HL Select Global Growth Shares - Q1 2023 Review

Gareth Campbell - Fund Manager

19 May 2023

Market Review

Despite bearish investor sentiment, Q1 saw positive equity returns across major equity markets as recession concerns eased and investors looked through near-term issues to focus on expected interest rate cuts later in the year.

Strong positive performance was particularly surprising given the quarter included a period of heightened volatility after the collapse of Silicon Valley Bank and Credit Suisse. These issues so far seem isolated and central bank actions have limited contagion from this risk.

Although global economies and employment have proven surprisingly robust, we still think a recession is the most likely outcome, so we have taken steps to increase resilience in the portfolio, by tilting exposures to those businesses that we consider less economically sensitive. We have increased the portfolio’s defensiveness, while retaining exposure to fast growing secular trends, leaving the fund more appropriately positioned to navigate what is still a very uncertain economic future.

As the quarter ended, leading economic indicators and employment data began to soften. This may be the start of things getting much worse, but equally central banks may successfully navigate a “soft-landing”. We have limited confidence in accurately forecasting the timing or path of global economies, so have continued to focus on identifying high quality businesses, which can adapt and grow through the economic cycle.

Performance Review

The HL Select Global Growth fund returned 7.89%* during the quarter compared to the FTSE World Index return of 4.81% and the IA Global sector average of 3.74%. The US was our largest positive contributor to performance, driven by Information Technology, Healthcare and Consumer Discretionary.

Since launch the fund has delivered a total return of 41.88%, compared to the FTSE World Index return of 45.97% and the IA Global sector average of 33.98%.

Past performance is not a guide to the future. Source: *Morningstar Direct.

N/A = the fund launched on 5 May 2019 so performance data before this is not available.

Positive and Negative Contributors to Performance

Our positive relative performance was driven primarily by stock selection, however in a reversal of last year’s trends the Energy, Utilities and Real Estate sectors all underperformed, and the fund currently has no exposure to these sectors.

Strong stock selection in Healthcare, Consumer Staples and Materials was the main driver of outperformance in the quarter. This is despite these sectors all underperforming the market during the quarter, highlighting how we have different exposures to the market as a whole and rewarding our patience in some businesses that had a more challenging 2022.

Charles Schwab was the only significant negative contributor to performance. It and other stock-specific issues are discussed in more detail below.

Positive Contributors

Past performance is not a guide to the future. Source: Bloomberg, 01/01/23 – 31/03/23.

Diversey received an acquisition offer of $8.40 per share from Solenis LLC in early March, which came after the shares had already rallied since the start of the year.

This ends a challenging period for both Diversey and its shareholders. We do think it undervalues the business’ long-term potential, but as a US listed, European focused business negatively impacted by high natural gas prices, it faced huge headwinds after Russia invaded Ukraine.

We underappreciated the commodity exposure of the business model to sharp unforeseen rises in prices. This negative impact to profitability then made its higher than typical leverage more concerning.

We count this as a lesson learned, we should be careful about sacrificing quality in search of higher returns and are thankful the share price recovery this quarter makes that lesson a little easier than at the end of 2022. We reduced our position size after the acquisition announcement.

Nvidia has had an excellent start in the fund, benefiting from increased excitement around the application of AI technologies. We trimmed the position during the quarter after it rallied strongly in the last few months. The stock has continued to do well and has huge long-term potential, but with this performance driven solely by earnings multiple expansion we thought it was prudent to reduce our exposure.

West Pharmaceuticals rallied after it announced Q4 results that were better than investor expectations. The business struggled through 2022, as pandemic-related tailwinds and uncharacteristic operational issues negatively impacted profits, but these seem to have been resolved more quickly than expected.

Microsoft continues to execute well, delivering a return roughly in line with the wider Information Technology sector. We trimmed the position at the end of the quarter.

Cryoport reversed some of last quarter’s poor performance. We still see the shares as undervalued and a unique way to invest in the fast-growing cell and gene therapy industry.

CAE's execution continues to improve with the civil business performing excellently and the absence of negative news from the defense segment reducing concerns about the business. The announcement that Frontier Airlines, a regional US Carrier, was adopting CAE’s Air Centre software is an incremental positive for a business area we don’t see as well understood by the wider market. Nonetheless, we trimmed our position because of increased macro concerns on more cyclical end markets.

Heineken’s 16% return in Q1 was above that of the rest of the consumer staples sector. Part of this was due to a reversal in the discount the holding company shares have, compared to the operating company, from a near 20 year low. We increased our position in January as we believe the business is higher quality than other consumer staples, yet trades at a substantial discount.

Negative Contributors

Past performance is not a guide to the future. Source: Bloomberg, 01/01/23 – 31/03/23.

Charles Schwab was surprisingly caught up in the recent US regional banking crisis, triggered by the collapse of Silicon Valley Bank. Concerns increased as investors worried about an increased pace of “cash-sorting.” This refers to cash deposits leaving in the search for higher interest rates. Some had questioned whether this would require Charles Schwab to sell long-dated investments at a loss.

We think Charles Schwab’s substantial liquidity, continued growth and supportive policies by the US Federal Reserve mean there is limited existential threat from this risk. It has highlighted that Charles Schwab now has a misalignment between its assets and deposits. This was caused by the company investing in longer-dated Treasury bonds where yields were higher, in the hope of boosting profits in the short term. The plan backfired when US interest rates rose faster and further than Schwab had predicted, potentially limiting the expected upside from higher interest rates.

Many investment “experts” have highlighted how easy it was to predict the collapse of Silicon Valley Bank, despite very few mentioning it without the benefit of hindsight. This lack of visibility is a reason why we have limited bank exposure. Charles Schwab might have had limited credit risk, but this “cash-sorting” issue has caused a substantial loss to the fund and is a risk our analysis should have given more weight to.

Recent news from the company has shown US retail investors don’t have the same fears about Charles Schwab as they had at other regional banks, as Charles Schwab has continued to see net client money inflows. This, combined with the limited credit risk in the business, means we believe it is very unlikely to see a permanent impairment to long-term value.

The position remains under review, as this issue may mean that earnings this cycle have peaked, and other investment opportunities are more attractive.

Experian continues to deliver consistent growth, but macro concerns were heightened after a competitor’s division, that has similar exposures to Experian’s consumer facing business, had disappointing results.

Vulcan Materials reacted negatively to results, as management’s guidance implied slower growth than main competitor Martin Marietta. We believe this is down to a more conservative management team, than any likely difference in execution.

One new risk to the business, however, is that regional banks fund a large portion of US construction. So the likely tighter lending conditions after the recent regional banking crisis may have an indirect negative impact on Vulcan Materials and its peers.

New Positions

Intuit is the leading provider of small business accounting software and DIY tax solutions for consumers in the US.

QuickBooks is Intuit’s accounting software brand and has over 8 million active customers, with 80% market share in the small business accounting market in the US.

Most of QuickBooks’ revenue is subscription based, resulting in predictable recurring revenue. As well as increasing the number of customers it serves, Intuit also aims to increase the ‘average revenue per customer’.

QuickBooks benefits from strong network effects, as accountants and businesses prefer to have compatible software. This means new customers are recommended to use QuickBooks by their accountants, while new accountants train on the QuickBooks software as that is what most of their customers will be using.

TurboTax is Intuit’s other large brand, providing products and services to enable people in the US to file their federal and state income tax returns quickly and accurately. TurboTax has an 80% market share of the paid ‘do-it-yourself’ tax return market.

Sold Positions

Phillips first reported an issue with its sleep apnea device in 2021 - it was a relatively small addition within an earnings release. It has since spiraled into a billion-euro recall, a sharp fall in market share and potentially billions in further litigation costs and damages.

Incremental news has been consistently negative, and we think this issue will likely drag on for multiple years, so, the business will struggle to outperform under these conditions.

Given its valuation relative to peers there is likely value within Phillips, but with management quality increasingly questioned we think it is unlikely they will unlock this in the short term.

The overall fall in business quality means it is no longer a suitable investment for HL Select. We sold the remainder of our position in January.

Portfolio Changes

Given increased concerns around a weakening macro environment we have made some small changes to increase the economic resilience of the portfolio. This led to us trimming CarSales, Booking and TriNet to fund additions to Heineken, Pernod Ricard, LSE and Experian.

We trimmed our position in GoDaddy to fund a new holding in Intuit. Both have small business exposure, but we think Intuit has a more resilient business model and the valuation gap had closed after strong relative performance by GoDaddy over the previous year.

We view Elekta as having higher economic cycle risk than other parts of healthcare because of its dependance upon large capital equipment sales. We think radiotherapy is an area of secular growth, but poor execution and concerns around market share losses to Siemens Healthineers, resulted in us reducing our position.