higher interest rates appear to be biting. Japanese equities strug­gled as well, with the TOPIX Index falling by 3.0 percent, despite weakness in the yen.

The Tareno Global Water Solutions Fund achieved a perfor­mance of ‑4.93% (R1 EUR).

Water funda­men­tals

Industrial Channel:

The industrial sector is performing well, driven by resho­ring initia­tives and industrial pretre­at­ment. This has helped demand remain strong despite challenges in the broader economic landscape. While some niches, like health­care and life sciences, show signs of slowing, the overall outlook for the industrial channel is favorable.

Municipal Channel:

In the short term, the municipal channel is stable, with backlog burn conti­nuing. However, there are concerns on the horizon, as senti­ment is starting to shift negatively, and the impact of recent interest rate spikes remains uncer­tain. The water/wastewater and environ­mental sectors have seen declines in project activity, indica­ting poten­tial challenges ahead.

Construc­tion:

Residen­tial demand is decre­a­sing, likely due to rising interest rates. Non-residen­tial construc­tion, surpri­singly, remains resilient. However, there are indica­tions that this sector may also face challenges in the near future. The Archi­tec­tural Billings Index dropped signi­fi­cantly in September, signaling poten­tial diffi­cul­ties ahead.

Agricul­ture / Irriga­tion:

The agricul­ture sector is facing headwinds from lower commo­dity prices. Corn prices are notably lower than a year ago, impac­ting demand for ag equip­ment.

Our month in water

October is a heavy month for earnings in the water space. Most results came in better than expected, but the sometimes clouded outlook in some cases led to erratic market reactions. There were solid reports from Badger Meter (higher margins, but already reflected in the price), Mueller Industries (beat expec­ta­tions, upping estimates), A.O. Smith (beat expec­ta­tions and raised guidance) and Gorman Rupp (strong revenue growth and increased margins). There were more muted reports from Pentair (in-line, but guidance trimmed), Franklin Electric (tepid results and lowered guidance), Xylem (below consensus on weaker margins) and Ecolab (bottom line missed, but revenues were strong).

Earnings left aside the top contri­bu­tors in October were the water utili­ties Severn Trent (+12%) and United Utili­ties (+11%). UK water compa­nies published their business plans for the 2025–30 period and the step up in invest­ment (mostly to reduce sewer overflow due to storm­water) was well received.

Everyone deserves a good scare on Hallo­ween

Ours came from Valmont Industries, a leading supplier of irriga­tion systems globally. Back in 2021 they invested about USD 300M to acquire an ag-tech company named Prospera. The idea was to integrate AI techno­lo­gies with center pivot irriga­tion to develop real-time crop analysis. At their capital markets day in May, Valmont gave an upbeat outlook for their ag-tech business giving the impres­sion that growth is excee­ding expec­ta­tions. Fast forward into October, Valmont missed expec­ta­tions as they took an impair­ment charge on Prospera (almost halve the amount they paid for it). Manage­ment mentioned slower growth and adoption rates than initi­ally planned. The stock lost almost 15% on the day as a conse­quence.

We decided to start exiting the position as it will take manage­ment some time to rebuild trust. We trimmed positions in Badger Meter and EVN AG in order to take some profit. We used part of the proceeds to build positions in Masco (plumbing supplies) and Idex (fluid handling).

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