Turning off the TAAP (Themes At Any Price)

May Outlook

Stock market investors are long themes and the promise of future growth related to these. ‘Thematic purity’ is, for now at least, more important than business fundamentals and certainly more important than the price one is paying to access future growth prospects. This has become as true of ‘the electrification of everything’ and the implications this has for grid investment (about which we have previously written in the Q3 2023 and Q1 2024 reports) as it is of the real thematic golden child, AI. History suggests this is unlikely to last.

Instead, it is more likely we are in the part of the market cycle when certain structural growth drivers seem so obvious that investors become overconfident in their ability to predict the future. Being exposed to an attractive growth market is not a sufficient precondition for a great investment. The growth that analysts forecast should be conservative and the valuation placed on these should be modest.

As we have said before, when the herd is focused on a handful of well-loved (and well-known) themes, most often it will be leaving bargains in plain sight elsewhere. Market efficiency as a concept is simply ‘whack-a-mole’ – efficiencies do emerge, but fresh inefficiencies pop up elsewhere. While we have had our share of beneficiaries of the current market’s myopic mindset driving up share prices, our go-anywhere approach and willingness to invest with a contrarian mindset means we can and are casting our net far wider.

We are investing in and investigating potential investments in a diverse opportunity set: academic journals, life sciences tools, PC makers, US utilities, and UK building materials. Meanwhile, a glimpse at our top performers during the past month show a market leader in equipment that produces lower carbon steel, a US infrastructure business, a paints business with a dominant market position in India, and one of the world’s leading wealth management companies. This breadth of ideas speaks to our ongoing opportunity to offer investors a well-balanced, attractively valued portfolio compared to highly concentrated, momentum-driven benchmark indices.

Market Overview

Global equity markets resumed their march upwards in May (MSCI ACWI +4.1% total return in USD). Stylistically, MSCI ACWI Growth (+5.1%) led MSCI ACWI Value (-3.0%), while large cap and the momentum factor both also returned to relative leadership (MSCI ACWI Equal Weighted +1.7% and MSCI ACWI Momentum +5.6%). New highs in equity benchmarks came alongside stabilisation in rates. The US 10-year bond yield fell slightly from 4.6% to 4.5% and real yields from 2.3% to 2.2%. A generally strong Q1 earnings reporting season, particularly from mega caps, supported continued US equity market leadership. Volatility did pick up towards month end and there have been pockets of weakness within Q1 reporting, such as parts of Consumer Discretionary and Software.

 

Strategy Update

Performance

The fund returned +0.1% in May. In comparison, the MSCI ACWI index returned +2.3% (all in GBP). Since inception, the fund has returned +27.5%, compared to the global benchmark’s +25.8%.¹

Danieli (+14% in GBP) was the largest positive contributor. A strong steel price was supportive, while a new broker initiating on the shares and a relatively rare interview in the press by Danieli’s CEO also brought more attention to the investment case.

Samsung Electronics (-7%) was the largest detractor within the portfolio. A press article suggested that its HBM (high bandwidth memory) products are yet to pass qualification for Nvidia. Samsung has dismissed the claims. Its issues in the current HBM generation are not new, but believe the bigger long-term prize is its potential to return to leadership in the next generation (HBM4). CDW (-9%) missed Q1 forecasts and lowered guidance for the year due to decision-making paralysis within its smaller company customer base around IT budgets. Owning no shares in NVIDIA, which rose +25%, or Apple, up +11%, detracted -1.0% from relative returns.

 

Activity

We added two new positions and exited four during May.

John Wiley & Sons is one of the world’s leading publishers of academic research, primarily via scientific, technical, medical, and scholarly (STMS) journals. Wiley is in the Recovery lifecycle phase, following M&A activity under prior management which diluted the quality of the business, and having come through challenges such as the shift from print to digital books and the move to open access journals. The interim CEO, who previously led the group between 2017-19, is refocusing the business by disposing of non-core businesses, such as University Services and Talent, and has set out clear strategic and financial goals. Wiley expects EBITDA margins of 24-25% in April 2026, compared to 21-22% in April 2024. Consistent 73-74% gross margins make this target very reasonable. The trough margin was originally expected to be ~20%, but the initial stage of the $130m cost savings supporting margin improvement has been delivered ahead of plan. Over the medium-term, management guides for sales growth in the low-to-mid single digits. Roughly half the revenues are recurring in nature under subscriptions, which provides stability but also working capital ‘float’; in other words, your customers pay you upfront and fund your growth. Allied with low capital intensity and attractive margins, even at low levels of sales growth the business model is highly cash generative. This has supported unbroken dividend growth for 30 years and the shares offer a 4% dividend yield today, helping underpin the downside. Following the initial recovery phase, we believe that Wiley will be a ~10% EPS compounder trading on ~10x earnings. Thinking about the valuation another way, its current 1.7x EV/Sales multiple compares to the 2.8x or 2.6x that were paid in recent years to acquire peers McGraw Hill and Houghton Mifflin, respectively.

JEOL is another under-the-radar company, listed in Japan. Group margins and return on capital have improved materially over the past three years and the market is currently pricing that these will mean-revert lower. We think this is unlikely because the key driver of the improvement is its Semiconductor Equipment business, which currently sits within the Industrial Equipment segment so is somewhat hidden. JEOL’s electron beam mask writer technology is very specialist, producing photomasks (templates) used in EUV lithography. It operates in a two-player market (~80% market share in leading edge nodes) and earns 40%-plus operating margins in a market which we expect to demonstrate strong structural growth over the next decade. Peers with similar margins trade on 9-12x EV/Sales, supporting our view that this business is undervalued within JEOL (we estimate an implied 2.5x multiple). The group also contains a strong Scientific & Metrology Instruments division, where it is the global market leader in transmission electron microscopes (TEMs), and a sub-scale Medical Equipment business which is a candidate to be sold once profitability improves.

JEOL replaced Nikon, which was sold as the share price converged with our fair value assessment. This follows an engagement programme over the past two years that was successful overall, although some concerns around capital allocation remain. We also sold positions in: Owens Corning, which reached our fair value and where we have reservations around the large acquisition recently announced; Harley-Davidson, which is cheap but risks being a value trap as the margin recovery investment case appears broken; Accenture, where the quant score has deteriorated (primarily weak earnings and technical momentum) – we see opportunity cost to holding the shares because risk-reward, although positive, is less attractive than other investments within the portfolio.

¹Inception: 7 July 2022. Fund: F share class (GBP), midday to midday pricing. Benchmark: close-of-business to close-of-business pricing. 

 

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