HL Select Global Growth Shares - Q4 2023 Review

Gareth Campbell - Fund Manager

5 February 2024

Market Review

2023 will be remembered for the recession that never happened. So, despite the fastest rate increases by the Fed since the 1980s, a banking crisis that caused the collapse of US and European institutions and escalating global conflicts in Ukraine and the Middle East, global equity markets delivered very positive returns.

Rapid shifts in sentiment and volatility meant it proved a challenging year for many investors. Q4 exemplified this, as dramatic change in growth and inflation expectations led to a mid-quarter reversal in performance, benefitting primarily growth and technology stocks.

We see AI, the performance of large cap technology and varying expectations around inflation and the “Fed-Pivot” (when would the US central bank cut interest rates) as the main themes that impacted 2023.

The largest US tech companies, currently referred to as “The Magnificent Seven,” performed exceptionally well as excitement around AI grew. On average they delivered returns of 111%. Given their large size this contributed the majority of index performance. For context, the Magnificent Seven’s $5 trillion increase in market cap in 2023, is more than twice the value of all the FTSE 100's members combined.

With 72% of S&P500 constituents underperforming, it is unsurprising this narrowness led to a weaker year for the majority of active funds. We think some of this performance is more justified than others. Nvidia for example has seen very positive earnings revisions, so the P/E multiple has fallen despite the 338% increase in the share price. Conversely, Apple and Tesla have seen a fall in earnings expectations, but a re-rating of the multiple has led to very strong returns for their shareholders.

The “Fed-Pivot” debate changed in October as inflation fell while the economy continued to perform. This increased expectations that a soft-landing was possible and brought forward market expectations of rate cuts to March 2024. The combination of these impacts led to a change in market leadership with growth and smaller cap stocks finishing the year strongly.

We were wrong about the risk of a recession in 2023, but we still think it is right to be cautious and remain focused on identifying businesses we think will be less impacted by a weaker economy or have strong secular support enabling them to grow even if the wider economy weakens.

Uncertainty remains common across the market and could lead to heightened volatility if data doesn’t support optimistic forecasts. However, we think in the wider context this will prove to just be noise. Where we have gained conviction over 2023 is that inflation was transitory, inflation expectations are anchored, and that longer term it will settle near central bank targets.

So, although we are not expecting interest rates to fall back to previous lows, we do agree that the path is lower. It may take less or more time than expected but the destination is the same, which leaves us optimistic longer term about our investment style and how the HL Select Global Growth fund is positioned versus the market.

Performance Review

The HL Select Global Growth fund returned 9.05% during the quarter 1 October to 31 December compared to the FTSE World Index return of 6.89%, resulting in 4% outperformance versus the benchmark over the year. The US was our largest positive contributor, driven by the Information Technology, Financials and Healthcare sectors. Industrials were our only meaningful negative contributor. Since launch the fund has delivered a total return of 59.3% compared to the FTSE World Index return of 63.2%. Past performance isn’t a guide to the future.

Positive and Negative Contributors

Our positive relative performance was driven by very good performance in Europe and North America during Q4.

Information Technology was the best performing sector, so we benefitted from being both overweight the sector and from good stock selection. Strong stock selection in healthcare and financials, combined with no exposure to the energy sector, were the other main drivers of our positive relative performance.

Negative relative performance in the industrial sector was largely due to stock selection, primarily CAE which is discussed in more detail below.

Positive Contributors

GoDaddy's performance in Q4 was exceptional. Prior to that the shares had lagged as we think investors had been overly focused on short-term trends of aftermarket revenue, while ignoring the changing business model that has been a core part of our investment thesis.

We added to the position in October as we think its new AI product could accelerate the business model shift to products and services, enabling it to better monetise its enviable position as the first point of contact with many new business owners.

Charles Schwab reacted positively to news that the pace of client transfers of cash balances into money market funds was slowing, which should support longer term profit growth.

Fiserv continues to perform strongly, delivering positive earnings revisions every quarter in 2023. We think the low P/E multiple is hard to justify given persistent strong performance and we see the acceleration in the Clover business segment as reducing the long-term risk of disruption.

Autodesk announced a new revenue model during its recent quarter. This additional complexity added to investor frustrations but has no real impact on underlying profitability. We think the stock mostly benefited from a wider rally across technology and growth stocks.

Teleflex had been unfairly punished by a fixation around the impact of GLP-1 weight control drugs, discussed in our prior blog. Its valuation multiple had fallen substantially below peers, yet despite these challenges it increased guidance and is expected to deliver annual revenue growth of over 5%. We added to the position in November as our analysis increased our confidence that investor concerns around GLP-1’s are misplaced.

Intuit released consistent and positive results, enabling the business to benefit from a broad recovery in growth and technology stocks. We trimmed the position in October to fund our addition to GoDaddy, as both businesses are driven by the strength of small and medium businesses.

Negative Contributors

CAE's civil business is at record levels, but the improvement in defence is taking longer than expected. We think these investor concerns were unjustly inflamed by a poorly constructed analyst report. We are confident that the defence business can return to high single digit margins as they work through loss-making legacy contracts. Irrespective of this, at the current multiple we think the civil business alone can justify the current valuation.

West Pharmaceuticals missed expectations as customers delayed restocking and new orders to 2024. We think the long-term position of the business is unchallenged and our below-average position size is driven purely by valuation. We trimmed the position in October to fund adds to Teleflex and Medtronic.

Aon followed up weaker than expected results by announcing the acquisition of NFP, a brokerage focused on mid-market customers. We accept the business is in an attractive market segment, but we think the high multiple paid limits the financial benefits in the next three years. We are reviewing the holding given increased complexity and leverage post the acquisition announcement.

Aptiv has struggled in 2024 as questions around margin expansion and slower electric vehicle penetration has increased scepticism around its ability to grow profits at a faster rate than the overall automotive industry.

New Positions

There were no new positions in Q4.

Sold Positions

Kornit's investment proposition seemed attractive, a printing technology that reduced water and chemical waste without negatively impacting product quality. A key need of a fashion industry that is one of the biggest causes of pollution and carbon emissions globally.

It was small and early-stage but had a strong net cash balance sheet, was profit generating and its key customer, Amazon, had invested in the business. But despite huge unmet need, demand fell post the pandemic and excess supply caused a substantial fall in revenue and profitability.

Our mistakes in analysis were not recognising that customers’ environmental ambitions run second to their focus on short-term profitability and that a capital equipment driven business model created unacceptable variation, limiting downside protection. Unfortunately, negative fundamentals were exacerbated by a decline in sentiment around growth and small cap stocks in 2022.

The escalating conflict in Israel added additional risks, resulting in us selling the position in October. It lost almost 80% of its value and our only smart decision was limiting our position size so the negative contribution to portfolio return was kept to less than 100bp.

Portfolio Changes

At the end of October, we increased our position in Medtronic and Teleflex as we thought concern around the impact of GLP-1s was misplaced and in November we trimmed our position in CarSales after very strong performance in 2023.

At the end of December, we trimmed our positions in Charles Schwab, Adobe, Booking, Sartorius Stedim, Intuit, Experian, GoDaddy and Autodesk after a strong run of performance. We used this to fund an increase in Compass Group and Heineken, which have both had weaker performance but should offer resilient growth irrespective of wider macro economy.