Disappointing year for Finsbury Growth and Income

Disappointing year for Finsbury Growth and Income – Finsbury Growth and Income (FGT) has posted its full-year results for the 12 months to 30 September 2021. During this period its NAV return was 10.6% while its share price total return was 6.3%, significantly underperforming its benchmark.

The chairman highlighted that the manager’s investment approach involves building a concentrated portfolio of companies that have strong brands and/or powerful market franchises, making it significantly different to its benchmark.

He said: ‘Such an uncorrelated portfolio will inevitably perform very differently from its benchmark (positively or negatively) over different periods of time. We believe that over time our investment approach, selecting companies with durable business models that generate consistently higher returns, will ultimately be reflected in the share prices of the companies we own and hence in the performance of the Company. However, there will be periods, such as now, when the market does not reward this approach.’

Two interim dividends for the year were declared, totalling 17.1 pence per share. The Income Statement shows a total gain of 88.0 pence per share consisting of a revenue return per share of 18.1 pence and a capital return per share of 69.9 pence.

Manager’s report:

After a 12-month period of disappointing NAV performance Shareholders will not be surprised to read that I have engaged in some navel-gazing. As always in such circumstances I come back to the companies to which we have committed your capital. I ask myself – how are the companies performing as businesses (which is not necessarily the same as how their share prices are performing)? And most important, as a team, we ask ourselves – are we invested in brands and franchises that are going to endure and preferably prosper over time? If we get that second question right, I must assume everything will work out just fine. Please read the rest of this report in the context of this opening paragraph.

The 17 biggest holdings in your portfolio (that is all holdings above 1% of the NAV) account for c.98% by value of the whole.

The remaining holdings each represent less than 1%. We may add to some of these smaller positions, but others will be disposed of, at a time and valuation of our choosing.

By most standards 17 holdings, making up essentially all portfolio assets, is exceptionally concentrated. This is deliberate. The Company’s portfolio is highly concentrated, because we have found this gives us the best chance of delivering the returns shareholders require to justify taking the risk of committing their precious savings to stock markets. We have no quibble with any rejoinder that what we do is risky. It is risky – both in the sense that the investment performance that results may turn out to be radically different from that of the benchmark our performance is measured against – in the Company’s case the FTSE All-Share Index. But also risky in the sense that holding such big positions exposes shareholders to the risk of outsize capital losses if something existentially bad befalls any of the companies.

So, while we know of no way to obviate the risk of differentiated investment performance, compared to the Index or other managers (whether our differentiated investment performance turns out to be notably better or worse than the average); by contrast it is in our power to limit the risk of permanent loss of capital, by seeking to invest only in “good” businesses. This is why we have always placed such a great emphasis on the predictability, financial conservatism and enduring relevance of the companies we have chosen to commit your savings to.

Because of the paramount importance of individual holdings in a strategy like the Company’s we have chosen to give an account below of the reasons why we own each of those 17 holdings. They are listed in descending order of size.

Diageo was the Company’s most successful stock over the last 12 months, and, partly as a result, is the biggest position, at just under 12% of NAV.

There are decade-long secular trends driving Diageo’s business. Most notably the propensity for consumers worldwide to drink less alcohol (which is a good thing), but instead to drink more of better-quality products. This growing taste for premium and super-premium beverage brands has accelerated with the incredible increase in consumer wealth over the last decade, notably in the USA and Asia. With arguably the best collection of prestige spirits brands (and Guinness) Diageo has been and will continue to be a prime beneficiary of these trends.

In addition, while we have no view as to whether the inflation pressures afflicting the world in 2021 will turn out to be ephemeral or entrenched, we are sure few companies are better positioned to maintain the real price of their products than Diageo. Would you sooner own a government bond on a running income yield of 2%, or Diageo on a starting dividend yield of 2%? We can’t help worrying that pension schemes around the world that choose the government bond ahead of Diageo, on the grounds that “equities are riskier than bonds”, are making a costly mistake.

RELX – Covid-19 lockdowns have evidently boosted the use of digital tools and data analytics across every industry. Andy Grove’s (ex-Intel CEO) prediction that in the future every company will be an internet company looks increasingly prescient; every company we know is working to become more digital. In the UK we are fortunate that the FTSE contains several major companies that own globally significant troves of data; data their customers need to run their institutions or businesses day-by-day. RELX is one such company – its services deeply embedded in the scientific research, legal and insurance communities. Listen to or read what the executives of RELX have to say about the opportunities still presented to this company and you will understand why it is the Company’s second largest holding.

LSE, like RELX, is another rare British company with globally significant data assets and the technology platform required to deliver data and analysis of that data at scale. It is true that a proportion of this data has been recently acquired, via its 2021 takeover of Refinitiv and also true that there are challenges involved in executing on a transaction of this size. But it is also apparent – on any consideration of the business and share price histories of similar companies, notably in the USA – that the rewards for shareholders of a successful integration of Refinitiv’s data and transaction venues with those of the LSE would be very high indeed.

UK investors complain their home index is too exposed to 20th century declining industries and there are too few domestic technology and data winners in the FTSE. Yet the weakness in LSE’s share price since the Refinitiv deal closed (and LSE has been a notable drag on the Company’s returns in 2021) shows those same investors reluctant to back this obvious contender to be a global tech winner. The iron rule still holds – for those investors who yearn for certainty before committing – by the time you know for sure, it will be too late.

Unilever has been a detractor from the Company’s performance over the last 12 months. Its wide diversification by brands and geography, that made it understandably “defensive” during the traumas of 2020, has counted against it. Especially so during the current period of rising input and logistics costs. It is undeniable that of all the consumer brand companies we own in the Company, Unilever is the one most at risk of a loss of pricing power across its product portfolio. Soap powder is more prone to price competition than Tanqueray or Crunchie Bars.

However, it is important to consider the lessons of Unilever’s long history. Over many, many decades Unilever has successfully exploited its global distribution, its marketing skills, the knowledge it learns about changing consumer tastes and, crucially the billions of pounds of annual cash flows it generates from its brands. It uses all these attributes to develop or acquire new brands. As a result, the shape of Unilever today is very different from that of 30 years ago. Why shouldn’t this formidable company continue to evolve and create value for its owners?

Some may counter that the Internet has changed everything for Unilever; for the worse. But at its recent results meeting, Alan Jope, CEO said: “It is a myth that the infinite shelf space of e-commerce favours middle and small-sized brands. E-commerce is very favourable to relevant big brands; they get first on the search and shopping list.” Even noting the key adjective “relevant” in that quote, if Jope is right (and maybe it is still too soon to be certain) then current pessimism about Unilever is excessive.

The Mondelez position results from our historic major holding in Cadbury, with Oreos, Toblerone and other beloved confectionery and snack brands added to the mix. I have slightly mixed feelings about the investment. Over the last ten years Mondelez stock is up 2.6x. That return looks very satisfactory compared to the dismal showing of the FTSE All-Share, up 44%. But I have to contrast it to NASDAQ over the same period – that index has gone up more than 5-fold, highlighting the rewards for investing in innovative, high-growth tech companies during a period of industrial change.

Mondelez is a terrific company of its type, likely to protect its owners against inflation and to grow in real terms, as consumers all over the world enjoy its treats. But can the Mondelez tortoise ever outpace the successful tech-stock hare? Probably not. But my conclusion is that it is valuable to own both types of company and if Mondelez’ shares are at $156 in 10 years ($60 today) we will be delighted and hope the Shareholders will be too.

Schroders recovered well from the COVID-19 bear market, both as a business and a share price. We continue to like being invested in an institution of such high reputation and financial conservatism. Schroders’ assets under management have reached a record high in 2021, of very nearly US$1trillion (important to express in US$, because most of its big competitors are in the US).

Promisingly the mix of Schroders’ assets has been shifting towards higher fee earning strategies, such as Private Equity and Wealth Management. We hope this means any future acceleration in Schroders’ asset growth will be rewarded with a big share price gain.

Burberry – A cash-rich (no financial debt) global luxury brand, with a longstanding and wonderfully valuable place in the affections of Asian consumers. You would think Burberry would be one of the most highly valued and admired companies in the FTSE 100. Certainly, there is no other company like it in the index. But not so. The British media and analytical community barely have a positive word to say about this iconic franchise. Oh well. We find it remarkable we have been able to become the biggest shareholder in Burberry on such attractive terms; but are grateful for the opportunity.

It is true, we are disappointed that CEO Marco Gobbetti is stepping down – returning to Italy. But his valedictory ruminations on the fashion industry are worth considering – “I find it fascinating – five or seven years ago it was much more limited. The audience for fashion and luxury was not as wide as it has become today. The big change is how fashion and luxury have permeated society. The pandemic has been a great accelerator of luxury. There is a generational change, with younger consumers in the US in particular becoming attached to brands and engaging with them like never before.” Luxury is definitely the right pond for investors to be fishing in today. And Burberry is definitely not a discarded shopping trolley at the bottom of that pond.

Sage – Few companies in your portfolio have tested my patience like this one. Look at the long-term price chart. Time and again the shares rally toward the peak of c£8. But each time the shares slip back, because the company persistently contrives to disappoint against its apparent growth potential. Many similar accounting software companies around the world have been great investments over the last two decades – Sage egregiously not. Other holders – including one we admire greatly – have had enough and sold out.

We are still invested for two reasons. First, in 2017 the previous CEO boldly made an ostensibly very expensive acquisition; Intacct, a US cloud software business. Four years later, Intacct has grown and its future prospects appear better than ever. Even on its own Intacct is worth an appreciable proportion of Sage’s market value, we think. Next, the current executive team has boldly accepted a drop in profit margins by investing more aggressively in new product development and marketing. We must hope better late than never.

Encouragingly, the board has sanctioned two share buybacks over the last year, of £300m each. Sage’s ability to do this speaks to its strong cash generation and balance sheet.

Hargreaves Lansdown – There is a cloud over the Hargreaves share price, relating to events of over two years ago. It is not obvious when or how those clouds will lift. All one can say is that Hargreaves’ business has gone from strength to strength over that time and that like so many digital and “platform” businesses around the world it has been a beneficiary of the great COVID-19-acceleration in consumer digital engagement. It is also worth noting that Hargreaves has a very strong balance sheet indeed as well as a highly profitable business.

Remy Cointreau/Heineken – I do not lightly invest outside the UK for the Company. It is after all a UK equity mandate. Mondelez was effectively inherited from Cadbury, but this pair are the two non-UK holdings we have deliberately chosen to invest in. It is no accident, given our predilections and historic perspectives that both Remy and Heineken should be family-controlled global beverage companies. Looking back at financial history it is apparent that beloved beverage brands offer exceptional longevity and pricing power and have thereby protected the wealth of owners for generations. Add to that the secular growth open to Remy and Heineken with their premium cognac and beer brands and there is scope for centuries more wealth creation.

Experian is one of the newer holdings in the Company, initiated in mid-2020. It is, like RELX and LSE, a globally important data/ analytics company that happens to have its primary listing on the London Stock Exchange. Frankly I should’ve invested in it years ago, but finally the pleading of my younger colleagues prevailed and we are now building what I expect will become one of the top holdings in the portfolio.

Daily Mail & General Trust (‘DMGT’) may or may not still be a constituent of your portfolio by the time you read this report. As I write this the company has received an offer for its outstanding equity by the controlling family shareholder. DMGT has always fascinated me as a collection of media and data assets, evidently very undervalued by other investors. The prospect of that value being crystalised by an offer at an all-time high for the share price has a definite appeal.

Fever-Tree is the other relatively new holding, and, like Experian, we intend to build it further. The shares present a challenge to investors. Its price earnings ratio is either absurdly high, if the company fails to develop its brand as successfully outside the UK as it has done here. Or it is absurdly low if Fever-Tree can truly become the world’s premium mixer brand.

Manchester United – Members of the Glazer family have now sold over £200m of shares in Manchester United in 2021. It seems probable the family does not intend to be an “eternal” owner of the franchise, but equally probable no change of ownership is imminent (or why would they sell?). The destiny of this extraordinary “trophy” asset is unclear, but we are content to remain minority holders of such a unique franchise.

Rathbones – The provision of private wealth investment management services is a growth industry in the UK. Rathbones has a deserved blue-chip reputation, a cash-rich balance sheet and is participating in that industry growth. We expect it to be a bigger and more valuable company over time.

A.G. Barr used to be a major holding in your portfolio, but the position has drifted down to just over 1%, as we have chosen to invest elsewhere across the portfolio and as the shares have languished – now barely higher than 10 years ago. The company remains profitable, with valuable brands and net cash on its balance sheet. We look to its board to find ways to deploy that cash to return Barr to growth and stock market favour. We’d happily add to our holding as its strategy gains traction.

CONCLUSION

As always in these Annual Reports I barely comment on macroeconomic conditions nor make any guess about the next move in the stock market and absolutely not about how the Company’s investment performance may develop. There is no point, in my opinion, speculating about factors that are unknowable. However, I do submit that your portfolio is made up of strong businesses, with the potential to deliver both business growth and investment value for patient investors. In this spirit may I confirm to shareholders that I have continued to add to my personal holding in the company. My family and I currently speak for 1.55% of the equity of the Company. This alignment of interest by no means guarantees successful investment returns, but I assure you the Company continues to command my keenest attention.

FGT : Disappointing year for Finsbury Growth and Income