News & Insight • Market Insights

05 July 2024 | William Buckhurst

Thoughts on 2024 - The Halfway Point

YFS VP Portfolio Funds

Over the first half of 2024, the Vermeer Partners Portfolio Fund returned +4.85% and the Growth Portfolio Fund (which has a higher equity content and, therefore, higher risk profile) returned +5.96%. The estimates for the ARC GBP Steady Growth PCI were +5.68% and the ARC GBP Equity Risk PCI +6.87%. Since launch (16^th October 2023), the Portfolio Fund has returned +9.78% while the Growth Portfolio Fund has returned +10.62%. The estimates for the ARC GBP Steady Growth PCI were +11.71% and the ARC GBP Equity Risk PCI +13.85%.

The estimated historic dividend yield on the Portfolio Fund is 2.89% and on the Growth Portfolio Fund it is 2.50%.

Global markets have continued to march higher.

The S&P 500 Index has risen by 16.27% (in sterling terms) this year and has notched more than 30 new all-time highs. Even the UK, often a laggard, has surged ahead with a positive return of 7.49%. Following a slight wobble in the French stock market (triggered by President Macron suddenly announcing snap elections), the UK’s main stock market retook its crown as Europe’s most valuable for the first time in nearly two years. Bond yields too have moved noticeably higher – in the US, the ten-year treasury yield rose from just below 4% to 4.40% by the end of the first half.  In the UK, gilt yields were as low as 3.6% at the start of the year but finished June at 4.23%. In most parts of the world, yields available on cash and shorter-dated bonds – the so-called risk-free rate – now sit significantly higher than the prevailing rate of inflation, giving investors for the first time in years a positive real rate of return on lower-risk investments.

Equity markets have been the place to be though, and the mood has been one of sunny optimism. The great French philosopher Voltaire, one of the leading figures of the late seventeenth and early eighteenth century intellectual and cultural movement known as The Enlightenment, or the Age of Reason, was concerned with the issue of relentless positivity. When he wrote his satirical masterpiece, “Candide, or Optimism” he creates one of the most memorable characters in all of literature, Dr. Pangloss, the idealistic tutor of the hero – the unreliable and naive Candide.  Pangloss tells Candide in every imaginable situation where they are subjected to misery and misfortune that “All is for the best in the best of all possible worlds.” Investors have taken a similarly “Panglossian” approach to the slew of economic data releases in 2024 so far, and it often feels hard to know what the market is cheering for. Markets rally on a “good news day” – for example a few Fridays ago when the US non-farm payrolls unexpectedly revealed a blow-out number of 270,000 new jobs created for May (against expectations of 180,000). Although positive economic data dampens the chances of a rate cut, it does reinforce the underlying strength of the US economy which should – in theory – translate into higher corporate profits.  Yet on a “bad news day” such as various data points in recent weeks showing downward revisions to personal spending patterns, slower ISM manufacturing data and falls in pending home sales, markets have also rallied in the hope that rates will be cut. It’s a “heads I win, tails you lose” situation and we worry that these levels of optimism may not be sustainable.

But at the end of the day, we are reminded that, despite its at times schizophrenic mood, the market can see that interest rates are ultimately coming down – there may still be the sting of lingering inflation and a “higher-for-longer” mood amongst central bankers, but the actual cost of borrowing is starting to fall.  Some recent Goldman Sachs research showed that this year US companies have been able to refinance almost $400bn of debt at lower interest rates.  And other parts of the world are starting to move central bank rates lower: the Bank of Canada was the first of the G7 central banks to cut interest rates last month. The following day, the European Central Bank also lowered borrowing costs for the first time in nearly five years. Elections in the UK and US (as well as many other parts of the world) complicate the timing around central bank decision making but the dot plots (charts published quarterly that shows where each member of the bank’s policymaking committee expects interest rates to be over the next few years) show August 1^st as the first Bank of England rate cut (presumably under a new Labour government?) and, in the US, rate cuts of 2.25% are priced in through to 2026.

Aside from rate expectations, there is, of course, another phenomenon that has been driving markets higher and that is Artificial Intelligence (AI). The emergence of large language models that enable computers to perform the sort of cognitive functions we usually associate with human minds, has the potential to transform productivity, enhance efficiency and reduce costs across a whole swathe of industries. It is not just the technology companies that have the potential to win.  As an example, one of our portfolio companies, the French pharmaceutical giant, Sanofi, recently announced that it is collaborating with OpenAI to build AI-powered software to accelerate drug development.  Paul Hudson, CEO of Sanofi, described the collaboration in a press release as “the next significant step in our journey to becoming a pharmaceutical company substantially powered by AI.”

The other theme boosting equity markets has been the rapid growth in popularity of GLP1s – the so-called weight-loss drugs such as Wegovy and Ozempic. Our long-standing investment in Novo Nordisk has been a resounding success and reported last week that its Wegovy drug has been approved for use in China sending the shares powering through 1,000 Danish Krone (up from around 200 DKK a few years ago, adjusted for the stock-split, which has become the must-have badge of honour for growth companies these days)

The result is that leadership has narrowed once again, and five US mega-cap technology stocks (Nvidia, Microsoft, Amazon, Meta, and Apple – of which we own Microsoft and Amazon) have accounted for around 60% of the S&P 500’s return year-to-date. Novo Nordisk now makes up around 7.5% of the entire European stock market and its performance has been a significant contributor to the rise in continental European indices this year. Meanwhile all evidence points towards the hedge fund community, both fundamental long-short and systematic, being very much behind this momentum trade.  Due to regulations, US and European mutual funds have size limitations on some of the biggest stocks in the world.  So, every time there has been a little wobble in any of the mega-cap growth stocks there has been the mutual fund wall of money coming in to put money to work.  At the same time, retail investors are buying these stocks and corporates are buying their own stock – we are seeing around $5bn of buybacks every day. In early May, Apple announced a share repurchase of $110bn, the largest share buyback in US history.  Many point to a 1999-style bubble forming but we should remember that valuations are much friendlier now than they were then.  In the late nineties, the nascent years of the digital revolution, positive fee cash flow, let alone profit, was almost non-existent – it is now prodigious. 

The positive sentiment around global stock markets prompted us to gradually increase our exposure to equities over the first half of the year (from around 61% to 66.5% on the Portfolio Fund; and 73% to 80% on the Growth Fund). We added new positions in L’Oreal, Amgen, Whitbread and IBM. We reduced exposure to UK REITs – rate sensitive, alternative income funds such as property and infrastructure continue to be frustrating and appear to catch little investor interest even on the days when there are encouraging signs that inflation is on the wane. We also sold our long-held position in the Bellevue Healthcare Trust following a sustained period of disappointing performance. Our position in the Japanese cosmetics business Shiseido was also sold, another disappointing performer and, when compared to L’Oreal, Shiseido’s cheaper valuation does not make up for L’Oreal’s brand strength.

On the funds side, and in response to concerns that we have had over recent performance, we decided to consolidate the two holdings in the Matthews Asia (ex-Japan) Total Return Fund and Bin Yuan Greater China Fund into a new position in the Federated Hermes Asia (ex-Japan) Fund. We continue to believe that a modest exposure to Asia and Emerging Markets (including China) will benefit the portfolios but have taken the view that the team at Federated Hermes will produce stronger risk-adjusted returns going forward.  The Federated Hermes Asia (ex-Japan) Fund is a £2.4bn UCITS fund investing in Asia (ex-Japan) equities. The team, led by Jonathan Pines, run around £3.5bn in total. Pines has been at Hermes since 2009. The fund employs a rigid contrarian style, investing in companies and regions that are out of favour.  Accordingly, the fund currently has an overweight position in China (c. 44% vs 28% in the MSCI index) and underweight India (c. 2% vs 22%).

Case Studies

L’Oreal is a true compounder with a very strong competitive position. It is the world’s number one cosmetics company with great returns on capital, profit margins and cash flow. It also boasts a track-record of best-in-class execution – its founding family has a significant shareholding, which helps to ensure truly beneficial long-term decisions can be made. Recent performance has been good – at the last quarterly results they showed that overall sales increased 8.3% year-on-year to €11.25bn with like-for-like sales growth of 9.4% vs 6.6% expected. Like-for-like sales growth was 10.7% vs 5.1% expected in the Professional Products unit with all divisions performing better than expected, led by Dermatological sales, which grew 21.9% as European and North American comp sales increased 12.6% and 12.3% respectively, both above consensus estimates. The company stated that they saw continued double-digit growth in Europe and ongoing strength in emerging markets had more than offset the only gradual recovery in North Asia as management noted they were confident in their ability to keep outperforming the market.

Whitbread owns Premier Inn, the UK’s leading mid-scale hotel operator with 850 hotels. They also own 800 restaurants, some integrated into hotels, others are separate with brands such as Beefeater and Brewers Fayre. Compared to many other hotel groups, Whitbread has a vertically integrated business model, owning the freehold on over half of its property estate, controlling distribution, hotel operations, brand and inventory distribution. The pandemic caused a significant shake out of independent hotels with many converted for alternative use. Total hotel supply fell from 715k to 686k rooms, back to levels last seen in 2013 and it is expected to remain below 2019 levels until 2028. Premier Inn are making the most of this opportunity to grow their footprint. They have 85,000 rooms (12% market share) and see long-term potential to grow to 125,000 rooms. The reduced competition and brand strength has resulted in increased margins. Return on Capital Employed (ROCE) has grown to 15.5% compared to a ten-year average of 13% pre-pandemic.

In 2016, they opened their first hotel in Germany and have been growing rapidly since. They have 10,500 open rooms with another 6,000 in the pipeline. Germany has a good mix of leisure and business travellers, and no brand has more than a 2% share. Like the UK, the independent sector has declined materially since the pandemic. The company intends to replicate their success in the UK and become the market leader. They are on track to break even for the first time on a run rate basis this year. The Food & Beverage segment has been the poor relation to the hotel offering, with reduced footfall from non-hotel guests impacting returns. The company recently announced a plan to sell 126 loss-making restaurants and convert 112 into new hotel rooms. This is a cost-effective way to satisfy increased demand and will provide much improved returns.

Current trading this year has been a little soft across the hotel industry. However, forward bookings are ahead compared to the same point last year. The share price has responded to the weaker market data, falling by almost a fifth this year and the shares now look attractively valued on a p/e ratio of 12x for 2025. The dividend increased to yield 3.4% and there is a £150m buyback.