Predictability in an era of disruption

Outlook

“Doubt is not a pleasant condition, but certainty is absurd.” Voltaire

The release of DeepSeek’s new reasoning model towards the end of January, with its eye-catching cost competitiveness claims, has done nothing if not throw the cat amongst the pigeons of the one ‘sure thing’ thematic trade of 2024 (and 2023). While we are not experts on leading edge AI, there are convincing arguments that this is a watershed moment which will either (a) materially accelerate the adoption and development of AI, or (b) reveal massive misallocation of capital in the AI arms race, as well as by investors seeking to benefit from AI’s ‘halo effect’ in areas such as power production. Perhaps it will be both, but our highest conviction is that “we just don’t know”.

The Fund’s capital is invested in companies where we believe the range of outcomes is ‘knowable’. This is quite different from certainty but allows us to have a good sense of the risk-reward and increase the probability of making attractive returns for our investors. Predictability can come in the shape of consistent growth and return on capital, which can become mispriced when the market favours more ‘go-go’ investments; but it can equally be found via the rise and fall of cycles or corporate self-help measures (such as restructuring).

Doubt is an unpleasant but necessary condition of equity investing. We aim to deal with uncertainty by investing in companies with a diverse spread of end markets, which are in control of their own destiny via cash generation and sturdy balance sheets. We cannot eliminate uncertainty, but with the current 7% FCF yield and double-digit earnings growth[1] within the portfolio we are well compensated for its presence. In summary, we feel well placed to deliver attractive compound returns over the coming years.

Strategy Update

Activity

We bought three new holdings and exited two existing holdings in January. Given the elevated level of activity, we will provide shorter summaries of the investment case than usual and will share more detail in our quarterly letter.

Allegion is an underappreciated compounder with persistently high return on capital generated through iconic security brands with leading market positions, a proven ability to expand margins over the cycle, and innovation dominance which positions it to deliver above industry growth. The key competitive advantage underpinning its high margins is its route-to-market, where it works hand-in-glove with architects and regulators to design building specifications. 50% of revenues are predictable replacement and aftermarket business[2] on a large, aged installed base. We were able to buy with a mid-teen IRR under our base case due to concerns around the short-term outlook for demand in its end markets.

Certara leverages its fully integrated biosimulation platform to streamline drug development efficiency. Biosimulation, in which Certara is a market leader, is an emerging tool that enables scientists to accurately model human and animal biological systems in drug discovery & development. Certara has a strong portfolio of blue-chip customers, a high level of recurring revenues, demonstrated proofs of concept, and a wide competitive moat. Its high margins are currently depressed by investment in R&D and building out its sales platform; we expect these to recover to the high-30s over a 5-year horizon, generating attractive growth in free cash flow (FCF) per share.

TSMC owns and operates the world’s leading-edge semiconductor factories, with over 90% market share in leading-edge nodes[3]. Our review of Samsung last quarter made us even more appreciative of the strength of TSMC’s model. It has spent decades optimising for and building ecosystems around its 500+ customers[4] (as covered in the excellent book Chip Wars), an advantage that is very challenging for any competitor to match. AI chips require the use of leading-edge technologies and advanced packaging solutions in addition to the operational excellence that enables high yields and supports the manufacturing of the larger chips that are found in AI servers. In the context of its guidance for 20% revenue CAGR over the next 5 years[5] , the starting valuation of ~19x our estimate of FCF offers attractive risk-reward. Our TSMC holding complements existing investments in other parts of the semiconductor supply chain.

We sold T Hasegawa and Treasury Wine Estates. Neither investment case is broken, but on our current analysis neither will achieve a 15% return on invested capital over our typical time horizon, and we see opportunity cost to holding these versus higher quality business models available at similar valuations. Progress with engagement at T Hasegawa has also been slower than hoped, so this also allows us to focus our attention on other holdings.

Performance

The Fund returned +6.7% in January. In comparison, the MSCI ACWI index returned +4.2% and the MSCI ACWI Value +4.8% (all in GBP).[6]

Henry Schein (+17% in GBP[7) was the largest positive contributor. Private equity firm KKR announced it has taken a 12% stake (with potential to go up to 15%) and has nominated two new board members from its ranks, alongside a third new board member. All look like excellent candidates. The share buyback was also increased. Baker Hughes (+13%) released another excellent set of results, beating expectations for profitability and new orders. Its guidance for 2025 was above analysts’ expectations, driven primarily by its Industrial & Energy Technology division. New holding Certara (+17%) rose sharply following its Q4 results, which were modestly better than expected, against the backdrop of improving sentiment for healthcare investment. Having no investments in NVIDIA, Apple, and Microsoft contributed +1.2% to relative performance.

John Wiley & Sons (-6%) was the only material negative contributor. There was no stock specific news during the month.

 

[1]  UBS HOLT

[2] Allegion

[3] https://www.mbi-deepdives.com/tsm/

[4] TSMC

[5] TSMC Earnings Release

[6] Fund: B share class (GBP), midday to midday pricing. Benchmark: close-of-business to close-of-business pricing.

[7] All performance and attribution data sourced 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.

The movements of exchange rates may lead to further changes in the value of investments and the income from them.

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.

 

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