HL Select Global Growth 1 Year Review

Steve Clayton - Fund Manager

7 May 2020

An eventful first year for HL Select Global Growth Shares has seen escalations of the US and China trade war, a UK general election and we are now managing through a global pandemic.

The fund has the flexibility to find companies we believe are the very best. It can invest across the world and in companies of all sizes, including higher-risk emerging markets or smaller companies where we see excellent growth potential.

Typically, only the 30 to 40 companies that we feel most confident about will make the grade. We want each to have the ability to lift the fund when things go well, as we aim for higher returns. It works both ways though, so it’s a higher-risk approach.

Despite the uncertainty throughout the year we have remained focused on identifying high quality businesses with long term growth potential that are in charge of their own destiny.

The HL Select investment philosophy has helped us avoid some of the worst hit areas of the market, such as banks and the energy sector, while the secular growth many of our companies benefit from has led to performance of 7.2%* over the last 12 months, compared to a negative total return of 2.1% from the FTSE World Index. As a team we are particularly pleased with the portfolio's resilience in the market down turn. Past performance isn’t a guide to the future.

A key part of this resilience comes from identifying businesses with unique characteristics which make them better positioned to thrive despite market conditions. One common theme that links many of these businesses is technology playing a more important role across the economy. For that reason our average portfolio weight in technology sector has been 28%, plus we have further exposure from holding global leaders such as Google, Amazon and Tencent which sit outside of the technology sector.

Our strongest performance in technology has been from our digital design and simulation businesses Ansys and Autodesk. These two businesses contributed 1.75% to the portfolio’s return, with Ansys delivering 39% since launch and Autodesk 24% since we added the position in October.

We still believe that the drivers supporting the growth of these businesses are early and they remain high conviction positions in the fund.

Outside the digital winners, analysis of business models and supply chains has identified other businesses which we believe will have superior growth over the long term. For example London Stock Exchange or Moody’s are essentially infrastructure which enable debt and equity markets to function efficiently. Collectively these two businesses contributed 1.9% to fund performance, delivering a 46% and 29% return respectively in the fund’s first year, far better than the broader financials sector where credit risk is increasingly questioned during a recession.

One of our strongest performing sectors has been healthcare, it is an area we found a lot of interesting businesses so on average has been almost 15% of the portfolio. Our businesses look very different to the healthcare sector with a focus on innovation within equipment and services versus pharmaceuticals. Stock selection has been a large driver of outperformance in healthcare with West Pharmaceuticals and Masimo both delivering almost 65% since launch, combined with DiaSorin, Coloplast and Fisher & Paykel they have collectively contributed 5% to the portfolios return.

We have sold the latter three businesses as we felt the share prices were increasingly stretched from their intrinsic value. In March we took advantage of market falls and added IDEXX Laboratories. IDEXX is a high quality business which is benefiting from rising levels of diagnostic procedures being performed upon companion animals. We think this theme can play out for a long time to come. The innovation, growth and barriers to entry in healthcare equipment and services make it an attractive sector to search for quality businesses.

Not owning any energy stocks contributed almost 2% to portfolio performance as the oil price more than halved when demand cratered due to the coronavirus. We used this as an opportunity to start a position in Texas Pacific Land Trust. Texas Pacific Land Trust owns 900,000 acres in West Texas and receives a royalty for the value of every barrel extracted from its land. With net cash on its balance sheet and exceptionally high margins from the royalty business model, it is a high quality way of benefitting from a recovery in oil prices.

Although we are pleased with our performance we haven’t always got it right. We look to learn from the inevitable missteps along the way and refine our investment process accordingly. Investing is never certain, not all of our ideas will work and unpredictable events will always have to be managed to the best of our ability with the information we have at the time.

Underperforming ideas can be divided into many categories, one way we like to distinguish them is by their cause and effect. Was the cause an analytical error we had control of, or was it a market condition we had no reasonable chance of foreseeing and has the effect meaningfully impacted the underlying intrinsic value of the business or just its short term share price performance?

Burford Capital is our biggest negative contributor to performance at almost -1.5%, this was a unique business and despite its modest market cap, a global leader in providing lending for litigation. After a short-selling attack the stock fell and as we couldn’t get the answers we wanted to the questions they had raised we sold the position. The sell currently looks like a good decision as the stock has since fallen further. However it also shows our original understanding was not strong enough.

Live Nation has been our second worst contributor to portfolio performance at -1.4%, -40% since we bought in July last year, all of this underperformance has been driven by the coronavirus as their business revolves around live music and sports events, which have stopped globally and show no signs of starting soon. We have since reduced our position size and with the benefit of hindsight should have acted quicker once we realised the breadth of the pandemic.

Ubisoft has contributed just under -0.5% to portfolio performance but less than 6 months after launch it was our worst performing stock with a -40% return. Ubisoft is a video game developer, it had just had a poor launch and then delayed the launch of its next three titles to give developers more time to improve them. After what had already been a poor period of performance the stock fell 20% in a single day. Our analysis was that pushing the launch back was a delay of cash flows and not a complete loss of them so the change in intrinsic value was far less than the share price. Happily the stock has since recovered much of its earlier weakness.

Align Technology was our third largest negative contributor with a -0.9% hit to portfolio return. Align Technology is the global leader in clear plastic aligners disrupting wire braces. We sold the business in October as uncertainty around competition and long term barriers to entry left us less certain of its longer term potential.

Consumer staples has been our worst performing sector contributing -1.7% to portfolio return. Much of this was -0.7% from Shiseido, a Japanese listed cosmetics business. Its margins were below peers and our analysis showed there was no reason why they couldn’t improve. We sold the position in March as concerns around the coronavirus’ impact on Asian demand and travel retail meant margin recovery was unlikely to materialise.

Uncertainty has never been higher in financial markets as many quality businesses with high barriers to entry and conservative balance sheets face ruin as their product or service can’t operate in a world trying to manage a global pandemic. Less than half the number of companies as usual are giving management guidance on revenue or profitability for 2020, consensus estimates are stale as analysts delay cutting forecasts, while debt covenants and credit risk haven’t been this important for 10 years. At HL Select we believe this uncertainty is exactly why we need rigorous fundamental analysis to help identify the intrinsic value of a business despite uncertain times.

The majority of our portfolio will always be focused on resilient businesses in control of their own destiny. But we have added to a few of our more cyclical positions that have been impacted by the virus, but which we believe will still turn out to be long term winners in their industries. One of the benefits of investing into fundamentally strong businesses is that when economies turn down, their strength can allow them to win market share off weaker rivals, or reinforce their competitive moats. We are being very careful when making these, checking credit risks and gaining conviction that an extended shutdown won’t significantly hurt the businesses' long term value.

With a slowing global economy and the severity of recession increasing with every day under lockdown we believe secular growth will be even more important in a world starved of growth. So there is no change in philosophy as we continue to look for high quality businesses, with predictable free cash flow, which we believe can grow over the long term.

Annual percentage growth

Past performance isn’t a guide to the future. Source: Lipper IM 07/05/2020.

N/A = performance for this time period is not available.

Performance data from Bloomberg to 1/5/20 unless otherwise stated.