International Growth: investor letter Q3 2024

Your capital is at risk. 

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 platforms, and utilising cloud-based services. 

Several companies across the portfolio could be categorised as ‘Covid beneficiaries’ as they experienced a dramatic acceleration in demand for their products and services. Meal kit delivery business HelloFresh saw its customer base surge 74 per cent to 7.3 million during the first year of the pandemic. 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 their businesses' maturity? 

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. 

The holding in cloud based website development platform Wix.com saw a substantial rise in revenue during the pandemic. In 2021 total revenue reached $1.3bn driven by an increase in website creation and online presence as businesses adapted to the new digital landscape. It continues to grow strongly today, with expectations of revenue to reach $2bn next year. It has made a solid contribution to the portfolio’s performance so far this year. 

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 fivefold 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 more recent addition to the portfolio Shopify, the ecommerce software business, where we have increased conviction in its growth opportunity and have been adding to the holding. We have also been impressed with the management at SEA, the South East Asian consumer internet company, and their ability to pivot the business in the face of a shifting digital commerce market as well as a more nascent opportunity in financial services. We are attracted to SEA’s business model; in some ways, it reminds us of how MercadoLibre looked many years ago. Given our increased confidence in the investment case, we have been adding to the holding. 

However, in some cases, we misjudged the stickiness of some of the Covid-induced changes in behaviour and the implications for portfolio holdings. We would include Zalando, HelloFresh and Japanese medical marketing company M3 in this category. With the perspective that only time can provide, we think these are now all more mature businesses than we previously perceived. They no longer clear the hurdle of being able to deliver the exceptional returns we require from holdings. We have therefore sold the positions in HelloFresh and M3 and continue to use Zalando as a source of funds. 

In each case, we reflect, learn, and enhance our approach for the future. But we must never forget the asymmetry of equity investing and the critical importance of a small number of big winners. We must also recall that even the most successful companies can 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 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 around 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 the holding in 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. 

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.

Dutch lithography business ASML has been one of the most valuable investments over the last ten years of the International 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 13 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 while monitoring the overall portfolio exposure to this important source of growth. 

Returning to ASML, we expect its cutting-edge lithography machines to remain a critical component in advanced semiconductor manufacturing.  

But the semiconductor exposure is not static. Earlier in the year, we added Japanese semiconductor testing business Advantest to the portfolio. The semiconductor industry has a series of niches, each dominated by a single player, like Advantest, and we may add similar companies as our assessment of the growth opportunities within the industry evolves. 

Broadening horizons

The digitalisation of the global economy is a consistent theme in the portfolio. However, our research is also steering us towards exciting new growth areas. 

One lesson we have taken from the Covid pandemic period is that in our search for exceptional growth businesses, we allowed the portfolio to become too narrowly focused. We have already made a good start at increasing the breadth of holdings in the portfolio and intend to continue to widen our research funnel and analysis to ensure we do not overlook potential growth opportunities across our opportunity set. This approach aims to maintain the potential for outlier returns but within a more diversified portfolio. 

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. We intend to build the holding in Novo Nordisk over time. The initial funding has come from a reduction in another Danish biopharmaceutical company Genmab. We continue to have confidence in the long-run outlook for Genmab but are conscious it faces some challenges in the short run as it negotiates the patent expiry of its main revenue-generating asset Darzalex.

We have also added Danish-listed DSV, the global freight forwarder to the portfolio. While multiple companies are involved in the relay race of transporting goods around the world, a freight forwarder is responsible for organising and ensuring the success of the whole journey. The global freight forwarding market is worth an estimated $200bn in annual revenue, growing faster than the global economy. It remains a highly fragmented industry, and DSV has an excellent acquisition track record with a ruthless cultural focus on driving operational efficiencies. 

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. We are also acutely aware that we have not delivered the investment performance you expect from us over the past three years. The journey to success for the companies in the portfolio will take time and patience. Some are succeeding today; some will succeed tomorrow; and some will fail. And although a few may falter, we believe the majority will excel, some far beyond our wildest expectations. We sincerely thank our clients for their continued support.

*MSCI EAFE Index prior to 30 September 2018

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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