JPMorgan Global Growth & Income (JGGI) has published its annual results for the year ended 30n June 2021, which its chairman, Nigel Wightman, describes as “another very satisfactory year for the Company”. During the year, the company’s benchmark, the MSCI AC World Index expressed in sterling, rose by 24.6%. JGGI’s returns were considerably better – an NAV total return of 32.3%, and a share price total return of 33.0%. This outperformance was the result of positive stock selection. Extracts from the investment managers’ report are provided below, which explore the returns in more detail.
Investment managers’ report – Portfolio review and spotlight on stocks
At the onset of the pandemic, we owned very high-quality businesses in sectors such as Media and Technology Hardware and Software, that we expected to benefit from established long-term trends. These businesses received fresh, in some cases startling, impetus from the pandemic to the extent that by autumn 2020, several were trading at substantial premiums to what we believed to be their intrinsic value. At the same time, many solid businesses in more economically sensitive sectors such as industrials, aircraft manufacturing, travel and banks were trading at significant, and, in our view unjustified, discounts to their true worth. We saw this as a meaningful opportunity, which we sought to exploit fully, by trimming our positions in some of the pandemic’s biggest structural winners and using the proceeds to gain greater exposure to high-quality businesses in these cyclical, unloved and undervalued areas of the market.
This strategy proved to be highly effective, as evidenced by our very strong performance against our benchmark over the past 12 months. The Company’s benchmark, MSCI All Country World Index, rose 24.1% in Pound Sterling. At the same time, the Company’s share price rose 31.8%. Our stock selection contributed positively across most sectors over the past year, with returns enhanced by our exposure to both quality cyclical stocks and to companies set to benefit from long term structural trends.
Many of the cyclical names that we purchased in mid-2020 have subsequently outperformed the market significantly, especially in the past six months, as vaccine programs dramatically improved the global economic outlook and bolstered investor confidence in these businesses. Our purchase of Lyft, the US rideshare company, is a great example. It was our best performing stock over the past 12 months, more than doubling in value since acquisition. We were attracted to Lyft by its strong balance sheet and its large share of a concentrated market, which ensured the company was well placed to survive the pandemic, despite market scepticism. And as economies began to reopen, and riders returned, the market’s assessment of its near-term prospects improved dramatically. We still own the stock, as we expect it to continue to perform well as demand reverts to pre-pandemic levels, and profitability improves accordingly. In our view, Lyft’s longer-term growth outlook is also very favourable, as it is likely to be a lead player in the development of the autonomous (driverless) vehicle rideshare market.
Another example of a name we added last year is American Express. This is a high quality business, which benefits from a consumer recovery as card spending recovers. However they were hit harder than most in the pandemic as large portion of their business comes from Travel & Entertainment. We purchased the stock as we believed that this spend would recover. Importantly, whilst we were uncertain exactly where this spending would return first – be it airlines, hotels, or eating out – with this company we knew we would capture that recovery, as regardless of category, the spend would occur on their card. The stock has been a very strong performer since we purchased it.
Our positions in companies benefiting from long term structural changes, especially tech-related themes, also continued to enhance returns over the period. The Company’s holdings in the Semiconductor space did exceptionally well. Demand for semiconductors has been robust across the board, but most notably from the Automotive and Industrial sectors, and we expect the increasing use of semiconductors in electric vehicles (EVs) and smart factories to underpin further growth in demand for chips. We diversified our exposure to this burgeoning industry via with the acquisition of names such as Applied Materials, a US company that supplies materials to semiconductor manufacturers. This position nicely complements our holdings in end product manufacturers such as Taiwan Semiconductor Manufacturing Company and its Dutch competitor, NXP Semiconductors. Global demand for semiconductors has been so strong that supply shortages have created bottlenecks in some industries. In the past, this has triggered instances of double ordering, which can pose a risk to earnings estimates. We have been monitoring the entire supply chain closely in recent months for signs of such practices, but to date, we have found no evidence of inflated demand, and we continue to hold these companies.
Alphabet, the parent of Google, the US online advertising behemoth, was another significant contributor to performance over the past year. The company was hurt at the beginning of the pandemic as businesses reduced advertising expenditures. However, as the world adapted to the constraints imposed by the virus, advertising spending returned to more normal levels, and Google increased its market share. In addition, YouTube, another Alphabet subsidiary, has gone from strength to strength, and Alphabet’s Google Cloud Platform continues to see exceptional growth, as more businesses use the cloud for data processing and storage.
Innovation is also proceeding at pace within the Healthcare sector, as evidenced by the rapid development of several different, but equally effective coronavirus vaccines. Within this sector, we favour businesses with a good track record of producing new and creative solutions to significant health challenges. Among our holdings, the US pharmaceutical company Eli Lilly had an exceptional year. This company has seen encouraging results from clinical trials of new treatments for diabetes, a disease which is likely to afflict increasing numbers of people over time. More recently, there has been progress on its breakthrough treatment for Alzheimer’s Disease, which appears likely to receive support from the US Federal Drug Administration (FDA). This will open a whole new market to Eli Lilly. Novo Nordisk, the Danish pharma company, was another notable contributor to returns. Like Eli Lilly, it focuses on diabetes treatments and its new anti-obesity drug, Wegovy, was recently approved for use in the US. This is the first drug treatment for one of the Western world’s most significant health issues and will no doubt prove very profitable for Novo Nordisk.
We are very pleased with the performance of these and other holdings, which more than offset the adverse impact of disappointing returns in some other areas. Insurance was the most challenged sector on a relative basis, as our holdings lagged the broader sector. Munich Re, a German reinsurance company, detracted most, for two reasons. Losses from natural disasters were particularly heavy in 2020, in large part due to a number of hurricanes and other catastrophes that struck the US. The company also sustained significant losses from COVID-related claims, and its share price remains under pressure due to fears about the extent of further claims arising from the pandemic. However, Munich Re has an exceptionally strong capital position, the management team has a proven willingness to return capital to shareholders and the company has been one of the best performers in the sector over the last 5 years on a total return (share price performance and dividends) basis. We continue to own the shares.
The Automotive sector also detracted from relative returns, mainly because we do not hold Tesla, the US electric vehicles (‘EV’) and battery manufacturer, which we believe is overvalued. While the operational performance of this company has surpassed all expectations over the past couple of years, in our view, its stellar share price gains has taken the stock well above its intrinsic value. We continue to prefer Volkswagen, the German auto producer, which is also developing EVs. After some teething problems, these vehicles are now coming to market, and we expect they will eventually earn Volkswagen a significant share of the EV market. Yet despite this favourable outlook, the stock is valued as if the company will cease to exist in a decade.
Investment managers’ report – Portfolio positioning and outlook
The particularly good performance of many of the cyclical stocks we acquired in the past year has prompted us to take some profits, reducing our exposure to many of these names. Holdings that we have trimmed recently include Norfolk Southern, a US rail company, and Adidas, the sportswear brand. However, there are many other high quality companies, with attractive long-term metrics, whose short-term outlook remains clouded by the lingering effects of the pandemic. We see many opportunities to buy these so-called ‘reopening’ stocks at very reasonable valuations.
For example, we have recently added to our holding in Booking.com, which is now a world leader in the provision of accommodation and other travel services. We also opened a position in Airbus, the French aircraft manufacturer, due to our confidence that demand for new aircraft will surpass current expectations over the next decade, as demand for air travel returns. This positive assessment is based in part on our conversations with over 500 businesses about their future corporate travel plans. We found that although many forecast a fall in the number of flights taken to attend internal company meetings, they expect total expenditure on flights to be greater in 2023 than in 2019, as client visits resume and firms send representatives to trade shows and conferences. Companies also foresee a move towards more business class travel – a shift designed to improve staff retention and overcome employees’ reluctance to travel in the post-pandemic era. This forecast rise in demand for flights, especially higher margin business class travel, will bolster profitability in the airline industry generally. Airbus, which continues to take market share from Boeing, its primary competitor, will certainly benefit from the associated increase in demand for aircraft.
We have also taken other opportunities to acquire good, but significantly undervalued, businesses in the Industrial and Banks sectors. For instance, we have recently added to Schneider Electric, a French manufacturer of energy management and industrial automation systems, Trane Technologies, a US supplier of air conditioning and heating products, and Wells Fargo, a US bank. However, we continue to avoid stocks we view as overvalued. To us, there appears to be significant risk to the valuations of some exceptionally high growth names, particularly in the US Software space.
We utilised gearing tactically during the review period, especially in autumn 2020, when we saw so many opportunities. However, after such an exceptional year for equity markets, we have since reduced the level of gearing, on the expectation that some market volatility is likely after such a favourable run. The most likely trigger for such volatility will be concerns about inflation. Investors are already worried that if inflation proves persistent, central banks will be forced to raise interest rates quickly to dampen inflationary pressures. Higher rates are likely to have significant adverse implications for equity valuations, particularly for the most expensive stocks, whose elevated multiples are often said to be ‘justified’ by record low interest rates. Concerns on this front have already unsettled markets and we expect further bouts of volatility over coming months. So, for the moment, we are biding our time on the redeployment of gearing, as we await more clarity on the inflation and interest rate outlook.
These percolating concerns about inflation and higher rates suggest that the global economic backdrop has shifted from its recovery phase to a more mid-cycle mode. Mid-cycle dynamics tend to support stock price rises, as well as drive-up interest rates along the yield curve, and, even if the trajectory will not be entirely smooth, we expect equity markets to continue making strong gains as this cycle progresses. It is therefore more important than ever for us to stay fully invested and focused on our global search for great businesses that will provide superior returns and outperform over the long-term.