RICHARD PHILLIPS: Good morning everybody. My name is Richard Phillips and I’d like to welcome you to today’s Man GLG Continental European Growth Fund presentation with my colleague Rory Powe. Format for this presentation: Rory’s going to do a quick overview of the fund and then go through performance year to date and through Q2. I would particularly like to highlight the performance since Rory took over the fund three years ago on October the 1st. Over these three years that has been very strong indeed. Rory’s then going to go through what’s added and subtracted to the performance over the last couple of quarters, and then go through the portfolio positioning at the present time, followed by an outlook for the asset class. But with that I’ll hand straight over to Rory.
RORY POWE: Thank you, Richard, and good morning everybody. Thank you for dialling in, and more importantly thank you for the support you’ve shown towards this fund in the last close to three years. I started running this fund on the 1st of October 2014. But if we look at page 2 where we summarise the portfolio management team, I was joined early 2016 by Virginia and Ivan. I’ve gone through this slide many times before, so I won’t repeat things on it, except to emphasise the strides we’ve made, I think, in the last 20 months since they joined in terms of the detail we’ve gone into on each of the holdings, and the extent to which we’ve formalised the way in which we model each position over the next five years. So a lot of my comments today will refer to that window, that 2017 to 2021 forecasting period, which very much informs the stock selection.
In terms of the approach and the philosophy, it’s summarised on page 3. And it just reiterates the fact that we are a bottom-up fund, quite concentrated. Today, we have 37 positions. We’re at the higher end of the range of 30 to 40. We don’t want to go much higher than that, and 40 is clearly the maximum. Our objective is to deliver annualised returns of at least 10%1. I’m pleased to say we’re comfortable ahead of those objectives since taking over the fund on the 1st of October 2014. But of course we will be judged on the next three years and the three years after that, so we’re not going to spend too much time talking about historic numbers. The philosophy is very clear; it’s to invest only in what we consider to be Europe’s strongest companies. We divide the portfolio into two: established leaders and emerging winners. The established leaders must always represent a minimum of 50%. They currently represent a relatively high level of 84%. Emerging winners must never be more than one third of the portfolio; currently they represent 16% of the portfolio. I’ve defined these before but do follow up if you have any questions on what we actually mean about established leaders and emerging winners, but the titles are pretty self-explanatory.
And then if we move to the next page and we look quickly at the performance, we had a strong second quarter this calendar 2017, driven by stock selection. It means that year to date we’re up 22.7%2 to the end of August; again, a good margin between that and the index. I think one way of summarising this year’s performance is that you can divide it into three elements. One is the market, the index has risen. If you strip out the currency by approximately nine to ten percentage points, currency has added approximately seven percentage points, and then our relative performance has added approximately six percentage points. So those three constituents have resulted in a very strong year-to-date performance, but of course the year is not over yet. And anyway our objective is to deliver annualised returns of at least 10%3 on a three-year rolling period. So these are really quite brief snapshots of our performance. And Richard kindly referred to the performance since we took over the fund, we’re pleased that the unit price has more than doubled since then, whereas the index is up by less than 50%, leaving us at the top of our peer group. But we don’t draw any comfort from that, we will be judged on the next three years and onwards.
In terms of the following page, just a bit more detail on first of all strong second quarter. It was entirely really down to stock selection rather than any help from sectors. Sectors had a pretty neutral impact on our performance. It was interesting that after quite a poor first quarter, in the second quarter of this year the names that had been performing well have largely continued to perform well, and I give some examples there. I’m pleased that Ferrari4 is in that list. It’s a relatively new position. It wasn’t in the portfolio in the first quarter; it joined the portfolio in April. It hit the ground running. It’s been an important contributor to our performance. But in addition to names either continuing to perform well or performing well for the first time in the Ferrari, some of the positions that were a drag on our Q1 performance performed much better in the second quarter. YNAP or YOOX NET-A-PORTER, a good illustration of that, and it just shows that sometimes patience can be rewarded. They had very strong first half numbers, their organic growth is back to where it should be at close to 20%, and they’re very much on track with their integration plans following the merger of YOOX and NET-A-PORTER.
Pandora continues to be a negative performer. So unlike YNAP it didn’t really bounce back in the second quarter. It’s been a costly name for us. I can answer questions on that. All I will say is that we believe that the brand remains in excellent shape. We are impressed by the revenues that brand generates globally, and how that isn’t reflected in the numbers of the group. Pandora forfeits a substantial amount of economics to third parties, be they franchisees or multi-brand wholesalers. And we think that strategy of reclaiming a large share of that forfeited economics is entirely sensible, and one that will be rewarding for shareholders. And we think a lot of investors have missed the point by focusing on the like-for-likes of the franchisees. But again I can answer questions on that.
And one reason we’ve kept it and maintained it and added to it since the beginning of the year is because of the compelling level of the valuation.
So the year to date is really a combination of stocks that have done well, stocks that have done poorly, thankfully the winners have comfortably outweighed the losers. And I would also make this point about 2017, so far, is that it’s been a year that has been rewarding I think for stock selection. We have been rewarded when we’ve been accurate with our stock selection. We’ve been punished where we’ve been either inaccurate or not sufficiently savvy about market sentiment. But long may that continue. The sort of polarised idiosyncratic nature of the stock market today resulting in quite considerable dispersion intra-sector not just inter-sector is one that plays to our hands, and it just really reminds us of the importance of being accurate with our stock selection. So I think that’s a good summary really of 2017 so far.
If we move to the next slide, the activity in the portfolio has meant that its positioning remains clearly biased in favour of the established leaders. The weighting in that element is at a high level of 84%. But what I would stress is that that should not come at the expense of earnings growth; indeed, since the beginning of the year I would, we can say that the earnings’ firepower of the portfolio has actually been increased. On our estimates the average weighted compound annual expansion and the EPS of the names in the portfolio stands at 17% for the period 2017 to 2021, and that’s a high number relative to where we’ve been let’s say eight months ago or 12 months ago or 24 months ago.
So the fact that we’ve increased the weighting of established leaders has not been to the detriment of the underlying earnings growth. And we think it’s important to reinvest in the earnings firepower of the portfolio. At a time when the global economy’s growing at probably more than 3½%, I think it’s important that we don’t pay high multiples for companies where the organic growth is 2, 3 or 4%. It’s important that we focus on those companies capable of much stronger organic growth, as long as it is sustainable, not just for our five-year forecasting period, but for the long term beyond that five-year forecasting period. And even though we don’t model beyond the next five years, we need to have conviction that the growth that we’ve identified can continue. The emerging winner weighting therefore has come down to 16%, but it remains an integral part of the portfolio.
I’ve already referred to our aversion to investing in what we rather rudely call bond proxies; some of the consumer staples would fall into that category. In a nutshell, we don’t want the portfolio to rely upon the vagaries of the macroeconomy, be they good or bad. So in the same way we don’t want to invest in companies that are very sensitive to the economic cycle. For the same reason we want to avoid those that are cyclical. Equally, we want to avoid expensive defensive stocks that are attractive simply for their sanctuary status. Instead our portfolio needs to consist of companies where there are genuine drivers behind their earnings and that firepower results in year five being a much higher number than year zero in terms of our estimates.
And then just to reinforce this point, we’ve added to Autoliv5, which has not been a great performer this year, where we think the market’s too obsessed with what’s going to be quite a flat earnings year for them in 2017, and not looking sufficiently closely at the growth that comes beyond that based upon the success they’ve having in winning tenders in the car safety market, resulting in their market share actually rising. We’ve added to Christian Hansen, to Pandora, as I mentioned earlier, to VAT, to Abcam5. So a number of our highest conviction names have been added to. And we’ve added new names in the form of Ferrari, Vitrolife, Carnival and NSAP. And again I’m happy to answer any questions about that. All of these actions should always be informed by our five-year view, and what is really a long-term approach.
Moving on to the following slide, it just summarises where we are. I’ve already described the split between established leaders and emerging winners. But also we have more than two-thirds of the portfolio invested in what we call mega and large caps. These are companies where market caps are more than €5bn. And I would expect the split to be roughly two-thirds/one-third going forward. And we’ve given a summary of the top 10 positions, which represent 49% of the fund. We always want the top 10 to be nearer 50% than 40% of the portfolio. We want to back our judgement on these companies with weightings that make a difference to performance. And of course, yes, that does come with downside risk as we’ve experienced with Pandora in 2017.
And then to just summarise on the environment, the European economy continues to enjoy a recovery which has traction. In the second quarter of this calendar year, the Eurozone grew at more than 2%6. Italy enjoyed its 10th consecutive quarter of economic expansion. The PMI numbers for Europe are at their highest levels since 2011. It’s clear that there is a recovery ongoing, and that is to be welcomed and contributes to the fact that I think the case for European equities is at the very least constructive. But also over the course of this year the political risk has become more subdued, not just after Macron’s victory in the French presidential elections, but also we need to remember the Dutch elections where the far right were kept out. And it’s interesting isn’t it how a number of the opposition parties in Italy are downplaying their opposition to the EU and the euro. So maybe they’re observing what’s going in here in the UK, and what happens when you leave and it’s not, it’s far from straightforward.
In terms of earnings growth, 2017 is a strong year for European corporate profits. That’s in stark contrast to the last five years where there has really been no earnings growth on average for the region. And clearly the stock market is welcoming this. Whether it’s sustainable at that pace is another question, and something we’re doubtful about, but I’ll come on to that in a second. And finally the last positive point for Europe is that the monetary environment remains benign. The last inflation number for the Eurozone was 1.5%7 in August, but actually if you strip out fuel and food the underlying inflation number was 1.2%. The ECB said last week that now it does not expect to reach its target of 2% inflation until 2020, which will be after Draghi has retired. And so there’s very little case for a tightening of monetary policy in Europe or the Eurozone to be more precise. So the quantitative easing programme will continue in 2018; albeit probably in a tapered form. Details of that will probably be forthcoming after the ECB meets in late October. But a rate rise is unlikely to precede the end of QE, and QE may not finish before the end of 2018. So a rate rise for the Eurozone probably is unlikely before 2019.
So the backdrop for us stock pickers I think is one where inflation remains low, pricing power is scarce and interest rates remain compressed. And this is not an environment where animal spirits are breaking out; on the contrary, the consumer, whilst in a much better place than a few years ago, remains circumspect. Circumspect because even though they may well be employed, many people in work in Europe at the moment would consider themselves to be underemployed. And secondly I think all of us feel threatened by robots and artificial intelligence, and how we can potentially be replaced, and I think that tends to inhibit consumer spending. It’s not an environment where companies are going to enjoy pricing power. And finally the stronger euro, which I think is symptomatic of a much better environment in Europe, so it’s welcome, will take the shine off European corporates’ profits expansion. Although I don’t think we should exaggerate that point. I think net net is a good thing, not a bad thing. A lot of companies are now much more naturally hedged than they used to be. They’ve done a much better job at matching their non-euro revenues with the non-Euro costs, and so let’s not exaggerate that point. But it’s clearly not a positive.
So just to finish this presentation I think with all of these points taken into account we need to remain extremely selective, and our insistence upon only investing in Europe’s strongest companies should not be compromised. And I think as long as we’re successful in executing that philosophy I think we will be rewarded, not on a quarterly basis or even an annual basis, but on a three-year rolling basis I remain confident that we can remain ahead of our objectives. Which to remind you is to deliver annualised returns of at least 10%8 and to surpass our benchmark by more than three percentage points on an annualised basis. And thank you for backing us over the last three years, and our job now is to vindicate your trust in the next three to five years. Thank you.
RICHARD PHILLIPS: Thank you very much, Rory. And as I said earlier there will be a transcript and a replay of the call sent to you over the next few days, and we’ll also put it on the website as well. If you do wish to ask a question please click on the tab and send it through. And we’ve got a couple here to kick us off with, and they’re both stock questions, Rory. The first one is regarding Ferrari: how did you react to the recent Morgan Stanley downgrade and the share price drop on that stock?
RORY POWE: Well to be fair to Morgan Stanley the Ferrari stock price of late has been very strong, and has on a short-term basis probably got a bit ahead of itself. Even we a few weeks ago took some money off the table in our Ferrari position, but it remains a 4% holding. But the other reason I think Morgan Stanley downgraded it, apart from the recent strength of the shares, is because they’re concerned that the management of Ferrari will maybe damage the brand or compromise the brand in its bid to grow revenues over the next five years. Just to remind you, Ferrari has a range of models which consists of six cars. Be they sports cars or GTs, it’s a very limited range. It’s occasionally reinforced with a one-off limited edition supercar, but essentially the range consists of approximately six models. And Ferrari is thinking long and hard about how it can leverage its brand more than it has done without compromising the exclusivity of the brand.
They sold 8,000 vehicles last year, and their revenues were just over €3bn9 . Those numbers are not consistent with the power and the potential of the brand. And that’s the main reason why we’re shareholders. But we think they will manage that growth and that leverage in a very sensible way. There’s talk of a sports utility vehicle, or a sort of crossover vehicle, and I have a lot of confidence in Sergio Marchionne, the CEO, in not producing the SUVs that you’ve seen from Lamborghini or from Bentley or from Porsche. I think you’ll see something which is not necessarily a sports utility vehicle, and one which maybe caters to the older Ferrari audience who are less exhilarated by speed and more attracted to the grace and the beauty of the vehicles and the brand. So we keep it as a core position, but we acknowledge why Morgan Stanley have done that, and I think they will be proved wrong in their scepticism about the extent to which the brand might be damaged.
RICHARD PHILLIPS: OK Rory, another couple to rattle through. What is the split between domestic earners and overseas earners within the portfolio?
RORY POWE: I think the broad crude way of answering this question is to say that approximately 70% of the fund is invested in global companies, and approximately 30% is invested in Europe-only companies, or European-centric companies. So that hopefully answers your question. Of course the global companies will in many cases have 40-50%, even 60% of the revenues in Europe. So you could say that 60-70% of the fund is exposed to Europe in terms of the economy. This is after all a European fund. Let me just quickly backtrack a little bit on what I’ve just said. That’s in terms of exposure to the region. But remember our European sensitive companies, be they only European sensitive or part of a global spread, are operating in markets where they drivers are structural, and where their top line is also coming from, the growth is coming from market share gains in those structurally growing markets. So we’re relying little upon the expansion of the economy – if there are tailwinds from the expansion of the European economy, then that’s welcome.
RICHARD PHILLIPS: A question now is on Carnival, and would it have been negatively impacted by the hurricanes of the last week?
RORY POWE: Yes, it would have done, and we’re yet to get the full details on how they have experienced the hurricanes. But they have, they were very proactive. Hurricane Irma was well flagged, it wasn’t a surprise. And they have moved their fleet, accordingly, and they’ve allowed passengers to disembark who wanted to disembark. I think the impact on their revenues will be limited.
RICHARD PHILLIPS: OK Rory, thank you for that. And that looks like all the questions that we’ve had for today. So thank you very much for dialling in today. As I say again we’ll have the replay and transcript sent to you over the next few days, and we look forward to speaking to you in the future. Thank you very much.
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