Amplifying the gain … and the pain

Outlook

One of the key concepts explored in investment writer Michael Mauboussin’s book, More Than You Know, is the stock market as a ‘complex adaptive system’[1]. The diversity of individual participants generates efficient outcomes in complex systems, that’s to say the collective outperforms the individual. Examples used to prove the power of the collective for decision-making come from nature (social insects such as ants and bees acquiring food or new nests), or from the use of experts by the US Navy to find a lost nuclear bomb (!). The stock market exhibits these characteristics, with multiple information sources, different investment approaches, styles and time horizons generally providing sufficient diversity to yield an efficient market – put another way, “when investors err independently, markets are functionally efficient”.

Markets lose this efficiency if there is a diversity breakdown, which in stock market terms means herding – or “making decisions based on the observations of others, independent of their own knowledge”. While there’s no single barometer for accurately and consistently measuring market phases where “one sentiment becomes dominant”, the respective returns to the momentum and value factors over the past 2 years would suggest some level of dominant sentiment coming into 2025 (e.g., positive on US exceptionalism, tech / AI at the expense of most other things).

A new amplifying factor for this herding has emerged in the past roughly 5 years – the rise of levered and inverse ETFs, particularly in the single stock domain. A recent note we read covered this in more detail[2], but for the uninitiated, “Leveraged ETFs aim to provide a multiple of the daily return of the index they track – for example, a 2x leveraged ETF will seek to deliver twice the daily return of the underlying. … An important characteristic to recognize is that they are designed for short-term trading – due to the way they are structured, their performance can deviate significantly from the underlying index over longer periods.”

Their growth has been staggering, most notably in the Tech & Semiconductor sectors and with single stock levered ETFs developing more recently, dominated by launches for long ETFs rather than short (inverse).

The growth of levered ETFs offers further evidence that:

1. Money has been crowding into areas where prices have already risen significantly.
2. An increasing amount of capital has a short-term, trading mindset rather than a long-term, investing one.

We agree with the note’s author that it is fair to assume these instruments “may be contributing to some of the intraday volatility in certain names and segments of the market and will be a relevant consideration in any large bouts of volatility particularly in the Tech arena.”[3]

In this environment of outsized single stock moves, we believe it has rarely been more valuable to have a clear and repeatable investment philosophy and process which is focused on the long term and pays due regard to valuations as a factor in returns. We continue to feel well placed to deliver attractive compound returns over the coming years, though we doubt that this will happen in a straight line!

Strategy Update

Activity

We bought one new holding and exited three existing holdings in February.

Howden Joinery is a vertically integrated kitchen and joinery supplier. Its ownership of most of the value chain supports an unrivalled high service trade-only in-stock local model that underpins sustainable premium margins and returns and an attractive runway for growth via market share gains and depot expansion (UK and Europe). A strong balance sheet (no debt) provides resilience through the cycle. Our entry point is offered by virtue of operating in a category that has been in sharp volume decline. The share price discounts limited cyclical recovery in the UK kitchen market, which is currently hovering near decade lows in volume terms. However, Howden offers a market leading and well invested franchise with material operating leverage to volume recovery as and when it emerges.

We sold Sanofi after it reached our assessment of fair value, and AGCO due to concerns that the risk profile is greater than it appears at face value following fresh analysis. A more prolonged dealer destocking than the market expects (based on analysis of AGCO’s off-balance sheet dealer receivables), paired with over $1bn net debt additions over 2024[4], leave little margin for error. We also sold FeverTree after it bounced sharply on a new US distribution partnership with Molson Coors. Lack of detail in the announcement and subsequent meetings make it hard to know the extent of the long-term upside, but we can have higher conviction that in the short-term our investment case around margin recovery is not likely to play out.

Performance

The Fund returned -3.6% in January. In comparison, the MSCI ACWI index returned -1.9% and the MSCI ACWI Value +0.2% (all in GBP).[5] Relative comparisons are distorted by a large positive move from the US market on the final day of the month (Fund returns are struck at midday).

Danieli (+17% in GBP) was the largest positive contributor. It is seen as a beneficiary of rebuilding in Ukraine in the event of a ceasefire. Steel demand may also increase if European countries follow through with defence spending commitments. Fiserv (+8%), Sony (+10%), and SS&C Technologies (+9%) all released strong results and positive guidance, which reinforced the respective investment cases. Having no exposure to Tesla and Amazon contributed +0.7% to relative performance.

Avantor (-26%) was the largest negative contributor. It offered guidance for 2025 organic growth which we view as conservative. The focus on US federal government budget cuts (‘DOGE’) has had a material impact on investor sentiment in life sciences, also impacting Certara (-17%), which retraced much of January’s move. Henry Schein (-10%) also gave back early year gains following cautious guidance for the year ahead. JEOL (-13%) fell alongside peers amidst concerns that less investment may be required in advanced semiconductor equipment.

 

[1] Predominantly explored in Part 4: ‘Science and Complexity Theory’.

[2] https://www.linkedin.com/pulse/rise-levered-etfs-bernie-ahkong-9vnte/

[3] https://www.linkedin.com/pulse/rise-levered-etfs-bernie-ahkong-9vnte/

[4] Company filings

[5] Fund: B share class (GBP), midday to midday pricing. Benchmark: close-of-business to close-of-business pricing. All performance data from Bloomberg Finance LP.

 

KEY RISKS

The value of investments and any income generated may go down as well as up in response to general market conditions and the performance of the assets held, and is not guaranteed. An investor may not get back the amount originally invested.

Past performance is not a reliable guide to future results.

Changes in exchange rates may have an adverse effect on the value, price or income of investments.

There is no guarantee that the Fund will meet its stated objectives.

There is a risk that any company providing services such as safe keeping of assets or acting as counterparty to derivatives may become insolvent, which may cause losses to the Fund.

 

For professional investors only.

Capital at risk.

 

For more information about the fund and how the fund is positioned, please visit our fund centre below: