Taking stock: Tech-tonic shifts

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“Throughout human history, we have been dependent on machines to survive. Fate, it seems, is not without a sense of irony.”

The Matrix, 1999

Dealing with a large and diverse investment universe, such as the one that Europe’s collective equity markets represents, poses an immediate challenge for fund managers. We use the Opportunity Matrix below to focus our attention towards the sectors where we feel we are most likely to find investment opportunities with a high degree of earnings dispersion. This matrix is the product of many years of study of the characteristics of different sectors and, as a result, the ratings of different sectors do not change frequently. They are, nevertheless, reviewed regularly to ensure the ratings remain valid.

Source: RWC Partners.

One sector that has consistently been an area of focus for us is technology. Historically, we have found an abundance of mis-priced investment opportunities, primarily among secular growth (typically software and IT services businesses benefiting from the trend towards automation), hyper growth (fast maturing young companies, enjoying rapidly increasing market penetration) and cyclical growth businesses (mainly in hardware, such as semiconductors).

It is also a sector in which we have consistently added value, through both sector allocation and successful stock picking. Since its inception in December 2017, the RWC Continental European Equity Fund has had an average allocation of 15.5% to the Information Technology sector, more than double that of the broader market. During this time, stocks from within the sector have collectively delivered more than 5% of performance, more than a third of the fund’s total return, making Information Technology the second best performing sector for the portfolio, behind Consumer Discretionary.*

Last week was, however, challenging for the European technology sector, because of a profit warning from one of it’s largest constituents, SAP. This is a company we know well, having owned it previously on several occasions. Indeed, it formed part of the RWC European Equity portfolios until earlier this year, but we sold it in March as the rapidly unfolding Covid crisis started to take its toll on equity markets. Having observed the operational performance of this business through two previous economic downturns (2001-02 and 2008-09), we felt that the business was likely to be less economically durable than the consensus appeared to be anticipating. On both of these previous occasions, SAP saw a sharp decline in software revenues as companies stopped sanctioning new projects. We believed there was a strong likelihood that we would see the same outcome in 2020 and, with the share price reflecting a more benign expectation, we concluded that we should recycle the capital into other opportunities where the outlook appeared more robust.

Since then, SAP has indeed seen a hit to its software licencing revenues, but the shares outperformed through the spring and into the summer despite our thesis being broadly correct. Overall, the technology sector has tended to outperform, viewed as a relative “winner” in the economic lockdowns we have endured (and indeed continue to endure!). Meanwhile, investors have been keen to view 2020 as a trough year for the likes of SAP and have valued shares on the prospect of “normal” 2021 profits. Last week, however, SAP’s profit warning has confirmed that trading remains very challenging for the business, and its difficulties will likely persist into the new year.

Elsewhere in the technology sector, our preference has evolved away from software businesses like SAP and towards hardware related businesses, such as European businesses that play a role in the semiconductor supply chain. Here, we see an industry cycle that is much more positively positioned, and recent results from the likes of Hexagon (see below) and Soitec (Europe’s leading 5G player) provide us with confidence that this remains a more attractive area of European technology for the time being. Last week’s profit warning from SAP was helpful from the perspective of relative performance. But more importantly, we believe that the technology companies which the portfolios do invest in are in good shape.

* Source: RWC Partners, based on a total return basis in Euros from 14 December 2017 to 31 October 2020.

Past performance is not a guide to the future. The price of investments and the income from them may fall as well as rise and investors may not get back the full amount invested.

This week’s highlights

British wealth management business, St James’s Place, has recently been under the spotlight because of a letter from an activist investor, which highlights the lack of operational leverage seen in the business over the last five years. Last week, we had a call with the activist investors, to discuss their analysis and to get a better understanding of their discussions with management and other shareholders. St James’s Place is a great business with a very successful business model, but engagement on the subject of the cost base could lead to positive change within the business after a period of investment and therefore better outcomes for its shareholders. This is a good example of our broader approach to governance issues, and we will look to engage further with company management directly, to form our own view of the likelihood of operating leverage improvements and how they may impinge upon future financial performance.

A strong set of results from the Norwegian industrial business Kongsberg, provided a modest boost to its share price in a challenging week for European equity markets. Our investment thesis here is progressing positively, with an order backlog within its portfolio of defence programs now beginning to come to fruition. After more than a decade of austerity and its implications for defence budgets globally, the stock market has become increasingly sceptical about the value of future orders for defence businesses. Geo-political tensions are rarely far from the surface, however, and Kongsberg is well-positioned to benefit from a more benign environment for defence spending, particularly in newer, technologically driven programs. Meanwhile, good execution in its maritime business is delivering margin improvements and incremental earnings upgrades.

Swedish technology business, Hexagon, delivered its best ever third quarter profits, which were well ahead of market expectations. China was the big driver of growth, with strength in its infrastructure, construction and electronics segments, more than offsetting the challenging conditions for its traditional automotive and energy solutions. Hexagon is a global leader in measurement and positioning sensors, and we believe the company is well-positioned to continue to benefit from the enduring structural trend towards a more automated world.

The names shown above are for illustrative purposes only and is not intended to be, and should not be interpreted as, recommendations or advice.

Unless otherwise stated, all opinions within this document are those of the RWC European and UK Equity Team, as at 5th November 2020.

The term “RWC” may include any one or more RWC branded entities including RWC Partners Limited and RWC Asset Management LLP, each of which is authorised and regulated by the UK Financial Conduct Authority and, in the case of RWC Asset Management LLP, the US Securities and Exchange Commission; RWC Asset Advisors (US) LLC, which is registered with the US Securities and Exchange Commission; and RWC Singapore (Pte) Limited, which is licensed as a Licensed Fund Management Company by the Monetary Authority of Singapore.

RWC may act as investment manager or adviser, or otherwise provide services, to more than one product pursuing a similar investment strategy or focus to the product detailed in this document. RWC seeks to minimise any conflicts of interest, and endeavours to act at all times in accordance with its legal and regulatory obligations as well as its own policies and codes of conduct.

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The Alternative Fund Managers Directive (Directive 2011/61/EU) (“AIFMD”) is a regulatory regime which came into full effect in the EEA on 22 July 2014. RWC Asset Management LLP is an Alternative Investment Fund Manager (an “AIFM”) to certain funds managed by it (each an “AIF”). The AIFM is required to make available to investors certain prescribed information prior to their investment in an AIF. The majority of the prescribed information is contained in the latest Offering Document of the AIF. The remainder of the prescribed information is contained in the relevant AIF’s annual report and accounts. All of the information is provided in accordance with the AIFMD.

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