JPMorgan Global Growth & Income (JGGI) has announced its annual results for the year ended 30 June 2022. During the year, JGGI provided an NAV total return of -3.4% and a share price total return of -4.8%, both of which compare to a return on the trust’s benchmark, the MSCI AC World Index of -4.2% (all in sterling terms). The chairman, Tristan Hillgarth, says that after delivering good performance during the first half of the financial year, the second half presented a challenging environment for equity investments.
JGGI’s managers (Helge Skibeli, Rajesh Tanna and Tim Woodhouse) say that after the strong rally that we have seen during the last couple of years, a period of consolidation is to be expected, although this does not preclude intermittent volatility and periods of equity market weakness, as has been seen in recent months.
Managers’ comments on performance review and spotlight on stocks
“We always view any such volatility as an opportunity to buy companies with compelling long term growth prospects, at more attractive prices. In this instance, we chose to concentrate on higher growth companies with large addressable markets and multiple growth channels, that are already generating significant free cash flow. We avoided the more speculative parts of the market. For example, we added to positions in companies such as Amazon, on weakness, but steered clear of all companies within the software sector, with the exception of Microsoft. We also maintained or increased our positions in cyclical names that we felt showed the most potential for earnings growth, thanks to their exposure to the reopening of economies after the pandemic subsided. We found opportunities in companies in several sectors, including restaurants (McDonalds), and travel-related businesses (Booking and Marriott). As pandemic-related hospitalisations declined, hospitals were able to resume elective surgeries, re-igniting demand for products such as hip and knee replacements. We added to our position in Zimmer Biomet accordingly.
“Our careful attention to valuations, and the opportunities generated by a return to more normal life, ensured that stock selection continued to be the primary driver of your Company’s outperformance over the past year. The top contributor to returns was Novo Nordisk, a Danish pharmaceutical company whose ground-breaking obesity treatment, Wegovy, has received widespread acclaim. In our view, the market opportunity for this drug is valued in tens of billions of dollars. In addition, Novo Nordisk’s core diabetes business continues to go from strength to strength. It has only one competitor in this field, Eli Lilly, and we expect this fast-growing market to be a profitable duopoly for many years to come. Novo Nordisk’s strong share price performance led us to trim the position size, but we continue to own the name, which we favour over Eli Lily given our belief in their opportunities in this market.
“Novo Nordisk was not the only healthcare company to contribute to performance over the review period. In fact, the Pharma/MedTech sector added the most value over the past year, thanks in further part to significant contributions from our positions in US drug manufacturers Bristol-Myers and AbbVie. Both these companies are subject to some controversy, and investors have doubts around the durability of their core franchises and competition positions once existing patents expire. We acknowledge that these companies face some risks, but in our view, the market does not fully appreciate either their capacity for cash flow generation over the next few years, or the potential value of their product pipelines. In the case of Bristol-Myers, the 2019 acquisition of Celgene, a US pharmaceutical company specialising in cancer and immunology drugs, added a number of exciting pipeline assets, not just in oncology, where Bristol has historically been strong, but also in new therapeutic areas like hematology (the treatment of blood disorders). We continue to own both Bristol-Myers and AbbVie.
“The software sector was the second highest contributor to returns at the sector level over the past year, thanks entirely to our exposure to Microsoft, which was the third largest contributor to performance at the stock level. We continue to like this company, which has two powerful growth drivers. Firstly, its Office business has one of the stickiest user bases of any product, and we believe its revenue base will continue to grow, reaching $100 billion by the end of the decade. The second source of future growth is Microsoft’s public cloud business, Azure, which, along with Amazon Web Services and Google Cloud, is poised to see exceptional expansion in the coming decade. Data consumption is only going to accelerate, and all three of these businesses will see significant growth in demand for both infrastructure and additional services. As noted above, we added to our position in Amazon over the review period, currently preferring it to Google as we control our exposure in advertising-related names.
“At the stock level, the fast food operator McDonalds was another strong positive contributor. As we anticipated, this company benefited from the economic reopening, as consumers returned to casual dining away from home. An additional attractive feature of the stock is that McDonalds is largely a franchised business. This insulates the company from inflationary pressures, because revenue is driven by the franchise fee, rather than the proceeds of owning and operating the restaurants directly. The company continues to execute well, and we see this as an excellent asset to own in a period of higher inflation.
“Of course, not every portfolio holding will always contribute positively to performance, and over the past financial year, the largest detractor from performance at the stock level was Lyft, the US ride sharing company. This company has seen a reversal of fortunes over the past year. This time last year, it was the largest contributor to performance for the financial year ended 30th June 2021 (FY21) and we wrote of our confidence in Lyft’s prospects. As part of a duopoly with Uber in the US ridesharing market, we felt Lyft was uniquely positioned to generate excellent margins in coming years. However, our expectations have been disappointed and the company’s contribution to performance during FY21 was more than offset by losses in the past year. There were several reasons behind Lyft’s share price decline. It has only recently reached profitability, so it was punished by the market in the past year’s selloff of unprofitable companies. Downward pressure on the share price was compounded by execution issues – while Uber invested in driver supply early in the economic re-opening, in anticipation of a recovery in demand for rides, Lyft failed to do so, and as a result, its recovery lagged. This triggered concerns that Lyft’s market share would undershoot previous forecasts. So, while we are very positive in the outlook for the rideshare market, our concerns over execution led us to exit Lyft, and purchase Uber instead. We like Uber’s more consistent delivery, and we believe it has more potential routes to profitability, including the food delivery and freight businesses.
“Adidas, the German sportwear retailer, also detracted from performance over the review period. As with Lyft, our confidence in this company deteriorated to such an extent that we felt it no longer belonged in a best ideas portfolio. Adidas has faced particular challenges in China, where consumers are moving towards local brands. We grew increasingly concerned that the company was underinvesting in products that would appeal to Chinese consumers. The scale of the potential opportunity in China was an important pillar of our initial investment case for Adidas, but with question marks over that, we felt it was prudent to redirect capital elsewhere, so we closed our position.
“Our decision not to own either Apple or Tesla also detracted from returns over the past year, as these two names have particularly large weightings in the Benchmark, and both performed well over the last 12 months. However in both instances, we believe that there are better opportunities elsewhere over the longer-term. Apple is an exceptional company, and demand for iPhones increased during the pandemic, as people sought to improve their connectivity. However, this brought forward future demand, at least to some extent, suggesting new iPhone sales will weaken in the near term. In addition, we believe Apple cannot maintain the recent pace of price increases of its iPhone range. Given the potential for sales growth to turn negative in coming quarters, and with no new products on the horizon to stimulate fresh demand, we prefer to own other companies within the Technology sector.
“In the case of Tesla, the company has done a fantastic job of executing in the past few years, but we believe its current valuation is excessive given the various challenges it faces. Indeed, the company will have to open between two and three new manufacturing plants every year for the next decade to reach a market share that justifies the current valuation, and we think this is unlikely, despite its execution capabilities. With increasing competition in the electric vehicle space, we prefer to own other auto manufacturers such as Honda, where valuations are much more attractive.
“At the sector level, not owning Apple was the primary reason why the Semiconductor/Hardware sector had the greatest adverse impact on returns over the year. However, our exposure to other Semiconductor names also detracted, as concerns over economic growth, as well as concerns over a pending build-up of inventory, meant a number of our holdings saw a significant pullback. Despite these near-term issues, companies like the Netherland’s NXP Semiconductors have strong structural tailwinds, thanks to the anticipated increase in the semiconductor content in vehicles over the next decade, so we are comfortable using this share price weakness as an opportunity to add to our positions.”
Managers’ comments on portfolio positioning and outlook
“The macroeconomic outlook is always a key consideration for us as we seek to build a portfolio that we believe will generate strong performance. At present, economic and political uncertainty is probably greater than at any other time during our careers. Persistent, historically high inflation is being compounded by the war in Ukraine. Central banks are responding with unusually aggressive interest rate increases, which risk driving major economies into recession. Investors are also increasingly nervous about escalating tensions between China and the west, over China’s ambitions to reclaim Taiwan.
“At times like these, it is important to remember lessons from previous crises, while at the same time understanding the limitations of historical comparisons. As Mark Twain said, “History never repeats itself, but it does often rhyme”. The similarities thus far between the current situation and previous episodes of extreme economic and financial market uncertainty appear to include the elevated valuations of ‘defensive’ companies, that can maintain earnings and dividends in challenging times, combined with a pullback in more economically sensitive cyclical companies. However, unlike in previous periods, we have not yet seen any easing in current, historically tight labour markets. Nor have we seen the negative earnings revisions we would typically expect given the current climate.
“Time will tell just how much this period will rhyme with the past, but in the meantime we believe it is prudent for us to focus on our strengths. As proven by our most recent, and longer-term performance, our expertise lies in the bottom-up selection of stocks with positive future prospects, and we maintain our search for such companies regardless of near-term market conditions. We are supported in this process by our research team, whose detailed knowledge of companies and industries provides the insights that underpin our investment decisions.
“In such uncertain times, it is equally important to ensure that the portfolio is not overly reliant on any individual macroeconomic outcome. ‘Balance’ is the word that we have used most often recently to describe the ‘shape’ of the portfolio, and in practice that means identifying the best opportunities across a range of sectors – some defensive, some more cyclical – but all capable, in our view, of generating strong performance regardless of the trajectory of the economy over the next 12 months.
“One example of our efforts to balance the portfolio is the recent change to our positioning in Japan. In the past few years we have struggled to find many compelling Japanese investments, and this meant that the portfolio was usually about 4% underweight to Japan. More recently though, we have moved to a neutral weighting. This decision was motivated in part by the fact that the valuations of high-quality Japanese cyclicals reached attractive levels, compared to their global peers. Historically, higher quality Japanese stocks have tended to trade at a significant premium to their foreign counterparts and competitors, but this premium almost completely eroded in the first months of 2022. The yen’s recent weakness has also increased the appeal of Japanese equities. The yen has depreciated by around 30% from its pre-pandemic levels, but we expect this weakness to be a short-term phenomenon. If we are correct, the yen’s revaluation will generate a sizeable tailwind for UK investors in coming years. Japanese names that we purchased include Bridgestone, a premium tyre manufacturer, Keyence, an industrial company that manufactures sensors and measuring instruments, and Tokyo Electron, a producer of semiconductor manufacturing machines.
“As discussed above, recent market volatility has also provided us with opportunities to add other new names (as well as top up existing positions) that we feel have been punished excessively in the market selloff, despite their favourable longer term prospects. We have focused on companies that have a history of executing well, but have some shorter-term issues that we expect to be resolved with time. One such new acquisition was Uber (mentioned above), whose guidance of $5 billion of EBITDA in 2024 is likely to prove conservative. We also opened a new position in Deere, the US agricultural equipment manufacturer. Deere has invested a significant amount in developing their ‘Precision Agriculture’ solution, which aims to give farmers higher crop yields at lower cost. By connecting their entire farms to the cloud, this product offering allows farmers to utilise data in innovative ways that facilitate more efficient seed placement and fertiliser distribution. We believe this will prove to be a powerful driver of growth for Deere in the coming decade.
“To fund these purchases, we have reduced or closed positions where fundamentals are deteriorating or valuations are no longer attractive. The Consumer Staples sector displayed both of these characteristics, and as a result we sold Coca Cola and Procter & Gamble, the US household and personal products supplier. While both companies are very well run, we think they will be forced to raise prices to cover rising costs, and this will erode demand and margins. Both companies also have stretched valuations, so we have chosen to prioritise other names. Deteriorating fundamentals were also the motivation for the disposal of Lyft and Adidas, as discussed above.
“We have kept gearing relatively tightly controlled, edging it up only slightly to around 2%. We believe this to be an appropriate level as we weigh significant macroeconomic uncertainty against the interesting investment opportunities we see at the stock level. Valuation spreads, which measure the gap between the cheapest and most expensive names in the market, are currently wide relative to history, which typically signals buying opportunities. However any decision to alter the level of gearing will be depend on the macroeconomic data released over coming months.
“This year brought news of the combination with the Scottish Investment Trust, which completed on 31st August 2022. There will be no change to our investment process as a result of this transaction. However, we are excited about the benefits it brings for both our existing and new shareholders, namely a reduction in fees and increased liquidity, and we look forward to a partnership with our new shareholders that is as fruitful as the one we currently enjoy with existing shareholders.
“As always, we appreciate your continued support. Current uncertainties are likely to persist over the coming year, but we invest for the long term, and we believe our portfolio is now well-positioned to weather any further volatility, so we urge you to stay invested through any future difficult periods, in order to realise the returns and outperformance we are confident our portfolio will deliver over time.”