Taking stock: A change in the weather

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“A change in the weather is known to be extreme,
But what’s the sense of changing horses in midstream?”

Bob Dylan, You’re a Big Girl Now, 1975

Across the RWC European and UK Equity team’s mandates, performance has been positive so far this year, with overweight exposures to the sectors that have tended to deliver the best returns, and an additional benefit coming through from successful stock selection. Meanwhile, our natural bias towards mid-cap stocks – those still large enough to offer decent liquidity, but small enough to avoid a broad following from the investment community, has also added value.

Nevertheless, although these trends had been beneficial to performance over 2020 as a whole, they have been unhelpful in recent days. In particular, last week saw a tangible rotation, with some of the stocks that have done well for the portfolios year-to-date, underperforming. This has been unhelpful in the short-term, albeit mitigated to an extent by a more positive performance from some of the portfolio’s 2020 laggards. The same trends have been evident across European equity markets more broadly in recent trading sessions.

We believe that a disciplined response is sensible in a situation like this. There is an obvious difference between a change in the weather (seasonal, short-term and highly predictable) and a change in the climate (complex, longer term and much harder to predict). Naturally, given the long-term nature of our investment approach, we are more concerned about shifts in the longer-term investment climate, than we are to the prevailing weather conditions as they change on a day-to-day basis.

A short period of more challenged performance is never comfortable to endure, but that does not necessarily mean that a change to the strategy is warranted. It is, however, an opportunity to revisit our fundamental thinking for each position and judge if the longer-term thesis still holds valid. If it does, there may be an opportunity to exploit the change in the weather by adding to the position at an even more favourable price.

Our sense currently is that this most recent rotation will be short-lived. It isn’t the first time this year that equity markets have seen a temporary reversal of enduring trends, and it may not be the last. From a fundamental perspective, however, we remain confident that our over-arching strategy remains relevant and appropriate for the current investment climate. In our view, this is a time to be watchful rather than overly active, but we will continue to tweak the portfolios to maintain their optimal shape.

This week’s highlights

As an example of the trends referred to above, the Spanish testing business Applus has been one of the portfolios’ weakest positions year-to-date. We have frequently revisited the fundamentals and have repeatedly concluded that our long-term investment thesis is not broken. Hence, in the face of obvious weakness in its industrial end markets during lockdown, we have maintained exposure to the business. Last week, Applus announced the acquisition of Besikta, a complementary Swedish business, in a deal that provided a welcome boost to its share price. Applus doesn’t need to raise equity to finance the acquisition, which has reassured investors about the company’s balance sheet and prospects. We believe that Applus can deliver modest but sustainable organic growth rates from here, which can continue to be augmented through further bolt-on acquisitions, as it consolidates a fragmented industry.

Global consumer staples business, Reckitt Benckiser, also performed well last week, following a decent Q3 trading update, which showed better-than-expected organic growth rates and contained an upgrade to its full-year guidance. Coming into 2020, with a new chief executive in place, we viewed Reckitt’s as a stock that had the ability to deliver consensus-beating growth rates. The pandemic has delivered an additional boost to revenue through the sale of considerably more disinfectant and cleaning products. From here, many analysts are questioning how long this additional Covid boost will last. Consensus revenue forecasts are flat for 2021 but, with the virus likely to remain with us for some time and the potential for a broader contribution from other parts of the business as the new CEO’s initiatives bear fruit, we are anticipating continued growth in the years ahead.

French healthcare business, Ipsen, delivered Q3 results last week, which were broadly in line with expectations. Results from its oncology division were slightly disappointing, with patient numbers lower than anticipated because hospitals have inevitably been focused on treating Covid patients. Ultimately, this is a temporary problem and our longer term confidence in Ipsen’s oncology business remains robust. More positively, expectations for a treatment for a very rare but potentially fatal bone disorder, have started to improve. Palovarotene was put on clinical hold in January, which led to a sharp fall in its share price and an opportunity for us to add this position to the portfolios as a recovery play. The most recent update on the asset suggests the probability of a commercial launch is now improving again, which is positive news for the share price and for patients.

Unless otherwise stated, all opinions within this document are those of the RWC European and UK Equity Team, as at 28th October 2020.

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