By Mark McSherry
Baillie Gifford’s £2.4 billion Monks Investment Trust plc said it has continued with “a run of poor relative returns that began two years ago” in what has been “a bruising period performance-wise.”
The current managers of the Monks fund are Spencer Adair and Malcolm MacColl.
Announcing the fund’s results for the six months to October 31, 2023, Monks chairman Karl Sternberg said it produced a net asset value (NAV) total return of -3.3% compared to +2.1% for the comparative index (FTSE World in sterling).
The fund’s share price total return was -7.3%, as its discount widened from 8.7% to 11.6%.
“This is disappointing,” said Sternberg.
“Beyond the seven mega-cap stocks in the US, growth stocks have been out of favour during a period of rising interest rates.
“We believe that in the long run growth stocks will continue to deliver better investment returns, particularly as technology continues to transform economies in sometimes unpredictable ways.
“We also share the investment managers’ optimism that the period of sharply rising rates is now behind us.
“Some of the underperformance, however, has been driven by specific stock selection, and commentary on the largest detractors from performance over the period is included in the managers’ report.”
The largest investments in the Monks portfolio currently include Microsoft, insurer Elevance Health, cement and aggregates firm Martin Marietta Materials, Amazon, Moody’s, Meta, building materials giant CRH, Alphabet, Indian energy firm Reliance Industries, media and ecommerce company Prosus, Mastercard, Ryanair and Pernod Ricard.
Monks’ managers said that among the largest detractors from performance in the six months were the holdings in The Schiehallion Fund — a closed-ended investment company managed by Baillie Gifford that invests in late-stage private companies — Pernod Ricard, and cosmetics firm Shiseido.
The managers said they have added to their holdings in Mark Zuckerberg’s Meta as they are “excited about its potential” and have “taken action by selling holdings poorly positioned in an environment of persistently higher inflation and interest rates …”
Monks’ managers said they have sold their shares in gene sequencing firm Illumina “as a result of significant management changes and poor operational execution of its acquisition of Grail …”
Edinburgh-based Baillie Gifford has around £217 billion under management and advice in active equity and bond portfolios for clients in the UK and throughout the world.
The managers of the Monks fund wrote: “The investment performance of Monks’ portfolio in the first half of its financial year has been disappointing.
“This continues a run of poor relative returns that began two years ago, which has erased – for the time being – the superior returns delivered for shareholders since the Global Alpha team took over eight years ago.
“This stands in contrast to our view of the long-term growth prospects of the companies in the Monks portfolio.
“Rapidly rising inflation and the increases in interest rates that began in the first half of 2022 suppressed investors’ appetite for growth assets and precipitated sharp share price falls of companies held in the Monks portfolio.
“The portfolio was too concentrated in rapidly growing, earlier-stage companies that bore the brunt of share price declines.
“We have taken action by selling holdings poorly positioned in an environment of persistently higher inflation and interest rates, while restoring greater balance across the portfolio’s three growth profiles (Stalwart, Rapid, Cyclical).
“Furthermore, we have strengthened the analytical inputs to our investment process, specifically, those related to valuations and stock correlations.
“We believe that good times are ahead for the portfolio. The inflation and interest rate environment is stabilising and we expect the portfolio to deliver substantially higher levels of earnings growth than the market …
“Since our team took over the management of the portfolio in March 2015, the company has produced a NAV total return +119.3% compared to +132.2% for the comparative index. The share price total return was +114.4%.
“Among the largest detractors from performance were the holdings in The Schiehallion Fund (a closed-ended investment company managed by Baillie Gifford that invests in late-stage private companies), Pernod Ricard (spirits and drinks), and Shiseido (cosmetics).
“Although the NAV of the Schiehallion Fund fell by 5%, it was a widening discount between the share price and NAV (from 25% to 50% in the period) that drove its underperformance.
“This reflects a more challenging operating environment for companies and investors’ aversion to assets whose valuations are founded on long-term potential.
“This has contributed to share price weakness across the portfolio more broadly too. We continue to favour a modest level of exposure to private companies (3.9% of the portfolio, of which Schiehallion is 1.5%), but are enthusiastic about the potential of both Schiehallion and the handful of directly held private securities (which include Bytedance and SpaceX that are also held in Schiehallion).
“The sharp share price falls (20-30%) for Pernod Ricard, the French spirits business, and Shiseido, the Japanese cosmetics company have, in part, been down to weaker demand from the Chinese market.
“Consumer appetite in China has been slower to return post-pandemic, which has been felt most acutely in ‘premium’ products of the type sold by Pernod and Shiseido.
“We believe that these developments are temporary.
“For example, in the case of Shiseido, it continues to focus on its ‘prestige’ brands (Cle de Peu, Anessa and Zanessa) in the Chinese market where we believe volumes and operating margins will be materially higher (versus 2019 levels) in the next 2-3 years.
“On a sector basis, the portfolio’s healthcare holdings have accounted for around 40% of the underperformance relative to the index over the period. For most of these, we remain enthusiastic about their long-term growth potential.
“For example, Moderna, the infectious disease vaccine producer, has seen revenue growth slow after demand for Covid vaccines fell. Whilst the share price spiked through the pandemic to over $400 and has fallen sharply, Moderna remains a relatively new position for Monks (purchased just two years ago) and the current price is above our initial purchase price (~$77 per share).
“Moderna has proven itself capable of executing and we believe that focusing on near-term demand for Covid vaccines ignores the strength of Moderna’s pipeline of treatments (36 programs in clinical trials deploying mRNA technology to make infectious disease vaccines).
“Our conviction in Moderna’s ability to be one of the leading biotech companies of the future, solving health challenges for millions of people, remains intact.
“In contrast, where long-term growth prospects are faltering, we have taken action. This is true for Illumina (gene sequencing). We have sold the portfolio’s holding as a result of significant management changes and poor operational execution of its acquisition of Grail (cancer testing), which it continues to contest with regulators.
“Despite the poor share price reactions we have seen, the operational progress of a majority of holdings remains on track. Several of our long-established cyclical operators, such as building and aggregates businesses Martin Marietta and CRH, have contributed positively to NAV.
“These companies continue to demonstrate exceptional capital allocation discipline and very strong pricing power that has driven robust growth in profitability. For example, Martin Marietta increased pricing by 17% and grew gross profits by 38% year-on-year.
“The strongest contributors have demonstrated increasing earnings power this year. This is true of Meta (social media) and Amazon (ecommerce and cloud). Mark Zuckerberg announced 2023 as Meta’s ‘year of efficiency’, indeed, revenue growth is returning to faster growth (+23% year-on-year) and net income rose 164% year-on-year.
“We believe this is only the beginning of a material uptick in Meta’s profitability. Its advertising estate (that includes Facebook, Instagram and Whatsapp platforms) reaches 3.6 billion users and is under-monetised. We are excited about its potential and have added twice this year.
“Amazon invested heavily in its logistics network during the pandemic. Utilisation rates are growing and its retail division is becoming more profitable, while its highly profitable Cloud computing division, Amazon Web Services, continues to make strong progress.
“Recent deals struck with other ecommerce platforms (such as Shopify and Pinterest) to provide fulfilment services for transactions on their platforms have underlined Amazon’s credentials as the leading provider of infrastructure in this market …
“It has been a bruising period performance-wise. But beneath the difficult headline numbers resides a portfolio in robust health.
“Forecast earnings growth – at nearly twice the market average – is coiled and ready to drive returns for shareholders in the years ahead …
“We know from experience that this is exactly the kind of environment where patience will be handsomely rewarded …”