International Concentrated Growth: investor letter Q3 2024

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Reflecting on the last few years

“The world cannot be understood without numbers. But the world cannot be understood with numbers alone.” 

This quote from Hans Rosling's book Factfulness emphasises the importance of both quantitative and qualitative understanding. Numbers provide a clear, objective way to measure and analyse the world, but they don’t tell the whole story. Context, human experience, and qualitative insights are also crucial to fully grasping complex realities. 

During the Covid pandemic, much of the economy was forced online. Remote working shifted from being optional for some to compulsory for many. Businesses expedited their digital transformation plans to adapt to the new normal. This included enhancing their online presence, developing ecommerce initiatives, and utilising cloud-based services. 

Several companies across the portfolio could be categorised as ‘Covid beneficiaries’. European online fashion retailer Zalando’s active user numbers grew 31 per cent to 42 million. MercadoLibre’s gross merchandise volume (GMV) grew to $6.1bn over the first three months of 2021 a year-on-year gain of 79 per cent! There are other examples beyond these. 

Financial reports provide a clear ex-post picture of a company's financial health, performance, and operations over a specific period. Those facts are obvious. However, understanding the long-term changes in consumer behaviour requires patience and a qualitative perspective. Were these businesses experiencing a permanent wholesale shift in customer preference? Or simply a pull-forward of demand and an acceleration in the maturity of their businesses? In each case, they remain substantially larger than their pre-pandemic state in terms of customers or revenues. However, it has taken time for their long-run economics and level of maturity to become clear. 

Long-term holding MercadoLibre has continued to go from strength to strength. GMV has more than doubled since the first year of the pandemic and now exceeds $45bn annually. Revenues have sustained growth in the 40 per cent range, with operating profits up 5 fold since the end of 2021. Driven by these impressive fundamentals, MercadoLibre continues to make an outstanding contribution to the portfolio’s returns.  

Similar patterns can be seen at Shopify, the ecommerce software business, where we have increased conviction in its growth opportunity and have been adding to the holding. 

However, in some cases, we misjudged the stickiness of some of the Covid-induced changes in consumptive behaviour and the implications for portfolio holdings. We would include Zalando in this category. With the perspective that only time can provide, we think it is now a more mature business than we previously perceived. It didn’t go into reverse following the pandemic but it is also not as high-quality a business as we would have hoped. It no longer clears the hurdle of being able to deliver the exceptional returns we require from holdings. We have therefore sold the holding. 

We will of course reflect, learn, and enhance our approach for the future. However, the nature of equity investing is inherently asymmetrical, and it's common for even the most successful companies to experience significant and prolonged declines in their share prices. This reality reinforces our commitment to maintaining patience within our investment process. 

Patience distinguishes our approach in a financial market that often lacks it. The principle of holding on, rather than selling, if we believe the opportunity remains, is fundamental.

MercadoLibre serves as a prime illustration of this philosophy. We maintained our investment through various challenges, including competition from Amazon, a shift in business model leading to dramatically reduced margins with significant investments in logistics, the most severe recession in Brazil's history and the aftermath of the pandemic. Despite experiencing substantial decreases in value, including a 70 per cent post-pandemic drop in share price, MercadoLibre's stock has since tripled in value and made all-time highs during the quarter. This mirrors the experience with Spotify we discussed last quarter. 

Performance drivers over the quarter

 After a stock has performed well, it’s sometimes tempting to think it was obvious. Hindsight bias, or the tendency to look back at an uncertain situation and think it was easily predictable, can be a powerful cognitive bias and something we strive to guard against. As the late Nobel laureate and one of the founding fathers of behavioural finance Daniel Kahneman put it, ‘hindsight bias makes surprises vanish.’ It is seldom obvious at the time. 

In the context of ‘Covid beneficiaries’, the holding in Moderna continues to detract from performance. Management recently downgraded financial guidance for this year as the respiratory vaccines market is proving more competitive than they initially expected. They also extended the timeline to reaching sustainable profitability. Patience is important.

We continue to believe Moderna’s mRNA technology platform will produce valuable assets, not only in the respiratory vaccine arena but also in areas like oncology, which could be far more valuable than the market currently anticipates or is willing to ascribe value to today. 

 The holding in the Chinese social ecommerce platform PDD currently carries a high level of perceived uncertainty, or to borrow from Donald Rumsfeld has more ‘known unknowns’ than other holdings. These fall into two broad categories: Risk of the Chinese authorities curtailing the domestic opportunity; and the geopolitical risk of having its international opportunity stymied. Before we took a holding in PDD for the portfolio, these risks were manifest in a persistent disconnect between its growth opportunities, the outstanding operational progress it is making, and its valuation. The gap widened over the quarter as the share price fell following oddly downbeat remarks from management during their quarterly earnings call regarding margin pressure and an increasingly competitive environment. Interpreting these comments is challenging particularly as we suspect the primary audience may not even be investors but instead the government. We found our own conversations with management reassuring. They spoke of wanting to invest in the opportunities that they are finding to grow the business. We continue to balance the risks associated with its investment case with the potential rewards on offer, maintaining a position of around 2 per cent in the portfolio.  

Dutch lithography business ASML has been one of the most valuable investments over the last ten years of the International Concentrated Growth strategy. During that period, ASML has experienced four drawdowns of over 30 per cent and it is one of the main detractors from performance during the quarter. We firmly believe that we are in the midst of a silicon-based industrial revolution and at approximately 17 per cent, Semiconductors & Semiconductor Equipment remains the largest industry by weight in the portfolio. There have been moments when this position appeared unwise in the short term, but this industry has consistently offered a rich vein of investment opportunities and portfolio returns. We remain committed to pursuing these opportunities with enthusiasm and determination. 

Returning to ASML, it is our expectation that the leading-edge lithography machines it produces will remain a critical component in advanced semiconductor manufacturing. Similarly, the competitive advantage NVIDIA has built in its powerful graphic processing units (GPUs), essential for generative AI model development and data centre operation is remarkable. However, during the quarter we have reduced the holding in both companies. 

For ASML this reflected that though lithography remains important for progress in semiconductors we expect there to be a greater range of drivers going forward. For NVIDIA we are conscious that the ability to make a large multiple return from here is now challenging and that there could be an air pocket in demand in the coming years. Whilst we believe the long-term implications of generative AI are still potentially profound we are aware that the pathway for hardware companies could be bumpy in the years ahead. They both remain significant positions in the portfolio, but reduced weightings better reflect their potential to continue to deliver outlier returns from current levels. 

We have used part of the proceeds from these reductions to further increase the holding in Taiwanese semiconductor foundry TSMC. We find the foundry business model particularly appealing at this juncture as they are positioned as technology-agnostic enablers of the world's increasing demand for compute. TSMC specifically should also be a net beneficiary of the current woes Intel is experiencing. In the battle for silicon sovereignty, Intel is too important an asset to the US government to be allowed to fail. Nevertheless, delays to capital expenditure plans due to budget constraints should allow TSMC to gain incremental market share. 

Broadening horizons

The digitalisation of the global economy is a consistent theme in the portfolio, and we have added some new holdings to it during the quarter. However, our research is also steering us towards exciting new growth areas. 

In healthcare we have taken a new holding in Danish biopharmaceutical company Novo Nordisk for the portfolio. Novo Nordisk has a long history of innovation and leadership in the healthcare sector, particularly in the treatment of chronic diseases such as diabetes and obesity. 

Our analysis suggests that the potential for the obesity market lies far beyond current market expectations and could reach $350bn over the next 10 years, and up to $500bn beyond that, with Novo Nordisk set to take a sizeable share. The insatiable demand in the self-pay market for its weight loss product Wegovy is unprecedented in the history of chronic disease management and is set to continue. Novo Nordisk’s strong clinical evidence and manufacturing capacity will result in a growing stream of cash flows that it can use to further advance its obesity pipeline, which is already the strongest in the industry. This includes developing drugs with improved efficacy, those that can be taken orally, or with new mechanisms of action, further expanding the market.

The funding has come from the sale of another Danish biopharmaceutical company Genmab as it faces increasing uncertainty as the patent expiry of its main revenue-generating asset Darzalex approaches. 

Having monitored the South East Asian consumer internet company SEA for several years, we have been impressed with the management's ability to pivot the business in the face of a shifting digital commerce market as well as a more nascent opportunity in financial services. In many ways it has reminded us how MercadoLibre looked some years ago. Given our increased confidence in the investment case, we have added SEA to the portfolio. 

We have also taken a position in Nu Holdings the Latin America neo bank. Nu is a founder-run digital bank operating in Brazil, Mexico and Colombia. After a decade of operation, the company has attracted over half of Brazil's adult population, mainly through organic customer acquisition. Its cost advantage over incumbent traditional banks is remarkable with an 85 per cent cost advantage over competitors allowing it to undercut fees while offering a superior customer experience. We think Nu can continue to gain market share in its current geographies with the option to expand into new geographies and adjacent business lines. 

Rational investing in an irrational world

"As a possibilist, I see all this progress, and it fills me with conviction and hope that further progress is possible. This is not optimistic. It is having a clear and reasonable idea about how things are. It is having a worldview that is constructive and useful.” 

Rosling described himself as a 'possibilist' a term he coined to distinguish his sanguine fact-based worldview from optimists who merely wished for progress. We, too, are possibilists. We deal in facts. We know that the companies we invest in provide products and services far superior to those who have gone before. The journey to success for the companies in the portfolio will take time and patience. Some are succeeding today; some will succeed tomorrow. This progress will lead to earnings and cashflows that surpass what the market currently anticipates and is willing to reward. Although a few may falter, we believe the majority will excel, some far beyond our wildest expectations. 

Source: Revolution, MSCI. US dollars. Returns have been calculated by reducing the gross return by the highest annual management fee for the composite. 1 year figures are not annualised.

Past performance is not a guide to future returns.

Legal notice: MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indexes or any securities or financial products. This report is not approved, endorsed, reviewed or produced by MSCI. None of the MSCI data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such.

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