HL Select Global Growth Shares – Q2 2021 Review

Gareth Campbell - Fund Manager

22 July 2021

Market Review

The debate over inflation and faster global economic growth continues. Will higher inflation be the new normal, or is it a passing blip? There is clearly an ongoing recovery in demand, at a time when the pandemic has left bottlenecks in global supply chains. These have created shortages, and these plus depressed prior year comparatives are pushing headline inflation data higher.

The excitement around GDP growth meant the strong Q1 performance of more cyclical sectors such as banks and energy continued in early Q2. However, by the middle of May, leadership had reverted to "growth stocks" and we saw strong performance from Technology and Healthcare sectors.

Undoubtedly inflation is increasing, but the key remains its persistence. If it is just a transient issue, then central banks will likely be more comfortable retaining a policy of low interest rates.

Inflation is typically reported as a single number; however, it is calculated from a basket of goods, so extreme moves in certain products or services can significantly impact overall inflation. For example, in May, the US reported inflation of 5%, but about 1/3 of that was driven just by used car prices. Particularly low inflation in 2020 also upwardly impacts the current rate of inflation.

We believe that wage inflation is a more important variable to monitor. If employees demand higher wages, due to the expectation of higher living costs, their employers have to increase prices to offset these additional costs. That can be the beginning of an inflation spiral.

Other experts believe that increased technology adoption, improving productivity, and demographic headwinds mean we will shortly be returning to the prior environment of low inflation, lower growth and lower interest rates.

We are unchanged in our belief that the secular drivers of growth across the portfolio remain as strong and persistent as ever before. In the short term, share prices may be impacted by changes in market sentiment. However, as these companies grow, their intrinsic value is increasing and compounding at a faster rate than the average company. This belief gives us confidence in our ability to deliver excellent long-term investment performance.

Performance Review

The HL Select Global Growth fund returned 5.97% during the quarter (to 31 March) compared to the FTSE World Index of 7.54%. The US continued its solid period of performance, while at a sector level Information Technology, Healthcare and Financials contributed the majority of performance over the quarter. Past performance is not a guide to future returns.

Our underperformance was driven primarily by stock selection, with a negative surprise from Haemonetics accounting for most of the difference.

Since its launch in May 2019, the fund has delivered a total return of 54.68%* compared to the FTSE World Index return of 37.55%.

Past performance is not a guide to the future. Source: *Lipper IM 30/06/2021

N/A = data for this period is not available.

Positive and Negative Contributors to Performance

Positive Contributors

Past performance is not a guide to the future. Source: Bloomberg to 30/06/2021

Moody's was our most substantial positive contributor during the quarter. The fund benefitted from our decision to more than double the position size between December and February after a period of sustained relative underperformance. Given the increase in valuation, we have since reduced the position back to a more average sized holding.

Pernod Ricard increased guidance and is benefitting from reopening hospitality, and travel, as Covid restrictions reduce across many parts of the world.

Adobe and GoDaddy have both had more challenging performances, year to date, but we believe excellent results and increased momentum around technology stocks helped deliver good performance during the quarter.

Negative Contributors

Even across such a short period, it is disappointing to report negative relative performance, despite the recovery in growth stocks since May. The majority of this was driven by weakness from Haemonetics, which we describe in more detail below.

Past performance is not a guide to the future. Source: Bloomberg to 30/06/2021

At the end of April, Haemonetics announced that they had lost a large, long-established contract (approximately 12% of revenue). This lost contract was surprising news and was taken badly by the market. A key reason we were attracted to the plasma industry was Haemonetics' dominant market position, seemingly low levels of competition and the company's new technologies, which we believed increased their value as a partner to critical suppliers.

Given we had viewed the company as significantly undervalued before this news, the 40% reduction in share price for a 12% loss of revenue seemed like an overreaction. However, it still isn't evident to us why their customer, CSL, decided to switch to Terumo of Japan. Terumo had not previously been a significant competitor to Haemonetics. The credibility of the Management has been severely impaired, and therefore, despite the fall in the share price, we thought it was appropriate to reduce our holding given the ongoing uncertainty.

Conversations with Haemonetic's management team and recent results have helped remove some fears. However, until there is more certainty on the pricing of Haemonetics new technology, we think the shares are unlikely to regain their prior multiple. For now, we remain holders and will continue to analyse the situation, learn from it and try to avoid these mistakes in the future.

Philips has initiated a voluntary recall for certain sleep apnoea, and respiratory devices, which it discovered had a defect earlier in the year. This recall is expected to cost the company some €500m. Phillips is a very diverse healthcare business with a market cap of €36 billion, so although this news is disappointing, it shouldn't be meaningful to its long-term success.

New Positions

No new positions were started in the quarter.

Sold Positions

No positions were sold in the quarter.

Portfolio Changes

We increased our holdings in Autodesk, Charles Schwab, Cryoport and Ubisoft in April as we believed all were undersized given their quality and growth potential.

After reviewing the payments sector in more detail, we reduced our PayPal position, maintained our position in Visa and increased our position in Fiserv.

Payments is an industry we are very positive about, given the high barriers to entry and long-term secular growth from increased penetration of electronic payments. PayPal's performance since the launch of the fund has been exceptional. As a result, we believe the elevated multiples of the business today could limit future shareholder returns versus other areas of the payment industry.

We think Fiserv is positioned to benefit from a reopening of the economy given their greater exposure to in-person transactions, while our work on the payments industry leaves us comfortable that fears about long term disruption are excessive. Despite this, Fiserv trades at a P/E multiple lower than the index and almost 1/3 of PayPal.