Mark Nichols and Mark Heslop, fund managers in the Jupiter European growth strategy, share their views on market activity, performance and positioning during the last half year.
During the turbulent first nine months of 2020 the European team’s strategies performed well, highlighting the more defensive qualities of our investment style. The last six months, however, have clearly been more challenging. Given the high volatility and the fast-changing macroeconomic outlook, we have not been surprised by the relative fund performance. That said, we thought it might be helpful to reflect on some of the market moves, changes in the funds and the underlying holdings.
Over the last six months (31/10/20-30/4/21) the Jupiter European Growth fund has returned a seemingly attractive 16% absolute return, but this compares to an index return of 30%. The market rally has been driven by an anticipation of a strong bounce back in the economy following a successful roll-out of vaccine programs supported by high consumer savings ratios and massive monetary stimulus.
A return to normal
In the near term, a return to normal activity will provide a lifeline for heavily indebted businesses that have been mothballed or surviving on the back of government support – although it may not ultimately save all of these companies.
Supply chains and port capacity have become restricted by reduced mobility (fewer flights and freight capacity, for example) and these supply constraints are clearly driving prices higher as demand rises with reopening.
This is all potentially good news for economically sensitive sectors, commodities and the banking sector. At the very least it is a sequentially better backdrop than they were looking at 12 months ago.
Outlook for banks
The more the market buys into and believes in the sustainability of inflation the more likely central banks will have to react and borrowing costs will follow inflation higher. In the near term this should enable banks to improve their net interest margins (NIM), which have been decimated by over a decade of historically low rates. Of course, rising NIMs at European banks remain a complex equation, while the long-term growth outlook for these assets remains very unclear as they tussle with regulation, technological disruption and changes to the way debt is issued.
Long term inflation expectations rising – from a low base
But long bond yields remain historically low
Source: Bloomberg, as at 15/5/21
In this context it is not surprising to see some of the best performance among European stocks coming from Energy, Banks, Consumer Discretionary and Materials sectors, areas of the market we are generally underweight.
FTSE World Europe index, 31/10/20-30/4/21. Source: Bloomberg
While the scale of our underperformance is uncomfortable, the broad rationale for the moves is understandable, particularly given the challenges these sectors have faced in recent years. We have seen similar moves in markets in our careers, notably in 2009 (dash for trash), 2012/2013 (Draghi’s “do whatever it takes”) and 2016 (Trump reflation trade).
Benefitting from the rebound
Critically for us, our underlying investments are themselves broadly performing ahead of, or in line with, our expectations, in operational terms. Many of our holdings will also benefit from improved economic activity, government stimulus and greater mobility. Consider Adidas, much of their retail footprint was closed in 2020 and they just guided to 50% organic revenue growth in 2Q 2021. RELX, our largest position, saw 15% of its revenue base decline by 70% in 2020 compared to 2019 with much of this revenue base set to re-open in 2H 2021. Amadeus, another top 10 holding, had negative revenues on an absolute basis in 2Q 2020. Amadeus recently said that April 2021 was the best month they have had since February 2020.
We do not know exactly how the inflation backdrop will unfold. On the one hand the economy could overheat, inflation could get out of control and ultimately central banks will have to tighten. We would expect this to very quickly make life very difficult for over-indebted corporates and governments, which will inevitably stifle economic activity and once again hurt many of the cyclical names that have enjoyed the recent rally. This may not be good for markets.
On the other, inflation may just be temporary, the consumer returns with gusto, we all start to travel again, and supply chains remain tight for a while – but supply will catch up with demand as both human and physical capacity come out of hibernation, and competition will keep a lid on pricing. This will be most apparent in companies with undifferentiated products and services. Margins in these businesses will ultimately be squeezed once again. This, also, may not be good for markets.
There may be a third way, we do not know, but whatever the outcome we are confident that our companies, thanks to their strong market positions, their differentiated offerings and fundamental pricing power will continue to benefit from the secular growth in their markets.
We have continued to take profits in some of the diagnostic names (Biomerieux, Diasorin, Grifols) that performed so strongly in 1H20. That said, valuations in these names have now fallen back to more attractive levels and the post-pandemic, long-term outlook for the industry remains positive. We have sold out of a couple of illiquid positions on the European and European Growth Funds that we were unable to build sufficient size in (namely Tecan and Belimo, both of which were sold at prices well in excess of the entry cost).
The main addition in recent months is Allfunds, the fund house distribution platform. Allfunds has developed a market leading and growing network of funds and fund distributors which we expect to continue to benefit from the growth of open architecture savings solutions offered by fund distributors. The Allfunds platform provides substantial efficiencies to both fund houses and distributors, whose offering becomes increasingly more attractive the more it grows. Near term revenue growth expectations for Allfunds are in the mid-teens, while this is also a tech IPO that produces c.70% EBITDA margins.
We have also started a position in leading core banking software provider group Temenos. This is a name that we initially reviewed in 1H20 but did not buy until after its peer SAP profit warned, providing us with a more attractive entry point. Banking software continues to be dominated by legacy in-house systems which are increasingly not fit for purpose in the modern world. Changing software is a big decision for banks, but in the face of mounting IT maintenance costs, rising competition from digital neo banks and the challenges/opportunities created by open banking, they are having to make these investments. Once made the savings can be substantial. We expect Temenos to reap the benefit of these trends for years to come. Temenos is another good example of a business with double-digit revenue growth potential at high margins. This is also an asset that was severely compromised in 2020 as banks did not spend on IT during a period of heightened uncertainty.
We would also highlight some names that were added to the portfolio over the course of 2020, including Nexi (Italian payments, growing double-digit this year), ASML (has more than doubled since purchase), LVMH and Partners Group. Combined with Allfunds and Temenos these new names represent slightly less than 15% of the portfolio NAV today — some fairly significant changes.
To sum up, we are long term investors that look to partner leading business franchises and managements as they strive to compound shareholder value. By doing so we believe we can deliver superior long term returns and reduce the risk of loss for our clients.
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