HL Select Global Growth Shares - Q3 2024 Review

Gareth Campbell - Fund Manager

11 November 2024

Market review

Q3 had a few bouts of heightened volatility, but despite concerns around employment slowing, the markets overall continued to grind higher, powered by signs of inflation falling and the US Federal Reserve implementing their first of many expected rate cuts.

The Japanese market had an isolated case of extreme price movement falling around 20%. There were multiple sophisticated explanations for the root cause and longer-term implications, but the sharp recovery and limited negative outcome reminds us that market volatility is more frequently an opportunity than a concern.

There was a change in leadership during the quarter with large cap, growth stocks and the technology sector all underperforming, as previously less-loved sectors and small cap stocks rallied. This improved the breadth of market performance, but it remains very low over the year. Of the 25 industry groups that make up the market only 10 have outperformed so far this year, highlighting how concentrated market performance remains.

AI leadership may have seemingly taken a breather, but its dominance of market returns has largely shifted to industrials and utilities. As the expected growth in electricity demand has led to higher expected profits and a higher multiple for the expected beneficiaries.

The remainder of the year will likely be dominated by the US election. We don’t expect it to be a smooth journey but do remind investors that far more stays the same than changes with a US president, particularly given the fractured state of both the House and Senate.

We expect President Trump’s ability to deliver the cuts to company taxes that he has talked of during the campaign to be limited by America’s weakening fiscal position. But that is still a more favourable outcome for American businesses than would have been likely had the Democrats prevailed.

Our defensive positioning proved helpful during the quarter as performance peaked during the sell-off and period of higher volatility, but a sharp recovery across major indices, generally hurt relative performance.

Overall, we are encouraged that fund performance improved with 50% of stocks outperforming. Changes we made are still too early to determine success, but we will continue to work on improving the portfolio’s ability to compound, while reducing risk of permanent loss.

Performance review

The HL Select Global fund returned -1.28%* during Q3, compared to the FTSE World Index return of 0.25%, resulting in 1.53% underperformance versus the benchmark.

A weaker dollar meant despite the global markets reaching record highs, the returns for UK-based investors were limited.

Europe was our largest positive contributor, with Financials and Healthcare our strongest sectors. Information Technology and Communication Services were our largest negative contributing sectors.

Since launch the fund has delivered a total return of 69.25% compared to the FTSE World Index return of 84.07%. Past performance isn’t a guide to future returns.

Positive and negative contributors

Our negative relative performance was led by underperformance in North America. Financials and Healthcare were our main positive drivers of performance, largely from stock selection. This was a bit of a reversal from last quarter as many names that had faced a challenging first half of the year delivered better performance.

All our underperformance was driven by our positioning within the Magnificent 7, the 7 large US tech stocks. We don’t have holdings in Meta, Tesla and Apple, which outperformed in the quarter. We think enthusiasm in Tesla’s autonomous driving capability is misplaced as regulatory conservatism is likely to favour a safer, more advanced solution like that provided by Alphabet’s Waymo. Apple’s iPhone sales are slowing, and we think software has long-term risks from anti-trust concerns, yet the stock remains near a record multiple. Not owning Meta has been a mistake given the strong business performance and re-rating, however we think it less compelling today given the premium valuation to Alphabet.

Industrials were the other main negative driver of relative performance. We think this is due to a combination of under-exposure to data centre capex and electricity grid investments, as well as some stock specific issues discussed below.

Not owning Real Estate or Utilities detracted 0.5% from performance as they were the best performing sectors in Q3. Not owning Energy added to relative performance, despite heightened concerns in the Middle East.

Positive contributors

Fiserv’s fundamental performance remains incredibly consistent and has a proven track record of high rates of compounding. Despite strong performance we don’t think the company’s quality has been fully appreciated by the market and we also think it is a likely beneficiary of any increased regulatory challenge to card networks, reducing risk across the portfolio. We reduced our holding to fund new ideas, but it remains one of our largest positions.

Sartorius Stedim Biotech is a high-quality business with excellent long-term growth prospects. Strong recent performance despite near term challenges and continued negative revisions led to us reducing our position in early October.

Teleflex’s setup into 2025 looks increasingly positive with more consistent growth in its core business and we think a recall of a competitor’s product will lead to an increase in profit estimates.

Adyen shares reacted positively to recent results which showed an improvement in business performance and a stabilisation in take rate (fee charged per transaction). This reduced fears of disruption from competition helping the business re-rate to a higher multiple.

Aon delivered better than expected organic growth rate, which helped the shares catch-up to peers, but we remain sceptical of recent acquisition.

Zebra Technologies performed well as results showed signs of a recovery in the business. We reduced our position as we think we previously underestimated its cyclicality given the use of distributors and limited recurring revenue.

Negative contributors

Alphabet results have been impressive, but the stock has been hurt by the loss of key court cases and an increased pace of investigation into anti-trust issues. The materiality of these varies and the timelines likely span years. We reduced our position in early October to manage risk at a portfolio level, but in our opinion and within the context of our total portfolio, the shares look attractive.

Microsoft has been an investor darling for years; we think recent weakness has been from Copilot functionality disappointing versus expectations and concerns about how this may impact pricing. In addition, heavy investment in capex is reducing earnings quality and lowering free cash flow. Longer term we still think Microsoft are likely a key beneficiary of AI, with their position as the operating system of major enterprises an unassailable advantage.

Amazon is executing well, and we think recent weakness was driven more by sentiment than fundamentals.

West Pharmaceutical Services has an exceptional long-term track record, but the hangover of growth from the pandemic continues to impact the wider industry. We are confident that once inventory diminishes, lead times will increase and orders will quickly recover, so although our addition at the end of Q2 may have been early, we are still confident in our thesis.

Adobe has jumped from AI darling to villain multiple times over the last couple of years. Recent weakness was driven by slightly weaker guidance, despite good results. Product competition has undoubtedly increased, but we think investors underappreciate that for Adobe’s key enterprise customers, uncertainty of IP ownerships within peers’ products limits adoption. Therefore, we think barriers to entry remain high.

New positions

BE Semiconductor Industries N.V. (BESI) is a leading global supplier of semiconductor equipment, specialising in the development and production of advanced packaging solutions. Simplistically these are devices that put chips on a circuit board or other chips.

The semiconductor capital equipment industry has evolved from hyper cyclical with limited value creation to a high-quality, high-margin industry with huge secular growth, as semiconductors are a key enabler of technological progress. We think this change was driven by increasing complexity in manufacturing leading to a consolidation of suppliers and higher barriers to entry for new entrants.

Our fear of the cyclicality had kept us out of the sector since the fund launch, which has been a costly mistake. Given our long-term investment we should have recognised the certainty of long-term growth and improving fundamentals of the businesses, outweighing the shorter-term risk of a cyclical correction.

The semiconductor cycle is currently depressed and as this recovers it should help support growth outside of AI applications. To manage cyclicality BESI have developed a highly variable cost structure by utilising a network of hundreds of suppliers and shifting manufacturing to Asia where costs are lower, and labour flexibility is higher.

We think advanced packaging is a very exciting sub-sector of semiconductor capital equipment as the physical limitations in shrinking chips means there should be a greater reliance on advanced packaging solutions to sustain improvement in efficiency or performance. We think this will lead to a shift in sector value chain away from front-end equipment towards packaging and testing equipment.

Hybrid bonding is a new technology that dramatically improves connectivity between chips, so we think it is a vital enabler of these advanced packaging methods to support new AI applications. BESI have 100% market share of current commercial applications, and although this will fall with new entrants, we think they will retain a large portion of this fast-growing market and could account for 30% of revenue within five years.

The recent share price weakness was due to delays in adoption of hybrid bonding in memory applications and the AI theme falling slightly out of investor focus. We think this created an attractive entry point for long-term investors given the business’s potential to grow profits at a 20% CAGR for the next five years.

Sold positions

No positions sold in Q3.

Portfolio changes

Our position in Autodesk was trimmed to help fund our position in BESI. Autodesk remains one of our largest and highest-conviction positions.