HL Select Global Growth Shares – Q4 2021 Review

Gareth Campbell - Fund Manager

4 February 2022

Market Review

Late 2021 saw inflationary pressures continuing to build in the USA. Consumer Price Inflation has already surged to almost 7% in the US, leaving households facing an ongoing squeeze on their standard of living. Eventually, the Federal Reserve ceased describing this resurgence as “transitory” and, as a result, have signalled a less accommodative monetary policy ahead.

In response to higher inflation, the US and European central banks suggested QE could end earlier than expected, while the Bank of England increased base rates for the first time in 3 years.

This scenario does raise the risk of a policy mistake as central banks have to manage inflation for the first time in a decade, without negatively impacting employment and GDP growth. At the same time, COVID continues to impact the economy and broader society.

Omicron appears less impactful than previous COVID variants, but its ability to spread more rapidly means that it can still pose significant challenges to public healthcare systems. Governments have seemed uncertain of the best route to manage the surge in cases, well demonstrated here in the UK, where we have multiple approaches taken by the devolved administrations.

Even if COVID has become less deadly, a large wave of infections, resultant quarantines, and isolation will disrupt industry and supply chains. This will delay the recovery to a “new normal”, and we believe, will extend this period of heightened inflation.

Longer-term, we think many factors pushing up inflation issues will return to pre-pandemic trends as new technologies and changes in the labour market improve productivity. However, the risk from persistent wage inflation is increasing.

Our investment philosophy’s focus on identifying companies with pricing power should help protect them longer-term from higher rates of inflation. We have also made some changes to better manage these risks.

Performance Review

The HL Select Global Growth fund returned 0.96% during the quarter compared to the FTSE World Index of 6.92%. The US was our leading geographical contributor to performance, with Information Technology, Financials and Materials the highest contributing sectors.

Q4 capped off a disappointing year for the HL Select Global Growth fund. There have been mistakes, which we aim to learn from and avoid in the future, but equally, some of our holdings continue to execute well, and we believe the market will recognise that over the long term.

Since launch, the fund has delivered a total return of 60.37% compared to the FTSE World Index return of 50.01%. Past performance is not a guide to future returns.

Past performance is not a guide to the future. Source: Lipper IM to 31/12/2021

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

Positive and Negative Contributors to Performance

Our negative relative performance was primarily driven by individual stock selection.

The underlying cause of the underperformance was a combination of COVID impacting businesses that would benefit from a return to normality, the relative underperformance of smaller cap stocks, and the stock-specific issues discussed below.

Positive Contributors

Microsoft is a high-quality business, which continues to outperform market expectations, justifying its large position size.

GoDaddy's strong results helped reduce investor concerns about growth. The pace of innovation accelerates with new commerce and omnichannel products, and we have used recent weakness to increase our position size during the quarter. In December, the activist investor Starboard revealed a 6.5% position in the company. Starboard hasn’t yet disclosed its reasoning, but we agree that there is substantial unappreciated value in the business.

Charles Schwab’s business is executing well with $139B of asset growth in the quarter. However, the likely reason for much of the share price performance is that it is a beneficiary of higher interest rates. This is the main reason why we added to the position during the quarter.

Vulcan Materials aggregates business has continued to show its pricing power and ability to improve profit per ton. In August, it completed the acquisition of US Concrete. It’s a lower quality business, but the acquisition highlights management’s confidence in the demand environment over the next few years. Infrastructure remains one of the few areas of bipartisan support, so although the Democrats “Build Back Better” bill initially failed, we believe it is still likely to pass with some changes in 2022.

Negative Contributors

Phreesia’s volatile share price doesn’t reflect the acceleration in revenue growth of the business. Management spooked investors during the last quarterly call: however, after speaking to them, we have confidence in the accelerated investment strategy and think execution will likely be much better than current expectations. As a small business trading on a high multiple, it also faced additional market-based pressure during the quarter. We took profits earlier in the year but used recent weakness to increase our position size as we still have conviction in the long-term opportunity.

CAE is the largest provider of pilot training solutions globally, so negatively reacted to the COVID 4th wave, emergence of Omicron and renewed travel restrictions. In times of stress, the business is treated more like an airline than a high-quality service business. We had reduced our position in October given concerns about COVID during the winter, but after the significant pullback, we used this as an opportunity to increase our position. As business and leisure travel recovers, we believe CAE is excellently positioned to benefit from this trend.

Ubisoft was a costly lesson to learn, but we have since sold the position and aim not to repeat the mistake in the future: it is discussed in more detail later.

Diversey is a relatively new holding and has had a disappointing start in the fund. They completed a secondary placing of new shares after recent results, which we used to increase our position size, but the stock has had limited support since. There are some challenges from cost inflation, but pricing power so far has been strong, so we still think the business looks undervalued compared to peers.

New Positions

Since our last quarterly update, we have added GXO Logistics and Amedisys to the fund.

GXO Logistics are the largest pure-play contract logistics company in the world. Contract logistics can be thought of as any activity or service which takes place in a warehouse.

Historically, contract logistics was a relatively simple outsourced service that would receive containers of products, break these down into pallets and then ship them onwards to retailers.

The growth of e-commerce has increased the complexity of logistics. For example, ASOS ships 30m units across 700,000 items, and dispatch needs to be made within 2 hours of the order having been placed to fulfil its delivery commitments. Up to 1/3 of delivered items will then be returned by the customer, so they need to be processed, repackaged, and then shipped to a new customer.

Technology, automation, and analytics are the only ways companies can manage this complexity. GXO’s leading position means we think it will likely continue to take market share, while the greater complexity of operating logistics should accelerate outsourcing.

GXO have a very capital-light business model, enabling them to generate very high returns on capital funding their organic growth and future acquisitions.

We think investors underappreciate the persistency of growth in the business and the growing barriers to entry, and as a result, we see the potential for excellent long-term returns.

Amedisys are a leading home health and hospice care provider in the US. These are outsourced healthcare services aiming to help a patient’s recovery or manage end of life care.

Patients often prefer home health because they can retain greater independence and higher quality of life. It can lead to better patient outcomes, lower costs and frees-up inpatient capacity for other treatments. Additionally, home health can be safer than inpatient treatment, as COVID has shown only too clearly. Payers prefer to support home health as it offers a lower cost than an inpatient facility, uses resources more efficiently, and delivers better care outcomes.

The Senior demographic is set to be the fastest-growing segment of the population for the next 30 years, while the US government is actively encouraging consolidation of healthcare service providers, given the efficiency savings and improvement in quality of care. We believe this makes Amedisys an attractive investment opportunity over the long term.

Scale, technology, and quality of care enable Amedisys to achieve much higher margins than the industry average. The US government sets pricing, but low industry average margins mean that cost inflation is added to prices. So, although margins are capped, we are confident they are sustainable, the main reason we value pricing power so highly across our holdings.

Amedisys had a challenging 2021 due to management misstep, which increased staff turnover within hospice sales, the pandemic, and concerns about wage inflation.

The staff turnover issue is now resolved, but we think the pandemic and wage inflation will likely impact near term results. For these reasons, we have limited our position size until we have a greater conviction in when these headwinds ease, despite the potential for excellent long-term returns.

Sold Positions

We completed a review of Ubisoft in August, which reiterated that although core parts of the investment thesis were intact, we needed to acknowledge the “hit-driven” aspect of the business.

Initially, the stock underperformed on fears of Far Cry 6 disappointing gamers, yet first sales data showed it performed well, but management again delayed the release of other games. So, despite a view that significant value exists within the business, we had no confidence left in management’s ability to execute and therefore couldn’t justify keeping our position.

Additionally, we thought that the emergence of a 4th COVID wave should have been positive for business, delaying our sale, but the shares continued to underperform.

Ubisoft business quality fell at the same time as our confidence in management’s ability to execute, and we were too slow to act as we believed the shares to be undervalued. This level of over conviction is a mistake we have learnt from and hope not to repeat.

Portfolio Changes

We took some profits from a number of our stronger performing holdings when valuations became less supportive. Trims were made to Pernod Ricard, Linde, CarSales, Aon and Moodys. We used the proceeds to fund new holdings and increase our position in GoDaddy, Fiserv and Autodesk.

Autodesk had a significant pullback after results: we thought that the difference in performance over 2021 between Autodesk and Adobe (another high quality, high growth software business) wasn’t justified, so we sold some Adobe and increased Autodesk to a top 5 holding.

Cryoport is a business we still think has enormous long-term potential, but after rallying more than 50% since we added to it in May, we reduced our position size. It has since underperformed substantially, so we added back to the position at the end of the year. This valuation discipline has helped improve returns over the long term.