The Liontrust GF Sustainable Future US Growth Fund returned -2.3% in US dollar terms in Q2, compared with the 3.7% return from the MSCI USA Index (its comparator benchmark) and the 1.8% return from the IA North America reference sector.
The concentration in returns in the US market that we witnessed throughout 2023 and in the first quarter of 2024 accelerated in the second quarter. According to Apollo, the percentage of stocks outperforming the S&P 500 Index for the first six months of the year fell to a 44 year low, with over three quarters of the companies unperforming the benchmark. From a style perspective, these trends played further into the narrow performance leadership from mega-cap technology stocks. The sheer size of both the market cap of these companies, and the large movements higher in their share prices, has made keeping up with the index very challenging for active managers. Furthermore, weakness from mid and small cap stocks – where we retain an overweight – has been exacerbated by AI and adverse movements in the US 10-year treasury yield.
Combined with this, a narrative began to emerge that software investment, which is such a key driver of overall business efficiency improvements, was beginning to stall, as business owners preferred to focus on AI opportunities. This was primarily driven by some disappointing numbers from a number of large software bellwethers, with Salesforce’s quarterly numbers the catalyst. At the same time, Apple’s announcement that it was targeting on-device AI led to strong performance across the supposed AI winners and those assumed to benefit from a replacement cycle in the smartphone industry.
Payroll provider Paylocity was the Fund’s most notable exposure to the investor rotation away from software names. Held under our Enabling SMEs theme, Paylocity is a leading Human Capital Management (HCM) software provider. Its products enable its customers, which are primarily small businesses, to manage the increasingly complex demands of managing its employees. Shares in the company had initially rose sharply in the quarter having lifted its annual revenue outlook and delivering a solid set of results. This share price move proved to be short-lived however, as the shares gave back ground over the quarter as the company was caught up in the general sell off both in software but also mid-caps. This sell-off has left the shares trading on a an all-time low multiple of 21x next year’s earnings.
Trex, a manufacturer of wood-alternative composite decking made from recycled materials, fell through the quarter, firstly after negative read-across from bellwether Pool Corp’s underwhelming Q2 results, before it provided conservative full-year guidance,overshadowing an impressive earnings beat. Held under our Delivering a circular materials economy theme, Trex is one of the largest recyclers of plastic film in North America, upcycling approximately 400 million pounds of plastic waste annually, nearly all of which comes from post-consumer sources such as shopping bags, newspaper sleeves, bubble wrap and package liners along with product overwrap, shrink wrap and stretch film used to palletize boxes.
IQVIA, the clinical research service company, slid after cutting its revenue forecast range for the full year. Held under our Providing affordable healthcare theme, IQVIA is a leading global provider of advanced analytics, technology solutions and clinical research services to the life sciences industry. The company connects healthcare organisations and patients with data in an effective way to ensure faster decision making on healthcare outcomes.
Turning to the portfolio positives, US medical technology company TransMedics was the top performer in Q2 following a strong earnings release. Held under our Enabling innovation in healthcare theme, TransMedics announced unexpectedly strong revenue growth alongside material expansion in profitability. As a reminder, the company manufactures organ transplant modules and facilitates a US-based national organ transfer program to ease the friction between donor and patient. At the point of our initial investment at the fund launch, the company was loss making yet in the latest quarter the company posted profits of c. $12m - these results demonstrate a remarkable improvement in profitability in less than a year.
Alphabet was another strong performer after reporting Q1 revenue that exceeded analysts’ expectations, buoyed by growth in its cloud computing unit. Held under our Providing education theme, Google’s Strong results was accompanied by an announcement of their first dividend, of 20 cents a share. They also announced a further share repurchase programme of $70 billion, reassuring investors that excess capital will be returned to owners.
Microsoft was another notable performer and a welcome outlier in the trend for software sector weakness. Its shares climbed after reporting better-than-expected quarterly sales and profit, lifted by corporate demand for the software maker’s cloud and artificial intelligence offerings.
Exposed to our Improving the resource efficiency of industrial and agricultural processes theme, Microsoft's software and services empowers businesses all over the world to be more efficient. Through its cloud offering it reduces the environmental costs of businesses to run compute power and storage, and through its cyber security products it protects businesses from being hacked.
With respect to changes to the portfolio, after a period of muted activity, we were unusually active in the quarter. We initiated a new position in $23 billion market cap company West Pharmaceuticals under our theme of Enabling innovation in healthcare. The company designs and produces high quality integrated containment and delivery systems for injectable drugs and healthcare products. Key customers include biologic, pharma, diagnostic and medtech companies. The focus here is on quality – excellence in manufacturing, scientific and technical expertise to ensure delivery of safe and efficacious drug products to patients. West's expertise and high quality standards facilitate the delivery of medicine to patients around the world and offers innovation and expertise to help maintain the quality and efficacy of impactful drug types like biologics injectables and cell and gene therapies.
We bought the stock following a difficult time for the broader healthcare industry which has experienced sustained destocking of inventory dampening the one year growth outlooks for drug containment companies like West. We believe these effects will prove short term in nature and that the underlying longer-term tailwinds of complicated biologics drugs needing high quality innovative solutions are underappreciated by the market. In the team we expect the overall trend towards biologic medicines and cell/gene therapies to remain into the next decade and beyond.
We also started a position in IRadimed, the manufacturer of MRI safe hospital equipment. The company, which fits into our Enabling innovation in healthcare theme, supplies MRI safe (i.e. non-magnetic) and portable patient monitors and intravenous infusion (IV) pumps. It also supplies consumables and services around these products. These technologies reduce the risk of, and time required in performing, MRI scans for those who require ongoing vital sign monitoring and/or infusion. The company is at the smaller end of where we will invest, with a market capitalisation of c.$600 million. In order to add a company of this size to the portfolio, our conviction must be high. The company has been profitable every year since its IPO in 2014, has a strong net cash position, and delivering operating margins of 27-30%. IRadimed is in the process of resubmitting a proposal for a new IV pump to the FDA which, if approved, should provide a clear path to revenue growth acceleration in the coming years. Lastly, management are highly aligned with us as shareholders, with the founder Roger Susi owning 36% of the shares outstanding.
Lastly, ServiceNow was added to our Leading in ESG management theme. The company has a terrific management team and a world-class culture, which is reflected in their market-leading approach to managing their key environmental, social and governance issues. ServiceNow builds workflow tools for companies to automate previously manual tasks. This reduces waste and by freeing up employee time thus helping makes companies more efficient and enabling employees to focus on tasks where they can add the highest value. We have been following the company for years, having first visited them back in 2018. We have been continually impressed at their ability to execute and grow regardless of the economic backdrop. We believe this is due to their short payback periods from their efficiency-improving products combined with a high performance culture. Our chief concern remains on valuation, with the shares trading on a punchy 49x forward earnings, it is one of the most expensive in the portfolio. If the company continues to execute we believe the current share price will look to be a good entry point five years from now but have sized the position to reflect our concerns on valuation.
To make way for the ServiceNow, we sold Adobe. We are concerned that generative AI competition may begin to eat away at the virtual monopoly that Adobe enjoys in its Creative Cloud business. This also follows the failed attempt to acquire competitor Figma, for they were due to pay a multiple of 50 times annual recurring revenue. The willingness to pay such a multiple reinforces our concerns regarding their competitive positioning and contributed to our conviction waning on the company.
We also exited our position in Illumina. The company has proven to be a disappointing investment and although they have now spun off the controversial Grail business, we are concerned the core Illumina business is experiencing a step change in the elasticity of demand for its products. As it’s dropped the price of sequencing a single genome, customers are potentially using that to improve their own margins, rather than it leading to significant growth in the number of genomes they sequence, which they typically have done in the past. Competition has also increased, and Illumina’s dominance of the sequencing market has been increasing under threat.
Finally, we also disposed of Equinix for several reasons. A short report suggested the company may be overselling the power capabilities of their data centres, which could prove problematic if AI causes the demand for power to continue to grow at pace. The long-serving CEO also announced he was leaving, somewhat unexpectedly. Lastly, the shares did not provide us with our desired annual expected return of 10%. . Equinix thus moves to the watch list and we will monitor the progress of the new CEO and potentially look to buy back the shares should the valuation become more attractive.
After the first year of the fund’s launch, we just wanted to thank our clients for their support. We are thrilled to be managing your capital and are excited about the future prospects for our portfolio.
Key Features of the Liontrust GF SF Global Growth Fund
KEY RISKS
Past performance is not a guide to future performance. The value of an investment and the income generated from it can fall as well as rise and is not guaranteed. You may get back less than you originally invested.
The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.
All investments will be expected to conform to our social and environmental criteria. Overseas investments may carry a higher currency risk. They are valued by reference to their local currency which may move up or down when compared to the currency of the Fund. This Fund may have a concentrated portfolio, i.e. hold a limited number of investments. If one of these investments falls in value this can have a greater impact on the Fund's value than if it held a larger number of investments. The Fund may encounter liquidity constraints from time to time. The spread between the price you buy and sell shares will reflect the less liquid nature of the underlying holdings. Outside of normal conditions, the Fund may hold higher levels of cash which may be deposited with several credit counterparties (e.g. international banks). A credit risk arises should one or more of these counterparties be unable to return the deposited cash. Counterparty Risk: any derivative contract, including FX hedging, may be at risk if the counterparty fails.
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